Companies within the same sector typically share similar capital structures and costs of capital. For example,...

 
 

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Companies within the same sector typically share similar capital structures and costs of capital. For example, most power utili- ties are engaged in fundamentally the same business; genera- tion, transmitting, and distributing electric power. The utility business is highly dependent upon expensive fixed-asset invest- ments (i.e., power plants) which are often financed with debt. Consequently, analysts expect companies within the same sec- tor or industry to have similar betas, capital structures, bond ratings, and WACCS. Disney is a diversified entertainment company. Its diversi fication exists because its revenues come from four different, but related, business segments-parks and resorts, studio enter tainment, broadcasting and media, and consumer products. Since there is no other enterprise quite like Disney, we exam- ine the WACCS of companies that operate within one or more of its segments. Beta The beta of a stock is a representation of how the stock moves with the broader equity market. Disney has a beta of 0.96 which implies that when the broad equity market goes up or down by one percent, Disney's stock will rise or fall by 0.96 percent. Low beta stocks, between 0.5 and 0.8, tend to be defensive. They do not rise much when the market rises, but they also do not fall significantly when the market falls. Disney's beta indi- cates a closer relationship to the market than any of its peers used in this case. | RISK FREE RATE The risk free rate is the U.S. government bond. A U.S. bond's yield is considered risk free because the U.S. has not and is not expected to default. TAX RATE The company's tax rate impacts the after tax cost of debt but has no bearing on either the cost of preferred equity or com- mon equity. The higher a company's tax rate the lower the after tax cost of debt. Consequently, as a source of capital, debt is a tax shield. PRE-TAX COST OF DEBT The pre-tax cost of debt can be determined by calculating the yield to maturity on the company's bonds. A bond's yield to maturity can be influenced by many factors including inflation, credit quality, macroeconomic fundamentals, and how the com- pany's bonds are structured. Betas of Companies Comparable to Disney Segments Al Data as of July 31 2019 Betas of Companies Comparable to Disney Segments All Data as of July 31 2019 160 1.40 120 096 1.00 089 0.77 0.80 0.60 0.40 0.20 0.00 140 121 1.10 0.82 0.86 081 Disney Six Flags Cedar Fair Lion's Gate Viacom Netflix Sally Bonity GameStop EXPECTED RETURN OF THE MARKET The expected return of the market is a fairly general observa- tion. In reality, no one knows by what degree the stock mar- ket will rise or fall over the next year. Nevertheless, in order to assess an individual stock we must have a view on where the broader market is heading. The expected return of the market is the same for every stock. Bloomberg LP. WEIGHTED AVERAGE COST OF CAPITAL/BLOOMBERG BUSINESSWEEK CASE STUDY Case Questions Use the Terminal Tutorial to calculate Disney's weighted average cost of capital (WACC) for Q1 2019. Bloomberg includes more elements in the WACC calculation than the textbook does. For our purposes, use the textbook formula with the data points from Bloomberg. Use the Bloomberg Terminal to gather the necessary data to make a similar calculation for Q2 2019. Using the Case Study Notes and the accompanying spreadsheet, calculate the WACC of