Fundamentals Of

Corporate Finance

Case Study: Walt

D i s n e y C o m p a n y sNguyn Thy Dng (Leader)
Sleeping Beauties Trnh Th Thu H
Bonds
Phm Khnh Huyn
Phm Thu Trang
on Th Loan Trang
Chu Phng Tho
Hong Th T Anh
Group 7
Advanced
Accounting K56
 Fundamentals Of Corporate Finance | Group 10 Advanced Accounting K56

Contents
............................................................................................... 0
A. Case Summary........................................................................2
B. Case Analysis.........................................................................3
I. Question 1.....................................................................................3
II. Question 2...................................................................................3
III. Question 3...................................................................................5
IV. Question 4...................................................................................5
V. Question 5.....................................................................................5
VI. Question 6...................................................................................7
VII. Question 7 + 8..............................................................................9
VIII. Question 9..............................................................................10
IX. Question 10...............................................................................12

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 Fundamentals Of Corporate Finance | Group 10 Advanced Accounting K56

A.Case Summary
In July 1993, the Walt Disney Company issued $300,000 in senior bonds
called Sleeping Beauties. The debentures carried an interest rate of 7.55%
payable semiannually, and were priced at par.
They were due to be repaid on July 15, 2093, a full 100 years after the date
of issue. However, at the company's option, the debentures could be repaid any
time after July 15, 2023 or 30 years after the issue date.
The issue caused a lot of comments among traders and portfolio managers:
They all felt that the bonds were too risky, yet profitable.
The issue was priced to yield 0.95% over the benchmark 30-year Treasury
bond. Analysts estimated that this was 0.15% to 0.20% more than Disney would
have paid it issued 30-year bonds.
Having the right to call the bond after 30 years for 103.02% of face value,
Disney had the best situation. If prevailing interest rates were low, it could call
the bonds and replace them with a cheaper issue. But if interest rates were high,
the bond could remain out, continuing to pay 7.55 for 70 more years.
Coca-Cola Co. had its own 100-year bond, issued of $150 million. The
bonds was priced to yield 7.455% over the benchmark 30-year Treasury bond,
but unlike Disneys bonds, were not callable.
The primary buyers of both Disney and Coca-Cola bonds were large
institutions, especially insurance companies and pension funds with defined
liabilities. There was also speculation that some Wall Street houses would find it
advantageous to break up the bonds into their component parts and sell the
pieces separately.

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 Fundamentals Of Corporate Finance | Group 10 Advanced Accounting K56

B.Case Analysis
I. Question 1
What are the cash payments associated with the Sleeping Beauties? Who
gets how much and when, per $100 of bonds issued? Consider the following
date: the issue date, the delivery date, the date of the first, second, etc. interest
payments, the maturity date. (Assume the bonds remain outstanding through
2093).

Answer:

Cash payments associated with sleeping beauties bond includes 100 as cash
outflow and 7.55% as cash inflow each year. At maturity, they get interest and
principle amount which is 100+7.55%= 107.55. Those who invested in sleeping
beauty bond will get 7.55% each year or 3.775 % semiannually. At maturity
they will get principal amount as well which becomes 107.5%.

II. Question 2
Open the sleeping beauty Excel Workbook, which contains a number of
worksheets. Double click on the Basic Spreadsheet. It contains a list of years
and payments made each year on the Sleeping Beauties. The NPV function in
Excel calculates values of cash flow streams for a given interest rate. Cell F15
in a box titled Present Value contain the formula, and shows the resulting price
of the bonds. What interest rate was used to calculate the price? Was it higher or
lower than 7.55%?

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 Fundamentals Of Corporate Finance | Group 10 Advanced Accounting K56

Answer:

Sleeping Beauty Basic Spreadsheet

Relativ Present
Calendar e Cash Flow Present Value
No Each Cash
Year Year per $100 Value Flow

6
1993 0 75.50
7
1994 1 7.55 75.50
8
1995 2 7.55 75.50
9
1996 3 7.55 75.50
10
1997 4 7.55 75.50
11
1998 5 7.55 75.50
12
1999 6 7.55 75.50
13
2000 7 7.55 75.50
14
2001 8 7.55 75.50
15
2002 9 7.55 75.50
16
2003 10 7.55 75.50
17
2004 11 7.55 75.51
18
2005 12 7.55 75.51
19
2006 13 7.55 75.51
20
2007 14 7.55 75.51
21
2008 15 7.55 75.51
22
2009 16 7.55 75.51
23
2010 17 7.55 75.51
24
2011 18 7.55 75.51
25
2012 19 7.55 75.51
26
2013 20 7.55 75.51
27
2014 21 7.55 75.51
28
2015 22 7.55 75.51
29
2016 23 7.55 75.52
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 Fundamentals Of Corporate Finance | Group 10 Advanced Accounting K56

