Ray Shore has been a very successful hotel general manager for a number of years. One of his long term colleagues, Joan Benning, is trying to start a small hotel asset management company and wants Ray to join her. Joan has actually scouted out a limited service hotel which just renewed their franchise agreement and is located in a tourist area. This hotel has 108 rooms. Her idea is to have Ray operate this hotel for a few years to ramp up the revenue and profit, and then sell it. The current owners are an older couple, and they are looking at retirement; so they are seeking someone to purchase this asset from them. The hotel is associated with a good brand but Joan thinks she needs to put some money into the project just to give the property a fresh look.
Joan gives Ray the following information. The purchase price is $10 million and she has budgeted to spend another $2.1 million in upgrades and remodeling. In addition, an estimated $775,000 of net working capital is expected to be infused into the project. Joan also expect to recover 100% of the net working capital when she sells the property in the future. If the purchase happens today, Joan would like Ray to manage it for 5 years, and she plans to sell the property at the end of year 5. Although there are different rules for depreciating the building itself and also the improvement on the building, to make this calculation simple, Joan uses a straight-line depreciation of 30 years for this analysis with no salvage value. Of course, when Joan sells this at the end of 5 years, the book value of the undepreciated portion will need to be compared to the sale price to determine any gains or losses, and also the tax implicaitons.
With an independent third-party consultant, Joan has determined that the hotel should reach revenues of $3,500,000 at the end of year 1. The consultant also has estimated a slower growth in sales of only 2.5% per year for the two years (year 1 to year 2, year 2 to year 3) but will then be enjoying a strong growth rate of 10% per year until it is sold at the end of year 5. Expenses for the hotel are estimated to be $2,600,000 for the first year with a growth rate of 5% per year.
To finance the entire purchase, Joan will be issuing bonds and will also be using part of her own savings as equity. She is looking at a 65% debt and 35% equity for this deal. She is issuing bonds with a maturity of 5 years, with a 5% coupon rate paying annual interest payments. The estimated sale price of the bond is at $1,100 due to the very attractive coupon rate in today’s low interest economy. Joan’s cost of equity can be estimated using the Capital Asset Pricing Model. Her average tax rate is at 32% and she has a beta of 1.5. The T-bill rate is 1.5% and the market risk premium is at 8%.
HRMA 4343 Project 2
Using EXCEL, set up all the given parameters for calculations. Label all variables properly. Then:
Tips for Project Completion:
Grading Rubric for Project #2
Since this project is completed in EXCEL, all calculations are expected to be performed within EXCEL using references to the parameters. Calculations done outside EXCEL and the answered typed into EXCEL will not be considered correct. Please again note that the “group” is for you to collaborate and learn from each other. Each student is to do their own EXCEL sheet and turn them in separately.
Criteria Points Points Earned
|Cost of debt||5|
|Cost of equity||5|
|Cost of capital||5|
|Net Cash Flow (Income stm format)|
|Entire Cash flow||30|
|NCF formula as a check||10|
|Capital budgeting decision|
|Investment decision – explain the rationale in full sentences and paragraphs such as the definitions of the methods used (payback, NPV, IRR) and how each decision is derived||15|