executive summary of (at most) two single-spaced pages that contains three items.

- Identify the key value drivers in the case from your perspective.

- Find the value of a subsidized loan from HK to the joint venture. Assume a non-amortized 20-year loan of HK$6 billion at a market interest rate of 11.36% (the 8.5% prime rate plus a 2.86% maturity premium). The subsidized rate is 10.86%, for a savings of 0.5% per year. Hong Kong?s corporate income tax rate is 17%. Ignore U.S. taxes.

- Map out a negotiation strategy.

For this exercise, I?d like you to focus on thenegotiation processand not on valuation per se. Think of yourself as the negotiator rather than as the finance geek. You do not need to dive into the details of the valuation to create your plan for the negotiation. Indeed, the spreadsheet is not very flexible and hence not very useful in this regard. The one exception to this emphasis on negotiation (as opposed to valuation) is your calculation of the value of the subsidized loan proposal.

Negotiable items include benefits (ownership ratio, profit distribution, royalty and management contract fees, expansion option in Phase II of the project), concessions (land premium, cash grant from HK to Disney, subsidized loan, tax holidays), and restrictions|prohibitions (share disposal upon exiting the deal, job guarantees, foreign labor importation, prohibition on other parks in HK or elsewhere in Asia, restriction on Phase II expansion, environmental clean-up).

HK Disneyland valuation (as of 1999) Required return calculation Assume: bE = bA[1+(D/E)(1-TC)] HK$ rates Tax 6.3% used as the risk-free rate Pure-play firms Estimated HK inflation pHK$ 4.3% Oriental Land Co. 0.48 22% 46.4% 0.41 Market risk premium 4.0% = (E[rM]-rF) Euro Disney SCA 0.40 153% 33.3% 0.17 HK Disneyland 0.65 147% 16.0% 0.29 HK tax rate Equity required return iEHK$ Assumptions Invested debt (HK$ millions) Invested equity (HK$ millions) Royalty rate on admissions Royalty rate on food, etc... Royalty rate on hotels Base management fee Variable management fee Gross profit margin (note d) Admin exp ratio (note f) Deprec/Amort ratio (note g) Dividend payout ratio Growth rate of terminal CF Disney's equity stake Year Time 16.0% Beta D/E rate Unlevered 2-year Exchange Fund yield beta 8.9% from the CAPM's Security Market Line 8400 5700 10.0% 5.0% 5.0% 2.0% 5.0% 37.0% 22.0% 5.0% 100% 4.3% 50.0% from Exhibit 5 - placed with 3rd parties from Exhibit 5 - from Disney and HK SAR of gross revenues from admissions (same as in the Tokyo Disneyland deal of case Exhibit 1A). of gross revenues from merchandise, food, and beverage (same as in the Tokyo Disneyland deal of case Exhibit 1A). of gross revenues from Disney hotels. of gross revenues. of EBITDA. of sales (average gross profit percent of Euro Disney SCA from 1994 to 1998 from case Exhibit 2B) of sales (average admin exp ratio of Euro Disney SCA from 1994-98 from case Exhibit 2B) Note g (below) Assumed equal to the inflation rate 1999 0 2005 6 2006 7 2007 8 2008 9 2009 10 2010 11 2011 12 2012 13 2013 14 2014 15 2015 16 2016 17 2017 18 2018 19 2019 20 2020 21 275 345 1863 6.0 287 360 1943 6.3 299 375 2027 6.7 312 391 2114 7.1 325 408 2205 7.5 339 426 2300 8.0 354 444 2399 8.5 369 463 2502 9.0 385 483 2609 9.5 402 504 2721 10.1 419 526 2838 10.8 437 548 2961 11.4 456 572 3088 12.1 475 596 3221 12.7 496 622 3359 13.2 517 649 3504 13.8 Pro forma income statement (in HK$ millions) Revenues on entrance fee 1642 Other revenue (food, etc.) 2060 Hotel revenue (note c) 1167 Total revenues 4869 Gross profit (note d) 1802 1814 2276 1217 5307 1964 2005 2515 1269 5789 2142 2216 2780 1324 6319 2338 2450 3073 1381 6904 2555 2710 3399 1440 7549 2793 2998 3761 1502 8261 3056 3318 4162 1567 9046 3347 3673 4608 1634 9914 3668 4067 5102 1704 10873 4023 4505 5651 1778 11934 4415 4991 6261 1854 13106 4849 5531 6939 1934 