each Disney segment comparable. Describe the primary WACC drivers that explain the differences between the WACC of Disney and its comparables. WEIGHTED AVERAGE COST OF CAPITAL/BLOOMBERG BUSINESSWEEK CASE STUDY 10 Cost of liquity 13 Cost of Debt Cost of Preferred liquity Cost of Debt 2.626 78.948 21.06 ST Debt to T Total Debt 0.42% 0.17 Let's click on the Cost of Debt tab so we can fill in another cell of our table. Weighted Average Cost of Capital Inputs 1-Effective Tax Rate Effective Tax Rate x Total Pre-Tax Cost of Debt Note Rate x ST Debt to Total Debt Disney's marginal tax rate is 21.06%. We need to find Disney's pre-tax cost of debt. It is listed on this table but the textbook uses the yield to maturity of the company's bonds, instead of the calculation methodology used by Bloomberg here. Disney WACC Elements Al Data as of First Quarter 2019 Metric Value Metric Value x Note Rate + Bond Rate x LT Debt to Total Debt 2.26 Beta 0.90 Equity 161,265 LT Debt to Total Debt x Debt Adjustment Factor Total Debt Short Term Debt Long Term Debt 0.83 Bond Rate Expected Return of the Market 10.76% Preferred Equity 1.24 Risk Free Rate 2.72% 20665.00 3487.00 1/1/6.00 Tax Rate 2106% Pre-Tax Cost of Debt Short-Term Debt Long-Term Debt Total Capital 6,009 20,082 187,356 In the command line, type DIS followed by the yellow F3 Corp key and press Enter or . WALT DISNEY CO Equity SECF DIS Corp SECURITIES DIS Corp DISH Corp DIS 7 03/01/2032 Corp DISCA Corn ** This is the Security Finder, or SECF, page for finding securities on the terminal. The "DIS Corp" command filtered the SECF page to show a table of all of The Walt Disney Company's bonds. The R column signfies the most relevant bonds which we can use as a proxy for the most actively Related Functions traded of Disney's bonds. Select the series with the highest relevance indicator (DIS 7.00 03/01/2032). to hide TWDC Enterprises 18 Corp (N DISH DBS Corp (Multiple Ma TWDC Enterprises 18 Corp Discovery Communications Corp Govt Loan Pfd CDS CDS Idx Muni 60) Excluded (147) Matured/Called, Non-Verified Bonds R Ticker Maturity Name Coupon DIS DIS 03/01/2032 TWDC Enterprises 1... 7.000 DIS |06/15/2027|TWDC Enterprises L... 2.950 DIS DIS 07/30/2016 TWDC Enterprises 1... 03/01/2037 Walt Disney Co/The 3.000 6.150 From the popup menu, select YAS (Yield and Spread Analysis). Change both the date boxes to March 29, 2019, the last trading day of Q1, and press Enter. Next to the Yield field, change Wst to Mty for Yield to Maturity and press Enter. DIS 7 03/01/32 Corp Settings 1) Yield & Spread > Graphs Pricing 4 Descr This bond has a yield to maturity of 3.29%. Disney's WACC table is now complete and ready to be used to answer the first case question. Disney WACC Elements All Data as of First Quarter 2019 Metric Beta Value Metric Value Spread DIS 7 03/01/32 ( 25468PBW5 92.41 bp vs 10yT 2% 02/15/29 0.90 Price 138.7869 102.2656 Expected Return of the Market Risk Free Rate 10.76% 2.72% Yield 3.290571 Mty 2.366492 Wkout 03/01/2032 @ 100.00 S/A Yld 66 Tax Rate 21.06% Pre-Tax Cost of Debt 3.29% Equity Preferred Equity Short-Term Debt Long-Term Debt Total Capital 161,265 6,009 20,082 187,356 Settle 03/29/19 03/28/19 Trade 03/27/19 Retro (Using hist price) Use the path described in the above Terminal tutorial, but instead of selecting Q1 at the start, select Q2. Beta Weighted Average Cost of Capital Case Calculations Cost of Capital Components Expected Return Risk Free of Market Rate Tax Rate Pre-Tax Debt Cost Bond Rating Equity Capital Structure Components Short-Term Long-Term WACC Debt Debt