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Bloomberg Businessweek
The Year Ahead 2019
Global Economics
Recessions
▷ An early warning system for downturns may be giving off mixed signals
20
Historically, the $15.4 trillion U.S. Treasury
market has offered one of the most reliable
barometers for the health of the American economy. Investors are particularly fixated on what’s
known as the yield curve, which depicts the
yields on government debt of different maturities at a given point in time.
The curve usually slopes upward as investors
typically demand higher returns for locking up
their money for a longer period. Occasionally,
the curve flips, with yields on short-term debt
exceeding those on longer bonds. That’s normally a sign investors believe economic growth
will slow and interest rates will eventually fall.
Research by the Federal Reserve Bank of San
Francisco has shown that an inversion has preceded every U.S. recession for the past 60 years.
The U.S. economy is 37 quarters into what
may prove to be its longest expansion on record.
Analysts surveyed by Bloomberg expect gross
domestic product growth to come in at 2.9 percent this year, up from 2.2 percent last year.
Wages are rising as unfilled vacancies hover near
all-time highs.
With times this good, the biggest betting game
on Wall Street is when they’ll go bad. Barclays
Plc, Goldman Sachs Group Inc., and other banks
are predicting inversion will happen sometime
in 2019. The conventional wisdom: Afterward
it’s only a matter of time—anywhere from 6 to
24 months—before a recession starts.
But there are reasons to wonder whether the
curve’s predictive powers remain intact. In the
wake of the financial crisis, the Federal Reserve
not only slashed interest rates, it also bought trillions of dollars in long-term government bonds.
At one point in 2017, the purchases pushed down
the term premium—the extra bonus investors
usually get to hold l onger-term debt—on 10-year
Treasury notes by a full percentage point,
according to one study.
While the Fed began raising short-term interest rates in December 2015, it didn’t start letting
the bonds on its balance sheet mature without
replacing them until October 2017, and that
process is ongoing.
The Fed projects three possible rate hikes in
2019. That on its own could be enough to erase
much of the gap between short-term rates and
longer-term ones. And if the Fed steps up the pace
of hikes, we could more easily see an inversion.
A pair of researchers at the Brookings
Institution in Washington caution that inversion
may not necessarily be the harbinger of a downturn this time. In an April web post, Michael Ng
and David Wessel wrote that the lingering effects
of the Fed’s extraordinary bond-buying program could be distorting the curve by weighing
down on the term premium. That means “that
U.S. Treasury Yield Curve
Nov. 13, 2010
Nov. 13, 2018
4%
3
2
1
0
1-year
5-year
10-year
30-year
DATA: COMPILED BY BLOOMBERG
relatively small increases in short-term interest rates relative to long-term rates could lead
to inversion.”
In an Oct. 29 note to clients, Scott Minerd,
global chief investment officer at Guggenheim
Partners, said that argument is flawed. It fails to
recognize that factors such as regulatory changes,
including those to money-market mutual funds,
and an increase in Treasury issuance have acted
in the opposite direction, putting upward pressure on long-term rates. The yield curve, Minerd
said, remains as reliable an indicator as ever.
�Liz Capo McCormick and Jeanna Smialek
Weighted Average Cost of Ca
Case Calculations
Cost of Capital Components
Beta
Expected Return
of Market
Risk Free
Rate
Tax Rate
0.95
10.4%
3.1%
12.0%
Six Flags
0.91
10.4%
3.1%
21.3%
Cedar Fair
0.63
10.4%
3.1%
15.4%
1.43
10.4%
3.1%
0.0%
0.82
10.4%
3.1%
8.6%
Viacom
0.9
10.4%
3.1%
1.7%
Netflix
1.36
10.4%
3.1%
0.0%
ULTA
0.64
10.4%
3.1%
24.1%
Sally Beauty
0.72
10.4%
3.1%
22.8%
Game Stop
0.87
10.4%
3.1%
60.0%
Target
Disney
Parks and Resorts
Studio Entertainment
Lions Gate
Broadcasting and Media
Fox
Consumer Products
Source: Bloomberg
All Data Effective 31 October 2018
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BLOOMBERG ANYWHERE, BLOOMBERG MARKETS, BLOOMBERG NEWS, BLOOMBERG PROFESSIONAL, BLOOMBERG TERMINAL and BLOOMBERG
name, mark or logo. All rights reserved.
