Phuket Beach Hotel (Final)

Phuket Beach Resort Case Analysis Graduate School of Business De La Salle University

I.

Statement of the Problem 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?

II.

Case Background Mike Campbell, General Manager of Phuket Beach Hotel is considering an offer made by Planet Karaoke Pub, a fast expanding company, which is looking for a venue in Patong beach area for setting up another outlet. The Board of Directors of the establishment had previously rejected several old offers because it offers low return on investment. The space was located on the second floor of the main building and was very much under-utilised. Planat Karaoke Pub offered to sign a four-year lease agreement with the hotel for rending part of the unused space. It proposed to pay: a. a monthly rental fee of 170,000 baht for the first two years; and b. thereafter, a 5% increment for the next two years. Planet Karaoke Pub required only 70% of the unused space measuring 3,000 sq. feet. This would allow the hotel to keep the remaining space for the creation of an alley two years later. Mike Campbell is contemplating on creating a pub operated by the management of the hotel itself since such establishments attract a lot of customers and tourists. Mike Campbell sought the assistance of Kornkrit Manming, the hotel’s Financial Controller to review the offer from Planet Karaoke Pub and estimating revenues and costs associated with an alternative project, Beach Karaoke Pub.

III.

Objectives With the given two alternatives on hand, this case aims to: a. 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 b. 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. c.

compute for the relevant cashflows associated with each projects

Submitted by: R. Bagunas, S. Chua, C. De Guzman, N. Padon, D. Palmones, J. Valeros, O. Velarde Submitted to: Prof. R. Queddeng

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d.

identify the different criteria to be used in evaluating the projects

e. assess the economic benefits associated with each of the capital projects f. rank the attractiveness g.

projects

using

various

measures

of

investment

compare the two projects based on the standard NPV measure a. Assumptions

2. The estimated total sales amounting to 4,672,000 baht for the first year of operation is a reasonable estimate and thus was applied with the 5% sales growth per annum. 3. The 25% fear factor is applied on the projected annual net room revenue representing 50% of the pub revenue – 50% from hotel guests. 4. Overhead expenses allocated to the Planet Karaoke Pub project amounting to 55,000 baht and 16% of sales representing salaries for the Beach Karaoke Pub project are considered irrelevant costs since these costs will not differ between alternatives. Both are allocated costs. 5. The weighted average cost of capital is 10.75% computed using 10% interest rate and 12% hotel owners’ cost of equity on its capital structure consisting of 25% debt and 75% equity respectively. The cost of equity is assumed to be after tax. 6. All payments and inflows assumed to have been made at the end of the year. a. Areas of Consideration 7. The two projects have unequal lives: Planet Karaoke Pub to run for 4 years while Beach Karaoke Pub to run for 6 years. 8. It was envisaged that the proposed pub would not affect the hotel’s future expansion plans. 9. The existing system ranked projects according to their average return on investment and payback period, regardless to the time value of money. 10.Similar development proposals had been rejected by the board because it required a long payback period. Other proposals were also discarded due to its low return on investment. Submitted by: R. Bagunas, S. Chua, C. De Guzman, N. Padon, D. Palmones, J. Valeros, O. Velarde Submitted to: Prof. R. Queddeng

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11.Staff for the karaoke pub could be recruited internally because the hotel had excess manpower and the excess staff had long-term contracts with the hotel. 12.Both projects have the same repairs and maintenance costs. 13.The Chief Security Officer had expressed his concerns and displeasure over the security problems that a karaoke pub might bring. This might attract unwelcome guests from outside and might in turn be a negative factor for the pub in terms of attracting tourists travelling with children, which accounted for 25% of the total patronage. This risk factor will be present in both the “lease” and “build” option. a. Alternative Courses of Action 14. Planet Karaoke Pub Phuket Beach Hotel to rent out an unused space owned by the Hotel located on the second floor of the main building. Advantages:  Additional source of revenue  Steady source of revenue in the form of “fixed” monthly rental  Take advantage of unutilised space  Tie-up with a company that is expanding fast in the country (“positive image”)  Company is exposed to lesser risk since it will be a third party who will be doing majority of the investment of the pub Disadvantages:  Will entail additional costs and investment  Limited control over overall pub operations  Problem on allocating overhead costs 15. Beach Karaoke Pub Phuket Beach Hotel to create its own pub Advantages:  Venture into a lucrative business spreading fast in the country  Have control over overall pub operations  Additional source of revenue  Complementary pub operation with its hotel business Disadvantages: Submitted by: R. Bagunas, S. Chua, C. De Guzman, N. Padon, D. Palmones, J. Valeros, O. Velarde Submitted to: Prof. R. Queddeng