14404 5330 6016 7547 2017 15580 5765 6542 8207 2104 16853 6235 7113 8923 2194 18230 6745 Interest exp from "Loan" worksheet (note e) Administrative expense (note f) Deprec/Amortization (note g) Total expenses 954 1071 243 2269 940 1167 265 2373 924 1273 289 2487 906 1390 316 2613 887 1519 345 2751 865 1661 377 2903 840 1817 413 3071 813 1990 452 3256 783 2181 496 3460 749 2392 544 3685 712 2625 597 3934 670 2883 655 4209 623 3169 720 4512 571 3428 779 4778 514 3708 843 5064 449 4010 911 5371 Earnings before tax -467 -409 -345 -274 -196 -110 -14 91 209 338 482 641 817 987 1172 1374 Preliminary notes Entrance fee (note a) Food & merchandise (note a) Hotel room rates (note b) Attendance in millions (Exhibit 6) Accum loss carryforwards -467 Taxable income 0 Tax 0 Net income -467 Residual cash flow to equity -224 Estimated terminal value (as a growing perpetuity) Initial equity investment -5700 PV of CFs at iEHK$ -5700 -134 NPV in HK$ 7152 -877 0 0 -409 -144 -1222 0 0 -345 -56 -1496 0 0 -274 41 -1693 0 0 -196 149 -1803 0 0 -110 268 -1817 0 0 -14 399 -1725 0 0 91 544 -1517 0 0 209 704 -1179 0 0 338 882 -697 0 0 482 1078 -56 0 0 641 1296 0 761 122 695 1416 0 987 158 829 1608 0 1172 187 984 1827 0 1374 220 1154 2065 -79 -28 19 63 105 143 180 214 246 276 304 305 318 332 345 -205 -438 -173 -611 -137 -748 -98 -846 -55 -901 -7 -908 46 -863 104 -758 169 -589 241 -348 320 -28 348 0 414 0 492 0 577 0 Cash flows to Disney (HK$ millions) Royalties - Admissions 164 181 200 222 - Food, merchandise, etc... 103 114 126 139 - Hotels 58 61 63 66 Base management fee 97 106 116 126 Variable management fee 90 98 107 117 Dividends from the joint venture (note h) 0 0 0 0 Disney's share of terminal value Disney's equity contribution -2,850 as a function of Disney's equity stake 245 154 69 138 128 0 271 170 72 151 140 0 300 188 75 165 153 0 332 208 78 181 167 0 367 230 82 198 183 0 407 255 85 217 201 0 450 283 89 239 221 0 499 313 93 262 242 0 553 347 97 288 266 320 602 377 101 312 288 414 654 410 105 337 312 492 711 446 110 365 337 577 Residual cash flow PV of CFs at iEHK$ 734 313 804 315 881 317 966 319 1061 322 1166 325 1281 328 1409 331 1871 403 2094 415 2311 420 2546 425 Cash flows relevant to Walt Disney Preliminary notes Disney's share of JV dividends (note h) Accum loss (if any) on project's profits NPV in HK$ -2850 -2850 8737 -234 -234 513 308 560 309 613 310 670 311 Notes: a Assume average 2005 spending by all attendees of HK$680; including entrance fee (HK$275), food and merchandise expense (HK$345) and travel expenses (HK$60) from page 6 of case. b 2005 hotel room rate = (Average room rate for high tariff A hotels in 1998) * (1+p HK$)7 from case Exhibits 4C and 8. c 2005 hotel revenue = (Room rates)*(# of rooms in Disney hotel)*(Avg occupancy rate for high tariff hotels 1990-98)*(365 days/year) = (HK$1,863.12)*(2100)*(0.817)*(365) = HK$1,166.75. d Gross profit margin = 37% of sales; i.e. average gross profit % of Euro Disney SCA from 1994 to 1998. [See Case Exhibit 2B.] Note: Including royalties and fees in this rate results in 37% = [1-(10% admission royalty)+(5% food royalty)+(5% hotel royalty)+(2% base mgt fee)+x]*(1-2% var mgt fee), where x = 39.05263%. e Assume the interest rate for commercial loans is 11.36% (prime + 2.86% maturity premium), where maturity premium is the difference between the one-week exchange fund bill rate (4.78%) and the 10-year exchange fund bond rate (7.64%) from November 1999. [See Case Exhibit 8.] f Administrative expense is assumed to be 22% of sales; i.e., the average administrative expense ratio of Euro Disney SCA from 1994 to 1998. [See Case Exhibit 2B.] g Depreciation is assumed to be 5% of sales; i.e., the average depreciation/sales % of h Assuming a 100% dividend payout ratio, but that the JV won't pay a dividend until it recovers any accumulated losses in the early years of the project 2021 