Problem H-6 Hb 482 The Litwiller Hotel's owners have invited Miller & Associates to consider managing their hotel for a ten-year period of time. The proposed post-opening management fee arrangement would be as follows: I. 2. Basic fee: 2% ofgross sales Incentive fee: 15% of total income before management fees and fixed charges. The payment of incentive fees is subject to the hotel's making its debt reduction payments and the hotel investing 6% of its annual sales for future replacement of FF&E. Any incentive fee not paid is accumulated until paid. Assume incentive fees are paid only on December 31, the last day of each year. Any unpaid incentive fees earns interest at 10% per annum until paid. The interest starts as January 1 of the following year and is paid on December 31 of that year. This interest expense is considered a fixed expense The expected sales of the Litwiller Hotel are S3,000 000 for 20X1 and are expected to increase by 5% each year. All operating expenses total 60% of total revenue. Fixed charges equal $750,000 annually excluding any interest on the unpaid incentive fees. The payments on debt, excluding interest expense, total $200,000 annually. Annual depreciation expense is estimated to be $150,000. Litwiller Hotel's average tax rate is 30%. Miller & Associates expects to incur operating expense exclusive of income taxes and depreciation equal to 80% of the basic fee. Assume that their average tax rate is 25%, respectively, and that all fees are taxed when earned regardless of when received. Further, assume depreciation expense equals $20,000 annually. If Miller& Associates accepts this contract, they will be required to invest $200,000 in the Litwiller Hotel's capital stock which would place them as 10% owners. Assume the Litwiller Hotel will pay a 5% dividend of the total of its capital stock each year as dividends. Required: 1. Calculate the cash flows from this management contract for Miller & Associates for the years of20x1-20X2 2. Based on your answer to Part I and the possibility of managing this hotel for ten years, what advice would you give to Miller & Associates? Should they sign this contract? Why or why not? (Be as specific as possible including addressing opportunity costs and ROI.) Problem H-6 Hb 482 The Litwiller Hotel's owners have invited Miller & Associates to consider managing their hotel for a ten-year period of time. The proposed post-opening management fee arrangement would be as follows: I. 2. Basic fee: 2% ofgross sales Incentive fee: 15% of total income before management fees and fixed charges. The payment of incentive fees is subject to the hotel's making its debt reduction payments and the hotel investing 6% of its annual sales for future replacement of FF&E. Any incentive fee not paid is accumulated until paid. Assume incentive fees are paid only on December 31, the last day of each year. Any unpaid incentive fees earns interest at 10% per annum until paid. The interest starts as January 1 of the following year and is paid on December 31 of that year. This interest expense is considered a fixed expense The expected sales of the Litwiller Hotel are S3,000 000 for 20X1 and are expected to increase by 5% each year. All operating expenses total 60% of total revenue. Fixed charges equal $750,000 annually excluding any interest on the unpaid incentive fees. The payments on debt, excluding interest expense, total $200,000 annually. Annual depreciation expense is estimated to be $150,000. Litwiller Hotel's average tax rate is 30%. Miller & Associates expects to incur operating expense exclusive of income taxes and depreciation equal to 80% of the basic fee. Assume that their average tax rate is 25%, respectively, and that all fees are taxed when earned regardless of when received. Further, assume depreciation expense equals $20,000 annually. If Miller& Associates accepts this contract, they will be required to invest $200,000 in the Litwiller Hotel's capital stock which would place them as 10% owners. Assume the Litwiller Hotel will pay a 5% dividend of the total of its capital stock each year as dividends. Required: 1. Calculate the cash flows from this management contract for Miller & Associates for the years of20x1-20X2 2. Based on your answer to Part I and the possibility of managing this hotel for ten years, what advice would you give to Miller & Associates? Should they sign this contract? Why or why not? (Be as specific as possible including addressing opportunity costs and ROI.)