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 Entails costs and investment  Presents financial risk to the company should the pub do not perform as expected.  Phuket management lacks experience or expertise on this new segment of business  Opportunity cost of 25% of the patronage may be lost when tourist felt it unsafe.  No study was presented whether a pub fits on the Phuket hotel. a. Analysis of the Case 16.Assess the economic benefits associated with each of the capital projects. What is the initial outlay? What are the incremental cashflows over the life of the project? What is an appropriate discount rate to use for discounting the cashflows of the project? The initial outlay for each alternative would depend on whether management is willing to undertake a risk in operating a business with perceived "security" issues. For ACA 1: Planet Karaoke Pub, it has an option of whether to invest 770,000 baht or 1,000,000 baht as initial outlay. As for ACA 2: it could either spend 1,700,000 baht or 2,100,000 baht depending on available funds and depending on payback period criteria. Should management opt for a shorter payback period, then naturally, it would have to spend on the lower range of its option investment amount. Weighted average cost of capital: debt 25% 10%

composition rate = (0.25*0.10)(1-0.30)+(0.75*0.12) =

25% fear factor: net room revenue 50% hotel guests -pub 25% reduction in revenue

Year 1 13,200,000.0 0 6,600,000.0 0 1,650,000.0 0

Cost

equity 75% 12% 10.75%

Year 2 13,464,000.00 6,732,000.00 1,683,000.00

Planet Karaoke Pub: 4 years Depreciation

Year 3 14,137,000.0 0 7,068,500.0 0 1,767,125.0 0

Year 4 14,844,000.00 7,422,000.00 1,855,500.00

upper limit 1,000,000.0 0


1 2 3 4 5 6

Factor at 10.75% 0.903 0.815 0.736 0.665 0.600 0.542 Year 5 15,140,000.0 0 7,570,000.0 0 1,892,500.0 0

lower limit 770,000.0 0

4

0.903 1.718 2.454 3.119 3.719 4.261 Year 6

15,443,000.00 7,721,5 00.00 1,930,375.00

Phuket Beach Resort Case Analysis Graduate School of Business De La Salle University / years annual depreciation

4 250,000.0 0

Operating Cash Flow (Lower Limit) Rental income less: 25% fear factor Net rental income less: relevant expenses depreciation Net Income Before Tax Less (30% Tax) Net Income Depreciation Operating Cash Flow

4 192,500.0 0

Year 1 2,040,000.0

Year 2 2,040,000.0

(1,650,000.0 0) 390,000.0 0 (10,000.0 0) (192,500.0 0) 187,500.0 0 (56,250.00 ) 131,250.0 0 192,500.0 0 323,750.0 0

0 (1,683,000.0 0) 357,000.0 0 (10,000.0 0) (192,500.0 0) 154,500.0 0 (46,350.00 ) 108,150.0 0 192,500.0 0 300,650.0 0

0

Year 3 2,142,000.0 0 (1,767,125.0 0) 374,875.0 0 (10,000.0 0) (192,500.0 0) 172,375.0 0 (51,712.50 ) 120,662.5 0 192,500.0 0 313,162.5 0

Year 4 2,142,000.0 0 (1,855,500.0 0) 286,500.0 0 (10,000.0 0) (192,500.0 0) 84,000.00 (25,200.00 ) 58,800.00 192,500.0 0 251,300.0 0

note: overhead expense, being an allocated cost, is not relevant. Operating Cash Flow (UpperLimit) Rental income less: 25% fear factor Net rental income less: relevant expenses depreciation Net Income Before Tax Less (30% Tax) Net Income Depreciation Operating Cash Flow

Year 1 2,040,000.0 0 (1,650,000.0 0) 390,000.0 0 (10,000.0 0) (250,000.0 0) 130,000.0 0 (39,000.00 ) 91,000.00 250,000.0 0 341,000.0 0

Year 2 2,040,000.0 0 (1,683,000.0 0) 357,000.0 0 (10,000.0 0) (250,000.0 0) 97,000.00 (29,100.00 ) 67,900.00 250,000.0 0 317,900.0 0

