In January 2014, the AZA Group had to decide definitively whether to undertake the construction of a hotel in the center of Valencia, for its subsequent rental or sale, or if it opted for other real estate investments on the same site. Multiple doubts arose about the methodology to decide the investment and even more about the criteria to decide this or other alternative investments1.

The AZA Group
The AZA Group has been dedicated to transportation for more than 80 years and that continues to be its core business. Over the years, the group has diversified its activity entering the logistics, real estate, parking and nautical businesses.
The AZA Group was chaired by its president and founder, Alfonso Zamorano Aguado (62 years old) and the Board was made up of his four children plus an external director. Each of the directors was in charge of a company as CEO. The president insisted on the need to develop business, so as not to become mere rentiers.
In 2007, at the peak of the economic boom in Spain, AZA Group had reached a turnover of 37 million euros, with assets of 52 million, a bank debt of 17 and an EBIT of 5 million. In 2013, and after 6 years of deep economic crisis in Spain, AZA billed 30 million, with an EBIT of
0.5 million; total assets of 93 million and bank debt 50.

A relevant question was what price to assign to the land:
a) The acquisition cost: 6 million.
b) The acquisition cost, updated with the Housing Price Index: 7.7 million.
c) The 2010 appraisal value of 13 million, or perhaps the most realistic 8 or 10 million.
d) One of the directors suggested that the cost of the land was a sunk cost, which should not be considered. In his opinion, only future cash flows were relevant for the analysis and decision.

Hotel Financing

Hotel Investment Decision: Return, Risk and Other Criteria
The Hotel project was well underway and all the key hypotheses in the case were already available. Construction of the Colón complex had begun and a decision had to be made whether to build the hotel and lease it to AC, as construction should follow the hotel operator's requirements.
Mr. Zamorano wanted to have the numbers to make a decision. For this, he had requested that the following information be prepared:
a) Forecast of income statement and balance of the hotel project10. Horizon: 10 years, year 0 in 2014 and year 10, 2024.
b) Expected return for the shareholder on money invested, which in this case was the land. The question was, what price to put on the lot in the spreadsheet. The return that the AZA Group required of its real estate investments was 6%; but was the investment in the hotel a real estate investment? Should they ask higher return to the hotel project?
c) Risks. AZA wanted to measure how sensitive the shareholder return would be to variations in the assumptions used. Above all, he wanted to know if the debt could be repaid with certain security.

d) What other criteria, other than return and risk, should they consider for the investment decision? How did the investment in the hotel fit within the AZA Group business structure?

Methodological Doubts
When applying the methodology, important doubts were raised that might have a relevant effect (or not) on the expected return and therefore on the investment decision:
a) Valuation of the land, which was the equity contributed by the shareholder.
b) Term of the loan. Would a longer-term be necessary to face the repayment of principal more comfortably?
c) Final value in year 10. Was it necessary to use perpetuity, assuming that the hotel would continue operating for another 15 or 20 years? Wouldn't it be more practical and even more realistic to use the estimated value of the property in year 10?
d) What return should they require from the hotel, 6% of the real estate investment, or more?

Assume that you are the independent director of the AZA Group Board. What would you answer to the various questions they raise? What do you advise them?