Financial Analysis for Wonderland Confectionaries Theme Park Finance Essay

Wonderland Confectionaries Inc. owns a successful chain of Restaurants and the company is considering diversifying its activities by investing in theme park business by constructing a theme park.

This report analyses the Wonderland's investment in the theme park to diversify its current business. Based on the information available from the market research undertaken by Wonderland and the investigation done on the closest theme park competitor, major investment appraisal methods were used to evaluate the above said investment. Recommendations are given based on the findings from the investment appraisal methods. Furthermore, investment appraisal method used in this analysis is compared with other major investment appraisal methods. In addition to that, financial and non-financial issues that management of Wonderland need to be aware of and suggestions on how to manage these issues are discussed. Further, a brief outline of the use of real options in project appraisal is given.

INTRODUCTION

Wonderland Confectionaries Inc. owns a successful chain of restaurants and the company is contemplating to diversify its business activities by investing in theme park business. In order to undertake this diversification process, the company is considering constructing a theme park, which would have a mixture of family and adventurous activities.

This report aims to analyse the Wonderland's investment in the theme park. Based on the information available from the market research undertaken by the company and the investigation done on a closest theme park competitor (Alice Limited), major investment appraisal methods will be used to evaluate the above said investment. Recommendations will be given based on the conclusions drawn from the investment appraisal methods used in this analysis. Furthermore, investment appraisal method used in this analysis will be compared with other major investment appraisal methods. In addition to that, financial and non-financial issues that management of Wonderland need to be aware of and suggestions on how to manage these issues will be discussed. Further, a brief outline of the use of real options in project appraisal will be given.

NET PRESENT VALUE

In order to calculate Net Present Value (NPV), Weighted Average Cost of Capital (WACC) needs to be calculated by using project specific approach as shown below. Main reason behind this is because WACC of the new project will represent the most accurate measure of cost of capital for the new project, which will be used as discount factor to calculate NPV. Further, Wonderland's funds can be viewed as a pool of resources. Company will withdraw money from this pool of funds to invest in the theme park project and add to the pool as new finance is raised or profits are retained. In this case, it is most appropriate to use an average cost of capital as the discount rate (BPP Learning, 2009, p.334).

From the above table - 10, it can be seen that theme park project has a positive net present value of £57,197,569 and as such Wonderland Confectionaries Inc. should accept the project. Positive NPV means that the project will increase the wealth of the company by the amount of the NPV at the current cost of capital. In other words, positive NPV means, if the theme park project is undertaken by Wonderland, it will offer a higher return than the return required by the company to provide satisfactory return to its sources of finance, which in turn means that the company's value will be increased and the project will contribute to shareholders wealth maximisation (BPP Learning, 2009, p.148). However, it is recommended for Wonderland to have a closer examination of the sales projections done for the project.

Evaluation of Net Present Value method compared to other major methods used

Net Present Value (NPV) is the difference between an investment's (theme park) market value and its costs. In other words, NPV is a measure of how much value is created or added today to Wonderland Company by undertaking the theme park investment (Ross et al., 2008, p. 232). NPV appraisal method is the best method for the financial analysis of theme park project is for the following reasons (LSBF, 2009, p.34):

• (a). Theme park project with a positive NPV increases the wealth of the Wonderland Company and consequently increases the shareholder's wealth.
• (b). Unlike ROCE and payback method, NPV takes into account the time value of money (a dollar today is worth more than a dollar tomorrow) and therefore the opportunity cost of capital.
• (c). Discount rate can be adjusted to take account of different level of risk inherent in different projects. In other words, higher discount rates can be set for riskier projects.
• (d). Better than payback and accounting rate of return method because NPV considers the cash flows over the whole life of the project rather than profit.
• (e). Superior to return on capital employed method because it focuses on relevant future cash flows.
• (f). Unlike internal rate of return, NPV method does not suffer the problem of multiple rates of return.

FINANCIAL AND NON-FINANCIAL ISSUES

There are number of financial and non-financial issues that the management of Wonderland needs to be aware as follow:

Financial Issues

It is essential for Wonderland to include only incremental cash flows during project appraisal, which means cash flows that are dependent on the projects implementation (Arnold, 2005, pp. 82).

It is important for Wonderland to include all opportunity costs and incidental effects in their investment appraisal (Arnold, 2005, pp. 83).

Wonderland should ignore sunk costs such as market research cost of £ 400,000, as these are not part of the theme park investment project. Market research cost is already incurred whether or not decision to construct the theme park goes ahead and is there for not incremental (Arnold, 2005, pp. 84).

