Phuket Beach Hotel Proforma for Final)

Financial Management. EBS ML. 4th course students. Case study. Phuket Beach Hotel. Valuing Mutually Exclusive Capital Projects.

Questions 1. Please asses the economic benefits associated with each of the capital project. What is Initial O What are the incremental cash flows over the life of the project? What is an appropriate discount r to use for discounting the cash flows of the project? SN 1 and SN 2 - 40%

2. Are the project comparable based on the standard NPV measure, given that they have unequal l What adjustment or alternative method is required in comparing such project? - 10% SN 3

3. How sensitive is your ranking to changes in the discount rate? What other "key value drivers" w the attractiveness of the project like patronage factor; amount of upfront investment; cost of capit Please estimate the sensitivity of your result to a change in any of the key value drivers. - SN 4 - 30

4. Which project should the hotel undertake? Why - 10 %

In case of Hotel, I would like to recommend to lease the Bar. First of all because of Payback period is m discounted).secondly Profitability ratio is also much higher, due to the fact that less investments are requ back is EAA which is segnificantly lower as well as ROI. In conclusion, I may say that, in short prospective option may seems to be more profitable in long term (+5 years). The final decision should be undertak because there are different options are available (see Sensitivi 5. Rank the projects using various measures of investment attractiveness. Do all the measure rank Why or why not? Which criterion is the best? - SN 5 - 10%

ect. What is Initial Outlay? propriate discount rate

they have unequal lives? ? - 10% SN 3

key value drivers" would affect stment; cost of capital, any of the key value drivers? ue drivers. - SN 4 - 30%

of Payback period is much shorter ib both scenarios (discounted and noninvestments are required to undertake the project. However the main draw at, in short prospective Lease is option is optimal, however in long term build on should be undertaken after the Hotel will secure a fixed rate of WACC, vailable (see Sensitivity analysis) all the measure rank the project identically?

EXHIBIT TN-1 THE LEASE OPTION: PLANET KARAOKE PUB - ANALYSIS OF OPERATING CASHFLOW

Project life Renovation cost Cost of capital (WACC) Increase in repairs and maintenance Patronage factor (Figure in bath except where otherwise stated) Year Net room revenue* Reduction in net room revenue

4 years 770000 baht 0.11 10000 0.5

0 0.13

Year Rental income Less: Depreciation expenses Increase in repairs & maintenance Reduction in net room revenue (a) Incremental operating income (b), ( c ) Less taxes (30%)

0

Net operating profit after taxes (NOPAT) Add: Depreciation Less Capital Expenditure

1 13200000 1650000

2 13464000 1683000

1 2040000 192500 10000 1650000 187500 56250

2 2040000 192500 10000 1683000 154500 46350

131250 192500 192500

108150 192500 192500

770000 1 770000 Free Cash Flow -770000 323750 300650 PVIF (WACC %) 1 0.9029 0.8153 Discounted free cash flow -770000 292325 245117 Notes:1. Average return on investment (ROI) is calculated as the average of the NOPAT over the life of the project divided by 2. The Equivalent Annual Annuity is that level annual payment over the life of the investment that yields a present value The annuity is determined by solving for "A": A= NPV/PVIFA n,k, where PVIFA =[(1+k)n - 1]/k n=number of periods * Net room revenue = Room revenue - Room operating expenses

(a) Consider externalities. Externalities represent the effect of a project on other parts of the firm. In this case, the possible re

(b) Identify the incremental cash flow. In evaluating the project in this case, we should focus on those cash flows that occur These cash flows, called incremental cash flows, represent the changes in the firm's total cash flow that occurs as a direct resu

( c ) Ignore sunk cost: a sunk cost is an outlay that has already been committed or that has already occurred, hence is not af In this case, the overhead and salary expenses of the excess labor can be considered as sunk cost.

