SHANGHAI DISNEYLAND CASE SOLUTION

The Walt Disney Company established its first theme park in 1955 in Anaheim,
California. The company (also vested in Media Networks, Studio Entertainment, and
Consumer Products) has since opened theme parks in Orlando, Florida, Tokyo, Japan,
and Paris, France. More recently, Disney broke ground in Hong Kong with the intention
of launching Hong Kong Disneyland on Lantau Island for approximately $2 Billion in
hopes of reaching what has largely been an untapped Chinese market.
Given competitor Universal Vivendis current plans to build a theme park for less than
$100 Million in Shanghai around 2006, Disneys entry into Chinas mainland has been a
source of speculation. The main issues surrounding a Shanghai capital investment
include financial potential of a new theme park and the potential qualitative and
quantitative risks involved.
After reading and solving this case, the student should be able to:

Forecast cash flows based upon sensitivities pertinent to a service-oriented

company in an emerging market
Evaluate effect of country risk upon discount rates to determine whether or not to
enter an investment
Understand the financial and economic effects of an emerging market government
on a project
Understand alternative ways of structuring a deal within an emerging market

An MBA student who has solved this case should be able to develop a thorough
understanding of how to evaluate risk and financial return within an emerging market. In
order to do this, the following solution is recommended.

MARKET SIZE ESTIMATIONS

The demographics of potential attendees not only help to size the market for Shanghai
Disneyland, but also determine the required size of the park and average ticket price. This
assessment is crucial since the average Shanghai resident (including both urban and rural)
has an annual income of only $1,000 USD. Although setting an affordable ticket price is
necessary to attract visitors, the tickets should also be priced to cover most of the
operating costs, since ticket prices generate 50% of total park revenues. Determining the
size of the market requires us to look at both the local Shanghai residents and its tourist
market. These groups are discussed below separately.
Shanghai Residents
Rural Households

Rural households were ruled out from this market for several reasons. Most rural
residents live in poverty, inhibiting them from this type of entertainment. Also, rural
residents not considered peasants lack enough disposable income to attend the park after
their normal expenditures have been covered. Therefore, it is very unlikely that Shanghai
Disneyland will capture this market.
Urban Households
Urban Households should be considered for this market for several reasons. Shanghai is
one of the wealthiest cities in China and its residents are considered the trendsetters of the
country. Therefore, its view of this park will influence other Chinese visitors that may
travel to Shanghai Disneyland. Attracting the urban market requires sub-segmenting this
16 million populated group based on their wealth distribution. Even though China has an
income disparity and lacks a middle-income group, it is expected that Shanghais wealth
distribution is slightly improved when compared to the overall country distribution.
Therefore, estimates of the wealth distribution of Shanghai should be assessed separately.
An income floor should be set for the target market to determine the potential penetration
rate for the mid-to-upper income group. The income floor used in this analysis is 30,000
yuan ($3,600 USD), which reduces the urban segment to 5 million. The percentage of
attendees estimated in this mid-to-upper group (80%) comprise of roughly 4 million
visitors.
Tourist Market
Domestic Tourists
The tourist industry in Shanghai is very large and provides a large influx of money into
the city. In 2000, 65.5 million domestic tourists visited Shanghai. Many of the tourists
were visiting Shanghai to conduct business, shop, or visit family and friends. A
conservative estimate of the penetration rate of this market is required. In our assessment,
12% was assumed for the mainland domestic tourists and 1% for the overseas domestic
tourists, which adds roughly 7.8 million visitors to the captured market for Shanghai
Disneyland.
Foreign Tourists
The same methodology applied for domestic tourists is considered for the foreign
segment. However, only 5% of this market will add an additional 75,000 to the captured
market.
Shanghai Disneylands 2010 Captured Market
Based on the demographic information provided, the key segments for Shanghai
Disneyland are local mid-to-upper income urban residents, domestic tourists, and foreign
tourists. The total market size for Shanghai amusement parks is estimated at roughly 72
million. Based on the above market analysis, Shanghai Disneyland is estimated to capture
15% of this market, with a 25% penetration from Shanghai urban residents and a 10%
penetration from the tourist market. This puts Shanghai Disneyland with an estimated

10.64 million visitors in its first year of operation. See Exhibits 1a and 1b for more
details on this analysis.
RISK ANALYSIS
The International Cost of Capital and risk calculator (ICCRC) theory was used to obtain
the cost of capital. To do this, a standard 4% U.S. risk free rate and a 4% U.S. risk
premium with a current U.S. Credit Rating of 93.10 was assumed. The institutional
investor credit rating for China is 58.90 out of 100. These factors provided a 16.10% cost
of equity. To accurately obtain the cost of equity for the Shanghai Disneyland project,
adjustments were made to this implied cost of equity by accounting for project-specific
risks that may differ from the overall risks of the country.
Major risks elements that would be affected by the project were identified and analyzed
and compared to a typical project in China. From this analysis it was concluded that some
components of the sovereign, operating, and financial risks needed to be adjusted. The
details are discussed below and the results are contained in Exhibit 2.
Sovereign Risks
The principal risk in a communist country is most likely expropriation. However, this risk
has been mitigated in this project since the government will have a controlling equity
stake (57%) in the project. Also, the Governments dependence on Disney to operate and
market the venture mitigates any major expropriation risk.
Shanghai Disneylands cash flows will not be greatly affected by currency risk since the
majority of the cash flows and debt service will be in the local currency.
The sensitivity of the project to wars, strikes, and terrorism is higher than the average
foreign investment project in this country. The tourism industry is significantly affected
by strikes, and war or terrorism would clearly have a severe and adverse impact on
revenues in this sector. Having a company that is an American cultural icon as a large
equity holder could further increase these risks.
China is a country with a considerable level of risk for natural disasters, but the projects
location in Shanghai reduces the overall risk of natural disasters when compared to
country averages.
Operating and Financial risks
There are a number of relevant operating risks, including possible cannibalization from
Hong Kong Disneyland. However, a minor amount of cannibalization can be expected
given the infrastructure of the country and the relatively light travel patterns of the
population between these areas.

