Case Analysis for Disney's Yen Financing

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Part I. The fundamental information of Walt Disney
The Walt Disney Company, a diversified international company operated entertainment and recreational complexes, produced motion picture and television features, developed community real estate projects, and sold consumer products. The company was founded in 1938 as a successor to the animated motion picture business established by Walt and Roy Disney in 1923. The company operated the Disneyland amusement theme park in Anaheim, California, and the Walt Disney World destination resort in Orlando, Florida. In addition to the domestic entertainment and recreation revenues from Disneyland and Walt Disney World, the company received royalties, paid in yen, on certain revenues generated by Tokyo Disneyland. Owned and operated by an unrelated Japanese corporation, Tokyo Disneyland was opened to the public on April 15, 1983. In year 1984, the consolidated revenues for The Walt Disney Company and its subsidiaries increased by almost 27% to $1.7 billion. Total entertainment and recreation revenues, including royalties from Tokyo Disneyland, increased by 6% to $1.1 billion in the fiscal year ended September 30, 1984. Net income totaled $97.8 million in 1984, an increase of 5% from 1983. During fiscal 1984, yen royalty receipts had been just over ¥8 billion, however, Disney foresaw a constant further growth at 10% to 20% per year over next few years. At the same time, there were volatile fluctuations in the yen/dollar exchange rate. Yen has depreciated almost 8% last year, which indicated a shrink in royalty receipts in yen. Rolf Anderson, the director of finance at The Walt Disney was considering various ways of hedging the exposure. Besides, considering the increased interest costs on high level of borrowing and excessive short-term loan and commercial paper, the company planned to reduce such short-term debts.

Part II. Should Disney hedge its yen royalty cash flow? Why or why not? Disney should hedge its yen royalty cash flow. During fiscal 1984, yen royalty receipts had been just over ¥8 billion, however, Disney foresaw a constant further growth at 10% to 20% per year over next few years. At the same time, there were volatile fluctuations in the yen/dollar exchange rate. The current spot rate of 248 yen/dollar represented almost an 8% depreciation in the value of the yen from 229.70 just over a year ago, indicating a shrink in royalty receipts in yen. The benefits of hedging:

Hedging can help smooth the royalty receipts in dollar, eliminating the operating exposure. Thus Disney could be able to focus more on the operation, rather than distracting by the exchange rate fluctuation. Hedging can help to reduce the translation exposure. As an international corporation, the fluctuation in the exchange rate can affect the earnings in the consolidated Income Statement. Some potential problems with hedging: Hedging might introduce other uncertainties, especially when Disney chooses to enter into some obligation, for example, forward, future and swap. The hedging is based on the forecast that the company will keep receiving increasing yen cash flows in the future years. However such forecast may not be guaranteed. Just consider the following situation: Disney has entered into a forward contract to hedge its yen income, while for some reasons, the income from Japan decreased or ceased to come. At the same time, yen is appreciating against dollar. Then Disney could lose a great amount of money for entering into the hedge. All the above, Disney should hedge its royalty receipts in yen, but with more cautious evaluation of different situation.
Part III. Hedging techniques available to the treasurer:
1. FX futures
Advantage: Foreign exchange future is an open market and its liquidity is good. Disadvantage: Firstly, the maturity is often two years or less which causes a mismatch between the period in which Disney want to hedge the fluctuations in the yen/dollar spot rate...
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