: CORPORATE GOVERNANCE AND DIFFERENCES IN CAPITAL BUDGETING CONCEPT AND METHODS BETWEEN AMERICAN AND JAPANESE COMPANIES

TOKYO DISNEYLAND AND THE DISNEYSEA PARK: CORPORATE GOVERNANCE AND DIFFERENCES IN CAPITAL BUDGETING CONCEPT AND METHODS BETWEEN AMERICAN AND JAPANESE COMPANIES

A CASE ANALYSIS ON

A CASE ANALYSIS ON
TOKYO DISNEYLAND AND THE DISNEYSEA PARK: CORPORATE GOVERNANCE AND DIFFERENCES IN CAPITAL BUDGETING CONCEPT AND METHODS BETWEEN AMERICAN AND JAPANESE COMPANIES

Cases in Financial Decision Making (F-506)

SUBMITTED TO

Dr. M. Sadiqul Islam Professor Dept. of Finance University of Dhaka

SUBMITTED BY
M.B.A. 12th Batch Group-11

G R O U P
Name
Md. Harun Or Rashid

L I S T
Roll 12-013
12-073 12-131

Sheikh Fahmida Md. Asikuzzaman Md. Mamun Siraj Md. Anjunur Rahman

12-165 12-166

Date of Submission- 12th November, 2011

Letter of Transmittal

November 12, 2011 Dr. M. Sadiqul Islam Professor Department of Finance University of Dhaka Subject: Submission of Report on Case analysis- Disney Sea Park. Dear Sir We are feeling immense pleasure as knuckling down to preparing this report as a partial requirement of course F-506(Cases in Financial Decision Making) at the threshold of submitting this Case study on Capital Budgeting Decision. We have been able to execute our assigned task within the timeframe although the possibility of making mistakes cannot be erased completely. We would like to mention that, we tried our best to prepare the case paper to our greater extent through reading, consulting, discussing the case among the members of our group. We are still learners and we are in the process of learning. So, at this moment we hope that you will pardon us and overlook them considering that we are still learners and you will give us the necessary suggestions that you always give for the improvement of our quality in future.

Yours Sincerely The members of Group -11 MBA, 12th Batch Department of Finance University of Dhaka

Acknowledgment
At first we want to express our heartiest gratitude to all mighty Allah for the successful completion of the project. Case analysis has been included in the MBA program with an objective to increase the analytical ability of the students. As a part of this objective our venerable course teacher Professor Dr. M Sadiqul Islam has included a series of case analysis in the course curriculum. We are Group-11 and our assigned case is The Disney Sea Park We express our sincere gratitude to our honorable course teacher Prof. Dr. M. Sadiqul Islam for his guidance, advice and assistance in preparing the assigned case. We are really grateful to our course instructor for his unstinted support, timely and sophisticated direction and finally eternal morale in learning the knowledge through preparing cases. For the persistent source of inspiration, we can take something in our life that should be the invaluable guidance in our life emanating from our teachers. So he should be placed on the podium. Finally we must thank all the group members as the report resulted from excellent group effort.

Objective of

the Case Study

The major objectives behind the case study are mentioned below:

To broaden the analytical ability

To fulfill the partial requirement of MBA program. To relate theoretical knowledge to practical oriented

problem.

To know how to take capital investment decisions.

Limitation of the Case Analysis

The major limitations of this report are:

Non-availability of information for better analysis

We have shortage of information to measure the riskiness of the project.

Methodology

Qualitative and Quantities analysis are made Some essential data which are not given are assumed All the information used in this report has been gathered

from the case regarding The Becker Corporation We have used some computer software to make the analysis

a viable one.

T
TOPICS

A B L E

O F

C O N T E N T S

Table of Contents
Page No.
v 1-2 3 4 5-6 7 8-11 12-13 14 15-18 19-20 20-24 25 26-30 31-35 36

Executive Summary Case Synopsis Overview of Oriental Land Economy Analysis Industry Analysis Company analysis SWOT Analysis Ratio Analysis Risk Analysis Business Risk Analysis Financial Risk Analysis Country Risk Analysis Prospective Analysis Valuation of OL without the Project Simulation Analysis Project Analysis Valuation of OL with the project Simulation Analysis Problem Analysis Recommendation

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Executive Summary
This report intends to cover a vast and very important area of importance of capital budgeting and investment. Here a case analysis has been done on Tokyo Disneyland and the Disneysea Park: Corporate Governance and Differences in Capital Budgeting Concept and Methods Between American and Japanese Companies . The first part is a case overview which states a brief description of Tokyo Disneyland and the Disney Sea Park. It is followed by a description of its economy and industry to determine its present situation of the industry where it exists. The next part provides an analysis of its competitive strategy. It follows expansion strategy. In company analysis part SWOT is done to depict the position of company in its industry. The next part is ratio analysis and risk analysis. The decomposition of earnings is done through using traditional approach of DU-Pont and the alternative approach. To evaluate the project NPV, IRR, ARR and Average cash Flow Return Method. All the methods provide favorable results to accept the project except for the ARR. There are also analyzed the corporate governance part. Walt Disney Company is USA based companies which follow Anglo-American type of corporate governance system. Tokyo Disneyland and Tokyo Disney Sea Park are Japanese based companies which follow Japanese-German type corporate governance system. There are sequentially analyzed the problem statement, probable solutions, and courses of actions, decision, recommendation and justification.

