Based upon the earnings before interest and taxes (EBIT) of $2,713 million and interest expenses of $ 666 million, Disney has an interest coverage ratio of 4.07 and should command a rating of A-, a notch above it's actual rating of BBB+. This income statement, however, is based upon treating operating leases as operating expenses. In chapter 4, we argued that operating leases should be considered part of debt and computed the present value of Disney's lease commitments to be $1,753 million. Consequently, we have to adjust the EBIT and EBITDA for the imputed interest expense on Disney's operating leases13; this results in an increase of $ 92 million in both numbers - to $ 2,805 million in EBIT and $ 3,864 million in EBITDA. Adjusted EBIT = EBIT + Pre-tax cost of debt * Present value of operating leases

= 2713 + .0525 * 1753 = 2805 Note that 5.25% is Disney's current pre-tax cost of debt.

Finally, to compute Disney's ratings at different debt levels, we redo the operating income statement at each level of debt, compute the interest coverage ratio at that level of debt and find the rating that corresponds to that level of debt. For example, table 8.6

begin by In 2003, estimates the interest expenses, interest coverage ratios and bond ratings for Disney at 0% and 10% debt ratios, at the existing level of operating income.

Table 8.6: Effect of Moving to Higher Debt Ratios: Disney







$ Debt



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Lessons From The Intelligent Investor

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