Advanced Financial Management of Walt Disney Company - Essay Example

Advanced Financial Management- The Walt Disney Company Contents Contents 2 Introduction 3 Walt Disney: A Brief Overview 3 Discussion 4 Importance of Capital Structure and Risk Return Relationship 4 Capital Structure of Walt Disney Company 4 Risk-Return policy of Walt Disney 5 Weighted Average Cost of Capital of Walt Disney 7 Leverage Ratio of Walt Disney 7 Current issues 8 Conclusion 10 Reference List 12 Bibliography 13 Introduction Advanced Financial Management aims at managing organizational funds efficiently so that the organizations can control their finances effectively and can achieve their financial goals. Capital Structure, Dividend Policy & Risk Return relationships are the most important aspects of advanced financial management policies that most of the corporate analyze in order to formulate their financial postulates (Bhat, 2008). Capital Structure is one of the most important criteria to establish the source of uninterrupted cash flow in the long run from a company’s perspective. Dividend Policy derived from the type of capital structure chosen by the company also affects the value of the company’s stock to a great extent that in turn may enhance the company’s bottom line. For this paper, the financial & investment strategies of The Walt Disney Company will be discussed in order to understand financial blueprints taken by the company from time to time & its effects on the company. Walt Disney: A Brief Overview Walt Disney is the second largest mass media company in the world with headquarter in California, United States. The common stocks of Disney are traded on New York Stock Exchange (NYSE) with a ticker symbol of DIS. As per the records, last time the company had paid dividend was on 16th of January, 2013 to all its shareholders. In the last financial year of 2013-14, the company has shown substantial financial improvement in terms of return on investment & shareholders, subsidiaries & joint ventures’ perspective. The company ranks 17th on Forbes in the list of most valuable brands with as low as 3% default risk as compared to their peer companies. In July, 2014 the US dollar bonds issued by the company were heavily traded as corporate fixed rate bonds near the best value. As a result of an exceptional trading volume of $ 28.9 million on 11th & 14th of July, 2014, Walt Disney became 16th most actively traded corporate bond issuer in the current financial year of 2014-2015 (Verma, 2012). Discussion Importance of Capital Structure and Risk Return Relationship The capital structure shows how a firm can finance its overall operations through optimum utilization of their sources of funds. Main sources of funds can be classified under Debt & Equity. Equity includes common stock, retained earnings & preferred stocks whereas debt includes bonds & bills i.e. long term payables (Baker and Martin, 2011). Using more debt instruments in the capital structure of a company increases the riskiness for the company due to continuous interest payment & obligation for payment of principle in long run. However, higher proportion of debt results in higher expected rate of return for equity holders due to increment in earning per share (EPS) because volume trading on equity. Hence, the optimum capital structure is the one that strikes balance between return & risk with a goal to maximize shareholder’s wealth. Dividend policy is another important criterion for the companies to consider in their financial & investment decision. Mature companies with stable earnings tend to have a high dividend payout ratio. However, long term shifts in earnings leads to change in dividend decisions. Dividend decisions are largely influenced by the tax structure. Generally, tax on dividends is higher than tax on capital gains. Therefore, under presence of corporate taxes, companies should restrict from paying dividends as investors expect higher return from dividend paying companies (Baker and Wurgler, 2002). Capital Structure of Walt Disney Company Over the last decade, Walt Disney has taken the strategy of using more equity participation in their capital structure. The reasons behind such actions may be attributed as non requirement of repayment. Using equity capital doesn’t involve any obligation of interest payment or payment of capital in the long run. Walt Disney Company has taken this advantage to enhance their short term profitability which enables the company for more expansion and helps them to meet short term expenditure and more investment on research and development, when required (Berk, et. al., 2013). Type % Amount Debt 24.8 14.8 Bill Preferred --- --- Equity 75.2 45.0 Bill (Source: Business Week, 2014) Another reason for Walt Disney to minimize debt in their balance sheet is to safeguard the organization from the risk of bankruptcy (Yahoo Finance, 2014). In an adverse business scenario, if a company fails to meet its interest payment obligations, the creditors can drag the company towards a bankruptcy. But in case of more equity participation in capital structure, the company