See SN 4 Sensitivity analyses: Cost of Capital PVIFA =[(1+k)n - 1]/k 8% PVIFA =[(1+k)n - 1]/k WACC% PVIFA =[(1+k)n - 1]/k 12 %

PVIFA 3.31210 3.11908 3.03730

Rate 0.0800 0.1075 0.1200

NPV 275944.11 214849.48 188992.20

PVIFA =[(1+k)n - 1]/k PVIFA =[(1+k)n - 1]/k PVIFA =[(1+k)n - 1]/k PVIFA =[(1+k)n - 1]/k PVIFA =[(1+k)n - 1]/k

14% 16% 18% 20% 22%

2.91370 2.79820 2.69010 2.58870 2.49361

0.1400 0.1600 0.1800 0.2000 0.2200

149885.44 113352.73 79173.36 47149.40 17103.01

Patronage factor 0 0.25 0.5 0.75 1 3 14137000 1767125

4 14844000 1855500

3 2142000 192500 10000 1767125 172375 51713

4 2249100 192500 10000 1855500 191100 57330

Decrease in net room revenue 25% 0% 6.25% 12.50% 18.75% 25.00%

Payback Period Discounted payback 120662.5 133770 Average return on investment (ROI) 192500 192500 IRR 192500 192500 MIRR Profitability index 313163 326270 NPV 0.7362 0.6647 EAA 230536 216871 PVIFA =[(1+k)n - 1]/k r the life of the project divided by average the upfront investment. stment that yields a present value just equal to the net present value of the entire cash flow stream. k)n - 1]/k n=number of periods k=discount rate.

e firm. In this case, the possible reduction in room sales should be considered in the analysis for both project.

us on those cash flows that occur if and only if we accept project. sh flow that occurs as a direct result of accepting the project. already occurred, hence is not affected by the decision under consideration.

EAA 83313.94 68882.38 62223.75

2.46 3.01 0.64 23% 18% 1.28 214849 68882.36 3.11908

51441.62 40509.16 29431.38 18213.54 6858.74

EXHIBIT TN-2 THE LEASE OPTION: PLANET KARAOKE PUB - ANALYSIS OF OPERATING CASHFLOW

Project life Upfront investment renovation equipment Tax rate Cost of capital (WACC %) Sales growth rate Food and beverage cost Salary Other operating expense Increase in repairs and maintenance Annual capital expenditure Patronage factor (Figure in bath except where otherwise stated)

6 years 800000 baht 900000 baht 30% 0.11 5% of sales 25 % of sales 16% of sales 22% of sales 10000 baht equal depreciation 0.5

Year Net room revenue* Reduction in net room revenue

0 0.13

Year Sales Less: Food and beverage cost Other operating expenses Depreciation expenses Increase in repairs & maintenance Reduction in net room revenue Incremental operating income

0

1 13200000 1650000 1 4672000 1168000 1027840 283333 10000 1650000 532827

Less taxes (30%)

159848

Net operating profit after taxes (NOPAT) Add: Depreciation

372979 283333 656312 283333

1

1700000

Less Capital Expenditure Upfront investment Free Cash Flow PVIF (WACC%) Discounted free cash flow

1700000 -1700000 1 -1700000

Payback period Discounted payback Average return on investment (ROI) IRR MIRR Profitability index NPV EAA PVIFA =[(1+k)n - 1]/k

3.84 4.95 77% 17% 14% 0.23 373043.3 87544.6 4.26118

372979 0.9029 336775

See SN 4 Sensitivity analyses: Cost of Capital PVIFA =[(1+k)n - 1]/k 8% PVIFA =[(1+k)n - 1]/k WACC % PVIFA =[(1+k)n - 1]/k 12 % PVIFA =[(1+k)n - 1]/k 14% PVIFA =[(1+k)n - 1]/k 16% PVIFA =[(1+k)n - 1]/k 18% PVIFA =[(1+k)n - 1]/k 20% PVIFA =[(1+k)n - 1]/k 22%

