Introduction

The Y Corporation is based in the United States of America (USA). It was founded in the early part of the last century when Mr Y produced cartoon films. These soon proved very popular as a form of family entertainment and the characters in the films became household names.

The Corporation established a theme park (based around the film characters) in the southern USA, where there was a warm and mainly dry climate. The theme park, known as Y-land, proved to be an immediate success, attracting millions of visitors each year. A whole range of family entertainment flourished, based on the original theme of the cartoon characters. These included shop, restaurants, hotels and amusement rides.

Following the success of Y-land in the USA, the directors of the Corporation established another Y theme park in Northern Europe. The rationale behind this was that although many Europeans visited Y-land in the USA, the cost of travel made visiting the attraction very expensive. The directors believed that establishing a Y-land in Northern Europe would enable European people to visit the attraction without incurring high travel expenses. Y-land Europe was built in a highly populated area of Northern Europe which is easily accessible. A factor which differentiates Y-land Europe from the theme park in the USA is that it is located in a region which is frequently affected by rain,and it does not enjoy a guaranteed warm climate. Y-land Europe did not in fact attract the volume of visitors that were expected and almost went bankrupt before receiving a massive cash injection from a wealthy donor who took part shares in the theme park.

Further strategic development

The Y Corporation is now considering building another theme park, this time in a tropical area in the Far East. Y-land FE will be part-funded by the host government in the Far East, which will take a 60% share in the park. The Y Corporation will fund the remaining 40%. Profits and losses will be shared in direct proportion to the shareholding of each of the joint venture partners.

It is believed that tourism and related sectors of the entertainment industry will benefit from the development as the theme park will attract more visitors to the region. Similar to the other two Y-land theme parks, the development will include many facilities such as hotels, bars and restaurants as well as the entertainment attractions.

It will take 2 years to build Y-land FE before paying visitors enter the park. The Y Corporation has based its estimates of visitors in the first year of operation (that is, after the 2 years of construction) on the following probabilities:

	Visitors	Probability
Optimistic	8 million	0.25
Most likely	3 million	0.50
Pessimistic	2 million	0.25

After the first year of operation, it is expected that the number of visitors will increase by 50% in the next year. The Y Corporation directors consider that this number of visitors will be the maximum and after that the theme park will suffer a reduction in the number of visitors (marketing decay) of 5% compound each year for the next 2 years. After 2 years, the directors expect the number of visitors each year to remain constant at this level.

The host government believes that the theme park will create about 15 000 new jobs in the area through servicing the facilities. It expects the construction of the park to create about 5 000 jobs in addition to the 8 000 who will be employed in land reclamation and other necessary infrastructure work associated with the project.

ADDITIONAL INFORMATION

Cost and revenue estimates

It is expected that the overall capital cost of the theme park will be 2 200 million. This sum will be spread evenly over the construction period and, for the purposes of calculation, the actual cash outflow may be assumed to arise at the end of each of the 2 years. The Y Corporation will be responsible for raising 40% of this sum.

In a year, the visitors are expected to be in the proportion of 40% adults and 60% children or people who will obtain a concession (reduction) on their entrance fees. For simplicity, the entrance charges will be set at a flat rate of $50 for each adult and $30 for each child or concession. There will be no further fees for entertainment after the entrance charge has been made to the visitor, i.e. entrance fees are expected to stay the same for the next 8 years

Past experience has shown that running expenses of the theme park show a certain level of consistency. In terms of labour, the cost follow the pattern of a 90% learning curve which applies on average to every 1 million visitors. This lasts for the first 2 years, after which the labour cost for each visitor become constant. The cost of labour at the time the park will open is expected to be $3 for each visitor. The effects of this are that the cumulative average direct labour costs in the first year of operation (i.e. year 3 of the project) are estimated to be $9.72 million (after being multiplied by the number of expected visitors in that year). The cumulative average labour costs for both the first and second years of operation (i.e. years 3 and 4 of the project) are expected to be $21.14 million (after being multiplied by the total number of visitors for the first 2 years of operation). After this point the learning effect is expected to cease.

The other direct costs, which are not subject to learning, can be assumed to be incurred at the rate of $2 for each visitor. Attributable fixed running expenses are estimated to be $100 million each year in cash terms.

In addition, the Y Corporation expects that its joint venture with the host government will earn average net contribution of $10 from the sale of souvenirs and refreshments and $100 from accommodation charges for each adult, child or concessionary visitor each year.

The cost of capital for the whole project is expected to be 15%.

Shareholder value

The Y Corporation believes that its main objective is to increase the wealth of its owners. The Corporation requires a gross return on investment of 22% after 8 years of income generated from the venture. It has been recommended to the directors of the Y Corporation that the return is calculated by taking the net present value of the project after 8 years of operation and dividing this by the gross initial undiscounted capital outlay of $2 200 million.

Ignore taxation, inflation and variations due to exchange rates.

Required:

1.1Evaluate the usefulness of Porters Diamond Theory (the competitive advantage of nations) in helping the directors of the Y Corporation to determine whether or not it should proceed with establishing Y-land FE.

1.2Produce a discounted cash flow (DCF) calculation for Y-land FE from the start of building work in the first year until 8 years of cash inflows have been generated (i.e. 10 years in total).

1.3Calculate the return on investment in accordance with the method recommended.

1.4Analyse and critically appraise the DCF calculation and the resulting return on investment as defined by the method recommended to the directors of the Y Corporation.

1.5Advise the directors as to whether they should proceed with Y-land FE. You should consider financial and non-financial factors in providing your advice.

1.6Discuss how the directors of Y Corporation can use shareholder value analysis to determine the development of its portfolio of products and services.