Katbuddys Confectionaries produces large range of chocolates and the company is now considering diversifying its activities by investing in theme park business through the construction of a theme park. The theme park would have a mixture of family activities and thrills.
Katbuddys has just spent £400,000 on market research into the theme park, and is encouraged by the findings.
The theme park is expected to attract an average of 20,000 visitors per day for at least five years.
The price of admission to the theme park is expected to be £25 per adult and £15 per child. 70% of visitors are forecast to be children. In addition to admission revenues, it is expected that the average visitor will spend £10 on food and drinks, (of which 40% is contribution, and £7 on gifts and souvenirs, (of which 45% is contribution).
All costs and receipts (excluding maintenance and construction costs and the realisable value) are shown at current prices; the company expects all costs and receipts to rise by 5% per year from current on a compound bases.
The theme park would cost a total of £500 million and could be constructed and working after 1 year of investment (I.e. revenue will start in year 2). Half of the £500 million would be payable immediately, and half in one years time. In addition working capital of £60 million will be required from the beginning of the project.
The non-current asset has an after tax realisable value between £100 million and £200 million after five years of the project.
Operation costs (excluding labour (please see below) are expected to be £17 million in the first year of operation, increasing by £5 million per year.
Insurance costs per annum are £3 million, of which £2 million per year is due directly to the theme park project.
Insurance and labour cost will be increased in line with the Consumer price i.e. 5% per annum compounded annually.
The project would require 1000 employees with a cost of £35 million per annum (at current prices). The dual use of existing advertising campaigns chocolate theme park will save a £3 million per year in advertising expenses.
Katbuddys has no previous experience of theme park management. However as part of the finance team, you have investigated the current risk and financial structure of its closest theme park competitor, Alton Limited.
Details are summarised below.
ALTON LIMITED, SUMMARISED BALANCE SHEET
£m
Non-current assets (net) 1,710
Current assets 630
Less current liabilities (570)
1,770
Financed by:
£1 ordinary shares 500
Reserves 700
1200
Medium and long term debt 570
1,770
After carrying out preliminary search for financing and investigating the industry further, your team has been able to gather the following information:
a) Katbuddys can procure a loan of £400 million loan at 8% fixed rate to provide the necessary finance for the theme park.
b) £300 million of the investment will attract 25% per year capital allowances on a reducing balance basis while the remainder will not, and tax is paid in the year it is incurred.
c) Corporate tax is at a rate of 35%.
d) The expected market return on equity is 12% and the risk free rate 3.5%.
e) Katbuddys current weighted average cost of capital is 9%.
f) Katbuddys market weighted gearing if the theme park project is undertaken is estimated to be 65% equity and 35% debt.
g) Katbuddys equity beta is 0.80.
h) The current share price of Katbuddys is 200 pence, and of Allton 400 pence.
i) Altons medium and long term debt comprises long term bonds with a par value of £100 and current market price of £93.
j) Altons equity beta is 1.50.
You are required to prepare a report analysing whether or not Katbuddys should undertake the investment in the theme park.
Your report should cover the following areas which have been indicated in your firms investment manual:
Net present value and any relevant advice to management on salient issues to be considered. (60 marks)
A suggestion of financial and non-financial issues that the management of Katbuddys need to be aware of and suggestions on how to manage these issues. (20 marks)
You have decided to take an initiative and include in your report a brief outline of the use of real options in project appraisal for management and as such will prepare an outline on the following options and how they may be applicable to the Katbuddys theme park project under appraisal
Abandonment
Expansion
Flexibility
Selling
And any other relevant option
(20 marks)