The capital maintenance expenditures are low in the early years, when the parks are still new but increase as the parks age. After year 10, both depreciation and capital expenditures are assumed to grow at the inflation rate (2%).

7. Disney will also allocate corporate general and administrative costs to this project, based upon revenues; the G&A allocation will be 15% of the revenues each year. It is worth noting that a recent analysis of these expenses found that only one-third of these expenses are variable (and a function of total revenue) and that two-thirds are fixed. After year 10, these expenses are also assumed to grow at the inflation rate of 2%.

8. Disney will have to maintain non-cash working capital (primarily consisting of inventory at the theme parks and the resort properties, netted against accounts payable) of 5% of revenues, with the investments being made at the end of each year.

9. The income from the investment will be taxed at Disney's marginal tax rate of 37.6%. The projected operating earnings at the theme parks, starting in the first year of operation (which is the second year) are summarized in Exhibit 5.1. Note that the project has no income or expenses until year 2 when the first park becomes operational and that the project is expected to have an operating loss of $262 million in that year. We have assumed that the firm will have enough income in its other businesses to claim the tax benefits from these losses (37.6% of the loss) in the same year. If this had been a standalone project, we would have had to carry the losses forward into future years and reduce taxes in those years.

These operating earnings can be contrasted with the after-tax cash flows in exhibit 5.2, with the projected capital expenditures shown as part of the cash flows. In estimating these cash flows, we have made the following adjustments:

• Added back the depreciation and amortization each year, since it is a non-cash charge

• Subtracted out the maintenance capital expenditures in addition to the primary capital expenditures since these are cash outflows

• Added back the after-tax portion of the allocated general and administrative costs that are fixed and therefore not an incremental effect of the project.

After-tax Fixed Allocated G&A = (2/3) (Allocated G&A Expense) (1 - tax rate) • Subtracted out the working capital requirements each year, which represent the change in working capital from the prior year. In this case, we have assumed that the working capital investments are made at the end of each year. The investment of $3 billion in Bangkok Magic Kingdom is shown at time 0 (as $ 2 billion) and in year 1 (as $ 1 billion). The investment of $0.5 billion that will not be recovered because it has already been spent is not considered because it is a sunk cost.

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