Question

Kim Hotels is interested in developing a new hotel in Seoul. The company estimates that the hotel would require an initial investment of $25 million. Kim expects the hotel will produce positive cash flows of $4 million a year at the end of each of the next 20 years. The project's cost of capital is 14%.

1. What is the project's net present value? Do not round intermediate calculations. Enter your answer in millions. For example, an answer of $1.23 million should be entered as 1.23, not 1,230,000. Round your answer to two decimal places.

   $    million

2. Kim expects the cash flows to be $4 million a year, but it recognizes that the cash flows could actually be much higher or lower, depending on whether the Korean government imposes a large hotel tax. One year from now, Kim will know whether the tax will be imposed. There is a 50% chance that the tax will be imposed, in which case the yearly cash flows will be only $2.9 million. At the same time, there is a 50% chance that the tax will not be imposed, in which case the yearly cash flows will be $5.1 million. Kim is deciding whether to proceed with the hotel today or to wait a year to find out whether the tax will be imposed. If Kim waits a year, the initial investment will remain at $25 million. Assume that all cash flows are discounted at 14%. Use decision-tree analysis to determine whether Kim should proceed with the project today or wait a year before deciding.

Answer 1

PART A

Cost of Capital 14%
	Years	Outflow	Inflows
Initial Investment	Year 0	-25
	Year 1		4
	Year 2		4
	Year 3		4
	Year 4		4
	Year 5		4
	Year 6		4
	Year 7		4
	Year 8		4
	Year 9		4
	Year 10		4
	Year 11		4
	Year 12		4
	Year 13		4
	Year 14		4
	Year 15		4
	Year 16		4
	Year 17		4
	Year 18		4
	Year 19		4
	Year 20		4
	Net Presnet Value	$1.49

Conclusion : Thus in the first senario the net present value of the project would $1.49 million and the NPV is calcuated using excel NPV formula which =NPV(14%,E5:E24)+D4 , refer to the screen shot of the excel sheet I have attached.

PART B

Cost of Capital 14%		If Tax is Imposed	If Tax is not imposed
	Years	Outflow	Inflow	Outflow	Inflow
Initial Investment	Year 0	-25		-25
	Year 1		2.9		5.1
	Year 2		2.9		5.1
	Year 3		2.9		5.1
	Year 4		2.9		5.1
	Year 5		2.9		5.1
	Year 6		2.9		5.1
	Year 7		2.9		5.1
	Year 8		2.9		5.1
	Year 9		2.9		5.1
	Year 10		2.9		5.1
	Year 11		2.9		5.1
	Year 12		2.9		5.1
	Year 13		2.9		5.1
	Year 14		2.9		5.1
	Year 15		2.9		5.1
	Year 16		2.9		5.1
	Year 17		2.9		5.1
	Year 18		2.9		5.1
	Year 19		2.9		5.1
	Year 20		2.9		5.1
	Net Present Value	($5.79)		$8.78
	Net Present value after 1 year		$4.39

Conclusion : He should accept the project if the tax is not imposed as it will have a positive NPV. The

NPV of the same after 1 year would be $4.39 million ( as it has 50% probablity of happening i.e.50% iof $8.78).

Expected NPV after 1 year		$4.39
Expected NPV today		$1.49

Thus Kim should wait for 1 year and see if the tax is imposed or not. { NPV values are calcuated in excel =NPV(14%,J5:J24)+I4 and =NPV(14%,L5:L24)+K4 }  

I have attached the excel sheet for your reference.