22 2022 23 2023 24 2024 25 539 677 3654 14.3 563 706 3811 14.9 587 736 3975 15.6 612 768 4146 16.2 7731 9699 2288 19719 7296 8402 10541 2387 21331 7892 9130 11454 2489 23073 8537 9918 12442 2596 24957 9234 378 4338 986 5702 298 4693 1067 6057 209 5076 1154 6439 110 5490 1248 6848 1594 1835 2098 2386 0 1594 255 1339 2325 0 1835 294 1542 2608 0 2098 336 1763 2916 0 2386 382 2004 3252 73,763 356 367 377 9143 670 0 771 0 881 0 1002 0 773 485 114 394 365 670 840 527 119 427 395 771 913 573 124 461 427 881 992 622 130 499 462 1002 36881 2801 429 3079 433 3380 437 40588 4819 HK Disneyland amortized loan repaid within 20 years after park opens Loan amount (HK$ milliions) Interest rate (fixed) Prime rate Maturity premium 8400 11.36% 8.50% 2.86% from Exhibit 5 Prime rate + maturity premium from Exhibit 8 from Exhibit 8 Loan repayment schedule (HK$ millions) Year 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 Beginning balance 8,400 8,274 8,135 7,979 7,806 7,613 7,398 7,158 6,892 6,595 6,264 5,896 5,486 5,029 4,521 3,955 3,324 2,622 1,840 970 Debt service 1,080 1,080 1,080 1,080 1,080 1,080 1,080 1,080 1,080 1,080 1,080 1,080 1,080 1,080 1,080 1,080 1,080 1,080 1,080 1,080 Interest payment 954 940 924 906 887 865 840 813 783 749 712 670 623 571 514 449 378 298 209 110 Principal payment 126 140 156 173 193 215 239 267 297 331 368 410 457 508 566 630 702 782 871 970 Ending balance 8,274 8,135 7,979 7,806 7,613 7,398 7,158 6,892 6,595 6,264 5,896 5,486 5,029 4,521 3,955 3,324 2,622 1,840 970 (0) For the exclusive use of K. Zhong, 2016. HKU-107 01/01/00 Hong Kong Disneyland (A): The Walt Disney Perspective \"The Chinese people love Mickey no less than Big Mac.\" - Mr. Michael Eisner, Walt Disney Chairman and Chief Executive 1 In 1998, Walt Disney Chairman and Chief Executive Mr. Michael Eisner returned to the States after his trip to China. Looking at the success of McDonald's in the most populous country in the world, Mr. Eisner was confident that Mickey would be welcome by the Chinese with a huge bearhug. In a letter to the shareholders published in early 1999, Chairman Michael Eisner said the time looked right for a major move into China.2 Yet, Walt Disney was treading cautiously after having learned their lessons in Paris. The company's proposal for a theme park in China had been on its agenda for at least seven years before it was presented to a potential partner in Hong Kong. Walt Disney Company The Walt Disney Company owned 100% of Disney Enterprises Inc. which, with its subsidiaries, was a worldwide entertainment company with operations in five business segments: media networks, studio entertainment, theme parks and resorts, consumer products and Internet and direct marketing. The company employed over 120,000 people worldwide, and had diversified investments in the following areas: 1 2 Amusement parks and resorts Filmed entertainment, such as live action motion pictures, animated motion pictures and original television programmes Real estate development for commercial and industrial properties General real estate brokerage financing and resort and property management services Iritani, E., \"Middle Kingdom or Magic Kingdom?,\" Los Angeles Times, 13 June, 1999. Iritani, E., (1999), \"Middle Kingdom or Magic Kingdom?\" Mary Ho prepared this case under the supervision of Dr S. H. Chan and Prof. Ko Wang for class discussion. This case benefits from a meeting with Mr. Mike Rowse, Tourism Commissioner of Hong Kong SAR. This case is not intended to show effective or ineffective handling of decision or business processes. This case is part A of a threepart case series about Hong Kong Disneyland (Part B, Part C) from the University of Hong Kong. It may be taught on a stand-alone basis or combined with the others into a joint-negotiation exercise. This case is part of a project funded by a teaching development grant from the University Grants Committee (UGC) of Hong Kong. Copyright 2000 The University of Hong Kong. No part of this publication may be reproduced or transmitted in any form or by any means - electronic, mechanical, photocopying, recording, or otherwise (including the Internet) - without the permission of The University of Hong Kong. Ref. 00/77C This document is authorized for use only by Kaiqian Zhong in HK-Disney JV: Disney perspective-1 taught by Kirt C. Butler, Michigan State University from October 2016 to April 2017. 