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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
Alternative Courses of Action
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
Alternative Courses of Action
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
Alternative Courses of Action
*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
Alternative Courses of Action
*DISCOUNTED PAYBACK METHOD
Planet Karaoke Pub
Table 8 Computation of Discounted Payback Period - Planet Karaoke Pub
Year 0 Year 1 Year 2 Year 3 Year 4
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
Alternative Courses of Action
*DISCOUNTED PAYBACK METHODBeach Karaoke Pub
Table 9 Computation of Discounted Payback Period - Beach Karaoke Pub
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6
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
Alternative Courses of Action
*INTERNAL RATE OF RETURN (IRR)Planet Karaoke Pub
Table 10 Computation of Undiscounted Payback Period - Planet Karaoke Pub
Year 0 Year 1 Year 2 Year 3 Year 4
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
Alternative Courses of Action
*INTERNAL RATE OF RETURN (IRR)Beach Karaoke Pub
Table 11 Computation of Undiscounted Payback Period - Beach Karaoke Pub
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6
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
Alternative Courses of Action
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
De Buton, Darwin V.Francisco, Francis R.
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