In a small seaside community called Reform Village, a huge company is proposing to enter

one of two projects. Project A is to build a five storey hotel on the pristine beachfront of

Reform Village. Project B is to build twenty self$-$ contained log cabins along the beach with

an additional two cabins for a restaurant and health spa.

Each project requires an initial investment of $$2000000$ and has no salvage value. The

investing company estimates the cost of capital to be $10\%.$ The company must choose either

project A or Project B$.$ The following cash flows are projected for Project A and Project B

over five years

Year Project A Project B

$2000$ $$6000000$

$2001600000400000$

$2002600000400000$

$20036000001000000$

$20046000001800000$

Additional Information

The citizens of Reform Village are divided over which project will benefit the villagers most.

Some villagers prefer the high rise hotel because of its potential for more jobs for villagers as

cleaners, cooks and waiters. In addition, villagers perceive that during the construction the

need for ordinary and skilled labour will help the large proportion of unemployed young men

in the village.

Some villagers on the other hand, believe the high rise hotel will threaten the local ecology

by its sheer size and extensive tunnelling necessary to erect such a structure on the

beachfront. These villagers will prefer to see smaller less imposing cabins constructed that

will maintain the village theme ant that will not significantly affect the natural environment.

Labour for these construction of these cabins will be somewhat less than for the hotel but

very skilled carpenters will be needed. There will be a high demand for cooks, cleaners and

swimming instructors as the cabin project will target families and aim to meet their personal

needs for special foods, baby sitters and cleaners. The villagers are a very powerful group

and can have an influence on the profitability of either project.

Required:

a$.$ Compute the payback period on each project. $[5$ marks$]$

b$.$ Using the payback period criterion, which project is more desirable? $[1$ mark$]$

c$.$ Compute the net present value of each project. $[9$ marks$]$

d$.$ Using the NPV criterion, which project is more desirable? $[1$ mark$]$

e$.$ List three non$-$financial factors mentioned in the problem which are important for

evaluating whether to invest in Project A or Project B$.[3$ marks$]$

f$.$ Based on your calculations of the payback period, net Present Value and the

non$-$financial factors listed in $($e$)$ discuss why the investors should choose:

$($i$)$ Project A

$($ii$)$ Project B