Walt Disney, an American amusement and entertainment company, obtains royalty payment from Tokyo Disneyland each year. The royalties were denominated in yen and were constantly growing and becoming significant for the business (8 billion dollars Yen in 1984, with 10-20% expected growth). Yet , the devaluation of the yen against the money could incur the risk of devaluation on the royalties to be received, indicating that Walt Disney should certainly perform hedging.
Different solutions are available. First is to (1) buy options to sell yens for dollars or to purchase dollars with yen.
Nevertheless this option been with us only for maturities of two years or significantly less, which is a lesser amount of than the time scale of 10 years that Walt Disney was taking into consideration. Same concern also can be applied for the 2nd solution, (2) the future legal agreements which would allow the company to exchange yen intended for dollar by a pre-defined rate. Also this issue could still persist if Walt Disney would like to (3) convert its existing dollar personal debt into yen liability as its Eurodollar be aware issues grown up in one to four years and a stunning rate is hard to find.
Furthermore this option does not provide any extra cash. Your fourth option of (4) FX forward contracts from the bank which may provide long-dated FX frontward rate would limit thecompany’s future credit capacity because the bank could consider these deals as a part of all their total publicity. (5) The Eurodollar financial debt has lengthy maturity as well, but the business current personal debt ratio is too high, and the (6) Euroyen bonds are generally not possible for this case due to constraint in the form of legislation from Western government.
You will find two available choices for Walt Disney, (7) creating a yen liability through loan from a Western bank, or perhaps (8) a great ECU/yen change proposed simply by Goldman Sachs. After calculating the IRR of each alternative, we came to the conclusion that the change has a lower IRR; therefore Walt Disney should go in this option.
WALT DISNEY AND ITS PARTICULAR PROBLEMS
Walt Disney started in 38 as replacement, beneficiary to the Walt and Roy Disney Business. Headquartered in Burbank, California Walt Disney had a wide range of activities including theme recreational areas (Disneyland, Walt Disney World), motion pictures, television programs and The Disney Channel, but also some peripheral activities including growing resort and home residential areas, commercial and industrial homes, as well as educational material and teaching supports. The company as well licensed its name to various client products businesses.
Consolidated earnings of Disney increased simply by 27% in 1984, total entertainment and recreation revenues increased simply by 6%, when film entertainment revenues improved by 48%. In total net income grew by simply 5%, total assets great by 15%, but the percentage of debt to collateral grew substantially as well.
In 1983, Tokyo Disneyland was opened, manage by an unrelated Japanese firm, paying royalties to Walt Disney Shows. By 1984 the royalties had more than doubled to JPY 8 billion dollars. The royalties were denominated in yen and the director of finance at business, Rolf Anderson, expected these royalties to grow simply by another 10-20% for the coming years. However the depreciation from the yen up against the dollar may incur substantial risks pertaining to Walt Disney, which should be hedged. In show 4 of the case it can be noticed howthe yen/dollar rate has increased from 225. 7 to 250. almost 8 from 1980 till mid-1985. In the subsequent sections our company is providing an analysis of possible alternatives for hedging the risks coming from the changing of the yen against the dollar.
POSSIBLE POSSIBILITIES WITH DISNEY TO HEDGE THE FOREIGN EXCHANGE RISK:
If we take the exchange rate of 1984 we. e. 237. 30 JPY/USD (see Case, p8) the revenue of Disney (8 billion yen) was comparable to approximately 33. 7 , 000, 000 USD. This kind of represented about 11. 6% of the Disney’s total working revenue with the year 1984. The developing revenue plus the depreciating yen can prevent some of the economic plans of Disney thus it was very important to Mr. Anderson to hedge this likelihood of foreign exchange. Stated below are the various options that had been available for Mr. Anderson to hedge this kind of risk.
First solution the fact that company could have used is to buy/sell choices. But the problem Mr. Anderson faced with this was the short-term nature on this solution. Indeed, such alternatives existed with at best a maturity of two years, that was not good enough to get the timescale he was considering (10 years horizon).
The Future Contracts alternative, which would permit the Walt Disney Organization to exchange Yens against Dollars at a pre-defined rate (and might protect them through the on-going depreciation), is apparently the same issue: it is extremely hard to find legal agreements with maturities of more than two years.
The Walt Disney Business could have joined a foreign currency swap because they did this past year by planning to convert component to their dollars debt in a yen liability. This type of hedge was short-term since Disney’s Eurodollar be aware issues grown up in one to four years. The problem regarding such hedging was first it absolutely was very difficult to find attractive yen swap costs for such maturities (one to several years), and secondly it could not provide any additional cash to Disney, which is anything Mr. Anderson was looking for.
That short-term concern could have been managed FX forward contracts. Unfortunately, the banks would consider these contracts as a part of their total exposure to Disney, and it would compromise Walt Disney’s ability to have credit in the near future. Their particular debt indeed, has already elevated drastically within the last two years and in addition they would not prefer to lever it more.
Disney could have thought of Eurodollar debts issue (whose maturity is usually long enough), which could always be swapped into yen. Although because the financial debt ratio of company was too high it absolutely was not a feasible option for Mister Anderson. Euroyen bonds were out of question because the current Japan Ministry of Finance guidelines didn’t enable Disney for this (see Circumstance, p5, 2).
The initial viable alternative in front of Disney was to produce a yen responsibility through a term loan from a Japanese bank on the lower Japanese people long-term interest rate. This option was attractive, since the proceeds obtained from this could have been used to settle their very own short-term financial debt, improving their debt composition by lowering the power. Mentioned beneath were the terms of the loan.
TERM LOAN IN JPY
It was a loan with a rule of JPY 15 billion dollars, the term with the loan was 10 years with interest rate of seven. 5% (annual percentage rate) paid semi-annually. It also experienced 0. 73% front-end costs and was a bullet financial loan where semi-annual interest payments are carried out and the theory is paid out at the maturity. So whenever we deduct the fees from the loan volume that Disney asked for they would be playing 14. 8875 (15%-0. 73% of 15) billion JPY. Also the interest Disney was required to pay each time equalled (7. 5% of 15 billion = 1 . 125 billion dollars JPY annually) 0. 5625 Billion JPY semi-annually. Whenever we calculate the IRR (internal rate of return) or perhaps basically the all in cost (AIC) of the debt:
The IRR comes to be able to be several. 804 % (semi-annually) or perhaps (1+3. 804%)2-1 = several. 753% yearly.
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