It is fundamental that Wonderland management to include only incremental costs during project appraisal. This becomes an important issues when it comes to overhead costs such as labour, insurance and operating costs, etc, which are not directly related to any one part of the company or one project. To access the viability of the theme park project, only incremental expenses that would be incurred by going ahead with the project should be included as other general overhead costs will be incurred regardless of whether project takes place or not (Arnold, 2005, pp. 84).

Even though interest on bank loan to be borrowed by Wonderland to invest in the theme park project does represent a cash outflow, this element should not be included in the cash flow calculations. The main reason is that, it will lead to double counting, as the opportunity cost of capital used to discount the cash flows already incorporates a cost of these funds (Arnold, 2005, pp. 85).

Before Wonderland commits to invest in the theme park project, it is vital to ensure funding for the project is available. Further, identifying the right finance option for the particular project is essential from the different varieties of financing options available (Business link, 2010).

Wonderland should consider potential risk of the theme park project. This could be done with the help of assessment of all the risks involved in the project such as delays, underlying assumptions not being reliable, sales forecast gone wrong, etc. Further, they could use sensitivity analysis to predict the impact these potential risks will have on the project (Business link, 2010).

Non- Financial Issues

It is important for Wonderland to see how theme park project fits with the existing business of the company. Further, they should consider how this project could contribute to overall strategic objective of the company (Business link, 2010).

Green Issues: It is important for Wonderland to consider the environmental impact that might be cause because of theme park project. It is vital for Wonderland to use most advance technologies to limit the damages caused to the environment because of the huge project. The main reason is that, companies who do not investment in green activities are considered now as irresponsible by the public who will in turn become customers of the theme park project.

Motivation of staffs: The effect on the staff is a crucial consideration to be made when investing in new projects. Arnold (2005, p. 76) states that "staffs enthusiasm and commitment will be central importance of the success of new projects". It is important for Wonderland to find ways to improve staff morale, making it easier to recruit and retain employees (Business link, 2010).

Customer satisfaction: Its important for Wonderland to find ways to satisfy the prospective customers of the theme park project by conducting market surveys, market observation and market experiment, etc (Arnold, 2005, pp. 76).

Government regulations: It is vital that Wonderland keep up to date with the government regulations and they should meet the requirements of current and future legislations (Business link, 2010).

Competitors: Wonderland should consider actions of their major competitors such as Alice Ltd before making the investment decision (Business link, 2010).

Trends: They should consider the future trends before making the investment decision to see the potentials in the theme park project. Further, it is important for Wonderland to anticipate and deal with future threats such as projecting intellectual property rights against potential competitors (Business link, 2010).

It should be noted that most of the above non-financial issues could be assessed with the help of post audit techniques where by company checks on the progress of theme park project by conducting post audits shortly after the projects have begun to operate. "This will allow Wonderland to indentify problems that need fixing, check the accuracy of forecasts and suggest questions that should have been asked before the project was undertaken" (Brealey and Myers, 2003, pp. 313-314).

REAL OPTIONS

A real option is "the right but not the obligation to undertake some business decisions; typically the option to make, abandon, expand, sell a capital investment" (Kodukula and Papudesu, 2006, pp. 53-64). If Wonderland decided to investment in the theme park project, it should be noted that there are many options available for them through out the life of the project to make strategic changes as follows:

• (a). Abandonment: This is option where by Wonderland can cease the project during its life if it is not viable for them to continue the project due to several reasons such as changes to demand, economy, etc. Due to changes in circumstances, Wonderland can decide to abandon the theme park project in order to terminate loss-making projects (Brealey and Myers, 2003, p. 625).
• (b). Expansion: Depending on the success of the theme park project, Wonderland can decide to expand its theme park project to gain more market share in this industry (Arnold, 2005, p. 562). If there is potential for growth opportunities in the future, the option to expand can provide significant value to the company (Kodukula and Papudesu, 2006, p. 110).
• (c). Flexibility: During the life of the theme park project, Wonderland will have the option to change inputs and output of the theme park projects for example, changes in suppliers or different pricing methods, discounts, etc in order to generate more profit from that project to the company (Brealey and Myers, 2003, pp. 630-631).
• (d). Selling: Option where by company decides to sell the whole project for several reasons such as loss making projects or company received an opportunity to sell project at profit if they decides to abandon its theme park project, etc.
• (e). Timing: Even though theme park project is giving a positive NPV does not mean that Wonderland should go ahead with the project today. Company has the option to wait if they can delay the investment decision where creating a trade of between cash flow today and cash flow in the future. Further, if they decided to wait, they could make a more informed and in the long run more value creating decision (Arnold, 2005, p. 563).

 

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