Question

A group of entrepreneurs want to purchase a rural hotel.

The renovation and purchase of the hotel has an estimated cost of €525,000.

This capital investment will be depreciated consistently over the next 5 years.

It is estimated that there will be 4,000 rooms total occupation per year, at a rate of €100 per room/night. Room occupation will rise by 5% year over year.

Running costs are estimated as €290,000 for the first year and will increase by 5% year over year.

The tax rate is 35%.

Step 1: Calculate the initial free cash flows correctly.

Step 2: If the partners require a minimum return of 8% on their investments, would you recommend that these businessmen buy the hotel? (Assume a continuous increase in cash flow of 1% from the 5^th year forwards). Why or why not?

Answer 1

Yes, I would recommend that these businessmen buy the hotel because the NPV is positive.

EBIT = Revenues - Running Costs
Depreciation = Initial investment / No. of years
= 525000 / 5 = 105,000 per year
FCFF = EBIT(1-t) + Depreciation

Terminal Value = FCFF of year 5 * growth rate %
Discount rate - Growth rate

= FCFF of year 5 * 1%
8% - 1%

NPV = PV of cash Inflows - PV of Cash Outflow