Phuket Beach Hotel

Phuket Beach HotelValuing Mutually Exclusive Capital

Projects

Objectives:

• this case aims to come up with a concrete recommendation to the board of directors of Phuket Beach Resort of which of the two alternatives will offer a higher return on investment.

• Also, the paper aims to determine if operating a pub in the hotel, whether by a third party or by management, will be a good investment on the part of the hotel.

Statement of the Problem

• Assess the economic benefits associated with each of the capital projects. What is the initial outlay? What are the incremental cash flows over the life of the project?

• What is an appropriate discount rate to use for discounting the cash flows of the project?

• Should the management of Phuket Beach Resort accept the offer made by Planet Karaoke Pub to set up an outlet inside the hotel or should the management operate a pub, Beach Karaoke Pub, by itself?

Analysis of Important Factorseach project involves two quite

dissimilar amounts:investmentstream of cash inflows

The two projects have unequal lives:Planet Karaoke Pub – 4 yrsBeach Karaoke Pub – 6 yrs

Analysis of Important Factorsthe investment rating procedures are

classified into two categories:methods that do not consider the time

value of moneymethods that consider the time value of

moneyexisting system of Phuket Beach

Hotel regardless of the time value of money:average return on investment payback period

Analysis of Important Factors

Payback Period is the length of time necessary to

recover the entire cost of an investment from the resulting annual net cash flows

A shorter payback period does not always means that one investment is more desirable than another.

Analysis of Important Factors

Return on Investment (ROI) is the average annual net income from

an investment expressed as a percentage of the average amount invested

The higher the rate of return in an investment, the lower the risk of not recovering it.

Alternative Courses of Action

Planet Karaoke Pub Beach Karaoke PubAdvantage Disadvantage Advantage Disadvantage

Additional source of revenue

Will entail additional costs and investment

Venture into a lucrative business spreading fast in the country

Entails costs and investment

Steady source of revenue in the form of “fixed” monthly rental

Problem on allocating overhead costs

Have control over overall pub operations

Presents financial risk to the company should the pub do not perform as expected.

Take advantage of unutilised space

Limited control over overall pub operations

Additional source of revenue

Phuket management lacks experience or expertise on this new segment of business

Table 1 Comparison of Economic Benefits between the Two Financial ProjectsTable 1 Comparison of Economic Benefits between the Two Financial ProjectsTable 1 Comparison of Economic Benefits between the Two Financial Projects

Table 1 Comparison of Economic Benefits between the Two Financial Projects


Planet Karaoke Pub Beach Karaoke PubAdvantage Disadvantage Advantage Disadvantage

Tie-up with a company that is expanding fast in the country (“positive image”)

Complementary pub operation with its hotel business

Opportunity cost of 25% of the patronage may be lost when tourist felt it unsafe.

Company is exposed to lesser risk since it will be a third party who will be doing majority of the investment of the pub

No study was presented whether a pub fits on the Phuket hotel.

Table 1 Comparison of Economic Benefits between the Two Financial Projects


Year 0 Year 1 Year 2 Year 3 Year 4

Rental Income - 2,040,00

0

2,040,00

0

2,142,00

0

2,142,00

0

Less:

Depreciation - 192,500 192,500 192,500 192,500

Increase in repair & maintenance

expenses

- 10,000 10,000 10,000 10,000

Decrease in net room revenue - 1,650,000 1,683,000 1,767,125 1,855,500

Additional Operation Income - 187,500 154,500 172,375 84,000

Less: Taxes - 56,250 46,350 51,713 25,200

Net Operating Income After Tax - 131,250 108,150 120,662 58,800

Add: Depreciation - 192,500 192,500 192,500 192,500

Less: Capital Expenditure 770,000

Operating Cash Flow (770,000

)

323,750 300,650 313,162 251,300

Discounted operating Cash Flow @ 10.75% (770,000

)

292,325 245,117 230,536 167,039

Analysis of Cash Flows – Planet Karaoke Pub(figures in Baht)

Analysis of Cash Flows – Planet Karaoke Pub(figures in Baht)

Table 2: Analysis of Cash Flows – Planet Karaoke Pub (figures in Baht)

Alternative Courses of ActionAnalysis of Cash Flows – Planet Karaoke Pub

(figures in Baht)Analysis of Cash Flows – Planet Karaoke Pub

(figures in Baht)

Table3: Analysis of Cash Flows – Beach Karaoke Pub(figures in Baht)

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6

Sales 4,672,00

0

4,905,60

0

5,150,8

80

5,408,4

24

5,678,8

45

5,962,7

87

Less:

Food & Beverage Cost 1,168,000 1,226,400 1,287,7

20

1,352,1

06

1,419,7

11

1,490,6

97

Other Operating Expenses 1,027,840 1,079,232 1,133,1

94

1,189,8

53

1,249,3

46

1,311,8

13

Depreciation 283,333 283,333 283,333 283,333 283,333 283,333

Increase in repair &

maintenance expenses

10,000 10,000 10,000 10,000 10,000 10,000

Decrease in net room

revenue

1,650,000 1,683,000 1,767,1

25

1,855,5

00

1,892,5

00

1,930,3

75

Additional Operating Income 532,827 623,635 669,50

8

717,63

1

823,95

5

936,56

9

Alternative Courses of ActionAnalysis of Cash Flows – Planet Karaoke Pub

(figures in Baht)Analysis of Cash Flows – Planet Karaoke Pub

(figures in Baht)