reduces risk due to the fact that equity holders don’t have any right except to tolerate such downturn (Huanga and Huengb, 2008). Such decision of the management had helped the company to survive in post recession period. Increasing advertisement costs of the company could be met due to less obligation of interest payment which led to availability of sufficient working capital which enables them to cover short term costs. However, equity investors are always focused on future earnings. Hence, short term investments of the company for future expansion & larger profitability expectations always encourages equity investors put to more money on the company mainly for its growth potential. Risk-Return policy of Walt Disney Risk Return relationship in managing finances of a company can be best established through Capital Asset Pricing Model which shows risk adjusted rate of return for a specified period of time (Huanga and Huengb, 2008). In other words, the expected return of a security equals to the risk free interest rate plus risk premium whereas risk premium can be defined as market return in excess of the risk free rate of return with an adjustment of market responsiveness. The formula can be summarized as, ra= rf + β (rm - rf ). Where, rf = Risk free rate of return. β = market responsiveness of the stock (Beta of the stock). rm = Expected Market Return. Hence, calculating the rate of return for Walt Disney Company (ra) = 0.0272 + 1.34 x (0.1347- 0.0272) = 0.0272 + (1.34 x 0.1075) = 0.0272 + 0.14405 = 0.17125. [Where, Risk free rate of return on Long Term Treasury Bills: 2.72%. Expected market return: 13.47% Systematic Risk on Walt Disney Company’s stocks: 1.34.] Hence, expected rate of return on Disney’s common stocks is 17.125% (Bloomberg, 2014). The risk free rate of return on long term treasury bills is 2.27% as on April, 2014. The risk premium that shows the difference between expected market returns and risk free rate of return is adjusted by market responsiveness beta. The average beta is calculated here as 1.34. Hence the risk premium is coming out to be 14.40%. So, as per Capital Asset Pricing Model (CAPM), the required rate of return becomes 17.125% which is approximately 1.5% lower than the return derived from dividend discounting model. The main reason behind the difference in two rate of returns is the discrepancy between actual beta & estimated beta. Low interest yield of treasury bills as against estimated figure due to slowdown of economy appears to be the main reason for such differences. But, CAPM is considered to be a more accurate measure as it involves both historical & future trend measurement while calculating returns. Apart from that, deviation of risk free rate of return from market return makes CAPM return more acceptable than dividend discount approach (Brunera, et. al., 2008). Weighted Average Cost of Capital of Walt Disney The Weighted Average Cost of Capital (WACC) is the minimum return that a company expects to earn in order to satisfy all its stake holders, depending on their existing asset. WACC is calculated considering the cost of each component that constitutes capital, multiplied by the proportional weight of each component (Amoid and Crack, 2004). Weighted Average Cost of Capital of Walt Disney Company in the current financial year can be calculated as: Cost of Equity Capital = CAPM return = 17.125%. Cost of Debt Capital = 1.50% (Yahoo Finance, 2014). After calculating the tax rate, cost of equity & cost of debt, the weighted average cost of capital (WACC) is coming close to 15%. Walt Disney being a diversified company having various source of income from five different segments such that Media Networks (44%), Amusement Parks (30%), Retail Products (7%), Studio Entertainments (17%) & Interactive Media (2%), WACC is not considered as a key factor for capital budgeting & project evaluation. The media network channel which is their priority business involves greater risks as it constitutes greater return expectations. Hence, this segment constitutes huge expenses on research & development as compared to other business channels. So, the company requires different discounting rate for different business channels in order to determine the expected debt equity ratio required for long term profitability of overall business operations (Brunera, et. al., 2008). Leverage Ratio of Walt Disney Most of the companies with high fixed costs experiences huge increment in operating revenue with expansion of output, after achieving their breakeven point, as compared to companies with high variable costs (Amoid and Crack, 2004).So, it is always expected from a company to maintain a sound leverage ratio to continue their business operations. During 2004, Walt Disney was carrying leverage ratio as high as 1.23 which indicated serious business risk (Amoid and Crack, 2004). Gradually, the company tends to maintain a practical leverage ratio by controlling their debt equity components and in 2013 they have achieved a stable leverage ratio of 0.79, ensuring solidity of business. Recent Leverage Ratio of DIS is as follows: DIS Leverage Ratio (June 30. 