Total Capital Target Disney 0.96 9.6% 2.4% 21.8% 3.0% A 248,699 21,923 36,311 306,933 Parks and Resorts Six Flags 0.89 9.6% Cedar Fair 0.77 9.6% 2.4% 2.4% 24.2% 17.0% 4.2% 4.8% B+ B+ 4,190 2,699 19 2,467 6,676 8 2,150 4,857 Studio Entertainment Lions Gate 1.21 9.6% 2.4% 0.0% 4.3% B- 2,666 439 2,838 5,943 Broadcasting and Media Viacom Netflix 1.1 9.6% 2.4% 1.46 9.6% 2.4% 22.0% 17.7% 4.5% BBB- 2.6% BB- 12,059 160,826 320 8,638 138 13,541 21,017 174,505 Consumer Products ULTA 0.86 9.6% 2.4% Sally Beauty 0.81 9.6% 2.4% Game Stop 0.92 9.6% 2.4% 22.7% 25.7% 23.5% 2.5% 20,034 211 1,654 21,899 6.9% BB 5.9% BB- 1,603 21 1,560 3,184 918 250 1,022 2,190 Source: Bloomberg All Data Effective 31 July 2019 Weighted Average Cost of Capital Scenario Changes Beta Market Cost of Capital Components Expected Return of Risk Free Rate Pre-Tax Tax Rate Debt Cost Rating Bond Capital Structure Components Short-Term Long-Term WACC Total Equity Debt Debt Capital Target Disney 0.96 9.6% 2.4% 21.8% 3.0% A Six Flags 0.89 9.6% 2.4% 24.2% 4.2% B+ 248,699 4,190 21,923 19 36,311 2,467 306,933 7.9% 6,676 6.3% Fed Rate Move Disney 0.96 9.6% 2.4% 21.8% 3.0% A Six Flags 0.89 9.6% 2.4% 24.2% 4.2% B+ 248,699 4,190 21,923 19 36,311 2,467 306,933 7.9% 6,676 6.3% Credit Rating Change Disney 0.96 9.6% 2.4% 21.8% 3.0% A Six Flags 0.89 9.6% 2.4% 24.2% 4.2% B+ 248,699 4,190 21,923 19 36,311 2,467 306,933 7.9% 6,676 6.3% Additional Debt for Fox Acquisition Disney 0.96 9.6% 2.4% 21.8% 3.0% Six Flags 0.89 9.6% 2.4% 24.2% 4.2% A B+ 248,699 4,190 21,923 19 36,311 2,467 306,933 7.9% 6,676 6.3% Bear Stock Market Disney 0.96 9.6% 2.4% 21.8% 3.0% A Six Flags 0.89 9.6% 2.4% 24.2% 4.2% B+ 248,699 4,190 21,923 19 36,311 2,467 306,933 7.9% 6,676 6.3% Tax Rate Increases Disney 0.96 9.6% 2.4% 21.8% 3.0% A Six Flags 0.89 9.6% 2.4% 24.2% 4.2% B+ 248,699 4,190 21,923 19 36,311 2,467 306,933 7.9% 6,676 6.3% Companies within the same sector typically share similar capital structures and costs of capital. For example, most power utili- ties are engaged in fundamentally the same business; genera- tion, transmitting, and distributing electric power. The utility business is highly dependent upon expensive fixed-asset invest- ments (i.e., power plants) which are often financed with debt. Consequently, analysts expect companies within the same sec- tor or industry to have similar betas, capital structures, bond ratings, and WACCS. Disney is a diversified entertainment company. Its diversi fication exists because its revenues come from four different, but related, business segments-parks and resorts, studio enter tainment, broadcasting and media, and consumer products. Since there is no other enterprise quite like Disney, we exam- ine the WACCS of companies that operate within one or more of its segments. Beta The beta of a stock is a representation of how the stock moves with the broader equity market. Disney has a beta of 0.96 which implies that when the broad equity market goes up or down by one percent, Disney's stock will rise or fall by 0.96 percent. Low beta stocks, between 0.5 and 0.8, tend to be defensive. They do not rise much when the market rises, but they also do not fall significantly when the market falls. Disney's beta indi- cates a closer relationship to the market than any of its peers used in this case. | RISK FREE RATE The risk free rate is the U.S. government bond. A U.S. bond's yield is considered risk free because the U.S. has not and is not expected to default. TAX RATE The company's tax rate impacts the after tax cost of debt but has no bearing on either