Year 3 2,142,000.0 0 (1,767,125.0 0) 374,875.0 0 (10,000.0 0) (250,000.0 0) 114,875.0 0 (34,462.50 ) 80,412.50 250,000.0 0 330,412.5 0

Year 4 2,142,000.0 0 (1,855,500.0 0) 286,500.0 0 (10,000.0 0) (250,000.0 0) 26,500.00 (7,950.00 ) 18,550.00 250,000.0 0 268,550.0 0

Alternative 1 (scenario one): Planet Karaoke Pub (Lower Limit) Submitted by: R. Bagunas, S. Chua, C. De Guzman, N. Padon, D. Palmones, J. Valeros, O. Velarde Submitted to: Prof. R. Queddeng

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Annual Operating Cash Flow

Renovation costs

Year(s) 1 2 3 4 0

Amount 323,750.00 300,650.00 313,162.50 251,300.00 770,000.00

NPV of cash flows 292,346.25 245,029.75 230,487.60 167,114.50 (770,000.00) 164,978.10

PV factor 0.903 0.815 0.736 0.665 1.000

Alternative 1 (scenario two): Planet Karaoke Pub (Upper Limit) NPV of Year(s) Annual Operating Cash Flow

1

Amount 341,000.0 0 317,900.0

2

0 330,412.5

3

0 268,550.0

4 Renovation

0

0 1,000,000.0 0

Beach Karaoke Pub: 6 years Depreciation Capital investment

PV factor 0.90 3 0.81 5 0.73 6 0.66 5 1.00 0

cash flows 307,923.00 259,088.50 243,183.60 178,585.75 (1,000,000.00) (11,219.15)

upper limit 1,200,000.0

lower limit 800,000.0

0

0 900,000.0

Other capital investment

0

Total capital invesment / years

0

annual depreciation

0

900,000.0 0

2,100,000.0

Net Income After Tax (Lower Limit) Year 1 Revenues less: fear factor (25%)

4,672,000.00 (1,650,000.00)

Net Revenue Less:Relevant Expenses Food and beverage (25%)

(1,168,000.00)

Other operating (22%)

(1,027,840.00)

Repairs

3,022,000.00

(10,000.00)

1,700,000.0 0

6 350,000.0

Year 2 4,905,600.0 0 (1,683,000.0 0) 3,222,600.0 0 (1,226,400.0 0) (1,079,232.0 0) (10,000.00 )

6 283,333.3 3

Year 3 5,150,880.00 (1,767,125.00) 3,383,755.00

(1,287,720.00) (1,133,193.60) (10,000.00)


Year 4 5,408,424.0 0 (1,855,500.0 0) 3,552,924.0 0 (1,352,106.0 0) (1,189,853.2 8) (10,000.00 )

Year 5

Year 6

5,678,845.20 (1,892,500.0 0)

(1,930,375.00)

3,786,345.20

4,032,412.46

(1,419,711.3 0) (1,249,345.9 4) (10,000.00 )

6

5,962,787.46

(1,490,696.87) (1,311,813.24) (10,000.00)

Phuket Beach Resort Case Analysis Graduate School of Business De La Salle University Depreciation Net Income Less: Tax (30%)

(283,333.3 3) 623,634.6 7 (187,090.4 0) 436,544.2 7 283,333.3 3 719,877.6 0

(283,333.33) 532,826.67 (159,848.00)

Net Income After Tax

372,978.67

Add: Gross Depreciation

283,333.33 656,312.00

(283,333.3 3) 717,631.3 9 (215,289.4 2) 502,341.9 7 283,333.3 3 785,675.3 0

(283,333.33) 669,508.07 (200,852.42) 468,655.65 283,333.33 751,988.98

(283,333.3 3)

(283,333.33)

823,954.62 (247,186.3 9)

936,569.02 (280,970.71)

576,768.24

655,598.31

283,333.33

283,333.33

860,101.57

938,931.65

note: salaries 16% is not relevant since workforce will be coming from hotel staff.

