Question

Busan Resort Hotel: Valuing an Independent Capital Project

Harris Ford, General Manager of Busan Resort Hotel, paced his office and considered to expand the business by opening a karaoke pub and will name it Beach Karaoke Pub. The project will require an up-front investment of US$750,000. This represents the cost of a modern-style décor. Other capital investment, including chairs, bar tables, kitchen set-up and karaoke equipment, will cost US$100,000. Michael expects revenue to be generated 50% from walk-ins and 50% from hotel guests. Total sales are estimated to be US$740,950 for the first year of operation. Michael arrives at this figure by assuming an average of 70 covers per day with an average check of US$29. With a seating capacity of 35, the pub has to turn tables at least twice a day. Operating hours of the pub will be from 5:00 p.m. to midnight. The projected length of the project is six years and sales are expected to grow at 5% annually.

Michael’s estimates for operating costs are as follows:

Food and beverage costs

25% of sales

Salaries

16% of sales

Other operating expenses

22% of sales

Depreciation:

Equipment & furniture depreciated equally over the life of the project using the straight-line method; with zero salvage value at the end

Annual capital expenditure

Equaled depreciation (Same with depreciation cost)

Michael estimates that salary expenses will account for 16% of sales. Staff can be recruited internally because the hotel has excess manpower at this point. The excess staffs has long-term contracts with the hotel and are kept in order to meet the demands of the growing business. Repairs and maintenance costs will account for 2% of sales. The interest rate or required rate of return is 12% and the corporate tax rate in Busan is 30%

3. Introduction

4. Purpose of the study/project

5. Case study overview

6. Calculation of the project

a) Net Investment (NINV)

b) Net Cash Flows (NCFs)

c) Payback Period (PP)

d) Net Preent Value (NPV)

e) Internal rate of return (IRR)

7. Analysis

8. Decision

9. Conclusion

10. References

11. Appendix

Answer 1

Introduction

Harris Ford, General Manager of Busan Resort Hotel, paced his office and considered to expand the business by opening a karaoke pub and will name it Beach Karaoke Pub.

Purpose of the study/project

The purpose of the project is to evaluate whether to do investment and open a karaoke pub. The project life is 6 years.

Case study overview

The project will require an up-front investment of US$750,000. This represents the cost of a modern-style décor. Other capital investment, including chairs, bar tables, kitchen set-up and karaoke equipment, will cost US$100,000. The projected length of the project is six years and sales are expected to grow at 5% annually.

Total sales are estimated to be US$740,950 for the first year of operation. This figure is arrived by assuming an average of 70 covers per day with an average check of US$29. Revenue to be generated 50% from walk-ins and 50% from hotel guests. The sitting capacity is of 35 persons. Operating hours of the pub will be from 5:00 p.m. to midnight.

The cost estimates are as follows

Food and beverage costs	25% of sales
Salaries	16% of sales
Other operating expenses	22% of sales
Repairs and maintenance costs	2% of Sales

The interest rate or required rate of return is 12% and the corporate tax rate in Busan is 30%. Equipment & furniture depreciated equally over the life of the project using the straight-line method; with zero salvage value at the end. Staff can be recruited internally because the hotel has excess manpower at this point. The excess staffs has long-term contracts with the hotel and are kept in order to meet the demands of the growing business.

Calculation of the project

a)	Net Investment (NINV)
	Up front investment			750,000
	Other Capital Investment			100,000
				850,000

b)	Net Cash Flows (NCFs)
				Year 1	Year 2	Year 3	Year 4	Year 5	Year 6
	Sales (5 % incremental each year)			740,950	777,998	816,897	857,742	900,629	945,661
	Food And beverage Cost (25% of Sales)			185,238	194,499	204,224	214,436	225,157	236,415
	Salaries (16% of Sales)			118,552	124,480	130,704	137,239	144,101	151,306
	Other Operating Expenses (22% of Sales)			163,009	171,159	179,717	188,703	198,138	208,045
	Depreciation			141,667	141,667	141,667	141,667	141,667	141,667
	Repairs and Maintenace Cost (2% of Sales)			14,819	15,560	16,338	17,155	18,013	18,913
	Total			623,284	647,365	672,650	699,199	727,076	756,346
	Profit Before Tax			117,666	130,632	144,247	158,543	173,554	189,315
	Tax (30%)			35,300	39,190	43,274	47,563	52,066	56,794
	Profit after Taxes			82,366	91,443	100,973	110,980	121,488	132,520
	Add: Depreciation			141,667	141,667	141,667	141,667	141,667	141,667
	Net Cash Flows (NCFs)			224,033	233,109	242,640	252,647	263,154	274,187
c)	Payback Period (PP)
	Cummulative Cash flows			224,033	457,142	699,782	952,429	1,215,583	1,489,770
	Payback period is the period when Total investment is recovered from your Cash inflows. In this case, in 4th year, total
	investment of US $ 8,50,000 is recovered.
d)	Net Present Value (NPV)
	Required rate of return is 12%
	Present Value (PV)		=	Cash Flow the a particular year
				( 1 + Rate of interest)^ no. of years
			=	224033	233,109	242,640	252,647	263,154	274,187
				(1+0.12)^1	(1+0.12)^2	(1+0.12)^3	(1+0.12)^4	(1+0.12)^5	(1+0.12)^6
				200,029	185,833	172,706	160,562	149,321	138,912
	Total Present value		=	Total of PV of all 6 years
				1,007,363
	Net Present value		=	Total Investment - Present value of Cash flows
			=	1007363- 850000
	Net Present value		=	157,363
e)	Internal rate of return (IRR)
			Year 0	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6
	Cash flows for all years		(850,000)	224,033	233,109	242,640	252,647	263,154	274,187
	IRR		=IRR(-850000,224033,233109,242640,252647,263154,274187)
	IRR		18%

7. Analysis

The NPV of the project is positive and it would give return of USD $ 157,363. Further IRR of the project is 18% which is greater than 12% of required rate of return.

8. Decision

It is recommended to go ahead with the Beach Karaoke Pub.

9. Conclusion

The opening of Beach Karaoke Pub seems to be profitable venture based on the assumptions made.

10. References

Capital budgeting and long-term financing decisions by Neil Seitz

11. Appendix

As above