the cost of preferred equity or com- mon equity. The higher a company's tax rate the lower the after tax cost of debt. Consequently, as a source of capital, debt is a tax shield. PRE-TAX COST OF DEBT The pre-tax cost of debt can be determined by calculating the yield to maturity on the company's bonds. A bond's yield to maturity can be influenced by many factors including inflation, credit quality, macroeconomic fundamentals, and how the com- pany's bonds are structured. Betas of Companies Comparable to Disney Segments Al Data as of July 31 2019 Betas of Companies Comparable to Disney Segments All Data as of July 31 2019 160 1.40 120 096 1.00 089 0.77 0.80 0.60 0.40 0.20 0.00 140 121 1.10 0.82 0.86 081 Disney Six Flags Cedar Fair Lion's Gate Viacom Netflix Sally Bonity GameStop EXPECTED RETURN OF THE MARKET The expected return of the market is a fairly general observa- tion. In reality, no one knows by what degree the stock mar- ket will rise or fall over the next year. Nevertheless, in order to assess an individual stock we must have a view on where the broader market is heading. The expected return of the market is the same for every stock. Bloomberg LP. WEIGHTED AVERAGE COST OF CAPITAL/BLOOMBERG BUSINESSWEEK CASE STUDY Case Questions Use the Terminal Tutorial to calculate Disney's weighted average cost of capital (WACC) for Q1 2019. Bloomberg includes more elements in the WACC calculation than the textbook does. For our purposes, use the textbook formula with the data points from Bloomberg. Use the Bloomberg Terminal to gather the necessary data to make a similar calculation for Q2 2019. Using the Case Study Notes and the accompanying spreadsheet, calculate the WACC of each Disney segment comparable. Describe the primary WACC drivers that explain the differences between the WACC of Disney and its comparables. WEIGHTED AVERAGE COST OF CAPITAL/BLOOMBERG BUSINESSWEEK CASE STUDY 10 Cost of liquity 13 Cost of Debt Cost of Preferred liquity Cost of Debt 2.626 78.948 21.06 ST Debt to T Total Debt 0.42% 0.17 Let's click on the Cost of Debt tab so we can fill in another cell of our table. Weighted Average Cost of Capital Inputs 1-Effective Tax Rate Effective Tax Rate x Total Pre-Tax Cost of Debt Note Rate x ST Debt to Total Debt Disney's marginal tax rate is 21.06%. We need to find Disney's pre-tax cost of debt. It is listed on this table but the textbook uses the yield to maturity of the company's bonds, instead of the calculation methodology used by Bloomberg here. Disney WACC Elements Al Data as of First Quarter 2019 Metric Value Metric Value x Note Rate + Bond Rate x LT Debt to Total Debt 2.26 Beta 0.90 Equity 161,265 LT Debt to Total Debt x Debt Adjustment Factor Total Debt Short Term Debt Long Term Debt 0.83 Bond Rate Expected Return of the Market 10.76% Preferred Equity 1.24 Risk Free Rate 2.72% 20665.00 3487.00 1/1/6.00 Tax Rate 2106% Pre-Tax Cost of Debt Short-Term Debt Long-Term Debt Total Capital 6,009 20,082 187,356 In the command line, type DIS followed by the yellow F3 Corp key and press Enter or . WALT DISNEY CO Equity SECF DIS Corp SECURITIES DIS Corp DISH Corp DIS 7 03/01/2032 Corp DISCA Corn ** This is the Security Finder, or SECF, page for finding securities on the terminal. The "DIS Corp" command filtered the SECF page to show a table of all of The Walt Disney Company's bonds. The R column signfies the most relevant bonds which we can use as a proxy for the most actively Related Functions traded of Disney's bonds. Select the series with the highest relevance indicator (DIS 7.00 03/01/2032). to hide TWDC Enterprises 18 Corp (N DISH DBS Corp (Multiple Ma TWDC Enterprises 18 Corp Discovery Communications Corp Govt Loan Pfd CDS CDS Idx Muni 60) Excluded (147) Matured/Called, Non-Verified Bonds R Ticker Maturity Name Coupon DIS DIS 03/01/2032 TWDC Enterprises 1... 