PVIFA 4.62290 4.26118 4.11140 3.88870 3.68470 3.49760 3.32550 3.16692

Rate 0.0800 0.1075 0.1200 0.1400 0.1600 0.1800 0.2000 0.2200

Decrease in net room revenue 25% 0 0% 0.25 6.25% 0.5 12.50% 0.75 18.75% 1 25.00%

Patronage factor

2 13464000 1683000

3 14137000 1767125

4 14844000 1855500

5 15140000 1892500

6 15443000 1930375

2 4905600 1226400 1079232 283333 10000 1683000 623635

3 5150880 1287720 1133193.6 283333 10000 1767125 669508

4 5408424 1352106 1189853.28 283333 10000 1855500 717631

5678845.2 1419711.3 1249345.94 283333 10000 1892500 823955

5962787.46 1490696.87 1311813.24 283333 10000 1930375 936569

187090.4

200852

215289

247186

280971

436544 283333 719878 283333

468656 283333 751989 283333

502342 283333 785675 283333

576768 283333 860102 283333

655598 283333 938932 283333

436544 0.8153 355911

468656 0.7362 345003

502342 0.6647 333906

576768 0.6002 346165

655598 0.5419 355284

NPV 566564.19 373043.31 293274.62 175074.01 67335.79 -31091.39 -121211.21 -203901.09

EAA 122556.01 87544.58 71332.06 45021.22 18274.43 -8889.35 -36449.02 -64384.74

Summary of result Lease Option Planet Karaoke Pub Payback period Discounted payback Average return on investment (ROI) IRR MIRR Profitability index

EAA

2.465 3.009 0.641 0.232 0.178 1.279

68882.36

Build Option Beach Karaoke Pub Payback period Discounted payback Average return on investment (ROI) IRR MIRR Profitability index

EAA

3.84 4.95 0.77 0.17 0.14 0.23

87544.58

The Build Option Patronage Factor 0 0.25 0.5 0.75 1

0.08 1370536 746546 122557 -501433 -1125422

0.11 1332436 709990 87545 -534901 -1157347

Cost of Capital 0.12 1314853 693092 71332 -550428 -1172189

0.14 1286391 663706 45022 -575663 -1196348

0.16 1257545 637910 18274 -601361 -1220996

0.14 1245531 640869 36207 -568455 -1173117

0.16 1234011 629862 25712 -578437 -1182587

0.14 40860 24837 8815 -7208 -23231

0.16 23534 8048 -7438 -22924 -38409

The Lease Option Patronage Factor 0 0.25 0.5 0.75 1

Cost of Capital 0.11 0.12 1263950 1256911 658428 651724 52906 46536 -552616 -558651 -1158138 -1163838

0.08 1279229 672952 66676 -539601 -1145877

Difference in EA (Build - Lease) Patronage Factor 0 0.25 0.5 0.75 1

0.08 91307 73594 55881 38168 20455

0.11 64486 51562 34639 17715 791

Cost of Capital 0.12 57942 41368 24796 8223 -8351

Decision Patronage Factor 0 Build 0.25 Build 0.5 Build 0.75 Rej. Both 1 Rej. both 0 Build 0.25 Build 0.5 Build 0.75 Rej. Both 1 Rej. both

0.08

0.11 Build Build Build Rej. Both Rej. Both Build Build Build Rej. Both Rej. Both

Cost of Capital 0.12 Build Build Build Build Build Build Rej. Both Rej. Both Rej. Both Rej. Both Build Build Build Build Build Build Rej. Both Rej. Both Rej. Both Rej. Both