Chapter1 1.1 Case Synopsis

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Oriental Land co Ltd. (OL) is a Japan based company. It had a negotiation with US based Walt Disney Company (WD). In 1979, Oriental land corp signed a license agreement with Disney Company (WD) to establish Tokyo Disneyland. The license agreement involves the design, construction, and operation of Tokyo Disneyland. . Walt Disney (WD) was not willing to pay anything for the construction of the park, but it wanted 10% royalty on the admission fee and sales of foods and beverages. An agreement was signed which stipulated a license of 10% on admission fee and 5 % on food, beverage and novelty goods. Tokyo Disneyland was a smashing hit. The first year it drew 10.3 million visitors, in line with WDs expectations. After the opening year, the number of visitors never went below 10 million and the number of visitors peaked in 1998, at 17.45 million. Walt Disney wished to maximize revenue from Japan through license fees. It therefore offered to build a new DisneySea park project in Japan with Oriental land corp. Tokyo DisneySea was to be a unique institution, a first of its kind in the world. Japan was an island country surrounded by the seas as such the Japanese had a strong attachment to a theme concerning the sea. The target audience was those adults who had been children when Tokyo Disneyland had been introduced. Walt Disney offered the same terms and conditions for new DisneySea Park. OLs management strongly opposed to the licensing fee format for DisneySea Park and express vies as we can hardly agree with a plan to do it under the same conditions. It is quite unfair if the US side is to take no risk, use the land free with no financial burden, but collect the royalty. To overcome deadlock in negotiations with WD, OLs senior executives asked the planning department to conduct a financial analysis as top priority. The senior management wanted to know how long it would take for the DisneySea Park to start generating profits.

Oriental Land Co Ltd

Oriental Land was established on 11th July, 1960. It has Paid-in capital of $0.53 billion and annual sales revenue is $1.53 billion. This corporation brought Walt Disney in Japan. The company was listed in Tokyo Stock Exchange in 1996. The share price in that year was pretty good but the price declined in 1997. The company is now trying to take two projects Tokyo Disneyland and Tokyo DisneySea Park. The negotiation in being conducted with US based Walt Disney to conduct these two projects.

Tokyo Disneyland
In 1979 Walt Disney negotiated the terms for Tokyo Disneyland with Oriental land corp and it had proven to be a tough negotiator. It offered only the know- how without shouldering any risk. It was not willing to pay anything for the construction of the park, 12

but it wanted 10% royalty on the admission fee and sales of foods and beverages. An agreement was signed which stipulated a license of 10% on admission fee and 5 % on food, beverage and novelty goods. At the time of negotiation, Walt Disneys financial position was weak. Under weak financial condition, collecting a fixed amount of money from their overseas partner was an attractive proposition for WD. In April 1979, Walt Disney Company (WD) signed a license agreement with Oriental land corp involving the design, construction, and operation of Tokyo Disneyland. Oriental land corp took less than three years to complete the construction of Tokyo Disneyland and opened its business in April 1983. The first year Tokyo Disneyland drew 10.3 million visitors in line with WDs expectations. The number of visitors reached 13.38 million in 1987 and the number of visitors pinnacled in 1998, at 17.45 million and the parks attendance figure never dropped below 16 million in the years that followed.

Tokyo DisneySea Park

Walt Disney wished to maximize revenue from Japan through license fees. It therefore offered to build a new DisneySea park project in Japan with Oriental land corp. WD expected income similar to that received for Tokyo Disneyland. Tokyo DisneySea was to be a unique institution, a first of its kind in the world. Japan was an island country surrounded by the seas as such the Japanese had a strong attachment to a theme concerning the sea. The target audience was those adults who had been children when Tokyo Disneyland had been introduced The two companies could not agree on the terms and conditions and the relationship between the two were unharmonious. OLs top management discussed with WD for better negotiation and WD responded that there is no point in any discussions. OL s top management strongly opposed to the same licensing fee format for the DisneySea Park. To overcome deadlock in negotiations with WD, OLs senior executives asked the planning department to conduct a financial analysis as top priority. The senior management wanted to know how long it would take for the DisneySea Park to start generating profits.

1.2 Background of Oriental Land Company Limited

Name

: Orient Land Co Ltd. 13

Date of establishment Paid-in Capital Sales Income before tax President Member of board Employees

: July 11, 1960 : 63 billion (US$ 0.53 billion) : 180 billion (US$ 1.53 billion) : 28 billion (US$ 0.24 billion) : Toshio Kagami : 28 : 2,493 (Full time) : 6,355 (Per time)

Address Main bank Major Shareholders

: 1-1, Maihama, Urayasushi, Chiba-ken, Japan : Industrial Bank of Japan, Mitsui Trust Bank : Mitsui Real Estate Corp (20.48%) : Keisei Electric Railway Corp (11.20%)

Tie-up Company

: Disney Enterprises Inc. (USA)

Chapter-2 2.1 Economy Analysis Japan

Japan has a large industrial capacity, and is home to some of the largest and most technologically advanced producers of motor vehicles, electronics, machine tools, steel 14

and nonferrous metals, ships, chemical substances, textiles, and processed foods. Agricultural businesses in Japan cultivate 13 percent of Japan's land, and Japan accounts for nearly 15 percent of the global fish catch, second only to China. As of 2010, Japan's labor force consisted of some 65.9 million workers. Japan has a low unemployment rate of around four percent. Almost one in six Japanese, or 20 million people, lived in poverty in 2007. Housing in Japan is characterized by limited land supply in urban areas.

GDP
GDP growth rate is low in Japan. Sometimes it was negative. The growth of GDP over the last five years is given below: Year 1993 1994 1995 1996 1997 GDP 0.44% 0.12% -0.50% -0.63% 0.53%

Inflation
Inflation rate is very low in Japan. From the year 1993 to 1995, inflation rate declined. Then in the year 1996 the rate started to climb up and it was 1.77% in 1997. Year 1993 1994 1995 1996 1997 Inflation 1.27% 0.69% -0.12% 0.13% 1.77%

Life style
Japanese peaple lead a very luxurious life. As the per capita income is very high they can spend lots of money for living a better life. Unemployment rate in Japan is very low. Most of the people are educated. People do not mind doing any sort of work. They love amusement. So they go for long drive and theme park. They have family tour to different places.