d Average Cost of Capital
Case Calculations
omponents
Capital Structure Components
Pre-Tax
Debt Cost
Bond
Rating
Short- Long-Term
Equity Term Debt
Debt
4.0%
A
5.9%
BB
5,892
4.0%
BB
3,033
5.6%
B
3.6%
180,888
2,063
7,955
2
725
3,759
5,312
390
2,468
8,169
BBB
92,053
1,054
18,469
111,576
5.7%
BBB
12,158
23
10,065
22,246
7.0%
BB
163,153
-
8,337
171,489
14,071
-
-
14,071
1,769
3,760
819
2,332
6.9%
BB
1,922
5.9%
BB
1,513
5,992
Total Capital
17,681
2.5%
157,215
WACC
69
-
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operational support. The following are trademarks and service marks of BFLP, a Delaware limited partnership, or its subsidiaries: BLOOMBERG,
BLOOMBERG.COM. Absence of any trademark or service mark from this list does not waive Bloomberg's intellectual property rights in that
Weighted Average Cost of Capi
Scenario Changes
Cost of Capital Components
Beta
Expected Return
of Market
Risk Free
Rate
Tax Rate
Pre-Tax
Debt Cost
Target
Disney
Six Flags
0.95
0.91
10.4%
10.4%
3.1%
3.1%
12.0%
21.3%
4.0%
5.9%
Fed Rate Move
Disney
Six Flags
0.95
0.91
10.4%
10.4%
3.1%
3.1%
12.0%
21.3%
4.0%
5.9%
Credit Rating Change
Disney
0.95
Six Flags
0.91
10.4%
10.4%
3.1%
3.1%
12.0%
21.3%
4.0%
5.9%
Additional Debt for Fox Acquisition
Disney
0.95
10.4%
Six Flags
0.91
10.4%
3.1%
3.1%
12.0%
21.3%
4.0%
5.9%
Bear Stock Market
Disney
Six Flags
0.95
0.91
10.4%
10.4%
3.1%
3.1%
12.0%
21.3%
4.0%
5.9%
Tax Rate Increases
Disney
0.95
Six Flags
0.91
10.4%
10.4%
3.1%
3.1%
12.0%
21.3%
4.0%
5.9%
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Australia and certain jurisdictions in the Pacific islands, Bermuda, China, India, Japan, Korea and New Zealand. BLP provides BFLP with
limited partnership, or its subsidiaries: BLOOMBERG, BLOOMBERG ANYWHERE, BLOOMBERG MARKETS, BLOOMBERG NEWS, BLOOMBERG
from this list does not waive Bloomberg's intellectual property rights in that name, mark or logo. All rights reserved.
Average Cost of Capital
Scenario Changes
Capital Structure Components
Bond
Rating
Equity
Short-Term
Debt
Long-Term
Debt
WACC
Total
Capital
A
BB
157,215
5,892
5,992
17,681
2,063
180,888
7,955
9.1%
8.1%
A
BB
157,215
5,892
5,992
17,681
2,063
180,888
7,955
9.1%
8.1%
A
BB
157,215
5,892
5,992
17,681
2,063
180,888
7,955
9.1%
8.1%
A
BB
157,215
5,892
5,992
17,681
2,063
180,888
7,955
9.1%
8.1%
A
BB
157,215
5,892
5,992
17,681
2,063
180,888
7,955
9.1%
8.1%
A
BB
157,215
5,892
5,992
17,681
2,063
180,888
7,955
9.1%
8.1%
Finance L.P. (“BFLP”) except that Bloomberg L.P. and its subsidiaries (“BLP”) distribute these products in Argentina,
BFLP with global marketing and operational support. The following are trademarks and service marks of BFLP, a Delaware
BLOOMBERG PROFESSIONAL, BLOOMBERG TERMINAL and BLOOMBERG.COM. Absence of any trademark or service mark
Weighted Average Cost of Capital
Case Study
Page 1
CASE STUDY
WEIGHTED AVERAGE COST OF CAPITAL
Analyze how the theoretical concepts of weighted average
cost of capital (WACC) connect to the real world by exploring
the impact of changing WACC variables on a company.
This lesson explores how several companies and industries
are impacted by changing variables in the weighted average
cost of capital (WACC) formula. To apply WACC learning to
real work complexities, we will examine how Boeing is
impacted by interest rates in class and then apply the same
lessons to Disney for homework.
Use these directions as a template or watch the
accompanying video tutorial.
Web: https://vimeo.com/303712847/ce9e9e8ec8
Terminal: PLYR VOD 332919204
Log in to the Bloomberg Terminal and type DIS, press
the F8 equity sector key, type WACC into the command line,
and then press GO.
Materials
HOMEWORK CASE STUDY HANDOUT
The Case Study reinforces the class lesson by asking you
to compare Disney’s WACC to those of its peers.
TERMINAL TUTORIAL VIDEO
A brief video explains how to gather WACC from the
Bloomberg Terminal.
This is the summary WACC page for Disney. The first thing
we need to do is time box the data. Under the Period
dropdown menu that says MR, for Most Recent, select Q1
and make the year 2018.
Web: https://vimeo.com/303712847/ce9e9e8ec8
Terminal: PLYR VOD 332919204
EXCEL SPREADSHEET
Calculate WACC for Disney’s peers with this spreadsheet’s
data.