1 For the exclusive use of K. Zhong, 2016. Production of consumer products such as computer software products for the educational market, and publishing books, magazines and comics A television station Marketing and distribution of mainstream music \"Disney\" stores carrying Disney merchandise Marketing of children's educational toys, play equipment, classroom furniture and activewear apparel Licensing of the company's characters and other intellectual property for use in connection with merchandise publications Radio stations Although Walt Disney had one of the best-known brands in the world and was the world's second-largest media company (behind Time Warner), its presence in the US market was threatened by a series of setbacks. During the year ended 30 September, 1999, the company reported a 30% slump in net income to US$1.3 billion. Its studio division was hard hit by the sluggish home video market and posted a 85% fall in operating income. The consumer product division, whose profits were derived from the sales of Disney toys and merchandise at its Disney Stores and the stores of other vendors, was also suffering. Income was down 24% for the year 1999. Disney's catalogue and Internet operations reported an operating loss of US93 million. Mr. Michael Eisner, Chairman and Chief Executive of Walt Disney, responded by trimming capital expenditure, restructuring operations and closing some businesses. Regional entertainment centres were closed and staff were laid off in television production. The store-opening schedule was postponed, and the number of manufacturers licensed to make Disney character products was reduced by a third. While most of its divisions reported lacklustre financial results, the theme park and resorts division was a strong performer and provided the steadiest source of growth for Walt Disney. During the year 1999, income from this sector increased 12% to US$1.4 billion, while revenue increased 10% to US$6.1 billion. To Walt Disney, cost-cutting at home alone might not bring a dramatic reversal of the group's fortune. It was imperative for the company to find a growth driver. The move of the theme park and resorts division into China might be able to bring the group back to the growth track from which it strayed since May 1998, when the company's stock price reached its peak in the1990s. Disney Theme Parks and Resorts Adding parks had been on Disney's agenda at least since 1961, i.e. six years after Disneyland opened in Anaheim, Southern California, in July 1955. It had cost US$17 million dollars to make and was built within one year. The company's second theme park opened in Florida in 1971. Having completed two large theme parks in the United States, Disney began to look for opportunities elsewhere. After five years of negotiations, the first foreign Disney theme park was opened in Tokyo, Japan, in 1983. Tokyo Disneyland To limit its risks, Walt Disney took no ownership in Tokyo Disneyland, which was controlled by a Japanese company known as Oriental Land Co. Oriental Land Co. was a land-reclamation company in partnership with Mitsui Real Estate and the Keisei Railway Company. According to the contract signed in 1979, Oriental Land was the owner and licensee while Disney was the designer and licensor. The contract gave Disney 5% of the gross revenue on all food and merchandise, 10% of the gross revenue on admissions, and 10% of any corporate sponsorship agreement, in exchange for US$2.5 million investment in the park. In 1980, the construction cost was estimated to be around US$250 million. Disney earned a fee for developing the park, retained complete design control, and retained This document is authorized for use only by Kaiqian Zhong in HK-Disney JV: Disney perspective-1 taught by Kirt C. Butler, Michigan State University from October 2016 to April 2017. 