2014) III. Quarter (March 31, 2014) II. Quarter (Dec. 31, 2013) I. Quarter (Sep. 30 2013) IV. Quarter (June 30. 2013) III. Quarter Y / Y Equity Change 4.56 % 6.65 % 8.07 % 14.26 % 8.82 % Y / Y Total Liabilities Change 3.17 % -4.02 % -1.98 % 1.92 % 4.94 % Leverage Ratio MRQ 0.84 0.84 0.88 0.79 0.85 Overall Ranking # 101 # 108 # 112 # 100 # 120 Seq. Equity Change 1.41 % 1.27 % -2.43 % 4.35 % 3.44 % Seq. Total Liabilities Change 1.36 % -2.96 % 8.46 % -3.29 % -5.7 % (Source: Business Week, 2014) Current issues Generally, it is expected from the blue chip stocks listed in National Association of Securities Dealers Automated Quotations (NASDAQ) to have stable earnings, consistent dividend payment on quarterly basis & long term growth in bottom line which ensures strong brand image of the companies. Except for the companies like Google or Apple where shareholders support managements’ decision to retain earnings to promote future growth, investors expect the blue chips to payout quarterly dividends uniformly so that they can be assured of the sound financial health of the companies (Collis and Montgomery, 1997). Walt Disney Company, in spite of being a blue chip stock, failed to payout dividend on quarterly basis on many occasions mainly due to having less debt components & heavy equity participation in their capital structure. In 1991, the company decided to pay dividend annually instead of quarterly basis. Currently, they are paying a dividend of $0.40 per share that indicates an annual yield of approximately 1% which does not indicate long term profit accumulation & sound growth potential of the company (Yahoo Finance, 2014). During the continuous bull market of 1980s & 1990s when Disney stocks soared up to $100 range multiples, the management took the decision to split up stocks in a ratio of 4:1 in 1992 & 3:1 in 1998 (Ross, 2008). Investors appreciated such decision as large no. of shares are always more acceptable in comparison to divided payment in a scenario when share price is rising high. Hence, during that favourable period, Walt Disney had succeeded to satisfy their stakeholders. But after that, when the market started declining during the past decade, mainly after the economic downturn in 2008-2009, the investors’ interest shifted from no. of units to dividend payments (In such investment arena, if the company could have announced even a 3% dividend payment, the investors’ mind would never raise questions on the company’s ability on future earnings (Huanga and Huengb, 2008). But the management’s inability to reformulate the capital structure and dividend policy of the company according to the changing market trends & business scenario, created doubts in investors’ mind on the company’s ability to continue uniform dividend payments in the long run. In fact, many blue chip investors don’t opt for Disney stocks only due to their annual dividend payments (Business Week, 2014). Hence, instead of raising its annual payout of $0.40, if Disney would have taken decision of a lower quarterly payout of $0.10, the company would be able to attract potential investors. Coming to debt part, though the balance sheet shows $12 billion of debt, the company’s various sources of income such that its own Disney Parks, Studios, Resorts, Disney’s cruise line etc, apart from their main operations in media networks, enables them to diversify their portfolio and hence, reduce the debt burden. However, post 2012, analysis shows that in order to perform well in a stagnant market and to satisfy and attract potential investors, Walt Disney will have to pay half of its earnings as dividend which will require sufficient cushion to the bottom line so that they can maintain such dividend payment in future as well, in occurrence of any further adverse movement in business cycle. Therefore, low participation of equity investors forced the company to rethink about their financial structure. Accordingly, the management has introduced a number of structural changes in their financial operations (Bloomberg, 2014). Considering the capital structure, in the current financial year of 2014-2015, the company is maintaining a debt to equity ratio of 33.01 whereas total debt to capital ratio is 24.82 which have enabled the company to payout dividend easily on quarterly basis. A sound current ratio of 1.6 has ensured the company’s ability to pay its debts as well as potential of reinvestments or distribution of extra profit among the shareholders, supporting the acceptability of company’s share price. Rise in earnings per share (EPS) of 1.04 against the estimation of 0.92 ensures positive market prospects i.e. the company’s profitability or ability of management to distribute more profits among the shareholders. Apart from that, high price earnings ratio of 19.85 indicates acceleration in future growth & investors’ anticipation towards the future performance and willingness to pay more for the company’s stocks (Jargosch and Jurich, 2014). Conclusion Walt Disney Company has been driving their business operations successfully since 1923. During