Alternative 2 (scenario one): Beach Karaoke Pub (lower limit) NPV of Year(s)

PV factor 1.00 0 1.00 0 0.90 3 0.81 5 0.73 6 0.66 5 0.60 0 0.54 2

Amount 800,000.0

Initial investment

0

0


0

0


1

0

900,000.0 656,312.0 719,877.6 2

0 751,988.9

3

8 785,675.3

4

0 860,101.5

5

7 938,931.6

6

Net Income After Tax (Upper Limit) Year 1

5

Year 2

cash flows (800,000.0 0) (900,000.0 0)

Year 3

592,649.74 586,700.24 553,463.89 522,474.08 516,060.94 508,900.95 1,580,249.84

Year 4

5,150,880.0 Revenues less: fear factor (25%) Net Revenue Less:Relevant Expenses Food and beverage (25%) Other operating (22%)

4,672,000.00 (1,650,000.0 0) 3,022,000.00 (1,168,000.0 0) (1,027,840.0 0)

4,905,600.00 (1,683,000.00) 3,222,600.00

(1,226,400.00) (1,079,232.00)

0 (1,767,125.0 0) 3,383,755.0 0 (1,287,720.0 0) (1,133,193.6 0)


5,408,424.00 (1,855,500.0 0) 3,552,924.00 (1,352,106.0 0) (1,189,853.2 8)

Year 5

Year 6

5,678,845.2

5,962,787.4

0

6

(1,892,500.0 0) 3,786,345.2 0

(1,930,375.0 0) 4,032,412.4 6

(1,419,711.3 0) (1,249,345.9 4)

(1,490,696.8 7) (1,311,813.2 4)

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Phuket Beach Resort Case Analysis Graduate School of Business De La Salle University (10,000.00 Repairs

)

Depreciation

0)

(10,000.00 (10,000.00)

)

(350,000.00)

0)

556,968.00

0

(167,090.40)

2)

326,312.00

389,877.60

8

350,000.00

350,000.00

0

676,312.00

739,877.60

8

(350,000.0

(10,000.00 )

(350,000.0

(10,000.00 )

(350,000.0 0)

(350,000.0 0)

602,841.4 Net Income Less: Tax (30%) Net Income After Tax Add: Gross Depreciation

466,160.00 (139,848.0 0)

(10,000.00 ) (350,000.0 0)

757,287.9 650,964.72 (195,289.4

(180,852.4 2)

6

869,902.3 5

(227,186.3 9)

421,988.9

(260,970.7 1)

530,101.5 455,675.30

7

350,000.00

0

805,675.30

7

350,000.0

608,931.6 5

350,000.0

771,988.9

350,000.0 0

880,101.5

958,931.6 5

note: salaries 16% is not relevant since workforce will be coming from hotel staff. Alternative 2 (scenario two): Beach Karaoke Pub (Upper Limit) Year(s) Initial investment

0


0


1 2 3 4 5 6

Amount 1,200,000.0 0 900,000.0 0 676,312.0 0 739,877.6 0 771,988.9 8 805,675.3 0 880,101.5 7 958,931.6 5

PV factor

NPV of cash flows

1.000

(1,200,000.00)

1.000

(900,000.00)

0.903

610,709.74

0.815

603,000.24

0.736

568,183.89

0.665

535,774.08

0.600

528,060.94

0.542

519,740.95 1,265,469.84

The appropriate discount rate to use for discounting the cashflows of the project would be the weighted average cost of capital computed using the provided percentages of debt and equity (25% and 75%) together with their relevant pre-tax rates - 10% and 12%, respectively. Applying the after-tax rate for debt, assuming the cost of equity is already after tax, would get an after-tax rate of 7% multiplied by 25% for a total of 1.75% for debt. Likewise for equity, multiplying its "after-tax" rate of 12% by its relevant weight, 75% and will get 9.00% for equity. Weighted average for debt - 1.75%, plus weighted average for equity - 9.00%, and will get weighted average cost of capital amounting to 10.75%. 17.Rank the projects using various measures of investment attractiveness. Do all the measures rank the projects identically? Why or why not? Which criterion is the best? Submitted by: R. Bagunas, S. Chua, C. De Guzman, N. Padon, D. Palmones, J. Valeros, O. Velarde Submitted to: Prof. R. Queddeng

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It would seem that the measures rank the projects identifically, all points to alternative two – own pub: Beach Karaoke Pub, with lower limit investment of 1,700,000 baht. The best criterion would be to use either NPV or IRR since both considers time value of money.


