Report on the proposed theme park investment The decision to invest in a major project must be evaluated using both

financial and non-financial information. From a financial perspective the estimated net present value of the investment will provide an indicator of whether or not the project will create wealth. Non-financial considerations will include the strategic fit of the investment with the company and its future plans. Financial evaluation Year Cash receipts: Adult admission Child admission Food (incremental cash flow) Gifts (incremental cash flow) Total receipts Expenses: Labour Maintenance Insurance Capital allowances Total expenses Taxable Taxation (30%) Add back capital allowances Initial cost Realisable value Working capital Net cash flow Discount factors (11%) Present values 0 1 2 41.25 34.37 13.75 11.46 100.83 15.00 2.12 (14.86) 62.50 122.06 21.23 6.37 14.86 62.50 (200) (200) 51.5 (251.50) .901 (226.50) 1.55 46.09 .812 37.43 1.59 39.75 .731 29.06 1.64 34.60 .659 22.80 250 1.69 280.36 .593 166.25 57.97 57.97 .535 31.01 3 42.49 35.40 14.16 11.80 103.85 19.00 2.19 (5.54) 46.88 111.77 7.92 2.38 5.54 46.88 4 43.76 36.47 14.59 12.16 106.98 23.00 2.25 1.08 35.16 105.43 1.55 0.47 1.08 35.16 5 45.07 37.56 15.05 12.52 110.17 27.00 2.32 5.68 26.37 102.06 8.11 2.43 5.68 26.37 6

(200) (200)

The estimated net present value is (US$140.05) million. Even if the higher realizable value estimate is used, the expected net present value is still significantly negative.

Notes (i) Receipts year 2 Adult admission Child admission Food Gifts (6,000) (360) (18) (1.03)2 (9,000) (360) (10) (1.03)2 (15,000) (360) (8) (0.3) (1.03)2 (15,000) (360) (5) (0.4) (1.03)2 = 41.25 million = 34.37 million = 13.75 million = 11.46 million

(ii) Capital allowances: It is assumed that allowances are available with a one year lag.

Year 0+1 2 3 4

Written Down Value 250 187.50 140.62 105.47

Capital Allowance (25%) 62.50 46.88 35.16 26.37

Year Available 2 3 4 5

No balancing allowances or charges have been estimated as the year 5 realizable value of fixed assets has been estimated on an after tax basis. As the hotel business is successful, it is assumed that allowances may be used as soon as they are available against other taxable cash flows of Bong Sopheap plc. (iii) Interest is not a relevant cash flow. All financing costs are included in the discount rate. The market research is a sunk cost. (v) Apportioned overhead is not a relevant cash flow. (vi) Although the company will save money by advertising in its existing hotels, this is not a change in cash flow as a result of the project and is not included in cash flows. (In effect the benefit from the savings is present as there is no cash outflow for advertising). (vii) Discount rate: The current weighted average cost of capital should not be used. The discount rate should reflect the risk of the investment being undertaken; theme parks are likely to have very different risk to hotels. The cost of capital will be estimated using the risk (beta) of Oun Sopheap plc, as Oun Sopheap operates in the theme park sector. The market weighted capital gearing of Oun Sopheap is: Equity 400 x 3-86 = US$1,544 m (78.3%) Debt 460 x 0-93 = US$428 m (21.7%) As the gearing of Oun Sopheap is much less than that of Bong Sopheap, the beta used to estimate the relevant cost of equity will need to be adjusted to reflect this difference in gearing. Assuming corporate debt is virtually risk free: Ungearing Oun Sopheap's equity beta:

Regearing to take into account the gearing of Bong Sopheap:

The cost of equity may be estimated using the capital asset pricing model. Ke = Rf + (Rm - Rf) beta equity Ke = 3.5% + (10% - 3.5%) 1.748 = 14.86% Kd is 7.5%, the cost of the new debt used for the project. The weighted average cost of capital relevant to the new investment is estimated to be: 14.86% (0.614) + 7-5% (1 0.3) (0.386) = 11.15% 11% will be used as the discount rate for the investment. Other relevant information The financial projections used in the estimated net present value are subject of considerable inaccuracy. It would be useful to know: (i) The accuracy of estimates of attendance levels and spending in the theme park. (ii) The accuracy of price and cost changes. (iii) Whether or not tax rates are subject to change. (iv) The accuracy of the estimate of realisable value in year four. (v) The accuracy of the discount rate estimate. The activities of Oun Sopheap are not likely to be of exactly the same risk as the theme park project. For a major investment it is unwise to rely on a single estimate of expected net present value. Sensitivity analysis or simulation analysis should be used in order to ascertain the impact on the expected NPV of changes in attendance and other key cash flows. It would be better to undertake simulation analysis, based upon different possible attendance levels, costs, risk, tax rates etc. in order to estimate a range of possible net present values, rather than use a single point value. A crucial question is what happens to cash flows beyond the company's four year planning horizon. The year five realisable values are asset values, not the value of the theme park as a going concern. The value as a going concern could be very different from the asset values, and have a major influence on the investment decision. Will the theme park investment lead to future opportunities/investments (real options), for example in other theme parks or leisure activities? If so the value of such options should be estimated, and should form part of the investment decision. Strategic and other issues The strategic importance of the venture to Bong Sopheap must also be investigated, as this may heavily influence the final decision. Bong Sopheap currently runs a successful hotel chain. It might be better to keep to its core competence in hotels rather than diversify into another sector. If new investments are sought are there better opportunities within the hotel sector? Any final decision must encompass all relevant non-financial factors of which little detail has been provided. Bong Sopheap must be satisfied that it can recruit an appropriately skilled labour force for the theme park, and should thoroughly investigate the competition in the theme park sector, and the likely reaction of competitors if it enters this new market.