Case Study
From this page we can fill in the capital structure elements
of our case’s WACC table, including the capital amounts for
equity, preferred equity, and debt.
Disney WACC Elements
All Data as of First Quarter 2018
To answer the Case Questions, use the
accompanying spreadsheet and the Terminal Tutorial
provided below.
The following instructions illustrate how to gather the
necessary data to calculate Disney’s WACC for the first
quarter of 2018 from the Bloomberg Terminal. This will help
you answer the first case question. The second case
question requires you to gather the data for the third quarter
of 2018.
Cost of Capital Components
Capital Structure
$ in Millions
Beta
Equity
Expected Return of the Market
Preferred Equity
Risk Free Rate
Short-Term Debt
6,009
Tax Rate
Long-Term Debt
20,082
Pre-Tax Cost of Debt
Total Capital
161,265
0
187,356
Clicking on the Equity heading in the Cost of Capital table
will bring up the terminal’s WACC worksheet for Disney’s
equity.
© Bloomberg L.P.
Weighted Average Cost of Capital
Case Study
Page 2
instead of the calculation methodology used by Bloomberg
here.
Disney WACC Elements
All Data as of First Quarter 2018
Cost of Capital Components
Beta
Expected Return of the Market
Risk Free Rate
Tax Rate
Pre-Tax Cost of Debt
Notice there are equity elements that may not have been
included in the textbook. That’s okay. Let’s go through this
page to fill in the data in our table.
The beta for Disney’s stock is 1.07, the risk free rate is
2.41%, and the expected return of the market is 9.17%. This
is all the data we need for equity in order to satisfy our
simplified WACC formula.
Capital Structure
1.07
Equity
$ in Millions
161,265
9.17%
Preferred Equity
2.41%
Short-Term Debt
6,009
17.79%
Long-Term Debt
20,082
Total Capital
0
187,356
In the command line, let’s type RELS, which is the function
for Related Securities, and press Enter or . Click the
Bonds category on the right.
Let’s click the R column to sort by the most actively traded
of Disney’s bonds. Select the series with the highest
relevance indicator.
Disney WACC Elements
All Data as of First Quarter 2018
Cost of Capital Components
Beta
Capital Structure
1.07
Equity
$ in Millions
161,265
Expected Return of the Market
9.17%
Preferred Equity
0
Risk Free Rate
2.41%
Short-Term Debt
6,009
Tax Rate
Long-Term Debt
20,082
Pre-Tax Cost of Debt
Total Capital
187,356
Let’s click on the Cost of Debt tab so we can fill in another
cell of our table.
Disney’s marginal tax rate is 17.79%. We need to find
Disney’s pre-tax cost of debt. It is listed on this table but the
textbook uses the yield to maturity of the company’s bonds,
From the popup menu, select YAS (Yield and Spread
Analysis). Change both the date boxes to March 29, 2018,
the last trading day of Q1, and press Enter. Next to the Yield
field, change Wst to Mty for Yield to Maturity and press
Enter.
This bond has a yield to maturity of 3.68%. Disney’s WACC
© Bloomberg L.P.
Weighted Average Cost of Capital
Case Study
table is now complete and ready to be used to answer the
first case question.
Disney WACC Elements
All Data as of First Quarter 2018
Cost of Capital Components
Beta
Capital Structure
1.07
Expected Return of the Market
Risk Free Rate
Tax Rate
Pre-Tax Cost of Debt
Equity
$ in Millions
161,265
9.17%
Preferred Equity
2.41%
Short-Term Debt
6,009
17.79%
Long-Term Debt
20,082
3.68%
Total Capital
0
Page 3
Beta
The beta of a stock is a representation of how the stock
moves with the broader equity market. Disney has a beta of
1.07 which implies that when the broad equity market goes
up or down by one percent, Disney’s stock will rise or fall by
1.07 percent. Low beta stocks, between 0.5 and 0.8, tend
to be defensive. They do not rise much when the market
rises, but they also do not fall significantly when the market
falls. Disney’s beta indicates a closer relationship to the
market than any of its peers used in this case.
187,356
Betas of Companies Comparable to Disney Segments
All Data as of October 31 2018
1.6
1
Calculate Disney’s weighted average cost of
capital (WACC) using the data provided in this
case for the first quarter of 2018. (Bloomberg
includes more elements in the WACC calculation
than the textbook does, so for our purposes let’s
use the textbook formula with the data points
from Bloomberg.)
1.43
1.36
1.4
1.2
1.0
0.95
0.91
0.8
0.82
0.90
0.87
0.64
0.63
0.72
0.6
0.4
0.2
0.0
Disney
2
Use the Bloomberg Terminal to gather the
necessary data to make a similar calculation for
the third quarter of 2018.
