Rio Disney Theme Park

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02 Nov 2017

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Introduction

In this report we will on behalf of Disney find out if investing in Brazil would be of benefit to the company. Throughout this report we will go through several steps to reach our final result. Based on this final result we would come to a conclusion whether Disney should go ahead with its project.

Project Analysis evaluates the potential merits of an investment, replacement or expansion decision to assess its value. This analysis drives the core of the corporate finance process along with the associated cash flows. The analysis is usually based on the past dataor future projections in respect to the project which in turn help to determine the incremental or discounted cash flows respectively. Management must allocate limited resources between competing opportunities (projects) through capital budgeting. This process is aided by the cash flow projections for each project.

The desirability criteria for a project vary with the business, the competitive environment and industry forces. In general, a company first of all needs to identify the cost of its decision (investment or expansion), which includes the cost of the assets along with other costs, to decide whether or not the business can afford to take on the project. The amount of finances required for the initial cash outlay must be within the budget limits of the company. The sources of finances can either be through equity, debt of retained earnings but should not exceed the budget limits. The initial cash out lay (cost of capital) is arrived at by adding up all the costs in the initiation process. The following are the costs to be added:

The initial investment includes the cost needed to start the project, such as fixed assets, installation and other costs.

In the specifics of our case, it would include the cost of constructing Magic Kingdom.

Research costs and Costs of obtaining the licenses would be designated as sunk costs already incurred and not recoverable in case the project is not undertaken. Sunk cost is cost already incurred and not relevant in the actual decision making.

The cost of constructing Epcot II will also be a part of this cost. Disney will fund the investment using the same mix of debt and equity that it uses for theme parks currently.

The next step is to determine the cash return on the project. The returns on the project are calculated using the capital budgeting techniques. Among the techniques used include NPV, IRR, FCF and payback period. When doing the evaluation using these techniques, a decision is made using the respective decision rules. For example, a project with a positive/ higher NPV is the most preferred. However, it is important to note that there are other factors that are put into consideration, which may not necessarily be of financial value. A project with a lower NPV may be accepted if the main goal of investment was to increase the market share.

The Operating Expenses and Revenue are calculated to get an idea of the cash flows associated with a project. Free cash flows are mostly preferred since investors can be able to ascertain their earnings and give the necessary recommendations so that they are not affected adversely by other factors.

Operating expenses are usually calculated at a percentage of the revenue generated by the project. The same rule is applied for the General & Administrative overheads. At this point of calculation the fixed and variable component of the costs also is estimated. The revenues and accounting earnings are converted into the cash flows and then compared to the hurdle rate to check if these are feasible. These are also time weighted for the final evaluation process. The hurdle rate refers to the minimum amount of returns from an investment that is required by a manager or investor. The higher the risks associated with a certain investment, the higher the hurdle rate. A project with higher rate of return and a relatively lower risk level is preferred.

Maintenance capital expenditures are necessary to keep the park in operational condition. The expenditure expenses in the initial years are expected to be lower than those in the subsequent years. Therefore, provision for depreciation will have to be increased with advancement of years.

The decision to accept or deny a project depends on the rate of return that such a project will generate. [yes, Important]The rate of return depends on a variety of factors. Some of the factors include the level of completion and availability of demand for the products and services of the company. Stiff competition will mean that the rate of return will be lower while low competition translates to higher rate of return. High demand will result into more goods and services bought hence high rate of return; Low demand translates into low rate of return. Any business needs to understand the risks and returns involved in a project. The rate of return helps to determine the long-term economic and financial profitability. The exchange rate risk is diversifiable risk. This is because a company can decide to invest in different markets around the world hence diversifying the risk. There are some markets that will have favorable exchange rates while others will have unfavorable rates. It is important to note that these rates change over time and thus not static.

The company has projects in a large number of countries (or)

The investors in the company are globally diversified. Investors from different markets globally can decide to invest in the stock of the company hence diversify risks. There are aspects of political risk especially in emerging markets that will be difficult to diversify and may affect the cash flows, by reducing the cash flows on the project. For Disney, this is the risk that we are incorporating into the cost of the project.

There are various ways to calculate the rate of return :[In a second paragraph?] [Perhaps we should just mention how it seems the group will calculate the WACC? They will use the way in the Disney pdf file previously attached that come from university in Germany]

Default spread on Country Bond: Here the country risk premium is based on the default spread of the bond issued by the country but only if it is denominated in a currency where a default free entity exists.

Relative Equity Market approach: Here the country risk premium is based on the volatility of the market in question relative to U.S market.

The NPV calculates the positive value generated by the project which can be zero or even negative, in which case the project is dropped whereas the IRR calculates the return compared to a given hurdle rate. The payback period measures the number of years required to recover the investment.

We have made the use of these three tools to determine our project acceptance criteria. The three main techniques used in the project evaluation are the NPV, IRR and Payback Period (PP). These methods are discussed below:

PaybackPeriod

The payback period is a very basic decision tool. We determine with this tool the time period involved to recover the initial investment for the project. The total cost of the project is divided by the cash inflow of each year to obtain the payback period. If a project is able to recoup its initial investment (at t=0) in a few years (depending on the overall factors affecting the project), it is accepted.