Chapter 3 INDUSTRY ANALYSIS

3.1 Porters Five Forces Model
Industry analysis helps to measure the profit potential of the industry in which the firm is competing because the profitability of various industries differs systematically and predictability over time. To analyze the industry situation `Porters Five Forces Model 15

has been used. By using this analysis the present industry situation is determined to make further decision. The result of industry analysis by using Porters Five Forces Model is given below: 3.2.1 Threat of New Entrants- Low The company is establishing Tokyo Disneyland and DisneySea park. This type of park establishment needs huge investment. Besides this the suitable and available place is also rare. So threat of New Entrants is very low. The company has been able to grow over a long period of time. By relying on past experience, company officials know to a large extent what the target customer wants. As Disney pretty much dominates the family entertainment market, it will be very difficult for a new organization to develop brand recognition, brand identification and product differentiation. Being a market leader has made it possible for the company to practice effective economies of scale in production. In addition, an extremely large amount of capital investment is required for new entrants into the industry if they want to compete with the Disney Corporation. Only very large companies can meet such large capital requirement. 3.2.2 Rivalry among Existing Firm-Low Very few players play the game in this industry. So intra industry rivalry is low. This sector has huge opportunity but scope for business expansion is limited as huge investment and suitable place imposes some constraints. So rivalry among existing firm is low. 3.2.3 Bargaining Power of Buyers-High The bargaining power of customers is high in the service and in the entertainment industry. Since a large number of customers are needed to make Disney's operations run smoothly, the customers have certain powers. Customers may be reluctant to spend the money needed to purchase the product. A majority of Disney's product mix focuses on intangible returns on the buyer's money. The case that some customers may not realize that they are getting such a return may increase the bargaining power of the customers.

3.2.4 Bargaining Power of the Supplier-High The bargaining power of supplier is very high as the licenser was tough party to negotiate with. Licenser was very hard with their terms and conditions and the party will not pay anything but take the royalty fees. So the bargaining power of supplier is very high. 3.2.5 Threat of Substitute Product-Low

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 Threats of substitute product are very low because the amusement park does not have any alternative product. Those who are eager to come to visit the park must visit. Obviously, other cartoon figures, theme parks, and movies can penetrate the market in which Disney is operating in, but this is not necessarily representing a significant threat.

So, the five forces model can be shown by the following diagram-

Threat of New EntrantsLow

Rivalry among Existing FirmLow

Threat of Substitute ProductLow

INDUSTRY PROFITABILIT Y

Bargaining Power of SuppliersHigh

Bargaining Power of BuyersHigh

Chapter 4 COMPANY ANALYSIS ter2: INDUSTRY ANALNALYSIS

4.1 SWOT Analysis
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SWOT analysis is a strategic planning method used to evaluate the Strengths, Weaknesses/Limitations, Opportunities, and Threats involved in a project or in a business venture. It involves specifying the objective of the business venture or project and identifying the internal and external factors that are favorable and unfavorable to achieve that objective. For the purpose of analysing the project Tokyo Disneyland and the DisneySea Park the SWOT analysis has been conducted for Oriental Land Corp (OL). The results of SWOT analysis are given below: Strength
1. Continious technical and management support are coming from Walt Disney. 2. Orient Land Corp and Walt Disney brand have merged together to produce a greater synergistic effect. 3. Around 2493 full time employees and 6355 part time employees are working in OL.

4. Highliner brand 5. The Industrial Bank of Japan and Mitsui Trust Bank was the second largest partner 6. OL got 750000 tsubo which is 10 times larger than the Disneyland in Los Angeles 7. Highly profitable business
8. The main strengths in internal resources refer to human resources and financial

stability Weakness 1. Customer would get bored with the existing attraction and facilities 2. WDs position in the Tokyo Disneyland contract-take no risk, just collect the fee 3. High overhead expenses Opportunity 1. High demand (Most of the customers were repeat visitors) 2. OL to be a potential future leader 3. The future of Japanese industries would shift toward the service industries 18

Threat 1. There is a chance of demand fall. Management is estimating a steady fall in demand after four years. 2. Charged higher licensing fee by the Walt Disney 3. The effects of an economic depression could make it too expensive for people to utilize the services and the products offered.

4.2 Ratio Analysis

Ratio analysis has actually been done to measure the historical performance of the company. For data constraint it was not possible to calculate most of the required ratios but some important ratios were calculated based on the provided data which would give the insight about the companys recent performance. The ratios those are calculated based on the historical date are given below:

Operating Profitability Ratio

Profitability ratios measure the specific companies expected ability to generate profit. Profitability ratio 1996 Operating profit margin 0.17 Net profit margin 0.09 ROA 0.04 1997 0.16 0.09 0.04

From the above given data the performance of the company for the year 1996 and 1997 is found. The performance of the company, in terms of operating profit margin, decresed slightly in 1997 than in 1996. It was due slight decrease in the Earning Before Interest and Taxes (EBIT). Net profit margin and Return On Asset (ROA) remains constant for both the years. The graphical presentation of these profitability is given below:

19

Efficiency Ratio
Efficiency ratio FAT TAT 1996 1.25 0.48 1997 1.36 0.51

Fixed asset turnover measures the company's ability to use its fixed assets to generate sales and Total asset turonver measures the company's ability to use its total assets to generate sales. Here the results of both fixed asset turnover and total asset turnover tells that the companys performance is improving. The trend of fixed asset turnover and total asset turnover are in increasing trend. Fixed asset turnover in 1996 was 1.25 and it increased to 1.36 in 1997. At the same way total asset turnover increased from 0.48 to 0.51 in 1997. Here, the graphical presentation of efficiency ratios is given:

Leverage Ratio
20

Times interest earned

1996 23.44

1997 29.05

Times interest earned ratio shows the company's ability to pay interest expenses with the current level of business activities. The times interest earned ratio for the company shows positive trend. This ratio is on increasing pattern. In the year 1996 the ratio was 23.44 which increased to 29.05 in 1997. So the companys performance is improving in terms of times interest earned. The graph for this ratio is given below:

4.3. DuPont Analysis

The DuPont system divides the ratio into several components that provide insights into the causes of a firms ROE and any change in it. It also provides additional insights into the effect of financial leverage on the firm and pinpoints the effect of income taxes on ROE. ROE is a comprehensive indicator of a firms performance because it provides an indication of how well managers are employing the funds invested by the firms shareholders to generate returns.

