B.Sc. International Business and Politics 3-day Exam Case Managerial Economics March/April 2012

IBP 3 day exam case study

Spring 2012

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General information

Upload and handing in of the assignment

The case study is uploaded on Sunday 25 March, 12 pm The assignment is to be handed in no later than Wednesday 28 March, 12 pm to:

IBP Programme at Dalgas Have 15, SV-046, 2000 Frederiksberg

3 copies of the assignment including appendices must be handed in. You may not hand in diskettes, e-mail or send by telefax. The assignment can only

be handed in printed on paper (hard-copy).

Identification, volume and format for handing in

The “Identification form” below should be filled in and placed on the front page of each of the three copies. The assignment must be handed in stapled in the top left-hand corner, and should not be inserted into plastic covers, be bound or the like. Do not put in an envelope. Student name CPR The assignment should include what is necessary and sufficient to answer the case. Ideally that is 20 pages “net”, i.e. excl. the front page and any appendices. The assignment excl. the front page and any appendices may not exceed 25 pages. The margin should be 2.5 cm (top, bottom, right and left), the size of type should be 12, and the line spacing single. Illustrations, graphs and tables etc. are included in the calculation of number of pages. However, an illustration, graph or table will never count as more than 1/3 of a page. Appendices in the form of calculation sheets and the like may not exceed 5 pages. It is expected that IT-tools will be used to the necessary and sufficient extent. It is permitted to turn in partially or fully handwritten material. However, the aforementioned page limit still applies.

Assignment service

The case is intended to be self-explanatory. However, in emergencies where serious consideration and assessment show obvious mistakes in the text or questions, an email can be sent to: mh.om@cbs.dk

In as much as we consider that it is a question of an unintentional lack of clarity in the case, and it can not be resolved with an appropriate or relevant assumption, we will upload a clarifying explanation on Learn alongside the assignment, as a correction. Actual help with the assignment, i.e. questions regarding theory etc. are not an option on this hotline. The sole purpose of this hotline is to be a “safety rope”.

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Postponement of the deadline for handing in

Illness, printer failure, computer virus, data lost on the hard disk, failure of means of transport etc., will not permit postponement of the deadline, instead it permits the right to take an eight hour written re-examination (in August).

The assignment

The students are to see themselves as consultants for the company’s management. This involves using managerial economic theory to consider the case problems and questions methodically and specifically. The case questions are to be answered based on the curriculum in managerial economics and with proper attention to:

Problem Assumptions Choice of model Solution of model (analytic/graphic) Discussion of the model’s results Conclusion

The questions will not be considered as answered satisfactorily, if only the results are stated. The assignment must contain relevant assumptions, an explanation of the choice of model, calculations and a discussion of the model’s results and conclusion. Each member of the group must be capable of elaborating on and explaining all elements of the written assignment and each member of the group must have taken part in answering each question. The questions in the 3 day case study are equally weighted. The groups may not directly or indirectly collaborate on the papers. Circumvention of this will be looked upon very sternly, and violations will be reported with the possibility of subsequent serious consequences for the continued course of study at CBS.

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As an important note before you begin, remember that this is not a task of juggling with mathematical niceties, let alone a test of quirky interpretations of the English language. It is not at all the point with Managerial Economics. It is however a task in using professional economic method and theory to solve basic business economic issues based on information from a real business where you as a student at the same time make a series of well-founded assumptions. Remember that your teachers and instructors are "at least" just as interested to see that you are capable of identifying which managerial economic theory and method to be used in the task response and establish sensible and well-argued assumptions, instead of just "adding two numbers together". Good luck