0.14

0.16 Build Build Lease Rej. Both Rej. Both Build Build Lease Rej. Both Rej. Both

Sensitivity Analysis - Two Factors Factors: Cost of Capital and Patronage Factor

Equivalent Annuity (EA) in baht

The Build Option

Patronage Factor

Cost of Capital 0.08

0.11

0.12

0.14

0.16

0

1370536

1332436

1314853

1286391

1257545

0.25

746546

709990

693092

663706

637910

0.5

122557

87545

71332

45022

18274

0.75

-501433

-534901

-550428

-575663

-601361

1

-1125422

-1157347

-1172189

-1196348

-1220996

0.14 1245531 640869 36207 -568455 -1173117

0.16 1234011 629862 25712 -578437 -1182587

0.14 40860 24837 8815 -7208 -23231

0.16 23534 8048 -7438 -22924 -38409

The Lease Option Patronage Factor 0 0.25 0.5 0.75 1

0.08 1279229 672952 66676 -539601 -1145877

0.11 1263950 658428 52906 -552616 -1158138

Cost of Capital 0.12 1256911 651724 46536 -558651 -1163838

Difference in EA (Build - Lease) Patronage Factor 0 0.25 0.5 0.75 1

0.08 91307 73594 55881 38168 20455

0.11 64486 51562 34639 17715 791

Cost of Capital 0.12 57942 41368 24796 8223 -8351

Decision

Patronage Factor 0 Build 0.25 Build 0.5 Build 0.75 Rej. Both 1 Rej. both

0.08

0.11 Build Build Build Rej. Both Rej. Both

Cost of Capital 0.12 Build Build Build Build Build Build Rej. Both Rej. Both Rej. Both Rej. Both

0.14

0.16 Build Build Lease Rej. Both Rej. Both

0.18 1228335 609723 -8889 -627501 -1246114

0.18 1222356 618706 15057 -588592 -1192241

0.18 5979 -8983 -23946 -38909 -53873

0.18 Build Lease Lease Rej. Both Rej. both Build Lease Lease Rej. Both Rej. both

0.18 1228335 609723 -8889 -627501 -1246114

0.18 1222356 618706 15057 -588592 -1192241

0.18 5979 -8983 -23946 -38909 -53873

0.18 Build Lease Lease Rej. Both Rej. both

I. Non-discount Cash flow Techniques a) Payback Period Advantages

Disadvantages 3.84 Build option

2.46 Lease option

Lease option is better because the Hotel will get their investment back quicker! Difference is 14 month b) Average return on investment Advantages

Disadvantages 0.77

0.64 Lease option

Build option

Build option is more profitable in case of return of investments (Hotel may consider it major factor in long term investment plan II. Discount Cash flow Technique

c ) Internal rate of return (IRR) Advantages

Disadvantages 0.23

0.17 Build option

Lease option

Lease option is preferable in case of on running business activities, 0,05 is significant difference in such project, and that can b d ) Modified internal rate of return (MIRR) Advantages Disadvantages 0.18

0.14 Build option

Lease option

Lease is option is more profitable even after all discounted options are taken, therefore it may give a strong argument in short e ) Profitability Index Advantages Disadvantages Lease option Build option 1.28 0.23 Lease option is much profitable f ) Net present Value Advantages Lease option 214849

Disadvantages Build option 373043.31

According NPV the lease option is still better, due to the fact that, difference between Invested Capital is around 1000000, and g) Equivalent Annual Annuity Advantages Lease option

Disadvantages Build option

3.12

4.26

r in long term investment plan)

in such project, and that can be a major factor to choose a Lease option

ve a strong argument in short term invsetment plan, rather than in long-term.

apital is around 1000000, and investers would like to see greater NPV from Build option

Using NPV Function Rate 10.8% N Cash Flows 0 ($770,000) 1 $323,750 2 $300,650 3 $313,163 4 $326,270 NPV $214,849.48

Numerical Solution for NPV Project A Rate 5.0% N Cash Flows PVIF(I%,N) DCF 0 ($770,000) 1 1 $323,750 0.9029 2 $300,650 0.8153 3 $313,163 0.7362 4 $326,270 0.6647 NPV

Using NPV Function Rate 10.8% N Cash Flows 0 -1700000 1 372979 2 436544 3 468656 4 502342 5 576768 6 655598 NPV $373,043.31

-$770,000.00 $292,325.06 $245,117.17 $230,535.89 $216,871.36 $214,849.48

Rate N

Numerical Solution for N 5.0% Cash Flows 0 -1700000 1 372979 2 436544 3 468656 4 502342 5 576768 6 655598

Numerical Solution for NPV Project A PVIF(I%,N)