21

D U P O N T A N A L Y 9 9I 6 1 9 9 7 1 9 9 8 1 9 9 9 2 0 0 0 2 0 0 1 2 0 0 2 2 0 0 3 2 0 0 4 1S S N e t P r o f i t A T / N 0e.1 7 1 00 s.1 6 1 0 0 .1 6 0 1 0 .1 6 1 3 0 .0 5 8 1 0 .0 6 1 4 0 .1 6 6 8 0 .2 3 0 1 0 .2 6 3 1 t S a le N e t S a l e s / T o t a l A 8s.6e% s 8 .8 % 8 .8 % 8 .9 % 9 .0 % 9 .1 % 9 .2 % 9 .3 % 9 .4 % s t ROA 4 .1 % 4 .5 % 4 .7 % 5 .1 % 5 .4 % 5 .7 % 6 .1 % 6 .6 % 7 .0 % A 4 .1 % 4 .5 % 4 .7 % 5 .1 % 5 .4 % 5 .7 % 6 .1 % 6 .6 % 7 .0 % T o ta l A s s e ts /S to c k h ld rs . E q u ity 1 0 6 .6 %1 0 6 .1 %1 0 5 .7 %1 0 5 .3 %1 0 4 .9 %1 0 4 .6 % ROE 5 .4 % 5 .7 % 6 .1 % 6 .5 % 6 .9 % 7 .3 %

NPM TAT LEVERAG E ROE

1 7 .1 % 1 6 .1 % 1 6 .0 % 1 6 .1 % 5 .8 % 6 .1 % 1 6 .7 % 2 3 .0 % 2 6 .3 % 8 .6 % 8 .8 % 8 .8 % 8 .9 % 9 .0 % 9 .1 % 9 .2 % 9 .3 % 9 .4 % 1 0 6 .6 %1 0 6 .1 %1 0 5 .7 %1 0 5 .3 %1 0 4 .9 %1 0 4 .6 % 5 .4 % 5 .7 % 6 .1 % 6 .5 % 6 .9 % 7 .3 %

Interpretation: The three factor model shows that financial leverage attributed most to the ROE to rise. Here we see that ROE is more sensitive with leverage than to assets and profit margin. The sensitivity of ROE is also changes dramatically as the time changes.

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Chapter 5 RISK ANALYSIS

Risk of Oriental Land can be categorized in four types: 1. Business Risk 2. Financial Risk 3. Country risk

5.1 Business Risk

Qualitative Risk Analysis

Product Obsolescence: Product obsolescence is reasonably moderate. Sensitivity with Business Cycle: The business is sensitive with business
cycle. As the present economic condition is downturn, the risk is said to be high. It implies when the economic condition will improve the risk may reduce.

Natural disaster: Earthquake hit Japan frequently. The amusement park

like Tokyo Disney Land can be destroyed.

Availability of Raw Materials: The raw materials are not available.

This type of business needs huge investment. Quantitative Risk Analysis

Volatility of Sales and Earnings:

Ave. Sales STD. Sales CV of Sales 2024.689 711.7342 0.351528

Interpretation: As C.V. of Sales is less than .5 for the end of year 2004. The sales volatility of Oriental Land is moderate because the sales had not been very steady over the last few years. We can interpret it in this way that the company is involved in such a business that there is not possibility of risk arising from the volatility of sales.
Ave. EBIT STD. EBIT CV of EBIT 260.3333 119.1164 0.457553

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Interpretation: By scrutiny last nine years earnings it was found mean earnings volatility is .4575 which is Moderate.

Degree of Operating Leverage (DOL):

Business risk depends in part on the extent to which a firm builds fixed cost into its operations- if fixed cost is high, even in small decline in sales can lead to a large decline in ROE. So, other things being constant, the higher a firms fixed costs, the greater its business risk. In a word, if high percentages of total costs are fixed, then the firm is said to have a high degree of operating leverage.

1996 Sales % change in Sales EBIT % change in EBIT

248. 5 1453.2

1997
1533.3 0.0551 246.9 -0.0064

1998
1564.9 0.0206 250.5 0.0146

1999

2000
1596 .1 0.01 96 94.6 0.63 2 32.2 4

2001
1627 .4 0.02 03 101. 9 0.07 72

2002
1660.4 0.4944 282.5 1.7723

2003
2481.3 0.2101 397.4 0.4067

2004
3002.7 0.1000 463.4 0.1661

0.0199 257.3 0.0271

DOL
-0.11681

0.7074 92

1.3615 49

3.80 55

3.5848 09

1.9355 74

1.6611 82

DOL is the only component of the overall business risk of the firm. The principal factors giving rise to business risk are variability of sales and production costs. The degree of Operating Leverage magnifies the impact of these factors on the variability of operating profit. DOL of -.1168 for 1997 indicates that for 1% change in sales causes a percentage change in EBIT that is .1168 for 1997. 24

BUSINESS RISK HIGH

5.2 Financial Risk
Degree of Financial Leverage (DFL): Financial risk is the additional risk placed on the common stock holders as a result of the decision to finance with debt. The use of debt or the financial leverage, concentrates the firms business risk on its stockholders. This concentration of business risk occurs because debt holders, who receive fixed interest payments, bear none of the business risk.

Interpretation: The DFL of Oriental land is not within a reasonable range which does pose threat to the stockholders interest. After 2003 the degree of financial leverage would be 5.82.

Time Interest Earned (TIE): TIE measures the firms ability to

measure all the fixed financial obligations such as interest payment by appropriately redefining numerator.