Use the path described in the above Terminal tutorial, but
instead of selecting Q1 at the start, select Q3.
3
Using the accompanying spreadsheet, calculate
the WACC of each Disney segment
comparable. Describe the primary WACC
drivers that explain the differences between the
WACC of Disney and its comparables.
Companies within the same sector typically share similar
capital structures and costs of capital. For example, most
power utilities are engaged in fundamentally the same
business; generation, transmitting, and distributing electric
power. The utility business is highly dependent upon
expensive fixed-asset investments (i.e., power plants)
which are often financed with debt. Consequently, analysts
expect companies within the same sector or industry to
have similar betas, capital structures, bond ratings, and
WACCs.
Disney is a diversified entertainment company. Its
diversification exists because its revenues come from four
different, but related, business segments--parks and
resorts, studio entertainment, broadcasting and media, and
consumer products. Since there is no other enterprise quite
like Disney, we examine the WACCs of companies that
operate within one or more of its segments.
Six
Flags
Cedar
Fair
Lion's
Gate
Fox
Viacom Netflix
Ulta
Sally Game
Beauty Stop
Expected Return of the Market
The expected return of the market is a fairly general
observation. In reality, no one knows by what degree the
stock market will rise or fall over the next year.
Nevertheless, in order to assess an individual stock we
must have a view on where the broader market is heading.
The expected return of the market is the same for every
stock.
Risk Free Rate
The risk free rate is the U.S. government bond. A U.S.
bond’s yield is considered risk free because the U.S. has
not and is not expected to default.
Tax Rate
The company’s tax rate impacts the after tax cost of debt
but has no bearing on either the cost of preferred equity or
common equity. The higher a company’s tax rate the lower
the after tax cost of debt. Consequently, as a source of
capital, debt is a tax shield.
Pre-Tax Cost of Debt
The pre-tax cost of debt can be determined by calculating
the yield to maturity on the company’s bonds. A bond’s yield
to maturity can be influenced by many factors including
inflation, credit quality, macroeconomic fundamentals, and
how the company’s bonds are structured.
Student Worksheet
Open the WACC Comparisons tab on the accompanying
spreadsheet for this lesson. Using formulas and the data
provided, calculate the WACC in the last row of the table
for Disney and its peers.
© Bloomberg L.P.
Weighted Average Cost of Capital
Case Study
Page 4
In the WACC Sensitivity tab on the
accompanying spreadsheet, alter the cells as
described below to see how changes to WACC’s
inputs impact the WACC. Write a few sentences
describing each change.
4
an increase in the Federal Reserve
reference rate
a two notch downgrade in Disney’s credit
rating
adding debt to Disney’s capital structure for
an acquisition
a downturn in the US equity market
an increase in Disney’s marginal income tax
rate
Fed Rate Increase
An increase of the Federal Reserve interest rate by 200
basis points (2.0%) lifts the borrowing costs of every debt
issuer. What is Disney’s adjusted WACC?
Credit Rating Change
A two notch downgrade in Disney’s credit rating should
increase its cost of debt to the same level as Six Flags, all
other conditions being equal. What is Disney’s adjusted
WACC?
Debt for Acquisition
In 2018, Disney announced it would acquire Twenty-first
Century Fox assets for $71.3 billion. Assume Disney paid
for the acquisition in cash by raising additional debt. What
is Disney’s adjusted WACC?
U.S. Equity Market Downturn
Equity market expectations may cool resulting in an
expectation that equity markets may only expand by 200
basis points (2.0%) over the coming year. What is Disney’s
adjusted WACC?
Increased Marginal Tax Rate
The tax rate cut has ended. A new administration is in
power. Assume Disney’s marginal tax rate rises to 30.0%.
What is Disney’s adjusted WACC?
THE BOTTOM LINE WACC creates an opportunity for investors
to be more rigorous about discount rates. Rigor is important, but
it’s worth remembering that every element we include in the
WACC calculation is determined by assumptions.
The BLOOMBERG TERMINAL service and Bloomberg data products (the “Services”) are owned and distributed by Bloomberg Finance L.P. (“BFLP”) except that Bloomberg L.P. and its
subsidiaries (“BLP”) distribute these products in Argentina, Australia and certain jurisdictions in the Pacific islands, Bermuda, China, India, Japan, Korea and New Zealand. BLP provides BFLP
with global marketing and operational support. The following are trademarks and service marks of BFLP, a Delaware limited partnership, or its subsidiaries: BLOOMBERG, BLOOMBERG
ANYWHERE, BLOOMBERG MARKETS, BLOOMBERG NEWS, BLOOMBERG PROFESSIONAL, BLOOMBERG TERMINAL and BLOOMBERG.COM. Absence of any trademark or service mark
from this list does not waive Bloomberg's intellectual property rights in that name, mark or logo. All rights reserved.