Wonderland Confectionaries Inc.

Wonderland Confectionaries Inc. owns a successful chain of Restaurants and thecompany is considering diversifying its activities by investing in theme park businessthrough the construction of a theme park. The theme park would have a mixture offamily activities and thrills. Wonderland has just spent £400,000 on market researchinto the theme park, and is encouraged by the findings.The following details apply:1. The theme park is expected to attract an average of 20,000 visitors perday for at least five years2. The price of admission to the theme park is expected to be £25 peradult and £15 per child. 70% of visitors are forecast to be children. Inaddition to admission revenues, it is expected that the average visitorwill spend £10 on food and drinks,3. All costs and receipts (excluding maintenance and construction costsand the realisable value) are shown at current prices;4. The company expects revenue to rise by 6% from current on acompound bases5. The theme park would cost a total of £500 million and could beconstructed and working after 1 year of investment .Half of the £500million would be payable immediately, and half in one year’s timewithout the effect of inflation due to a signed agreement. In additionworking capital of £60 million will be required from the beginning of theproject and is expected to increase year on year in line with the inflationfactor of the revenue (6%)6. The non-current asset has an after tax realisable value between £100million and £200 million after five years of the project.7. Operation costs (excluding labour (please see below) are expected tobe £17 million in the first year of operation, increasing by 5% per year.8. Insurance costs per annum are £3 million, of which £2 million per yearis due directly to the theme park project and Insurance cost willincrease in line with the Consumer price i.e. 6% per annumcompounded annually9. labour cost will be increased by 7% each year on compounding basisand the project would require 1000 employees with a cost of £35 millionper annum (at current prices).10. The dual use of existing advertising campaigns restaurant theme parkwill save a £3 million per year in advertising expenses.11. The Theme park will be operated 7 days a week for 365 days a yearand will be maintained during the night.Wonderland has no previous experience of theme park management. However aspart of the finance team, you have investigated the current risk and financial structureof its closest theme park competitor, Alice Limited. Details are summarised below.ALICE LIMITED, SUMMARISED BALANCE SHEET£mNon-current assets (net) 1,710Current assets 630Less current liabilities (570)1,770Financed by:£1 ordinary shares 500Reserves 7001200Medium and long term debt 5701,770After carrying out preliminary search for financing and investigating the industryfurther, your team has been able to gather the following information:a) Wonderland can procure a loan of £100 million loan at 8% fixed rate to provide thenecessary finance for the theme park.b) £300 million of the investment will attract 20% per year capital allowances on straightline 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% and this is applicable for both Alice andWonderlandd) The expected market return on equity is 12% and the risk free rate 3.5%.e) Wonderland’s current weighted average cost of capital is 9%.f) Wonderland’s market weighted gearing if the theme park project is undertaken isestimated to be 80% equity and 20% debt.g) Wonderland’s equity beta is 0.80.h) The current share price of Wonderland is 200 pence, and of Alice 400 pence.i) Alice’s equity beta is 1.50The expected return and the risk free rate are all nominal and as such any cost ofcapital derived will be a nominal cost of capitalREQUIRED:You are required to prepare a report analysing whether or not Wonderland shouldundertake the investment in the theme park.Your report should cover the following areas which have been indicated in your firm’sinvestment manual:1. Net present value and any relevant advice to management on salient issues to beconsidered (60 marks)2. A suggestion of financial and non-financial issues that the management ofWonderland need to be aware of and suggestions on how to manage these issues.(20 marks)3. You have decided to take an initiative and include in your report a brief outline of theuse of real options in project appraisal for management and as such will prepare anoutline on the following options and how they may be applicable to the Wonderlandtheme park project under appraisal• Abandonment• Expansion• Flexibility• Selling• And any other relevant option