As we can see from the sheet, cell F15 in a box titled Present Value caculated
by =NPV(10%,C16:C115)

According to basic spread sheet they used the 10% interest rate to derive the
price of bond. 10% interest rate is higher than 7.55% which is used to calculate
net present value. We examined that higher interest rate give us low net present
value as compare to 7.55% interest rate.

III. Question 3
We calculate the price of bond at 7.55% which give us cash flow of $100. At
8.55% interest rate the present value is $88.31 which shows that when the
interest rate rises, the present value would decrease from par value.

Answer:

We have: P = (100*0.0755)* +

In this question the prevailing interest rate increased by 1%

from 7.55% to 8.55%. First, we calculate the price of bond at
7.55% which give us cash flow of $100. At 8.55% interest rate
the present value is $88.31 which shows that when the interest
rate rises, the present value would decrease from par value.

IV. Question 4
If the interest rate dropped by one percentage point, what would be the price
of the Sleeping Beauties become?

Answer:

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 Fundamentals Of Corporate Finance | Group 10 Advanced Accounting K56

When interest rate dropped by 1%, from 7.55% to 6.55%. The present value
of sleeping beauty bonds becomes 115.24 which are greater than par value.

V. Question 5
a) Is this a reasonable range of interest rates to consider over a 100-year
horizon?

Answer:

a) YES, this is a reasonable range of interest rates to consider a over 100-

year horizon.

Interest rates vary according to:

the government's directives to the central bank to accomplish the

government's goals

the currency of the principal sum lent or borrowed

the term to maturity of the investment

the perceived default probability of the borrower

supply and demand in the market

as well as other factors.

100-year is a very long time, so interest rate may not be stable. It means that
the range from 2% to 20% is a reasonable range of interest rates to consider
over a 100-year horizon.

b) Calculate the value of the Sleeping Beauties for each of the interest rates
(ranging from 2% to 20%).

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 Fundamentals Of Corporate Finance | Group 10 Advanced Accounting K56

Answer:

Bond value of Sleeping

Interest rate
Beauties
2% $ 339.20
3% $ 243.78
4% $ 186.99
5% $ 150.61
6% $ 125.76
7% $ 107.85
8% $ 94.38
9% $ 83.89
10% $ 75.50
11% $ 68.64
12% $ 62.92
13% $ 58.08
14% $ 53.93
15% $ 50.33
16% $ 47.19
17% $ 44.41
18% $ 41.94
19% $ 39.74
20% $ 37.75

VI. Question 6
a) Compare the prices of the Sleeping Beauty and Napping bonds at the
initial interest rate of 7.55%. Why are they the same? What does this
say about the expected price path of the Sleeping Beauties as time
passes, if interest rates remain around 7.55%?
b) Suppose interest rates fluctuate wildly during the next two years and
then stabilize again at around 7.55%. What do you predict would
happen to the price of each of the bonds?

Answer:

a. According to excel sheet maturity, the prices of sleeping and napping

beauty bonds are $100 at the interest rate of 7.55%. As discount rate and

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 Fundamentals Of Corporate Finance | Group 10 Advanced Accounting K56

coupon rates are same the price of both bonds would be equal. As time
passes, if interest remain around 7.55% than the expected price of bond
will be around $100. With the change in maturity the interest rate gets
affected but here interest rate is same so expected return is also same.
b. If interest rate fluctuates and again stabilizes around 7.55 than two effects
are occurring. One is when interest rate increase to 7.55% in market than
prices would decrease of bond. On the other hand if interest rate is
decrease by 7.55% than its prices automatically increase in the market.
Changing occurs in both sleeping and napping beauty bond is quite
different. Change occurs in sleeping beauty bond is greater than napping
beauty bonds because sleeping beauty bonds have long term maturity as
compare to napping beauty bonds. The cash flows of first two years
would change.