7.000 DIS |06/15/2027|TWDC Enterprises L... 2.950 DIS DIS 07/30/2016 TWDC Enterprises 1... 03/01/2037 Walt Disney Co/The 3.000 6.150 From the popup menu, select YAS (Yield and Spread Analysis). Change both the date boxes to March 29, 2019, the last trading day of Q1, and press Enter. Next to the Yield field, change Wst to Mty for Yield to Maturity and press Enter. DIS 7 03/01/32 Corp Settings 1) Yield & Spread > Graphs Pricing 4 Descr This bond has a yield to maturity of 3.29%. Disney's WACC table is now complete and ready to be used to answer the first case question. Disney WACC Elements All Data as of First Quarter 2019 Metric Beta Value Metric Value Spread DIS 7 03/01/32 ( 25468PBW5 92.41 bp vs 10yT 2% 02/15/29 0.90 Price 138.7869 102.2656 Expected Return of the Market Risk Free Rate 10.76% 2.72% Yield 3.290571 Mty 2.366492 Wkout 03/01/2032 @ 100.00 S/A Yld 66 Tax Rate 21.06% Pre-Tax Cost of Debt 3.29% Equity Preferred Equity Short-Term Debt Long-Term Debt Total Capital 161,265 6,009 20,082 187,356 Settle 03/29/19 03/28/19 Trade 03/27/19 Retro (Using hist price) Use the path described in the above Terminal tutorial, but instead of selecting Q1 at the start, select Q2. Beta Weighted Average Cost of Capital Case Calculations Cost of Capital Components Expected Return Risk Free of Market Rate Tax Rate Pre-Tax Debt Cost Bond Rating Equity Capital Structure Components Short-Term Long-Term WACC Debt Debt Total Capital Target Disney 0.96 9.6% 2.4% 21.8% 3.0% A 248,699 21,923 36,311 306,933 Parks and Resorts Six Flags 0.89 9.6% Cedar Fair 0.77 9.6% 2.4% 2.4% 24.2% 17.0% 4.2% 4.8% B+ B+ 4,190 2,699 19 2,467 6,676 8 2,150 4,857 Studio Entertainment Lions Gate 1.21 9.6% 2.4% 0.0% 4.3% B- 2,666 439 2,838 5,943 Broadcasting and Media Viacom Netflix 1.1 9.6% 2.4% 1.46 9.6% 2.4% 22.0% 17.7% 4.5% BBB- 2.6% BB- 12,059 160,826 320 8,638 138 13,541 21,017 174,505 Consumer Products ULTA 0.86 9.6% 2.4% Sally Beauty 0.81 9.6% 2.4% Game Stop 0.92 9.6% 2.4% 22.7% 25.7% 23.5% 2.5% 20,034 211 1,654 21,899 6.9% BB 5.9% BB- 1,603 21 1,560 3,184 918 250 1,022 2,190 Source: Bloomberg All Data Effective 31 July 2019 Weighted Average Cost of Capital Scenario Changes Beta Market Cost of Capital Components Expected Return of Risk Free Rate Pre-Tax Tax Rate Debt Cost Rating Bond Capital Structure Components Short-Term Long-Term WACC Total Equity Debt Debt Capital Target Disney 0.96 9.6% 2.4% 21.8% 3.0% A Six Flags 0.89 9.6% 2.4% 24.2% 4.2% B+ 248,699 4,190 21,923 19 36,311 2,467 306,933 7.9% 6,676 6.3% Fed Rate Move Disney 0.96 9.6% 2.4% 21.8% 3.0% A Six Flags 0.89 9.6% 2.4% 24.2% 4.2% B+ 248,699 4,190 21,923 19 36,311 2,467 306,933 7.9% 6,676 6.3% Credit Rating Change Disney 0.96 9.6% 2.4% 21.8% 3.0% A Six Flags 0.89 9.6% 2.4% 24.2% 4.2% B+ 248,699 4,190 21,923 19 36,311 2,467 306,933 7.9% 6,676 6.3% Additional Debt for Fox Acquisition Disney 0.96 9.6% 2.4% 21.8% 3.0% Six Flags 0.89 9.6% 2.4% 24.2% 4.2% A B+ 248,699 4,190 21,923 19 36,311 2,467 306,933 7.9% 6,676 6.3% Bear Stock Market Disney 0.96 9.6% 2.4% 21.8% 3.0% A Six Flags 0.89 9.6% 2.4% 24.2% 4.2% B+ 248,699 4,190 21,923 19 36,311 2,467 306,933 7.9% 6,676 6.3% Tax Rate Increases Disney 0.96 9.6% 2.4% 21.8% 3.0% A Six Flags 0.89 9.6% 2.4% 24.2% 4.2% B+ 248,699 4,190 21,923 19 36,311 2,467 306,933 7.9% 6,676 6.3%