this long period of time, the management has experienced many economic restructuring, financial turmoil & changes in business cycle and accordingly they have taken financial & operating decisions to bring structural changes within the company so that the company can run their operations profoundly in a ever changing, complex business scenario (Ross, 2008). From the current financial statements, it is evident that the company has been able to grow its revenue over the previous year from $45 Billion USD to $48.80 Billion USD by adopting financial structural changes following the modern financial management theory. Capability of Walt Disney Company to manage its finances so efficiently that leads to reduction in the percentage of sales to cost of goods sold from 55.36% to 54.12%. This reflects in the company’s profitability that shows a sharp growth of $7.5 Billion USD in the current financial year from $6.5 Billion USD. However, there are substantial scopes for the company to improve its business operations & financial decisions. Though the company has already raised their dividend payment from $0.35 in 2009 to $0.86 in 2013, investors still expect the company to hike dividend payment after retaining sufficient cash for future investments for further growth, considering adequate cash flow in the current financial year, supported by stock price appreciation in the time of buy back of shares (Jonas, 2012). According to the estimations, the industry is expected to grow at a rate of 25.80% whereas growth rate for Walt Disney Company in the next financial year is projected as 15.80%. Being one of the leading companies in Broadcasting & Entertainment industry with very few competitors, the company should maintain a growth rate of more or at least at par with the industry growth rate. The management should consider these areas of improvements where they are facing challenges in the current financial system. However, past records have shown that strong management & financial support system of the company will successfully encounter the challenges, smoothing growth path for the company. Reference List Amoid. T. and Crack. F., 2004. Using the WACC to Value Real Options. Financial Analysts Journal, 60(6), pp. 22-25. Baker, H. and Martin, G., 2011. Capital Structure and Corporate Financing Decisions: Theory, Evidence, and Practice. New York: John Wiley & Sons. Baker, M. and Wurgler, J., 2002. Market Timing and Capital Structure. The Journal of Finance, 57(1), pp. 1-32. Berk, J., DeMarzo, P., Harford, J., Ford, G., Mollica, V. and Finch, N., 2013. Fundamentals of Corporate Finance. Sydney: Pearson Higher Education AU. Bhat, S., 2008. Financial Management. New Delhi: Excel Books India. Bloomberg, 2014. DIS:US. [Online] Available at: < http://www.bloomberg.com/quote/DIS:US> [Accessed 2 December 2014]. Brunera, R., Lia, W., Kritzmanb, M., Myrgrenc, S. and Pagec, S., 2008. Market integration in developed and emerging markets: Evidence from the CAPM. Emerging Markets Review, 9(2), pp. 89-103. Business Week, 2014. Walt disney co/the (DIS:New York). [Online] Available at: [Accessed 2December 2014]. Collis, D. J. and Montgomery, C. A., 1997. Corporate Strategy: Resources and the Scope of the Firm. Colorado: Westview Press. Huanga, P. and Huengb, J., 2008. Conditional risk–return relationship in a time-varying beta model. Quantitative Finance, 8(4), pp. 381-390. Jargosch, R. and Jurich, J., 2014. The Walt Disney Company Patent Landscape Analysis. Pensacola: IPGenix LLC. Jonas, J., 2012. Great Recession and Fiscal Squeeze at U.S. Subnational Government Level. Missouri: Andrews McMeel Publishing. Ross, A.S., 2008. Modern Financial Management. New York: McGraw-Hill Irwin. Verma, N.M.P., 2012. Recession and Its Aftermath: Adjustments in the United States, Australia, and the Emerging Asia. Berlin: Springer Science & Business Media. Yahoo Finance, 2014. The Walt Disney Company (DIS). [Online] Available at: [Accessed 1 December 2014]. Bibliography Breuer, P., 2000. Measuring Off-balance-sheet Leverage. Washington DC: International Monetary Fund. Chandra, P., 2008. Financial Management. Noida: Tata McGraw-Hill Education. Gabler, N., 2007. Walt Disney: the biography. California: Aurum. KEVIN, S., 2008. SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT. New Delhi: PHI Learning Pvt. Ltd. Nanto, N.D., 2009. The Global Financial Crisis: Analysis and Policy Implications. Darby: DIANE Publishing. Pratt, S. and Grabowski, R., 2010. Cost of Capital: Applications and Examples. New York: John Wiley & Sons. Ringe, W., Gullifer, L. and Théry, P., 2009. Current Issues in European Financial and Insolvency Law: Perspectives from France and the UK. London: Bloomsbury Publishing. Rosenfield, P., 2006. Contemporary Issues in Financial Reporting: A User-Oriented Approach. London: Routledge. Sharifzadeh, M., 2010. An Empirical and Theoretical Analysis of Capital Asset Pricing Model. New York: Universal-Publishers. Swanson, Z., Srinidhi, B. and Seetharaman, A., 2003. The Capital Structure Paradigm: Evolution of Debt/equity Choices. New York: Greenwood Publishing Group. Read More