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Fundamentals Of Corporate Finance | Group 10 Advanced Accounting K56

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 Fundamentals Of Corporate Finance | Group 10 Advanced Accounting K56

VII. Question 7 + 8
Present Value
Intere
st Sleeping Napping
Rates Beauties Beauties

2% $339.20 $149.85
3% $243.78 $138.81
4% $186.99 $128.79
5% $150.61 $119.69
6% $125.76 $111.41
7% $107.85 $103.86
7.55% $100.00 $100.00
8% $94.38 $96.98
9% $83.89 $90.69
10% $75.50 $84.95
11% $68.64 $79.68
12% $62.92 $74.86
13% $58.08 $70.43
14% $53.93 $66.36
15% $50.33 $62.61
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 Fundamentals Of Corporate Finance | Group 10 Advanced Accounting K56

16% $47.19 $59.16

17% $44.41 $55.98
18% $41.94 $53.04
19% $39.74 $50.32
20% $37.75 $47.80

- While comparing the interest rates greater than 7.55% (8% to 20%) of both
the bonds, we found that napping bonds are worth more as compared to sleeping
bonds and the reason for this is the lower duration to maturity of the bonds. As
the interest rate increases, present value of sleeping bonds decreases rapidly
than napping bonds. E.g. when interest rate changes from 8% to 9%, present
value of sleeping bonds decreases by $10.49 ( from $94.38 to $83.89) whereas
present value of napping bonds decreases by $6.29 ( from $96.98 to $90.69).

- In the same way, while comparing the interest rates less than 7.55% (2% to
7%) of both the bonds, we found that sleeping bonds are worth more than
napping bonds because now the longer duration is favorable for a the company
since the interest rates have declined.

Present Value of a 100-year and a 10-year

Bond as a Function of the Interest Rate
$200.00
$150.00
$100.00
$50.00
$0.00
Present Value

Interest Rate

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 Fundamentals Of Corporate Finance | Group 10 Advanced Accounting K56

VIII. Question 9
In July 1993, the Walt Disneys common stock was trading in the range
$36 to 41 per share. It paid dividends of $0.25 per share annually, on earnings of
$1.08 (estimated for the fiscal year ending in September 1993).

a. What pattern of cash flows do holders of Disney common stock

expect? How does the pattern compare to the Sleeping Beauties?
The pattern of cash flows that would be paid to the common stock
holders (Dividends and Share prices) would depend on the earnings at
the end of the fiscal year.
For the holders of the Sleeping Beauties, this pattern (Coupon rate and
Principle) is fixed and then would receive fixed interest payments on
their bonds.
b. If Disney bonds pay 7.55%, what rate of return should one expect for
holding Disney common stock?
Those who are holding Disney common stock will expect rate of
return be higher than 7.55% because holding stock has more risks than
bonds.
c. How much must Disneys stock price go up this year to give an
investor that rate of return?
Avarage price of stock (1993) = $ 38.5
Rate of return (r) = + > 7.55%

- 1 > 0.0755 > 1.0755

P1 > 41.15

So the avarage price of Disney stock have to increase to be more than

$41.15 this year.

d. How fast must Disney increase its dividends, to merit such an increase
in its stock price?
P0 = ; P1= =
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 Fundamentals Of Corporate Finance | Group 10 Advanced Accounting K56

= 1+g > 1.067

g > 0.067 g > 6,7 %

So Disney must increase its dividends more than 6,7% to merit such an
increase in its stock price

IX. Question 10
Is Disney a good candidate for a leveraged recapitalization? Why or why
not?

Answer:

In corporate finance, a leveraged recapitalization is a change of the

companys capital structure, usually substitution of equity for debt.

Leveraged recapitalization is used by privately held companies as a means of

refinancing, generally to provide cash to the shareholders while not requiring a
total sale of the company.

In the case of Disney, the company could issue bond (like a way to solve
debt) as a way of raising money, because it can have tax benefits and can
enforce a cash discipline.

Due to the trust of investor to Disney, it is a big chance for Disney to gain
money from selling bonds. It gives the company a financial leverage. When the
amount of cash inflow higher than the operating expenses of the company then
its financial leverage increases.

Moreover, leveraged recapitalization can help Disney as a tax shield. A

higher debt means the lower tax the company has to pay.

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 Fundamentals Of Corporate Finance | Group 10 Advanced Accounting K56

In addition, when the company sells bonds as a tool of debt, the amount of
assets goes down. It makes Disney less attractive to the companies that are
looking to make a bid on it.

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