Question

Net Present Value Method—Annuity for a Service Company

Welcome Inn Hotels is considering the construction of a new hotel for $70 million. The expected life of the hotel is 10 years with no residual value. The hotel is expected to earn revenues of $19 million per year. Total expenses, including depreciation, are expected to be $14 million per year. Welcome Inn management has set a minimum acceptable rate of return of 10%. Assume straight-line depreciation.

a. Determine the equal annual net cash flows from operating the hotel. Round to the nearest million dollars.
$ million

Present Value of an Annuity of $1 at Compound Interest
Periods	8%	9%	10%	11%	12%	13%	14%
1	0.92593	0.91743	0.90909	0.90090	0.89286	0.88496	0.87719
2	1.78326	1.75911	1.73554	1.71252	1.69005	1.66810	1.64666
3	2.57710	2.53129	2.48685	2.44371	2.40183	2.36115	2.32163
4	3.31213	3.23972	3.16987	3.10245	3.03735	2.97447	2.91371
5	3.99271	3.88965	3.79079	3.69590	3.60478	3.51723	3.43308
6	4.62288	4.48592	4.35526	4.23054	4.11141	3.99755	3.88867
7	5.20637	5.03295	4.86842	4.71220	4.56376	4.42261	4.28830
8	5.74664	5.53482	5.33493	5.14612	4.96764	4.79677	4.63886
9	6.24689	5.99525	5.75902	5.53705	5.32825	5.13166	4.94637
10	6.71008	6.41766	6.14457	5.88923	5.65022	5.42624	5.21612

b. Calculate the net present value of the new hotel using the present value of an annuity of $1 table above. Round to the nearest million dollars. If required, use the minus sign to indicate a negative net present value.
Net present value of hotel project: $ million

c. Does your analysis support the purchase of the new hotel?
, because the net present value is  .

Answer 1

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Particulars	Y0	Y1	Y2	Y3	Y4	Y5	Y6	Y7	Y8	Y9	Y10	Total
Purchase cost	(70.00)	-	-	-	-	-	-	-	-	-	-	(70.00)
Revenues	-	19.00	19.00	19.00	19.00	19.00	19.00	19.00	19.00	19.00	19.00	190.00
Expenses	-	14.00	14.00	14.00	14.00	14.00	14.00	14.00	14.00	14.00	14.00	140.00
Net Earnings	-	5.00	5.00	5.00	5.00	5.00	5.00	5.00	5.00	5.00	5.00	50.00
Add: Depreciation	-	7.00	7.00	7.00	7.00	7.00	7.00	7.00	7.00	7.00	7.00	70.00
Net Cash flow	(70.00)	12.00	12.00	12.00	12.00	12.00	12.00	12.00	12.00	12.00	12.00	50.00
PV Factor at 10%	1.00	0.90909	0.82645	0.75132	0.68302	0.62093	0.56448	0.51316	0.46651	0.42410	0.38555
PV of Net Cash flow	(70.00)	10.91	9.92	9.02	8.20	7.45	6.77	6.16	5.60	5.09	4.63	3.74
Since the PV is coming positive i.e $ 3.74 millions, so the firm should accept the proposal.