Part 1: Disneys Weighted Cost of Capital You work in Walt Disney Companys corporate finance and treasury department and have been assigned to the team estimating Disneys WACC. You must estimate this WACC in preparation for a team meeting later today. You quickly realize that the information you need is readily available online. 1. You will first have to download into excel Disneys Financial Statements for the past 2 fiscal years. Go to SEC EDGAR Company Search and use the option to the right using Disneys Ticker DIS to look for the information. Remember to use the 10Ks (these have the annual reports) 2. Go to http://finance.yahoo.com. Under Market Data you will find the yield to maturity for 10-year Treasury bonds listed as 10 Yr Bond(%). Collect this number as your risk-free rate. 3. Still in Yahoo Finance, in the box next to the Look Up button, type Walt Disneys ticker symbol DIS), and click Search. Once you see the basic information for Disney, find the current stock price and click Key Statistics on the left side of the screen. Collect Disneys number of shares outstanding and beta. (You can also find the number of shares outstanding in the financial statements that you downloaded in step 1) 4. Calculate Disneys cost of equity capital using the CAPM, the risk-free rate you collected in step 2, and a market risk premium of 10%. 5. To get Disneys cost of debt and the market value of its long-term debt, you will need the price and yield to maturity on the firms existing long-term bonds. Go to http://finramarkets.morningstar.com/BondCenter/Default.jsp?, click Search, click Corporate, type Disneys ticker symbol (DIS), and click Show Results. A list of Disneys outstanding bond issues will appear. Assume that Disneys policy is to use the yield to maturity on non-callable 10-year obligations as its cost of debt. Find the non-callable bond issue that is as close to 10 years from maturity as possible. (Hint: You will see a column titled Callable; make sure the issue you choose has No or it is blank in this column.) Find the yield to maturity for your chosen bond issue (it is in the column titled Yield) and enter that yield as your pretax cost of debt into your spreadsheet. Next, copy* and paste the data in the entire table for the first two pages of info listed for Disney the FINRA web pages into Excel . [For a quick way to do this, refer to Appendix 1] *COPY ONLY THE INFORMATION FOR BONDS LISTED ON THE FIRST TWO PAGES OF BONDS LISTED FOR DISNEY AND THE ONES THAT HAVE PRICE AND YIELD AND THAT ARE NON CALLABLE (THE ONES THAT DONT HAVE A YES ON THE CALLABLE COLUMN), . EVENTHOUGH TO GET THE TRUE COST YOU WOULD NEED TO DO ALL, NOT ALL BONDS HAVE INFO. 6. You now have the price for each bond issue, but you need to know the size of the issue. Returning to the Web page, go to the row of the bond you chose and click the Issuer Name in the first column (this will either be Walt Disney Company or ABC or another subsidiary). This brings up a Web page with all of the information about the bond issue. Scroll down until you find Amount Outstanding on the right side. Noting that this amount is quoted in thousands of dollars (eg $60,000 means 60 million) record the issue amount in the appropriate row of your spreadsheet. Repeat this step for all of the bond issues. 7. The price for each bond issue in your spreadsheet is reported as a percentage of the bonds par value. For example, 104.50 means that the bond issue is trading at 104.5% of its par value. You can calculate the market value of each bond issue by multiplying the amount outstanding by Price /100. Do so for each issue (listed on the first 2 pages of bonds) and then calculate the total of all the bond issues. This is the market value of Disneys debt. 8. Compute the weights for Disneys equity and debt based on the market value of equity (Market Capitalization) and Disneys market value of debt, computed in step 5. 9. Assuming that Disney has a tax rate of 35%, calculate its effective cost of debt capital. 10. Calculate Disneys WACC. 11. Calculate Disneys net debt by subtracting its cash (collected in step 2) from its debt. Recalculate the weights for the WACC using the market value of equity, net debt, and enterprise value. Recalculate Disneys WACC using the weights based on the net debt. How much does it change? 12. How confident are you of your estimate? Which implicit assumptions did you make during your data collection efforts? 13. Looking at the yields of all the Disney bonds outstanding, How would have the WACC changed if you had calculated the cost of debt using the information for all the bonds outstanding instead of just using the 10 year bond (Do an estimate. Dont recalculate) Part 2. New Ride Your next assignment is to determine if Disney should invest in a new theme ride so you need to determine net cash flows and NPV and determine if the project is viable or not. Capital expenditures to produce the ride will initially require an investment of $1.7 billion. Other development costs that will be required to finish the ride is $800 million this year. Any ongoing costs for upgrades will be covered in the margin calculation below. The ride is expected to have a life of five years. First-year revenues for the new ride are expected to be $3,500,000,000 ($3,500 million). The ride revenues are expected to grow by 37% for the second year, and then increase by 5% for the third, decrease by 15% for the 4th and finally decrease by 25% for the 5th (final) year of operation. Your job is to determine the rest of the cash flows associated with this project. Your boss has indicated that the operating costs and net working capital requirements are similar to the rest of the companys products. Since your boss hasnt been much help, here are some tips to guide your analysis: 1. You will need to use the Financial Statements that you downloaded in Part 1. 2. You are now ready to determine the free cash flow. Compute the free cash flow for each year using : Free Cash Flow = (Revenues Costs- Depreciation) x(1- Tax Rate) + Depreciation Capex Change in NWC Set up the timeline and computation of the free cash flow in separate, contiguous columns for each year of the project life. Be sure to make outflows negative and inflows positive. a. Assume that the projects profitability will be similar to Disneys existing projects and estimate costs for each year of your project by using the average ratio of non-depreciation costs to revenue for the last 2 fiscal years (in practice you really tend to use at least 4 years worth of data, but for this exercise 2 years will suffice): (Costs of Goods Sold + SG&A)/Sales You should assume that this ratio will hold for this project as well. You do not need to break out the individual components of operating costs in your forecast. Simply the forecast to the Total Cost of Goods Sold + SG&A +R&D for each year. Determine Disneys tax rate as 1- (Income After Tax/Income Before Tax) in the last fiscal year reported. Note that on Disneys income statement on Google Finance, there is a difference between operating income and income before tax. That difference is due to small adjustments. Ignore this issue and simply focus on the Income Before Tax line. Recalculate the WACC form Part 1 using this tax rate. Calculate the net working capital required each year by assuming that the level of NWC will be a constant percentage of the projects sales. Use Disneys last 2 fiscal year average NWC/Sales to estimate the required percentage. (Use only accounts receivable, accounts payable, and inventory to measure working capital. Other components of current assets and liabilities are harder to interpret and are not necessarily reflective of the projects required NWCe.g., Disneys cash holdings.) To determine the free cash flow, calculate the additional capital investment and the change in net working capital each year. Determine the NPV of the project with WACC calculated in Part 1 step 10 and the projects IRR For the NPV calculation remember to add the first CF when you are using the excel function =NPV(rate, CF1:CF5) + CF0 For the IRR include all cash flows in your excel calculation. Should Disney invest in the project?