DCF 1 0.9029 0.8153 0.7362 0.6647 0.6002 0.5419

NPV

-$1,700,000.00 $336,775.32 $355,910.52 $345,002.82 $333,906.23 $346,164.61 $355,283.81 $373,043.31

Rate Time Cash Flow Discounted NCF Cumulative NCF Discounted Payback Period

Project X 12% 0 1 -770000 131250 -770000 292325.06 -477674.94 N/A N/A

2 108150 245117.17 -232557.77 N/A

3 120662.5 230535.89 -2021.88 N/A

4 133770 216871.36 214849.48 3.01

Rate Time Cash Flow Discounted NCF Cumulative NCF Discounted Payback Period

Project Y 12% 0 1 2 -1700000 372978.67 436544.27 -1700000 336775.32 355910.52 -1363224.68 -1007314.17 N/A N/A N/A

3 468655.65 345002.82 -662311.34 N/A

4 502341.97 333906.23 -328405.11 N/A

5 6 576768.24 655598.31 346164.61 355283.83 17759.5 373043.32 4.95 N/A

WACC Time Cash Flows IRR

1% 0 -770000 23.20%

1% 1 323750

WACC Time Cash Flows IRR

1% 0 -1700000 17.35%

1% 1 372978.67

1% 2 300650

1% 3 313162.5

1% 4 326270

Project B 1% 1% 2 3 436544.27 468655.65

1% 4 502341.97

1% 5 ###

1% 6 ###

Project A Cost of Capital N

10.75% Cash Flows 0 1 2 3 4

MIRR

-$770,000 $323,750 $300,650 $313,163 $326,270 17.78%

Project B Cost of Capital 10.75% N Cash Flows 0 -$1,700,000 1 $372,979 2 $436,544 3 $468,656 4 $502,342 5 $576,768 6 $655,598 MIRR 14.47%

WACC Time Cash Flows PI

WACC Time Cash Flows PI

11% 0.9029 0.8153 0.7362 0.6647 0 1 2 3 4 -$770,000 $323,750 $300,650 $313,163 $326,270 1.28

Project B 1 0.9029 0.8153 0.7362 0.6647 0.6002 0.5419 0 1 2 3 4 3 4 -$1,700,000 $372,979 $436,544 $468,656 $502,342 $576,768 $655,598 0.23

N Cash Flow Regular Payback Period

0 ($770,000) N/A

1 $323,750 N/A

2 $300,650 N/A

3 $313,163 2.46

4 $326,270 N/A

N Cash Flow Regular Payback Period

0 ($1,700,000) N/A

1 $372,979 N/A

2 $436,544 N/A

3 $468,656 N/A

4 $502,342 3.84

3 $576,768 N/A

4 $655,598 2.00

0 -770000

1 323750

Project A 2 3 300650 313162.5

4 Sum 326270

ROI 1263832.5

0.64

Project B 0 1 2 3 4 5 6 Sum -1700000 372978.67 436544.27 468655.65 502341.97 576768.24 655598.31

3012887.1

ROI 0.77

Interest Rate Periods Annuity Factor

Annuity Factor 10.75% Interest Rate 4 Periods 3.12 Annuity Factor

10.75% 6 4.26

See SN 4 Sensitivity analyses: Cost of Capital PVIFA PVIFA =[(1+k)n - 1]/k 8% 3.31210 PVIFA =[(1+k)n - 1]/k WACC% 3.11908 PVIFA =[(1+k)n - 1]/k 12 % 3.03730 PVIFA =[(1+k)n - 1]/k 14% 2.91370 PVIFA =[(1+k)n - 1]/k 16% 2.79820 PVIFA =[(1+k)n - 1]/k 18% 2.69010 PVIFA =[(1+k)n - 1]/k 20% 2.58870 PVIFA =[(1+k)n - 1]/k 22% 2.49361

8.00 10.75 12.00 14.00 16.00 18.00 20.00 22.00

NPV -81092.97 29937.55 -57166.40 -49798.75 -44108.70 -39583.13 -35898.39 -32840.38

EAA