25

Interpretation: Time interest earned is decreasing after 1999. In the first year it is 27.85 times and in 2004 it will be 11.36 times

FINANCIAL RISK IS LOW

5.3.Country Risk Japan: Political risk: There is a political stability in Japan. Socio economic conditions and investment profile
is favorable for the investors both from home and abroad. Intensity of external and internal conflicts is very limited and the country is ranked in very good position in case of eliminating corruption from the country. There is a systermatic law enforcement system which elables the country to eliminate all sorts of inequility. Japan is a constitutional monarchy where the power of the Emperor is very limited. As a ceremonial figurehead, he is defined by the constitution as "the symbol of the state and of the unity of the people". Power is held chiefly by the Prime Minister of Japan and other elected members of the Diet, while sovereignty is vested in the Japanese people State intervention in economic affairs is always closely watched by investors for what it means for their decisions on where to allocate money, although this is usually more of a worry in emerging markets than in developed economies.

Economic Risk:
Japan is the third largest national economy in the world, after the United States and China, in terms of nominal GDP, and the fourth largest national economy in the world, after the United States, China and India in terms of purchasing power parity. After achieving one of the highest economic growth rates in the world from the 1960s through the 1980s, the Japanese economy slowed dramatically in the early 1990s, when the "bubble economy" collapsed, marked by plummeting stock and real estate prices. Japan eventually recovered from its worst period of economic stagnation since World War II. Real GDP in Japan grew at an average of roughly 1% yearly in the 1990s, compared to growth in the 1980s of about 4% per year. 26

 Financial Risk:
Japan's public debt was more than 200 percent of its annual gross domestic product, the largest of any nation in the world. According to Moody's rating Japan's long-term sovereign debt rating is Aa2 inline with the size of the country's deficit and borrowing level. The service sector accounts for three quarters of the gross domestic product. Japan has a large industrial capacity, and is home to some of the largest and most technologically advanced producers of motor vehicles, electronics, machine tools, steel and nonferrous metals, ships, chemical substances, textiles, and processed foods.

USA Political risk:

Political risk is becoming a growing concern for investors in the United States as the government plays a larger and more controversial role in private enterprise because of the financial crisis. Political risk is becoming more of a U.S. issue as some investors howl over what they see as arbitrary intrusion by the government in business affairs. In assessing political risks in emerging markets, investors often look at factors such as the stability of the government and the soundness of its economic policies. In developed countries, they assess things such as proposed changes to the tax system and the resulting impact on corporate profits. Risks in the United States include fears the dollar could dive because of the rapidly growing budget deficit and the potential for inflation because of radical moves by the Federal Reserve to flood the financial system with money.

Economic Risk:
The US has the most powerful, diverse, and technologically advanced economy in the world, with a per capita GNP of $21,800, the largest among major industrial nations. In 1989 the economy enjoyed its seventh successive year of substantial growth, the longest in peacetime history. The expansion featured moderation in wage and consumer price increases and a steady reduction in unemployment to 5.2% of the labor force. In 1990, however, growth slowed to 1% because of a combination of factors, such as the worldwide increase in interest rates, Iraq's invasion of Kuwait in August, the 27

subsequent spurt in oil prices, and a general decline in business and consumer confidence. Ongoing problems for the 1990s include inadequate investment in education and other economic infrastructure, rapidly rising medical costs, and sizable budget and trade deficits.

Financial Risk:
The nation endured a deep recession throughout 1982. Business bankruptcies rose 50 percent over the previous year. Farmers were especially hard hit, as agricultural exports declined, crop prices fell, and interest rates rose. But while the medicine of a sharp slowdown was hard to swallow, it did break the destructive cycle in which th economy had been caught. By 1983, inflation had eased, the economy had rebounded, and the United States began a sustained period of economic growth. The annual inflation rate remained under 5 percent throughout most of the 1980s and into the 1990s.

FINANCIAL RISK: FINANCIAL COMPONENTS RISK Maxi. Score U.S.A Japan

Sequence

A B C D E

Foreign debt as a % of GDP Foreign debt service as % of exports C/A as a % of exports Net int'l liquidity as months of import cover Exchange rate stability
Total

10 10 15 5 10 50

10 10 15 5 10 50
Very Low Risk

9 9 15 4 9 46
Very Low Risk

Economic Risks:
Sequence ECONOMIC RISK Components Maxi. Score U.S.A Japan

A B C D E

GDP per head Real GDP Growth Annual Inflation rate Budget balance as a % of GDP Current account as a % of GDP
Total

5 10 10 10 15
50

5 10 9.5 9 15
48.5 Very Low Risk

5 10 10 8 15
48 Very Low Risk

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Sequence A B C D E F G H I J K L

Political Risk Component Government Stability Socioeconomic Conditions Investment Profile Internal Conflict External Conflict Corruption Military in Politics Religious Tensions Law and Order Ethnic Tensions Democratic Accountability Bureaucracy Quality Total Label of risk

Points (max.) 12 12 12 12 12 6 6 6 6 6 6 4 100

U.S.A 12 10 11 11 10 3 6 4 5 5 6 2 85 Very Low Risk

Japan 12 11 10 11 11 4 6 4 4 5 6 3 87 Very Low Risk

Political risk:

Composite Risk Rating: CPFER = 0.5(PR+ER+FR) Category of Risk Political Risk Economic Risk Financial Risk Total CPPFER Risk level
U.S.A Japan

85
48.5

87
48

50 183.5 91.75 Very Low risk

46 181 90.50 Very Low Risk

According to the ICRG rating system, U.S.A gets the highest score of 91.75 out of 100, Japan gets almost same score of 90.5 that is 1.25 less than U.S.A. However, these two countries get Very Low Risk rating.

