8/2/2019 Bong Sopheap Hotels Plc Owns a Successful Chain of Hotels

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Bong Sopheap Hotels plc owns a successful chain of hotels. The company is considering diversifying itsactivities through the construction of a theme park near London. The theme park would have a mixture offamily activities and adventure rides. Bong Sopheap has just spent US$230,000 on market research intothe theme park, and is encouraged by the findings.

The theme park is expected to attract an average of 15,000 visitors per day for at least four years, afterwhich major new investment would be required in order to maintain demand. The price of admission tothe theme park is expected to be US$18 per adult and US$10 per child. 60% of visitors are forecast to bechildren. In addition to admission revenues, it is expected that the average visitor will spend US$8 onfood and drinks, (of which 30% is profit), and US$5 on gifts and souvenirs, (of which 40% is profit). Thepark would open for 360 days per year.

All costs and receipts (excluding maintenance and construction costs and the realizable value) are shownat current prices; the company expects all costs and receipts to rise by 3% per year from current values.

The theme park would cost a total of US$400 million and could be constructed and working in one yearstime. Half of the US$400 million would be payable immediately, and half in one years time. In additionworking capital of US$50 million will be required from the end of year one. The after tax realizable valueof fixed assets is expected to be between US$250 million and US$300 million after four years ofoperation.

Maintenance costs (excluding labor) are expected to be US$15 million in the first year of operation,increasing by US$4 million per year thereafter. Annual insurance costs are US$2 million, and thecompany would apportion US$25 million per year to the theme park from existing overheads. The themepark would require 1,500 staff costing a total of US$40 million per annum (at current prices). BongSopheap will use the existing advertising campaigns for its hotels to also advertise the theme park. Thiswill save approximately US$2 million per year in advertising expenses.

As Bong Sopheap has no previous experience of theme park management, it has investigated the currentrisk and financial structure of the closest UK theme park competitor, Oun Sopheap plc. Details aresummarized below.

Oun Sopheap plc, summarized balance sheet

US$ millionFixed assets (net) 1,440Current assets 570Lesscurrent liabilities (620)

1,390

Financed by:US$1 ordinary shares 400Reserves 530

930

Medium and long term debt 4601,390

Other information:

i. Bong Sopheap has access to a US$450 million Eurosterling loan at 75% fixed rate to provide thenecessary finance for the theme park.

ii. US$250 million of the investment will attract 25% per year capital allowances on a reducingbalance basis.

iii. Corporate tax is at a rate of 30%.

8/2/2019 Bong Sopheap Hotels Plc Owns a Successful Chain of Hotels

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iv. The average stock market return is 10% and the risk free rate 35%.v. Bong Sopheaps current weighted average cost of capital is 9%.vi. Bong Sopheaps market weighted gearing if the theme park project is undertaken is estimated to

be 614% equity, 386% debt.vii. Bong Sopheaps equity beta is 070.viii. The current share price of Bong Sopheap is 148 pence, and of Oun Sopheap 386 pence.ix. Oun Sopheaps medium and long term debt comprises long term bonds with a par value of

US$100 and current market price of US$93.x. Oun Sopheaps equity beta is 145.

Required:Prepare a report analyzing whether or not Bong Sopheap should undertake the investment in thetheme park. Your report should include a discussion of what other information would be useful toBong Sopheap in making the investment decision. All relevant calculations must be included inthe report or as an appendix to it. State clearly any assumptions that you make.