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Helnan International is a smaller, international hotel group. It has substantial experience in upgrading first class hotels in different parts of the world, including the Middle East and North Africa. In Egypt, it has been a leader in developing hotels in destinations such as Sharm-El-Sheikh, Alexandria, Port Said, and Fayoum. It has now focused on its newly leased property in Taba Bay with a view towards renovating and expanding the facility. Helnan Taba Bay has considerable potential for developing into a favourite tourist destination with its location at the mouth of the Aqaba Gulf in the Egyptian Sinai. It is situated in an area of natural beauty, with the historically significant Pharoah Island in the immediate vicinity. The primary objective is to expand Helnan Taba Bay’s capacity by 100 rooms, to a total of 214, and to renovate the entire property. The total investment cost will be EGP (Egyptian Pounds) 53.4 million. This is planned to be financed by an EGP 26.7 million equity contribution and an anticipated EGP 26.7 million loan facility from an international financing institution. SALES AND MARKETING Product Definition The hotel can be considered to offer the following products/services: • Normal overnight stays with breakfast and meals at reasonable prices • Weekday training sessions, seminars and workshops with meals – for companies,

embassies, and public authorities • Lunch for travel agencies passing through Taba on visits to tourist attractions, either

in the Sinai or further away. If requested by guests, the hotel will arrange visits to sites and attractions in the area. Both limousine/taxi services and experienced guides are available. However, so far this service to guests is not given priority by management as it wants to focus on its core activities of rooms, food and beverages, and other services in the hotel itself.

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The hotel itself boasts 114 attractively decorated rooms, which will increase to 214 with the planned expansion. All rooms come equipped with air conditioning, satellite television with multi-lingual channels, direct-dial phone, and minibar. Each also has an outdoor terrace which provides a magnificent view of the sea. Global Market Trends and Customer Analysis Tourism 2020 Vision is the World Tourism Organization's long-term forecast and assessment for the first 20 years of the new millennium. An essential outcome of the Tourism 2020 Vision is quantitative forecasts covering a 25-year period, with 1995 as the base year and forecasts for 2010 and 2020. Although the evolution of tourism in the last few years has been irregular, UNWTO maintains its long-term forecast for the time being. The underlying structural trends of the forecast do not appear to have changed significantly. Experience shows that in the short term, periods of faster growth (e.g., 1995, 1996, and 2000) alternate with periods of lesser growth (e.g. 2001 – 2003 and 2008 - 2009).

UNWTO's Tourism 2020 Vision forecasts that international arrivals are expected to reach nearly 1.6 billion by the year 2020. Of these arrivals, 1.2 billion will be intra-regional travellers and 378 million will be long-haul. Analyzing the tourist arrivals by region shows that by 2020 the top three regions will be Europe (717 million), Asia Pacific (397 million), and the Americas (282 million), followed by Africa, the Middle East, and South Asia. Asia Pacific, the Middle East, and Africa are forecasted to grow at over 5% per year, compared to the world average of 4.1%. The more mature regions of Europe and the Americas will likely grow more slowly than average. Europe will maintain the highest share of world arrivals, although it will likely decline from 60% in 1995 to 46% in 2020.

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Tourism Continues to Grow in Egypt Prospects for tourism in the Middle East can vary sharply by country. Nevertheless, despite elevated political tensions the region has proven resilient in its ability to attract tourists. This is seen in the strong results Egypt, Jordan, and the Persian Gulf countries experienced between 2006 and 2010.

Egypt is a major destination for international tourists, thanks to its pyramids, pharaonic ruins, and resort destinations on the Red Sea. Its tourism industry has grown significantly in recent years, with the number of actual visitors nearly tripling from 5.1 million in 2000 to 14.7 million in 2010. This sector is vital to the national economy, and the Egyptian Tourist Authority in New York reports that hotels and restaurants contributed about USD 11 billion to GDP in 2010 (i.e., 5% of total). The 2011 tourist season has been slow due to the Arab Spring turmoil, but thanks to Egypt’s first-class attractions tourists are expected to return in 2012 as the political situation stabilizes. Egypt’s tourism growth is centred around six tourist areas, namely Cairo, Alexandria, Luxor, Aswan, and the Red Sea and Sinai areas. Hurghada is the primary destination on the Red Sea, while Sharm El Sheikh, Dahab, Nuweiba, and Taba are the main Sinai destinations. The Red Sea and Sinai’s growth is predominantly focused on foreign tourists, whereas Alexandria and Aswan have seen most of their increases come from domestic travellers. Tourist Arrivals to Egypt In terms of the make-up of Egypt’s tourists, the following percentages have been typical in recent years:

• Western Europe - 44% • Eastern Europe – 31% • Middle East – 12% • Africa – 3% • United States – 3% • Other – 7%

. Within Western Europe, the United Kingdom has accounted for the highest number of tourists, followed by Germany, Italy, and France. Russia is clearly the leader in Eastern Europe, while for Arab countries Libya sent the most visitors in 2010. This will change in 2012 due to Libya’s internal strife, but Saudi Arabia and Palestine are becoming increasingly important.

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Tourists Segments in Egypt Today, tourists are increasingly looking for an all-encompassing experience instead of simply a place to visit. According to the Egyptian Tourist Authority (ETA), tourists respond positively to the visual images they see in promotional literature such as television advertising, film commercials, and full-colour brochures. Consequently its promotional activities stress the unique history, cultural experience, and local flavor of the destinations tourists can visit. This marketing is geared toward the following tourist segments: Business Travel Cultural/Historical Tourism Amusement Attractions Nature/Adventure Resorts Cruises Shopping Gaming

Tourism Promotion in Egypt The Egyptian Tourist Authority (ETA) is the government agency charged with promoting international tourism to Egypt. The ETA’s business plan calls for it to increase Egypt’s share in each of the above tourism sectors by an average of 10% to 12%. To this end, its 2010 budget of $48m was divided between international promotional campaigns ($30m), joint advertising with tour operators ($10m), and tourism fairs around the world ($8m). One area of particular focus within the ETA is the regional Arab market. After Western and Eastern Europe, this is its largest customer base, and Egypt would like to increase it. The ETA is therefore working to expand this on two primary fronts. First, it is promoting short trips to major cities like Cairo or Alexandria which can be easily reached from Arab capitals, as well as Nile River cruises such as a four-night excursion from the Mediterranean Sea to Luxor. Secondly, the ETA is beginning to promote Egyptian tourism in emerging Arab markets like Oman and Algeria – countries which did not send significant numbers of tourists in the past but are now seen as viable candidates. Egypt’s Comparative Advantages Some of Egypt’s comparative advantages as a tourist destination are: Year-round tourism due to reliable, excellent weather Scenery: Red Sea, Sinai, Lake Nasser, Lake Qaroun, the Nile, the Deserts of Egypt,

etc. Historical/cultural sites, in particular the early Egyptian civilisations Proximity to Europe Low costs

One key reason for the increase in the country’s tourism growth is that Egypt continues to be one of the most competitively priced tourist destinations, according to the World Travel and Tourism Authority. Inexpensively priced but high quality hotels are a key part of this equation.

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Revenue Outlook at Helnan Taba Bay The main challenge facing Helnan Taba Bay is to increase its revenue despite its location in a low-cost tourism country. The key is to position the hotel as the preferred resort in the Taba area and leverage this strength to maintain a strong hotel occupancy. As it solidifies its reputation in the local area, Helnan can benefit from its high-margin Food & Beverage sales as customers return to enjoy its ambience. Competitors Helnan Taba Bay has several competitors in the local area. The strongest of these are listed in the table below, along with their respective amenities and key criteria.

Criteria Helnan Taba Bay (Post-Expansion) Tobya Hotel Sea Star Hotel

Star Rating 4-Star 4-Star 4-Star Avg Room Rate (EGP) 250 120 80 No. of Rooms 214 78 173 Food & Bar Sites 3 3 4 Conference Facilities Limited No Limited

Strengths Location, affiliation

with Helnan Close to Taba Owner has travel agency - easy to promote

Beach / Waterfront Yes No No Staff 203 70 130 Distance from Taba 5 km 2 km 8 km Distance from airport 33 km 35 km 30 km