2 For the exclusive use of K. Zhong, 2016. significant control over park operations through a series of highly detailed operating manuals. The basic facts of the park are presented in Exhibit 1A. However, by minimising its risks and taking no ownership in Tokyo Disneyland, Walt Disney wound up limiting its return on what turned out to be one of the most popular theme parks in the world. [Refer to Exhibits 1B & C for the financial performance of Oriental Land.] Although royalties received had grown from US$40 million in 1983 to about US$125 million in 1999, Walt Disney had given up the chance of maximising its return from the success of this first foreign theme park. The company had even given up paying US$20 million for the sole right to sell merchandise to Tokyo Disneyland, which turned out to be a high-profit business that generated US$350 million in 1998 3. Disneyland Paris \"The failure to take an ownership in Tokyo Disneyland was exceptionally costly...Frank (Wells) and I were determined to be primary owners if we undertook a new theme park in Europe.\" - Mr. Michael Eisner, Chairman and Chief Executive of Walt Disney 4 When Mr. Michael Eisner and then-president Mr. Frank Wells came to the company in 1984, they were determined to avoid the mistake made in Tokyo. Disneyland Paris, then called Euro Disney, was opened in France in 1992. Mindful of the costly mis-step in Tokyo, Walt Disney decided to become a partner in the investment. Talks between Disney and the French government started in the early 1980s and lasted for two-and-a-half years. At first, the project was estimated to be worth about US$1 billion and the original name was Euro Disney. The initial financial arrangement was that Walt Disney would hold a 49% equity in the project, while the French government would put in a cash grant and a loan and would finance much of the infrastructure. However, the theme park's early performance did not meet Walt Disney's expectations. It was overbuilt and overloaded on debt. Costs escalated to US$5 billion due to a number of design and construction changes, with the aim of making the park perfect. Between 1992 and 1994, the park was in the financial doldrums, for the following reasons 5: The US$4 billion debt posed a huge financial burden on the park; Interest rates were double those estimated; Tourist spending was lower because of the recession in Europe; Half the revenue projected to come from real estate development did not materialise as a result of the collapse of the property market in France; A strong franc made it expensive for visitors, resulting in a low attendance that fell below the expected annual 10 million for the period. In late 1994, Euro Disney was saved by a huge financial restructuring effort: lenders temporarily suspended interest payments on the debt for 24 months and allowed the park to postpone paying back the principal for three years; Disney agreed to forgo management fees from 1992 to 1998 and sold off its equity to raise funds; and a Saudi Arabian prince invested US$500 million in the park. The name of the park was also changed to Disneyland Paris in order to add a connotation of romance and magic that might attract more European visitors. Refer to Exhibit 2A for the basic facts about Disneyland Paris. By 1995, the park announced 3 Reckard E., \"Disney Discovering It's a Small World After All\