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
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 - 3

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
discounted).secondly Profitability ratio is also much higher, due to the fact that less investments are req
back is EAA which is segnificantly lower as well as ROI. In conclusion, I may say that, in short prospectiv
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 Sensitiv
5. Rank the projects using various measures of investment attractiveness. Do all the measure ran
Why or why not? Which criterion is the best? - SN 5 - 10%

pital project. What is Initial Outlay?

is an appropriate discount rate

iven that they have unequal lives?

project? - 10% SN 3

at other "key value drivers" would affect

ont investment; cost of capital, any of the key value drivers?
e key value drivers. - SN 4 - 30%

because of Payback period is much shorter ib both scenarios (discounted and nont that less investments are required to undertake the project. However the main draw
ay say that, in short prospective Lease is option is optimal, however in long term build
al decision should be undertaken after the Hotel will secure a fixed rate of WACC,
ons are available (see Sensitivity analysis)
ness. Do 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)

4 years
770000 baht
0.1075
10000
0.5

Year
Net room revenue*
Reduction in net room revenue

0
0.125

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

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
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 a
2. The Equivalent Annual Annuity is that level annual payment over the life of the investment that yields a present value ju
The annuity is determined by solving for "A": A= NPV/PVIFA n,k, where PVIFA =[(1+k) n - 1]/k n=number of periods
1

* 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 aff
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 =[(1+k)n - 1]/k 14%

PVIFA
3.31210
3.11908
3.03730
2.91370

Rate
0.0800
0.1075
0.1200
0.1400

NPV
275944.11
214849.48
188992.20
149885.44

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

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

16%
18%
20%
22%

2.79820
2.69010
2.58870
2.49361

0.1600
0.1800
0.2000
0.2200

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.
ment that yields a present value just equal to the net present value of the entire cash flow stream.
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
51441.62

2.46
3.01
0.64
23%
18%
1.28
214849
68882.36
3.11908

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%
0.1075
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
0.125

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

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

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

Patronage
factor
0
0.25
0.5
0.75
1

4
14844000
1855500

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

2
13464000
1683000

3
14137000
1767125

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
5678845.2
1352106
1419711.3
1189853.28 1249345.944
283333
283333
10000
10000
1855500
1892500
717631
823955

5962787.46
1490696.865
1311813.241
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

0.1075
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

0.08
1279229
672952
66676
-539601
-1145877

0.1075
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

0.1075
64486
51562
34639
17715
791

Cost of Capital
0.12
57942
41368
24796
8223
-8351

Decision
Patronage
Factor
0.08
0 Build
Build
0.25 Build
Build
0.5 Build
Build
0.75 Rej. Both
Rej. Both
1 Rej. both
Rej. Both
0 Build
Build
0.25 Build
Build
0.5 Build
Build
0.75 Rej. Both
Rej. Both
1 Rej. both
Rej. Both

0.1075

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

0.14
Build
Build
Build
Rej. Both
Rej. Both
Build
Build
Build
Rej. Both
Rej. Both

Sensitivity Analysis - Two Factors

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

Factors: Cost of Capital and Patronage Factor

Equivalent Annuity (EA) in baht

The Build Option

Patronage
Factor

Cost of Capital
0.08

0.1075

0.12

0.14

0.16

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

-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

0.1075
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

0.1075
64486
51562
34639
17715
791

Cost of Capital
0.12
57942
41368
24796
8223
-8351

Decision
Patronage
Factor
0 Build

0.08

0.1075
Build

Cost of Capital
0.12
Build
Build

0.14

0.16
Build

0.25
0.5
0.75
1

Build
Build
Rej. Both
Rej. both

Build
Build
Rej. Both
Rej. Both

Build
Build
Rej. Both
Rej. Both

Build
Build
Rej. Both
Rej. Both

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
2.464934339
Lease option

Disadvantages
3.84
Build 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 t
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
373043.3

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
3.119078571

Disadvantages
Build option
4.261181

in long term investment plan)

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

e 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
0
1
2
3
4
5
6

Numerical Solution for N

5.0%
Cash Flows
-1700000
372979
436544
468656
502342
576768
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
2
3
4
-770000
131250
108150
120662.5
133770
-770000 292325.0564 245117.1726 230535.8902 216871.3602
-477674.944 -232557.771 -2021.88076 214849.4795
N/A
N/A
N/A
N/A
3.00932295

Rate
Time
Cash Flow
Discounted NCF
Cumulative NCF
Discounted Payback Period

Project Y
12%
0
1
2
3
4
-1700000 372978.6667 436544.2667 468655.6467 502341.9707
-1700000 336775.3198 355910.515 345002.8235 333906.2325
-1363224.68 -1007314.17 -662311.342 -328405.109
N/A
N/A
N/A
N/A
N/A

5
576768.2
346164.6
17759.5
4.948696

6
655598.3
355283.8
373043.3
N/A

WACC
Time
Cash Flows
IRR

WACC
Time
Cash Flows
IRR

1%
0
-770000
23.20%

1%
1
323750

1%
2
300650

1%
3
313162.5

Project B
1%
1%
1%
1%
0
1
2
3
-1700000 372978.6667 436544.2667 468655.647
17.35%

1%
4
326270

1%
1%
1%
4
5
6
502341.9707 576768.2 655598.3

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

0
1
2
3
-1700000 372978.7 436544.3 468655.6

4 Sum
ROI
326270
1263832.5 0.641341

Project B
4
5
6 Sum
502342
576768.2359 655598.3
3012887.101

ROI
0.772287

Interest Rate
Periods
Annuity Factor

10.75%
4
3.119078571

Annuity Factor
Interest Rate
Periods
Annuity Factor

10.75%
6
4.261181313

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