1. Define the market and provide arguments for what market form you think prevails

2. Which factors do you consider important to include when determining the demand function

3. Give examples of substitute and complementary products/services 4. Explain income elasticity and argue for how you think Helnan sees income

elasticity for their products/services Pricing Taba Bay’s management is confident that with its pending renovations, beach-front location, and international brand it will become the Taba destination of choice for tourists, business professionals, and upscale residents in the area. Actual room rates for travel agencies will be negotiated between Helnan Taba Bay and potential travel agencies. In order to introduce the hotel to various travel agencies and build its reputation and brand awareness, Helnan Taba Bay will offer certain travel agencies a lower introductory price than will generally be available. Out of general business experience over the last many years Helnan’s management roughly estimates that European travel agencies’ price elasticity is numerically equal to 3 at a room price of EGP 250 and a corresponding volume of 100 rooms sold (occupied).

5. Calculate and draw the P and the MR function

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Most of the costs of operating the hotel can be considered fixed as they are incurred no matter how many guests and rooms are actually sold, and consequently only a smaller part are variable costs directly related to the actual number of rooms occupied. The marginal cost function has been estimated as: For 0<Q<70: MC = 100 – Q , where Q represents rooms actually sold/occupied For Q≥70: MC = -40 + Q , where Q represents rooms actually sold/occupied

6. Calculate the optimal price and average number of rooms sold under these assumptions

A new and interesting market segment that has grown over the last years is customers from more wealthy Gulf countries. Helnan’s management is of the opinion that this market segment is quantitatively smaller but also less price sensitive. Market research indicates that the demand from this market segment could be an average 10 rooms sold if price is EGP 400 and an average 20 rooms sold if price is reduced to EGP 200. Demand is assumed linear in between.

7. Calculate and illustrate the optimal pricing and quantity on the two market segments if prices are differentiated

8. What is the gain in profit from differentiating prices compared to not differentiating prices on the two market segments?

9. What are the conditions for being able to differentiate prices and do you advice Helnan to pursue this pricing strategy?

10. What other types of pricing strategies would you advice Helnan to consider? RAW MATERIALS AND INPUTS For its day to day operations, Helnan Taba Bay uses domestic suppliers which combine high quality and stellar reputations. This often means using larger and professional suppliers in Cairo instead of smaller local businesses in Taba. For this reason vegetables, juice, meat and groceries are bought from companies in Cairo. However, seafood is purchased from local fisherman in Taba. A few things, like liquor, are bought through local companies in Cairo that import them from abroad. LOCATION AND SITE OF PRODUCTION Pre-expansion Facilities Prior to its expansion, Helnan Taba Bay’s facility consists of the following buildings:

1- Reception, lobby, and administration offices 2- Guest rooms – 114 total

• Chalets building (30 rooms) • Right wing of Rooms building (52 rooms) • Left wing of Rooms building (32 rooms)

3- Restaurant building with kitchen 4- Swimming pool building with stores and shops below 5- Service building with general hotel supplies and laundry facilities 6- Staff cafeteria and maintenance office 7- Staff housing facility

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8- Diving center building 9- Hotel boat launch

In addition, Helnan Taba Bay has a large 65,000 m2 tract of beachfront property east of the main road. It also has 55,000 m2 of vacant land on the west side of the road. Land use In 2010 Helnan International entered into a 20-year lease agreement with Misir Sinai Company, which owns the property. Helnan Taba Bay has obtained the necessary hotel operating license from the Ministry of Tourism, as well as the licenses needed for alcohol and live music.

