“I don’t know, Bharath,” said Arun Poddar, Bharath’s close friend and business partner. “It looks risky to me.”

Bharath Chaturvedi had just proposed that Arun go into business with him by purchasing the Carlton Hotel. The 400‐room property was for sale and Bharath thought it would be a great investment. Bharath was an experienced hotel manager and would manage the hotel. His friend Arun had a financial net worth high enough that he certainly could, if he chose to do so, personally fund the purchase of the hotel.

“The owners only want $5,000,000 for the property. With just a few minor changes and better management,” said Bharath, “I could easily get the net operating income (NOI) up to $700,000 per year. That’s twice what it was last year!”

1. Based on the information provided by Bharath, compute the capitalization rate based on last year’s NOI for the hotel. Next, compute the capitalization rate for the hotel assuming that Bharath is correct and that he can make the changes necessary to achieve his target NOI. What is your assessment of each cap rate?

2. Assume you were Arun, what additional information would you want to see from the hotel’s current owners before you would seriously consider making the investment suggested by Bharath?

3. Consider that Arun, if he decided to buy the property, could elect to fund the property himself or arrange with his bank for 50% debt financing. What factors would you advise him to assess before he decided which of these two funding options would best help him meet his own investment goals?