9



10



11



12



13


18.Are the projects comparable based on the standard NPV measure, given that they have unequal lives? What adjustment or alternative method is required in comparing such projects? The projects are comparable based on the standard NPV measure even though they have unequal lives. In NPV, cash flows are discounted into the present time. All are put on "equal" footing, as if all the "inflows" would be received today, and as if all the "outflows" would be spent today. Thus, the relevant time value of money being considered, evaluation is comparable. The only adjustment required would have to be in terms determining and evaluating the most effective cost of capital in decision-making.


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15


19.How sensitive is your ranking to changes in the discount rate? What other “key value drivers” would affect the attractiveness of the projects? Estimate the sensitivity of your result to a change in any of the key value drivers.

at 8% Alternative 1 : Planet Karaoke Pub (Lower Limit)


Renovation costs

Year(s) 1 2 3 4 0

Amount 323,750.00 300,650.00 313,162.50 251,300.00 770,000.00

PV factor 0.926 0.857 0.794 0.735 1.000

NPV of cash flows 299,792.50 257,657.05 248,651.03 184,705.50 (770,000.00) 220,806.08

PV factor 0.926 0.857 0.794 0.735 1.000

NPV of cash flows 315,766.00 272,440.30 262,347.53 197,384.25 (1,000,000.00) 47,938.08

Alternative 1: Planet Karaoke Pub (Upper Limit)


Renovation

Year(s) 1 2 3 4 0

Amount 341,000.00 317,900.00 330,412.50 268,550.00 1,000,000.00

Alternative 2 : Beach Karaoke Pub (Upper Limit) Submitted by: R. Bagunas, S. Chua, C. De Guzman, N. Padon, D. Palmones, J. Valeros, O. Velarde Submitted to: Prof. R. Queddeng

16


Initial investment Other capital investment Annual Operating Cash Flow

Year(s) 0 0 1 2 3 4 5 6

Amount 1,200,000.00 900,000.00 676,312.00 739,877.60 771,988.98 805,675.30 880,101.57 958,931.65

PV factor 1.000 1.000 0.926 0.857 0.794 0.735 0.681 0.630

NPV of cash flows (1,200,000.00) (900,000.00) 626,264.91 634,075.10 612,959.25 592,171.35 599,349.17 604,126.94 1,568,946.72

PV factor 1.000 1.000 0.926 0.857 0.794 0.735 0.681 0.630

NPV of cash flows (800,000.00) (900,000.00) 607,744.91 616,935.10 597,079.25 577,471.35 585,729.17 591,526.94 1,876,486.72

PV factor 0.909 0.826 0.752 0.683 0.621

NPV of cash flows 294,288.75 248,336.90 235,498.20 171,637.90 (478,170.00) 471,591.75

PV factor 0.909 0.826 0.752 0.683 1.000

NPV of cash flows 309,969.00 262,585.40 248,470.20 183,419.65 (1,000,000.00) 4,444.25

Alternative 2 : Beach Karaoke Pub (Lower Limit)


Year(s) 0 0 1 2 3 4 5 6

Amount 800,000.00 900,000.00 656,312.00 719,877.60 751,988.98 785,675.30 860,101.57 938,931.65



Renovation costs

Year(s) 1 2 3 4 0

Amount 323,750.00 300,650.00 313,162.50 251,300.00 770,000.00



Renovation

Year(s) 1 2 3 4 0

Amount 341,000.00 317,900.00 330,412.50 268,550.00 1,000,000.00

Alternative 2: Beach Karaoke Pub (Upper Limit) Year(s)

Amount


PV factor

NPV of cash flows

17

Phuket Beach Resort Case Analysis Graduate School of Business De La Salle University Initial investment Other capital investment Annual Operating Cash Flow

0 0 1 2 3 4 5 6

1,200,000.00 900,000.00 676,312.00 739,877.60 771,988.98 805,675.30 880,101.57 958,931.65

1.000 1.000 0.909 0.826 0.752 0.683 0.621 0.564

(1,200,000.00) (900,000.00) 614,767.61 611,138.90 580,535.71 550,276.23 546,543.07 540,837.45 1,344,098.97

Alternative 2: Beach Karaoke Pub (Lower Limit)


Year(s) 0 0 1 2 3 4 5 6

Amount 800,000.00 900,000.00 656,312.00 719,877.60 751,988.98 785,675.30 860,101.57 938,931.65

