Question
Grand River Tourism is planning a new hotel on the Grand River near Paris, Ontario. The tourism industry is expecting considerable growth over the next
Grand River Tourism is planning a new hotel on the Grand River near Paris, Ontario. The tourism industry is expecting considerable growth over the next decades as the Baby Boomers enter their retirement years. The hotel planned will contain a spa, restaurant and accommodation for up to 300 guests. GRT is looking at two alternatives in this regard.
Option 1: Build Their Own Hotel
GRT is privately held by the HoldCo Family. HoldCo expects that the investment in the hotel and land will be $3,750,000. The investment will be staged over the period 2012 and 2013 with $1,000,000 spent in 2012 and $2,750,000 spent in 2013. Start up of operations will be January 2013 with Revenues in 2013 and 2014 being $700,000 per year with variable operating expenses of $600,000 per each year and fixed operating expenses of $100,000 per each year. In 2015 HoldCo expects the hotel to be operating at 100% capacity with Revenues in each of the years 2015 through 2022 being $1,600,000 per annum. Variable operating costs in each year from 2015-2022 will be $800,000 annually. Corresponding fixed operating costs in each year over this period would be $200,000 per annum. This Hotel can be sold at a value of $3,000,000 at the end of 2022. HoldCo uses an investment hurdle rate of 8% per annum which reflects both its cost of capital and investment risk factors.
Option 2: Syndicate with Hilton Hotels and Operate Only
HoldCo can consider an Operating License managing a hotel on behalf of Hilton Hotels Canada. Hilton will construct the hotel at its cost with HoldCo operating the hotel and earning a fee annually for this service. Under this arrangement HoldCo must buy a license for $1,000,000 payable to Hilton directly in 2012. HoldCo would earn a management fee of $100,000 in 2013 and $200,000 in each of the years 2014 2022. HoldCos hurdle rate again is 8%.
Complete the Timeline for this Case including the investment figures and cash inflows.
(i) In Excel prepare an analysis of the Payback, Net Present Value and Internal Rate of Return for each Option. (ii) Prepare a recommendation as to which Option you would recommend the HoldCo Family pursue. (iii) Would your recommendation change if there was a risk that the Revenues in Option 1 only reach 50% of those currently projected with a corresponding reduction in variable operating costs?
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