Question

​(Replacement chains​) Destination Hotels currently owns an older hotel on the best beachfront property on Hilton Head​ Island, and it is considering either remodeling the hotel or tearing it down and building a new convention​ hotel, but because both hotels would occupy the same physical​ location, the company can only choose one project-that ​is, these are mutually exclusive projects. Both of these projects have the same initial outlay of $ 1,800,000. The first​ project, since it is a remodel of an existing​ hotel, has an expected life of 9 years and will provide free cash flows of $ 400,000 at the end of each year for all 9 years. In​ addition, this project can be repeated at the end of 9 years at the same cost and with the same set of future cash flows. The proposed new convention hotel has an expected life of 18 years and will produce cash flows of $ 280,000 per year. The required rate of return on both of these projects is 9 percent. Calculate the NPV using replacement chains to compare these two projects.

Answer 1

	Remodelling	New Convention
NPV	873480.04	651575.03

Remodelling has higher cash flows and hence is a preferred option.

WORKINGS

Cash flow as below

Year	Remodelling	New Convention
0	-1800000	-1800000
1	400000	280000
2	400000	280000
3	400000	280000
4	400000	280000
5	400000	280000
6	400000	280000
7	400000	280000
8	400000	280000
9	-1400000	280000
10	400000	280000
11	400000	280000
12	400000	280000
13	400000	280000
14	400000	280000
15	400000	280000
16	400000	280000
17	400000	280000
18	400000	280000