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The Grove is a medium priced hotel located in the suburbs of a major city. It has 250 bedrooms, a dining room, a bar and
\"The Grove" is a medium priced hotel located in the suburbs of a major city. It has 250 bedrooms, a dining room, a bar and a reception hall. Its occupancy rates are high during the working week (Monday to Thursday nights) but at the weekend (Friday to Sunday nights) there is little activity and few overnight guests. The directors of The Grove wish to expand the hotel and its facilities to attract weekend guests and local residents by acquiring an adjacent site. They are condent that they would obtain planning permission for the proposal. The site of 10,000 square metres is available for purchase at 0.5 million. The directors propose to build a smart facility providing a large function room for wedding receptions, corporate dinners etc., a restaurant and bars. It is expected that a proportion of people attending functions would book into the bedrooms in the main hotel. There will also be a health club of swimming pool, gymnasium, sauna etc. Local residents could take out membership of the health club at an average price of 40 per month. Acquisition of the site, detailed design work and obtaining planning permission will take one year. Construction of the health club will cost an estimated 2.5 million and 1 million will be needed for Fixtures and Fittings. Initial marketing will cost 100,000. Payment for these will occur by the end of the second year. The club will open for business at the commencement of year 3. It will be actively marketed but, the directors recognise that it will take time to build up its reputation. They have made the following projections of activities: . Additional Club Functions ' Bedroom Bookings Membership Oe-eratin Year 1 60 100 400 Operating Year 2 80 200 800 On-eratin Year 3 100 300 1200 1600 Operating Year 5 -10 150 500 2000 The directors have assumed that each function will make a contribution (over and above the variable catering and staff costs) of 2,000. Each additional bedroom occupied in the main hotel will make a contribution of 100. Marketing will cost 50,000 per year. The xed operating expenses of the function room will be 40,000 per annum and of the health club will be 200,000 per annum. For nancial accounting purposes the new building will be depreciated on a straight line basis over 50 years and the Fixtures and Fittings will be depreciated on a straight line basis at 10% starting from the rst year of operations. Taxation should be ignored. (Question continues on next page) Required: (a) Prepare a cashow for the project covering the two years of acquisition and construction and the rst 10 years of operation (As an inow in year12, you should bring in the land at its initial value, plus the written down value of the buildings and fixtures and fittings). Using a 10% discount rate, calculate the Net Present Value (NPV) of the project. Discount Factors for 10% are shown in the table below (you should assume that all cashflows would be at the end of each year). (12 marks) (b) Calculate the payback (in terms of approximate number of years of operation) for the project (you should assume that all cashflows accrue evenly throughout the year). (2 marks) (6) Based on your answers in (a) (b) above make reasoned recommendations on the viability of the proposal. (3 marks) (d) The costs and revenues used in your calculations above may not be absolutely certain. Identify the areas which need greater certainty in order for you to be confident of your recommendations? How would you handle the uncertainty in your estimates
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