The technology for this project would be provided by Disney, therefore there are no
financial mitigating factors; rather, this project is closely tied to the government.
In summary, the adjustments for the tourism sector and the project specific risks reduce
the cost of equity required by the shareholders from 16.10% to 16.09%.
CASH FLOW ANALYSIS
The assumptions and results of the cash flow analysis used in this solution are
documented below.
Capital Structure
The capital structure information is summarized in Exhibit 9.

The project was conservatively assumed to be $1.27B (based on the Hong Kong
park and Universals investment in Shanghai), including $70M for construction of
one hotel
Structure is 60% Debt / 40% Equity with Disney holding 43% of the equity
Investment schedule of the capital is spread over 5 year construction period from
2004-2008
On-going capital expenditures are assumed to start at $38.52M in 2009 and grow
by 3% (inflation) every year; these are for new attractions at the park and
upgrades for the hotel

Revenues
Revenues were assumed to come from the following sources: park admissions,
merchandise, food and beverage, main entrance fees (parking, lockers, etc.), and hotel
revenues. The revenue calculations are summarized in Exhibits 5, 6, and 7.
Admissions revenues were based on attendance figures from Exhibit 1B and ticket price
information from Exhibit 5. An initial attendance of 10.64M was assumed for 2008 and
based on past attendance figures for other Disney venues, this number was expected to
grow at a 1.5% annual rate. To keep things simple, only two ticket types were assumed
a one-day pass and an annual pass. 90% of attendance is expected from one-day passes.
Merchandise and food and beverage revenues were estimated assuming a fixed level of
income ($5.03 each for merchandise and food & beverage in 2008) for each visitor to the
park. This number was based on information from other Disney parks adjusted for the
Shanghai market.
Main entrance fees are small and were assumed to be $0.5M in 2008. It was assumed
this number would grow every year at the rate of inflation (3%).

Finally, hotel revenue assumptions are summarized in Exhibit 7. These conservative

estimates were based on a moderate level hotel.
Operating Expenses
Operating expense information is summarized in Exhibits 3, 7, and 8.

Park operating expense information (Exhibit 8) was based on data from other
Disney venues adjustments, particularly for cheaper labor and merchandise,
were made for the Shanghai market
Hotel operating expenses (Exhibit 7) were assumed to be 65% of hotel revenues
$20M in startup costs for advertising and marketing were assumed in 2008
5% royalty fees that would be paid to Disney were assumed to be an expense for
this project

Debt Repayment
A proposed debt repayment schedule is provided in Exhibit 10.

Debt was taken on according to the investment schedule in Exhibit 9

Repayment begins in 2008 with the beginning of operations
Debt accumulates interest in years 2004-2017
Assumed repayment horizon of 10 years with equal annual payments and an
interest rate of 6%

Depreciation
A depreciation schedule is included in Exhibit 11.

China allows straight-line depreciation over 20 years

Assumed began depreciating assets as soon as investment was made

Taxes
The corporate tax rate in China is 30%. Deductions for interest on debt and depreciation
expenses are allowable. Additionally, losses can be carried forward for five years. Note
in Exhibit 3 that the losses from 2004-2007 were carried forward to 2008 and 2009.
NPV, IRR, and Cash Flows
The NPV, IRR and Cash Flow calculations are summarized in Exhibit 3. The cash flows
were projected out over 25 years and discounted back using the 16.09% cost of equity
discussed in the previous section. The result is a positive NPV of $19.2M and an IRR of
17% (which is greater than the 16.09% hurdle rate).

REAL OPTIONS
Finally, there are a variety of options to consider that could potentially add value to this
project. For example, Disney could wait on constructing a theme park in Shanghai until
Universal Studios opens their operation. This would give Disney the opportunity to
observe Universals undertaking and apply any benchmarks to their project. However,
given Universals relatively poor track record at opening resorts, the value of this option
is likely small. More significant options probably include the following:

Build more hotels at a later date

Build a Downtown Disney entertainment center with shopping, restaurants and
bars after the theme park has established operations
Eventually increase the size of the park by adding another gate, i.e. Epcot
Center in Orlando

Specifically, the hotel option should increase the value of the project. With the existence
of one hotel in the original project, Disney has the opportunity to gauge the market. This
would certainly reduce the uncertainty and risk associated with building more hotels at a
later date. Thus, there should be significant value for Disney in waiting to make a
decision on further hotel construction for this project.
CONCLUSION
Based on these calculations and methodology, the students who review this case will
most likely find that it is indeed a good business proposition for Disney to enter the
Shanghai market. Students writing up this case should not only touch upon the points
listed above, but should also delve into the unquantifiable benefits of expanding the
Disney brand within Chinas market. This point should be especially important should
students find their calculations indicate the project would be a negative NPV or a below
hurdle rate IRR. Recommendations made could also include the following:

Begin negotiations with Chinese government

o Government equity stake and debt provisions
o Land and infrastructure provisions
Disney must make the argument that a Shanghai Park would not substantially
damage Hong Kong
Escalating political tensions on the Korean peninsula could change the risk
assessment