Table3: Analysis of Cash Flows – Beach Karaoke Pub(figures in Baht)

Additional Operating Income 532,82

7

623,63

5

669,50

8

717,63

1

823,95

5

936,56

9

Less: Taxes 159,848 187,090 200,852 215,289 247,186 280,971

Net operating Income After Tax 372,97

9

436,54

4

468,65

6

502,34

2

576,76

8

655,59

8

Add: Depreciation 283,333 283,333 283,333 283,333 283,333 283,333

Less: Capital Expenditure 1,700,000 283,333 283,333 283,333 283,333 283,333 283,333

Operating Cash Flow (1,700,000) 372,97

9

436,54

4

468,65

6

502,34

2

576,76

8

655,59

8

Discounted Operating Cash Flow

@ 10.75%

(1,700,000) 336,77

5

355,91

1

345,00

3

333,90

6

346,16

5

355,28

4

Alternative Courses of ActionWeighted Average Cost of CapitalTable 4 Appropriate Discount Rate

*The cost of capital for debt before tax is 10%. Since income tax affects the capital cost, the tax

rate of 30% should be deducted from the original 10%. So,Capital Cost (Debt)= 10% x (100% - 30%)

= 10% x 70% = 7%

Type Capital Cost Weight Weighted Cost

Debt 7%* .25 1.75%

Equity 12% .75 9.00%

Total 10.75%

Weighted Average Cost of Capital

Alternative Courses of ActionTable 5 Computation of NPV - Planet

Karaoke PubPlanet Karaoke Pub

Cash Inflow/ outflow

Discount Factor

Total

Cash Inflows:

Year 1 323,750 .9029 292,325

Year 2 300,650 .8153 245,117

Year 3 313,163 .7362 230,536

Year 4 326,270 .6647 216,871

Cash Outflow:

Year 0 (770,000) 1 (770,000)

NPV 214,849

Table 6 Computation of NPV - Beach Karaoke Pub

Beach Karaoke Pub

Cash Inflow/ outflow

Discount Factor

Total

Cash Inflows:

Year 1 372,979 .9029 336,775

Year 2 436,544 .8153 355,911

Year 3 468,656 .7362 345,003

Year 4 502,342 .6647 333,906

Year 5 576,768 .6002 346,165

Year 6 655,598 .5419 355,284

Cash Outflow:

Year 0 (1,700,000) 1 (1,700,000)

NPV 373,043.31

* NET PRESENT VALUE >> screening decision


*NET PRESENT VALUE >> preference decision

Project Profitability Index= Net Present Value of the project Investment Required

Table 7 Project Profitability Index

Investment

Planet Beach

Net present value

(a)

214,849 373,043.31

Investment required

(b)

770,000 1,700,000

Project profitability

index, (a) ÷ (b)

0.28 0.22


*DISCOUNTED PAYBACK METHOD

Planet Karaoke Pub

Table 8 Computation of Discounted Payback Period - Planet Karaoke Pub


Cash Flow (770,000) 131,250.00 108,150.00 120,662.50 58,800.00

Discounted

Net Cash

Flow

(770,000) 292,325.06 245,117.17 230,535.89 167,039.00

Cumulative

NCF

(477,674.94) (232,557.77) (2,021.88) 165,017.12

Discounted

Payback

3.01


*DISCOUNTED PAYBACK METHODBeach Karaoke Pub

Table 9 Computation of Discounted Payback Period - Beach Karaoke Pub


Cash Flow (1,700,000) 372,978.67 436,544.27 468,655.65 502,341.97 576,768.2

4

655,598.3

1

Discounte

d Net

Cash Flow

(1,700,000) 336,775.32 355,910.17 345,002.82 333,906.23 346,164.6

1

355,283.8

3

Cumulativ

e NCF

(1,363,224.6

8)

(1,007,314.1

7)

(662,311.3

4)

(328,405.1

1)

17,759.50

373,043.3

2

Discounte

d Payback

4.95


*INTERNAL RATE OF RETURN (IRR)Planet Karaoke Pub

Table 10 Computation of Undiscounted Payback Period - Planet Karaoke Pub


Cash Flow (770,000) 131,250.00 108,150.00 120,662.50 58,800.00

Net Cash Flow (770,000)323,750.00 300,650.00 313,162.00 251,300.00

Cumulative NCF

(446,250.00) (145,600.00) 167,562.00 418,862.00

Payback Period

2.46


*INTERNAL RATE OF RETURN (IRR)Beach Karaoke Pub

Table 11 Computation of Undiscounted Payback Period - Beach Karaoke Pub


Cash Flow

(1,700,000) 372,978.67 436,544.27 468,655.65 502,341.97

468,655.65

502,341.97

Net Cash Flow

(1,700,000)372,979.00 436,544.00 468,656.00 502,342.0

0

468,656.0

0

502,342.00

Cumulative NCF

(1,327,021.00)

(890,477.00)

(421,821.00)

80,521.00

549,177.00

1,051,519.00

Payback Period

3.84


Planet Beach

Undiscounted Payback

Period or Factor of the

IRR

2.46 3.84

Internal Rate of Return 23% 17%

Table 12 Internal Rate of Return

Conclusions and Recommendations

Conclusions and Recommendations• factors that the management needs to

look into before venturing into this business:a. Current Financial Standing of the Resortb. Current Organizational Structure of the Resortc. Organizational Objective of the Resortd. Competitorse. Market Size

Phuket Beach HotelValuing Mutually Exclusive Capital

Projects

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Documents

Phuket Beach Hotel