Question

Disney is currently trading at $131.75 per share. It has 1.81 billion shares outstanding, and has a beta of 1.08. Disney. Disney has $68.31 billion worth bonds outstanding in market values. The last class of bonds that Disney issued had a coupon rate of 6% (coupon payments are paid semi-annual), and have a 1,000 face value. The bonds currently have 27 years left to maturity and are currently trading at 1045.70. Disney does not have any preferred stock outstanding. The expected market risk premium is 7%, and the current Treasury bill rate is 2.15%. Disney has a tax rate of 21%

A. Given the above information, what is Disney’s WACC?  

B. Disney’s last year dividend was $1.76. The dividend has been growing by 5% each year and expected to continue to do so forever. What is Disney’s WACC if you use the average of CAPM and the DCF (dividends) for Disney’s cost of equity.  

C. Disney has the following coefficients on the Fama-French 3 factor model: b: 1.04, s:-1.2, h: 1.08

The market risk premium is 4.90%, the size (SMB) risk premium is 3.25%, and the value premium (HML) is 3.80%. What is estimated cost of equity using the 3-factor model? What will Disney’s WACC be if only this estimated cost of equity is used?  

D. Disney is thinking about opening up its own line of fast-food restaurants. To estimate the cost of equity, Disney is using the following Firm’s information to get an estimated cost of equity:

Company Name	Beta	Debt to equity Ratio	Debt Beta
McDonald’s	.68	.26	.10
Jack in the Box	1.68	.58	.30
Yum Brand’s	0.86	.45	.20
Wendy’s	1.11	.30	.25

E. Estimate the average unlevered equity beta for the group of comparison. Then, re-lever the beta to get an estimate for Disney’s fast food levered beta (using Disney’s current capital structure (D/E), and the associated cost of equity using the CAPM model and the assumptions in problem 2. Assume Debt beta of .20.   What is Disney’s WACC if this estimate cost of equity is used?

Answer 1

E = P x N = 131.75 x 1.81 = 238.4675

D = 68.31

C = D + E = 68.31 + 238.4675 = 306.7775

Wd = D / C = 68.31 / 306.7775 = 22.27%

We = 1 - Wd = 77.73%

Cost of debt, Kd = 2 x Rate (Nper, PMT, PV, FV) = 2 x Rate (2 x 27, 6%/2 x 1000, -1045.70, 1000) = 5.67%

Cost of equity, Ke = Rf + Beta x Rmp = 2.15% + 1.08 x 7% = 9.71%

Part (a)

WACC = Wd x Kd x (1 - T) + We x Ke = 22.27% x 5.67% x (1 - 21%) + 77.73% x 9.71% = 8.54%

Part (b)

Ke as per DCF = D1/P0 + g = 1.76 x (1 + 5%) / 131.75 + 5% = 6.40%

Hence, Ke = average of two Ke's = (9.71% + 6.40%) / 2 = 8.06%

Hence, WACC = Wd x Kd x (1 - T) + We x Ke = 22.27% x 5.67% x (1 - 21%) + 77.73% x 8.06% = 7.26%

Part (c)

b: 1.04, s:-1.2, h: 1.08

The market risk premium is 4.90%, the size (SMB) risk premium is 3.25%, and the value premium (HML) is 3.80%.

estimated cost of equity using the 3-factor model = Rf + b x Rmp + s x SMB premium + h x HML premium = 2.15% + 1.04 x 4.90% - 1.2 x 3.25% + 1.08 x 3.80% =  7.45%

Hence, WACC = = Wd x Kd x (1 - T) + We x Ke = 22.27% x 5.67% x (1 - 21%) + 77.73% x 7.45% = 6.79%

Part (d)

Formula connecting unlevered beta, levered beta and beta of debt:

So, we will calculate the unlvered beta for each fo the companies using the formula above:

Company Name	Beta	Debt to equity Ratio	Debt Beta	Tax rate	Unlvered beta
McDonald’s	0.68	0.26	0.1	21%	0.5812
Jack in the Box	1.68	0.58	0.3	21%	1.2464
Yum Brand’s	0.86	0.45	0.2	21%	0.6869
Wendy’s	1.11	0.3	0.25	21%	0.9452
Average					0.8649

Average unlevered beta = 0.8649

D/E = Wd / We = 22.27%/ 77.73% =  0.2865

HEnce, levered beta = 0.8649 x (1 + (1 - 21%) x 0.2865) - (1 - 21%) x 0.2865 x 0.20 =  1.0154

Hence, cost of equity = Ke = Rf + Beta x Rmp = 2.15% + 1.0154 x 7% = 9.26%

WACC = Wd x Kd x (1 - T) + We x Ke = 22.27% x 5.67% x (1 - 21%) + 77.73% x 9.26% = 8.19%