PV factor 1.000 1.000 0.909 0.826 0.752 0.683 0.621 0.564

NPV of cash flows (800,000.00) (900,000.00) 596,587.61 594,618.90 565,495.71 536,616.23 534,123.07 529,557.45 1,656,998.97



Renovation costs

Year(s) 1 2 3 4 0

Amount 323,750.00 300,650.00 313,162.50 251,300.00 770,000.00

PV factor 0.877 0.769 0.675 0.592 1.000

NPV of cash flows 283,928.75 231,199.85 211,384.69 148,769.60 (770,000.00) 105,282.89

Amount 341,000.00 317,900.00 330,412.50 268,550.00 1,000,000.00

PV factor 0.877 0.769 0.675 0.592 1.000

NPV of cash flows 299,057.00 244,465.10 223,028.44 158,981.60 (1,000,000.00) (74,467.86)

Amount 1,200,000.00

PV factor 1.000



Renovation

Year(s) 1 2 3 4 0

Alternative 2 : Beach Karaoke Pub (Upper Limit)

Initial investment

Year(s) 0


NPV of cash flows (1,200,000.00)

18

Phuket Beach Resort Case Analysis Graduate School of Business De La Salle University Other capital investment Annual Operating Cash Flow

0 1 2 3 4 5 6

900,000.00 676,312.00 739,877.60 771,988.98 805,675.30 880,101.57 958,931.65

1.000 0.877 0.769 0.675 0.592 0.519 0.456

Amount 800,000.00 900,000.00 656,312.00 719,877.60 751,988.98 785,675.30 860,101.57 938,931.65

PV factor 1.000 1.000 0.877 0.769 0.675 0.592 0.519 0.456

(900,000.00) 593,125.62 568,965.87 521,092.56 476,959.78 456,772.71 437,272.83 954,189.39

Alternative 2: Beach Karaoke Pub (Lower Limit)


Year(s) 0 0 1 2 3 4 5 6

NPV of cash flows (800,000.00) (900,000.00) 575,585.62 553,585.87 507,592.56 465,119.78 446,392.71 428,152.83 1,276,429.39

at 16% Alternative 1: Planet Karaoke Pub (Lower Limit)


Renovation costs

Year(s) 1 2 3 4 0

Amount 323,750.00 300,650.00 313,162.50 251,300.00 770,000.00

PV factor 0.862 0.743 0.641 0.552 1.000

NPV of cash flows 279,072.50 223,382.95 200,737.16 138,717.60 (770,000.00) 71,910.21

Amount 341,000.00 317,900.00 330,412.50 268,550.00 1,000,000.00

PV factor 0.862 0.743 0.641 0.552 1.000

NPV of cash flows 293,942.00 236,199.70 211,794.41 148,239.60 (1,000,000.00) (109,824.29)



Renovation

Year(s) 1 2 3 4 0

Alternative 2: Beach Karaoke Pub (Upper Limit)

Initial investment Other capital investment

Year(s) 0 0

Amount 1,200,000.00 900,000.00


PV factor 1.000 1.000

NPV of cash flows (1,200,000.00) (900,000.00)

19

Phuket Beach Resort Case Analysis Graduate School of Business De La Salle University Annual Operating Cash Flow

1 2 3 4 5 6

676,312.00 739,877.60 771,988.98 805,675.30 880,101.57 958,931.65

0.862 0.743 0.641 0.552 0.476 0.410

582,980.94 549,729.06 494,844.94 444,732.77 418,928.35 393,161.98 784,378.03

Alternative 2 : Beach Karaoke Pub (Lower Limit)


Year(s) 0 0 1 2 3 4 5 6

10.75% Alternative 1 (Scenario One): Planet Karaoke Pub (Upper Limit) Alternative 1 (Scenario Two): Planet Karaoke Pub (Lower Limit) Alternative 2 (Scenario One): Beach Karaoke Pub (Upper Limit) Alternative 2 (Scenario Two): Beach Karaoke Pub (Lower Limit)

Amount 800,000.00 900,000.00 656,312.00 719,877.60 751,988.98 785,675.30 860,101.57 938,931.65

8%

PV factor 1.000 1.000 0.862 0.743 0.641 0.552 0.476 0.410

10%

NPV of cash flows (800,000.00) (900,000.00) 565,740.94 534,869.06 482,024.94 433,692.77 409,408.35 384,961.98 1,110,698.03 14%

