I. Situation and Problem
The Walt Disney Company, founded in 1938, is an international company operating diversified business portfolio including motion pictures production, consumer products, entertainment and recreational complexes operation and community real estate projects. Heardquartered in Burbank, California, the company operates entertainment and recreation businesses across the United States. In addition, royalties on revenues generated by Tokyo Disneyland also contribute to the company’s revenue. In 1984, consolidated revenues for The Walt Disney Company was $1.7 billion and net income totaled $97.8 million.
Despite fast growth of all lines of businesses, Mr. Anderson, the director of finance at The Walt Disney Company was concerned about the company’s exposure to exchange risks as the yen swung wildly in the past years. Hedging off the exchange risks benefits the company by stabilizing the cash inflows, which grants the company with easier cash management, more room for investment-planning and lower risks of financial distress. High expectation on the future growth of yen royalty receipts makes hedging even more imperative since declining exchange rate could possibly wipe out the future increasing yen revenue. Table 1 demonstrates how exchange risk may reduce profitability of the bank using the exchanges rate over the past five years. Assuming the royalty revenues grow with CPI, as yen depreciated, the revenue can only afford less and less equivalent goods or service in U.S.
Year Yen/Dollar U.S. CPI Japan CPI Royalty income or equivalent (Yen in million) Equivalent Purchasing Power (USD in million)
1980 225.7 100 100 7,123.78 0.316
1981 220.1 110.4 104.9 7,472.84 0.308
1982 248.3 117.1 107.8 7,679.43 0.264
1983 237.4 120.9 109.9 7,829.03 0.273
1984 237.3 126.1 112.3 8,000.00 0.267
On the other hand, hedging is also costly and can limit exchange gains. Some hedging strategy may also be considered...