(14) The Sporthotel: Hyatt International is considering building a hotel next to a new hockey arena in a city that is one of three vying for a new NHL franchise. The NHL will announce which city will be awarded the franchise in one year, and that team will begin playing three years from today. Because Hyatt would like to be the official hotel of the NHL team, the property must be ready for guests when the first game is played in three years. It takes three years to build the hotel. Begin Hotel Project NHL Makes Franchise Decision Hotel Completed For simplicity sake, we'll remove time value from the analysis by assuming that the discount rate is zero. Unrealistic yes, but the calculations become much easier. A. Projected Costs (all figures in millions of dollars) Over 3 Years: $1 S2 First year (Purchase Rights and Pemits, Build Foundation) Second Year (Construct building shell, attach plumbing) Third Year: (Finish interior and fumishings) TOTAL B. Projected long-term and terminal cash flows: The sum of all future cash flows gives us an estimate of the value of the hotel in three years (in millions of dollars): S8 If the city gets the franchise If the city does not get the franchise C. NPV Analysis: Is the hotel's NPV positive or negative? [Answer) Either $3 (found by $8-$5) or -$3 (found by $2-$5) D. How can Hyatt make the decision today to build or not to build? They can base their decision on the probability that the city will get the franchise. NPV = {P * $8 + (1-P) * $2} - 5 Where P=probability that the city is awarded the franchise If P = 33.33%, then NPV = {333 * $8+.667 * $2} - $5=$1 If P=66.67%, then NPV = .667 * $8 + .333 * $2} -$5 = $1 If P = 50.00%, then NPV = {.500 * $8 +.500 * $2} -$5 = $0 E. We can also solve for the value of P that makes NPV = $0 P* ($8 - $5) + (1-P) * ($2 - $5)= $0 P*(3) + (1-P)*(-3)=0 3P - 3 + 3P = 0 6P = 3 and so P = 3/6 = 50% F. Conclusion from NPV Analysis: If Hyatt believes that the chances of being awarded the franchise are greater than 50%, it would be wise to build the hotel. If on the other hand their analysis leads them to believe that the chance of being awarded the franchise is less than 50%, they should reject the Sport Hotel. If they believe that the probability is exactly 50%, they should be indifferent. This question is a variant of the Sport Hotel example that was presented in class, in the class notes, and in the Real Option chapter. The change to consider is this: suppose that the value of the hotel is one of two values: $9.6 million if the city is successful in obtaining the franchise (and not $8 million as in the original problem) or $3.5 if the city is not successful in obtaining the franchise (and not $2 million as in the original problem). All other aspects of the problem are the same as originally presented. Incorporating these new values, and the real option, what is the new NPV of the project? million Place your answer in millions of dollars using at least three decimal places. For example, the answer of nine hundred seventy five thousand would be entered as 0.975 and not as 975000. CHECK