16%

164,978.1 0

220,806.0 8

471,591.7 5

105,282.8 9

71,910.2 1

(11,219.1 5)

47,938.0 8

4,444.25

(74,467.8 6)

(109,824.2 9)

1,580,249.8 4

1,876,486.7 2

1,656,998.9 7

1,276,429.3 9

1,110,698.0 3

1,265,469.8 4

1,568,946.7 2

1,344,098.9 7

954,189.3 9

784,378.0 3

As the rate increases, the amount of discounted cash flows decreases. The key value driver would be the present value factor used and the length of time for the project to be finished. Since a dollar today is not worth a dollar tomorrow, the shorter the project is, the more attractive it would seem. However, care should be taken especially for projects involving unequal cash flows.

IV.

Conclusion

Based on the computations done by the group given the current and projected financial data of the two alternatives, the group recommends that Phuket Beach Resort builds its own pub because of the figures that we derived from the computations of IRR, ROI, Payback Period, and NPV. Submitted by: R. Bagunas, S. Chua, C. De Guzman, N. Padon, D. Palmones, J. Valeros, O. Velarde Submitted to: Prof. R. Queddeng

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Although it is financially attractive for Phuket Beach Resort to build and operate its own pub, there are also other factors that the management needs to look into before venturing into this business: a. Current Financial Standing of the Resort:  Are the owners financially capable of supporting such venture? b.

c.

Current Organizational Structure of the Resort:  Is the current management set-up of Phuket Beach Resort prepared for the operation of a new outlet such as a pub?  Is the existing manpower line-up of the resort skilled in operating a pub? Organizational Objective of the Resort:  Did the owners of Phuket Beach Resort envisioned such expansion?

d.     e.  

Competitors How many competitors are there in the market? How are the financial muscles of the competitors? How is the market situation for pub? What is the foreseen growth of the industry?

Market Size Is the market big enough to welcome another competitor? What is the projected market growth in the next 5 years?


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V.

Recommendation Annual returns for each investment alternative are related to the net investment to arrive at a certain rate which in turn are compared with the minimum standard established based on the lowest acceptable rate of return. Generally, the investment rating procedures are classified into two categories: (1) methods that do not consider the time value of money; and (2) methods that consider the time value of money. Although not any one of these methods serves every purpose, nevertheless, the determination of the most appropriate method to be used would be dependent upon the circumstances and needs of a particular situation. The existing capital budgeting system at Phuket Beach Hotel ranks projects according to their average return on investment and payback period; neglecting the fact that both investment ranking alternatives do not consider time value of money. This does not present an accurate measurement of investment profitability especially since a dollar today is worth more than a dollar a year from now. Recognition of time value of money is important in capital budgeting decisions. Business investments commonly promise returns that extend over fairly long periods of time and therefore it is necessary to employ techniques that recognize the time value of money. The Payback Period is the length of time necessary to recover the entire cost of an investment from the resulting annual net cash flows. Payback period is not a true measure of the profitability of an investment. It simply tells the manager how many years will be required to recover the original investment. A shorter payback period does not always means that one investment is more desirable than another. It has not inherent mechanism for highlighting differences in useful life between investments. Such differences can be very important, and relying on payback alone may result in incorrect decisions. It does not consider time value of money. Cash inflow to be received several years in the future is weighted equally with cash inflow to be received right now. Although it can be also be very useful under certain conditions since it can be used as a screening tool and is often of great importance to new firms that are “cash poor.”


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The return on investment ranking of investment alternatives, on the other hand, does not focus on cash flows. 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. The concept of return on investment shares a common weakness with payback period. It fails to consider that the present value of an investment depends on the timing of its future cash flows. Cash flows receive in the later life of an investment may be of less value today than cash flows received late in the life of an investment Net income figures are related to the initial investment of the project Discounting future cash flows is a technique that does into account cash flow timing issues. The present value of the future cash flow is the amount that a knowledgeable investor would pay today for the right to receive that future amount. Arriving at a present value depends on - the amount of future cash flows, the length of time that the investor must wait to receive the cash flow, and the rate of return required by the investor. Discounting is the process by which the present value of cash flows (the discounted cash flows) is determined.


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Phuket Beach Hotel (Final)

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