11. Explain the way leasing functions Timing of the Expansion Project Helnan International expects to secure financing by 2012. The construction blueprints and requests for quotation can begin once financing is received and should take 3 months. The construction itself is expected to take 12 months, making for a total project lead-time of 15 months after financing is approved. TECHNICAL SET-UP AND INVESTMENT NEEDS Expansion Program Helnan has analyzed the infrastructure improvements needed to expand from 114 to 214 rooms. Other activities which the expansion will cover include the following:

• Kitchen / Food & Beverage • Civil defence and fire safety • Laundry • Retail shops • Communication systems – computer, internet, television, satellite, telephone • Offices and engineering workshops • Staff housing, staff recreation, and staff club areas • Swimming pool • Health club • Water treatment plant • Electrical and HVAC systems • Beach area • Parking and security • Landscaping

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HUMAN RESOURCES AND MANAGEMENT Pre-Expansion Staffing Helnan Taba Bay currently has a staff of 103 people. This includes free-lance staff in Housekeeping, Kitchen, and Food & Beverages whom the hotel’s management brings in during high occupancy periods. In the kitchen area Helnan did some analysis on number of meals served as a function of kitchen staff – it turned out that the relationship can be described as:

Number of Staff

1 2 3 4 5 6 7 8 9

Meals served 5 13 24 34 40 44 46 45 42

12. Draw the MPL , APL and TPL and explain 13. How many employees should optimally be hired for the kitchen?

Post-Expansion Staffing After the expansion program is complete, Helnan Taba Bay expects to add approximately 100 new employees. This will keep the ratio of staff to hotel guests at nearly 1:1. Consequently, Helnan’s management will come close to doubling the number of employees in each department.

14. How do you in theory optimize the combination of input factors in the long run and try to relate this to Helnan’s expansion plans by giving examples

15. In general, what issues related to business ethics would you advice Helnan to consider?

FINANCIAL EVALUATION Investment Costs

Investment costs for the expansion and renovation of Helnan Taba Bay will come to EGP 53.4 million. Helnan International Hotels is prepared to invest EGP 26.7 million of equity into this project and plans to close the remaining 50% financing via a loan from a financing institution. The investment can be described as follows: GROSS INVESTMENT (EGP)

Construction 26,000,000 FF&E, Equipments/Installations 27,050,000 Pre-operational exp. 330,000 Total investment 53,350,000

Profitability

The base case financial projections estimate revenues at EGP 6.8 million in Year 1, with a rise to nearly EGP 26.3 million by Year 10. This growth will come as the hotel’s capacity expands and as facilities are improved. Occupancy is expected to increase from 50% to

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70% over the period. Given the limited information available, Helnan’s management has for simplicity assumed that the budget from year 5 and onwards remains unchanged. This budget is based on conservative assumptions given the present situation in Egypt, so it might improve. Some key assumptions are:

• Total number of rooms available is calculated as 365 days x number or rooms • Food revenue is 60% of room revenue • Beverage revenue is 40% of room revenue • Room cost is 15% of room revenue in year 1 and 10% in all subsequent years • Food cost are 34% of food revenue • Beverage cost are 25% of beverage revenue • Administrative cost are 5% of total revenue • Sales cost are 5% of total revenue in year 1 and 3% is all subsequent years • Maintenance cost are 10% of total revenue

All details are provided in the Excel Annex (Ten-Year Budget), with a summary given below:

16. Provide your own assessment of the business risk for this investment 17. Propose the discount rate you think should be applied for the investment

and provide arguments Management is aware that operations continue after year 10 and that there must therefore be some kind of terminal value at this point in time, however, they are not certain how to assess this value

18. Advice Helnan’s management on how to assess terminal value at year 10 and provide a suggested estimate of this terminal value

19. Based on the information at hand, do your own financial evaluation of whether the investment is worthwhile pursuing and state all your assumptions

20. Analyse and provide calculations with regards to the investment uncertainty

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Helnan has been approaching a number of financing institutions with regards to establishing finance for the planned EGP 26.7 million needed in loan capital. A financing institution has made an offer on the following terms: Principal € 3,200,000 Instalment free period (grace) 2 years Repayment schedule 10 years (incl. grace period) serial loan with

quarterly payments Front end fee payable at loan disbursement 1.5 % Administration fee per quarter € 5,500 Nominal interest rate 14 %, paid at a quarterly rate of 3.5%

21. Illustrate the loan’s cash flow over the 10 years 22. Calculate the effective annual interest rate 23. Apart from the loan’s effective annual interest rate what other issues would

you consider?