COUNTRY RISK IS LOW

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Chapter 6 Prospective Analysis

Assumptions of Method:
A seven year projection with sensitivities was computed by OLs planning department. Future income and expenses were estimated for up to seven years based on 1996-1997 historical data. The following financial assumptions were made: 1. An initial capital investment in Tokyo DisneySea park 400 billion (US$3.4 billion) will be made in 2000

2. The number of visitors will remain the same during the next four years and will increase 30% in 2002 when Tokyo DisneySea Park will be opened. They will increase 10% in 2003 and 2004. In 1997, the average admission fee per person was 10,421 (US$88.30). Given the deflationary climate, admission fees will increase by 2% annually during the four years after 1997, and will increase by 15% in 2002 at the opening of Tokyo DisneySea Park and will again increase by 10% in 2003. In 2004, admission fees will remain at the same rate as in 2003. If the new project is not undertaken, the number of visitors will remain the same during the seven year period and administrative fees will increase by 2% annually over those seven years. 3. Opening cost other than depreciation (67% of sales, the ratio of 1997 data), administrative expense (7%) and other expenses (4%) will increase proportionately with the increase in sales. These projections will be applied despite OLs decision to invite or not.

4. Depreciation of the 400 billion (US$3.4 billion) investment in 2000 will be conducted using the straight line method over 20 years.

5. Terminal value= CF for the fifth year/ discount rate

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6. Funds borrowed as of 1997 totalled 23 billion (US$195 billion), for which

interest payments in 1997 were 1 billion (US$8.5 million) (the debt interest rate is 4.34%). It was assumed that the cost of future borrowing would be 4.34% (the same as that in 1997). It was also assumed that for future investments, twothird would be financed by the internal holding reserves and capital increases (including the issuance of preferred stocks) and the one- third would be financed by borrowings. This assumption was made based on the past performance of the company.

7. The Japanese rate of taxation was 43%.

6.1 Valuation of the Oriental Land Without the Project

Outcome: The valuation has been done using above mentioned assumptions and the results are as follows in Million-

Enterprise Value Equity Value Equity value per share

$5,148.25 $4953.25 4.95

6.2 Simulation Analysis (by using Crystal Ball)

Probability distributions are assign to each of this factors based on managements assessment of the probable outcomes. Thus the possible outcomes are charted for each factor according to their probability of occurrence. Once Probability distributions are determined the next step is to determine the internal rate of return or NPV calculated at the risk free rate that will result from the random combination of the factors. This is how simulation analysis works.

Assumptions of Simulation:
Assumption: Administrative expenses Triangular distribution with parameters: Minimum 6% Likeliest 7% Maximum 8%

31

Assumption: Admission fees(US $)

Lognormal distribution with parameters: Location Mean Std. Dev.

0% 2% 0%

Assumption: Operating cost

Location Mean Std. Dev.

Assumption: Other expenses

0% 67% 7%

Normal distribution with parameters: Mean Std. Dev.

4% 0%

Assumption: Taxes

Lognormal distribution with parameters: Location Mean Std. Dev.

Assumption: WACC

0% 43% 4%

Lognormal distribution with parameters: Location 0.00% Mean 5.00% Std. Dev. 0.50%

Enterprise Value

32

Trials Mean Median Mode Standard Deviation Variance Skewness Kurtosis Coeff. of Variability Minimum Maximum Range Width Mean Std. Error

Forecast values 1,000 $5,172.27 $5,145.24 --$1,425.35 $2,031,636.3 4 0.0773 3.18 0.2756 $720.81 $9,866.34 $9,145.53 $45.07

Interpretation: From the simulation analysis, we can state that, the mean enterprise value is 5172.27, whereas the CV is 27.56% which implies the low riskiness of the firm.

Equity Value

33

Interpretation: From the simulation analysis, we can state that, the mean equity value is 4977, whereas the CV is 28.64% which implies the low riskiness of the firm.

Trials Mean Median Mode Standard Deviation Variance Skewness Kurtosis Coeff. of Variability Minimum Maximum Range Width Mean Std. Error

Forecast values 1,000 $4,977.27 $4,950.24 --$1,425.35 $2,031,636.3 4 0.0773 3.18 0.2864 $525.81 $9,671.34 $9,145.53 $45.07

Upside & Downside Risk in Enterprise Value

34

Variable Operating cost WACC Taxes Other expenses Administrative expenses Admission fees(US $)

Enterprize Value Downsid e Upside Range $6,841.5 $3,441.6 $3,399.9 8 0 9 $5,975. $4,611.9 $1,363.6 58 5 4 $5,551. $4,907.1 88 7 $644.72 $5,352. $5,148.1 08 3 $203.95 $5,327. $5,173.1 08 3 $153.95 $5,186.6 $5,323. 4 25 $136.61

Input Downsid e 59% 4.38% 38% 3% 7% 2% Upside 76% 5.65% 49% 5% 7% 2% Base Case 67% 4.98% 43% 4% 7% 2%

Interpretation: From the tornado chart it can be observed that enterprise value is most sensitive positively with WACC and negatively with the operating cost.

Sensitivity Analysis:

35

Interpretation: As in the Sensitivity chart followed by this simulation graph shows that the enterprise value is most sensitive to the changes in operating cost and the sensitivity accounts for 64.8%. Next to WACC it is sensitive with discount rate.

Interpretation: As in the Sensitivity chart followed by this simulation graph shows that the equity value is most sensitive to the changes in operating cost and and the sensitivity accounts for 64.8%. Next to WACC it is sensitive with discount rate.