Net Present Value (NPV)

The net present value decision tool is a very effective decision tool. The difference between cash outflows and cash flows generated by a project is its NPV. The future cash flows are discounted with the target rate of return to account for the time value of money.

Projects are accepted when NPV is positive and declined if negative.The project with the highest NPV is accepted between alternative projects.

Internal Rate of Return (IRR)

The internal rate of return is the discount rate where a project breaks evens or when the NPV equals 0. The project with an IRR higher than the cost of financing is accepted.

With a capital budgeting process in place, a company can easily decide which projects are acceptable and which projects are unacceptable. A project involves financial commitment as well as its own set of risks. Delays, cost overruns need to be avoided and are important considerations for selecting a project.

Sometimes, the IRR is compared to the hurdle rate which is the minimum rate of return on a project or investment required by a manager or investor. In order to compensate for risk, the riskier the project, the higher the hurdle rate. A WACC on the other hand is the overall required return and is used to determine the economic feasibility of projects. It is the appropriate discount rate to use for cash flows with risk that is similar to that of the overall firm.

We have also attempted a breakeven analysis to determine the point at which the revenue from this decision will equal the cost associated with the earning of the revenue. Break-even analysis indicates the margin of safety which is the amount that revenues can fall up to while still staying in business.

The Disney plan is to include a "Magic Kingdom" for its Theme Park in Brazil to be constructed, beginning immediately, and becoming operational at the beginning of the second year, and a second theme park modeled on Epcot Center at Orlando to be constructed in the second and third year and becoming operational at the beginning of the fourth year. The earnings and cash flows are estimated in nominal U.S. Dollars.

[Should be put before we begin talking about how we calculate?]

All investment projects are eithermutually exclusive or independent. An independent project is one where the decision to accept or reject the project does not affect other projects for the company.[Put on top where one define a investment project so it is all together and not spread out,_thereby_more_structure][Something_is_also_wrong_with_the_formatting_here…]

A mutually-exclusive project is one which affects the acceptance of another project. Most investment decisions fall into this category. Here the element of opportunity cost might be pertinent to compare the benefits forgone by selecting an alternative project. [Same here put under or with explanation of projects..]

Walt Disney Theme parks are one of four major business segments of The Walt Disney Company. Disney theme parks hosted about 119.1 million guests in 2009, making them the world's most popular parks.These parks contribute a major share to Disney’s profit.[This should be before talking about how to calculate]

[Below about Brazil should be under about Disney, but before about how we proceed with our decision making process]

Brazil has great potential to build and run a Disney theme park modeled on Euro Disney in

Parisand Disney World in Orlando due to its growing economy and populationgiven the fact that Disney World in Florida is hugely popular with Brazilians (it being the nearest Disney Park from Brazil) .The proposal is to build just such a park in Brazil around Curitiba or around Rio de Janeiro. If a similar park is built in Brazil, both the rich and the poor will be benefitted.[Below in this paper some similar issues with the popularity of Disney World in Florida is stated; please put them together and make it more so it hangs better together] [And not forget to talk about cannibalization effect, I think that might be a important factor, and is it related to opportunity cost as building the new Theme park might result in lower visiting in Florida, is that good since crowded? Or?]

Aggregate investment declined to a low 18.1% of GDP in 2012, down from 19.3% of GDP in 2011. For the year as a whole, real GDP grew a weak 0.9% in 2012,following the also below-trend 2.7% expansion recorded in 2011(Goldman-Brasil).With these statistics for Brazil, the theme park would mean increase in aggregate investment as well as the growth rate of real GDP.Benefits from the government as a return for investing in their country could also follow once the park generates revenue from tourists and the tax component for them.

With these enhanced socio-economic conditions in Brazil, the theme park is a great idea for the whole of South America. After allBrazil is the largest country in South America with the biggest population and GDP.The Disney park will also serve as one of the tourist attractionof Brazil. Though there are other theme parks in South America around Sau Paulo like the Hopi Hari and the Play center,Fantasilandia (Santiago, Chile), Parque De La Costa (Buenos Aires Province, Argentina), Beto Carrero World (Penha, Brazil), none of them is situated near Rio. Furthermore,Brazil being one of the BRIC countries, has a lot of families and young people[state whether young people and families are the main visitors and any statistics over demographics in Brazil?]

Brazil is also organizing the next Football Worldcup (2014) and Olympics Games (2016) and is getting international attention. Brazilians are the third most popular visitors (behind US and Japanese) at Walt Disney World in Orlando.These statistics work in favour of the decision to build the park in Brazil.One needs to bear in mind the fact that the security to avoid theft and crime within the park should be strong. So Surveillance Camera etc. need to be in place. [More about the cannibalization effect or what can avoid it or it would be relevant, how the cannibalization effect would affect Disney World in Florida]

Curitiba is the coldest state capital in Brazil. Its airport closes about every morning due to fog during the winter. There are no international flights, not even for other SouthAmerican countries, from there. So the decision about this location needsreconsideration as it could prove to be a failure with problems in connectivity for the tourists. [State if the airport is the only international airport? If so I can see it would be not easy traveling] [And is it far from Rio?]



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