Chapter 7 Project Analysis

36

In 1997, Japan's Oriental Land Corporation and the Walt Disney Company, its licenser for Tokyo Disneyland, had intense discussions about the possibility of building an additional theme park called Tokyo DisneySea Park. The difference in the economic and political assessment of the project between the American and Japanese firm was the root cause of disagreement. Japan and USA use significantly different capital budgeting techniques. The difference in decision making between Japanese and American firms also reflects the difference in corporate governance techniques between the two countries. For example, the principles of discounted cash flow, such as the new present value (NPV) and the internal rate of return (IRR), are widely used outside the realm of Japanese corporate finance. Although familiar with these tools, Japanese executives rarely use them and often consider them invalid tools for the decision-making process. Instead, Japanese corporations have come to rely on the average accounting return method for their financial analyses. The reason behind Japanese businesses rejecting NPV and IRR lies in Japan's socio-economic conventions and the nation's history. Major theme parks problems Theme parks as destination attractions Problems to be addressed Need for larger site Traffic Large amounts of water required Seasonability in employment in most areas Disney Sea Park can overcome all the problem through its huge available land and Japan was an island country surrounded by seas. American corporate financiers differed greatly from their Japanese counterparts in their evaluation of the 400 billion investment for the development of the Disney Sea Park in 2000. Using the American method, a positive NPV was calculated and the IRR was higher than the hurdle rate of OL. This suggested that the Disney Sea Project was an appropriate and feasible investment. Conversely, from the perspective of the traditional Japanese average accounting return method, the rate of return was very low and even reflected negative figures. Using this method, the Disney Sea Park seemed neither attractive nor sensible. IBJ the main bank of OLs tried to mediate the diverging projections. IBJ told OL that upon successful conclusion of the mediation between OL and WD, they would be interested in financing the project if the project analysis appropriately combined both the American and Japanese methods. With regard to the analyses, IBJ presented a third method which is average cash flow return method.

7.1 Valuation of the Oriental Land With the Project

Outcome: The valuation has been done using above mentioned assumptions and the results are as follows in Million37


Enterprise Value Equity Value Equity value per share $8354.20 $8159.20 8.15

7.2 Simulation Analysis (by using Crystal Ball)

Probability distributions are assign to each of this factors based on managements assessment of the probable outcomes. Thus the possible outcomes are charted for each factor according to their probability of occurrence. Once Probability distributions are determined the next step is to determine the internal rate of return or NPV calculated at the risk free rate that will result from the random combination of the factors. This is how simulation analysis works.

Assumptions of Simulation:

Assumption: Administrative expenses Triangular distribution with parameters: Minimu m 6% Likeliest 7% Maximu m 8% Assumption: Operating cost Lognormal distribution with parameters: Location 0% Mean 67% Std. Dev. 7% Assumption: Other expenses Normal distribution with parameters: Mean 4% Std. Dev. 0%

38

Assumption: Taxes Normal distribution with parameters: Mean Std. Dev.

43% 4%

Assumption: WACC Lognormal distribution with parameters: Location 0.00% Mean 5.65% Std. Dev. 0.57%

Enterprise Value

39

Trials Mean Median Mode Standard Deviation Variance Skewness Kurtosis Coeff. of Variability Minimum Maximum Range Width Mean Std. Error

Forecast values 1,000 $8,467.43 $8,448.52 --$2,137.07 $4,567,064.2 8 0.1243 3.27 0.2524 ($306.28) $16,577.98 $16,884.25 $67.58

Interpretation: From the simulation analysis, we can state that, the mean enterprise value is 8467.43, whereas the CV is 25.24% which implies the low riskiness of the firm.

Equity Value

Interpretation: From the simulation analysis, we can state that, the mean equity value is 8272.43, whereas the CV is 25.83% which implies the low riskiness of the firm.

40

Trials Mean Median Mode Standard Deviation Variance Skewness Kurtosis Coeff. of Variability Minimum Maximum Range Width Mean Std. Error

Forecast values 1,000 $8,272.43 $8,253.52 --$2,137.07 $4,567,064.2 8 0.1243 3.27 0.2583 ($501.28) $16,382.98 $16,884.25 $67.58

Upside & Downside Risk in Enterprise Value

Variable

Enterprise Value Downsid Upside Range

Downsid

Input Upsid

Base

41

Operating cost WACC Taxes Other expenses Administrative expenses

e $10,869. 65 $9,776.5 5 $8,897.5 7 $8,650.5 6 $8,613.3 1

e $5,804. 29 $7,377. 80 $8,099. 69 $8,346. 71 $8,383. 95 $5,065. 36 $2,398. 75 $797.88 $303.85 $229.36 59% 4.95% 37% 3% 7%

e 76% 6.39 % 49% 5% 7%

Case 67% 5.62% 43% 4% 7%

Interpretation: From the tornado chart it can be observed that enterprise value is most sensitive positively with WACC and negatively with the operating cost.

Sensitivity Analysis:

Interpretation: As in the Sensitivity chart followed by this simulation graph shows that the enterprise value is most sensitive to the changes in operating cost and the sensitivity accounts for 64.8%. Next to WACC it is sensitive with discount rate.

42

Interpretation: As in the Sensitivity chart followed by this simulation graph shows that the equity value is most sensitive to the changes in operating cost and and the sensitivity accounts for 64.8%. Next to WACC it is sensitive with discount rate.

Chapter 8 Problem Analysis

The problem statement in concise format can be listed as below1. Whether Oriental Land undertakes the project in current weak economic

condition?
2. Whether the companys current profitability and earnings capability would be

able to sustain the investment period?

3. Whether Disney Sea Park creates any non-financial benefit? 4. Is Tokyo Disney Sea Park brings success for both USA and Japan?

Solution of problem 1
Tokyo Disney Sea Park was to be a unique institution, a first of its kind in the world. Japan was an island country surrounded by sea and as such the Japanese had a strong attachment to a theme concerning the sea. The target audience was those adults who had been children when Tokyo Disneyland had been introduced. The economic conditions in 1997 were weak, OL had to decide whether to undertake a project as large 43

as the Tokyo Disney Sea Park. To solve this problem we do scenario analysis based on with the project and without the project. There is calculated enterprise value based on changing the number of visitors in each year. The first scenario is If number of visitors will be decreased by 10% for the reason of economic downturn in every year then what will be enterprise and equity value?

Probability Enterprise Value Enterprise Value (Without the Project) (With the Project)
10% 20% 30% 40% 50%
$3,072.82 $1970.09 $1,395.56 $1,106.26 $960.79 $3,838.20 $2,711.49 $2,125.23 $1,830.87 $1,683.65

Probability Equity Value (Without Equity Value (With the Project) the Project)
10% 20% 30% 40% 50% Here under first scenario the
$2,877.82 $1,775.09 $1,200.56 $911.26 $765.79 $3,643.20 $2,516.49 $1,930.23 $1,635.87 $1,488.65

enterprise value without the project is $3072.82 million

and with the project is $3838.20 million and the equity value without the project is $2877.82 million and with the project is $3643.20 million. We consider the probability of decreasing the number of visitors up to 50%. Under all scenario enterprise value and equity value with the project is higher than the without the project. So, Oriental Land undertakes the project in current weak economic condition.

Solution of problem 2
In 1997 and 1998 the net income and cash flow are positive. An initial capital investment n Tokyo Disney Sea Park of 400 billion (US $3.4 billion) will be made in 2000. If the OL take the project, net income will decrease but cash flow will increase. The depreciation amount will be increased for the reason of investing a new project. In 2002 the number of visitors will increase for the Disney sea Park. In 2002 net income will increase more under new project than that of OL existing project and it will continue up to 2004. The net income would show positive in 2000 and 2001. So the 44

companys current profitability and earnings capability would be able to sustain the investment period. The new project will generate the income after 2003.

Without the project

1997 Depreciati on Income Cash flow 93.9 134.7 228.6 1998 93.9 138.7 232.6 1999 93.9 142.8 236.7 2000 93.9 147 240.9 2001 93.9 151.5 245.4 2002 93.9 156 249.9 2003 93.9 160.6 254.5 2004 93.9 165.6 259.5

With the project

1997 Depreciati on Income Cash flow 93.9 134.7 228.6 1998 93.9 138.5 232.4 1999 93.9 142.8 236.7 2000 263.3 22.5 285.8 2001 263.3 29.9 293.2 2002 263.3 134.4 397.7 2003 263.3 201.6 464.9 2004 263.3 240.9 504.2

Solution of problem 3
Stake holders position analysis in case of taking the project: Most of the stake holders are opposing the proposed project of Tokyo Disneyland and the DisneySea Park as the licenser (Walt Disney Company) not giving anything. Walt Disney Company was not taking any risk but demanding a high royalty on admission fees and sales of foods and beverages. The points why most of the stake holders oppose the projects are given below: Stake holder Relationship OL 1. Risk is not being shared with WD. Mitsui Real Estate Group 20.48% owner of OL 2. 10% royalty is not rational. 3. Future is always uncertain. So a contract of 50 years does not 45 with Point of Objection

make sense.
1. No investment and no risk

IBJ and Mitsui Trust Bank

Banker of OL

taking

by

WD.

So

collecting royalty fee is not justifiable.

American management and Japanese management Management Goals Strategies Main function Organization Main Member Relation to Stockholder Business Transaction Japanese Firm American Firm Market share Return on Investment Long-term Short-term Production, Selling and Finance & Planning R&D Organic Employees Open Market and Keiretsu Long Mechanic Stockholder Open market and family group Short

Differences in American and Japanese corporate governance: There is a huge differece in American and Janpanese corporate governance culture. Because of these differences the decision changes in case of operating business and taking projects in America and Japan. The problem intensifies when a company from any of these countries operates its business in the other country. The differences in the corporate governance between these two countries are given below: Points of differences Corporate governance system Board member Objective of the firm In America Anglo-American type In Japan Japanese-German type

Fewer than 15 More than 30 Maximizing return of the Maximizing corporate wealth shareholders and benifit for all stakeholders Average Accounting Return (Stakeholders)

Capital

budgeting NPV, IRR

techniques Agency problem

(AAR) Agents (Managers) are Principals goals 46 goals

likely to have their own themselves can have different

Term

of

value Short

term

value Long

term

value

maximization Employment strategy

maximization to meet the maximization market expectation Mostly temporary permanent available is but Mostly permanent but

also temporary is also available

For these differences in corporate governances the decision is affected in Japan in case of taking projects like Tokyo Disneyland and DisneySea park. But its existing project Walt Disney made profit despite hefty icensing fees that were an average 7% of sales. Although main stakeholder were not agreed but Tokyo Disney Land bring success. Tokyo Disney Sea Park can also create huge employment opportunity. The project will directly add new jobs as a result of its construction and operation. It will also induce new jobs as a result of income spent by workers filling these direct jobs, and may, in addition, result in indirect employment, to that extend that direct employment leads to local purchases of materials and services. The additional employment generated by the proposed project is a beneficial impact for job growth in Japan.

Solution of problem 4
NPV IRR ARR ACR
$415.24 8.5% -1.05% 7.41`%

The project will be successful for both Walt Disney and Disney Sea Park. There is done financial feasibility study of the Disney Sea Park project. Using the American, a positive NPV was calculated and IRR is higher than the hurdle rate. This suggested that the Disney Sea Project was an appropriate and feasible investment. Walt Disney is also charged large amount of licensing fee. Walt Disney can collect a fixed amount of money from Disney Sea Park. Whereas Disney Sea Park represented a key part of OLs strategic vision. This is needed to convince WD and OLs stakeholders to commit to this new venture. The cash flow return method showed a return on the investment higher than calculated under the traditional average accounting return method. IBJ is a main bank of OL and it would be interested in financing the project.

47

Recommendation
Determining the risk and evaluating the project we come to the conclusion that the project should be accepted.
The accounting cash flow return method have fulfilled the threshold except for the ARR

NPV and IRR have also fulfilled the threshold. In Anglo-American market, the firms have to strive to maximize the return of shareholder.

Cash flow with the project is higher than the cash flow without the project and

net income with the project will be increased up to 240.9 million in 2004. Enterprise value with the project is $8,354.20 which is higher than the
without the project

In Japanese market a firm had to treat shareholder on a par with

other stakeholder, such as management, labor, suppliers, creditors, the local

community and the government. In Oriental Land Banks hold 28.35% share of the company. IBJ is an OLs main bank and it would be interested in financing the project. If the project will incur profit, creditor as well as government will be benefitted. This project focus on long term stakeholder wealth maximization 48

49