Investment Timing Option: Option Analysis

Kim Hotels is interested in developing a new hotel in Seoul. The company estimates that the hotel would require an initial investment of $20 million. Kim expects the hotel will produce positive cash flows of $3 million a year at the end of each of the next 20 years. The project's cost of capital is 13%.

Kim expects the cash flows to be $3 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 $2.2 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 $3.8 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 $20 million. Assume that all cash flows are discounted at 13%. Use the Black-Scholes model to estimate the value of the option. Assume that the variance of the project's rate of return is 0.0585 and that the risk-free rate is 6%. Enter your answers in millions. For example, an answer of $10,550,000 should be entered as 10.55. Do not round intermediate calculations. Round your answer to three decimal places.

Use computer software packages, such as Minitab or Excel, to solve this problem.

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Investment Timing Option: Option Analysis

Kim Hotels is interested in developing a new hotel in Seoul. The company estimates that the hotel would require an initial investment of $20 million. Kim expects the hotel will produce positive cash flows of $3 million a year at the end of each of the next 20 years. The project's cost of capital is 13%.

Kim expects the cash flows to be $3 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 $2.2 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 $3.8 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 $20 million. Assume that all cash flows are discounted at 13%. Use the Black-Scholes model to estimate the value of the option. Assume that the variance of the project's rate of return is 0.0654 and that the risk-free rate is 8%. Enter your answers in millions. For example, an answer of $10,550,000 should be entered as 10.55. Do not round intermediate calculations. Round your answer to three decimal places.

Use computer software packages, such as Minitab or Excel, to solve this problem.

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1. Sjcam used a penetration pricing strategy to introduce its Legend action camera to compete with the latest GoPro offering. Which of the following conditions would argue for using a penetration pricing strategy when introducing this new camera?

a. A large potential market exists, even at a high price.

b. Technological problems still exist for competitors, prohibiting their entry into the market for at least six months.

c. Increasing volume substantially reduces production costs.

d. Consumers perceive a price-quality relationship.

e. The product is relatively price insensitive (price inelastic).

2. Apple offers its iPhone XS for $999, under the presumption that consumers see the smartphone as priced at “something over $900” rather than “about $1,000.” This is an application of what pricing strategy?

a. prestige pricing

b. below-market pricing

c. odd-even pricing

d. target pricing

e. customary pricing

3. Which of the following would be an example of a variable cost for a hotel like the Marriott Marquis Hotel, which caters to an upscale clientele?

a. the average daily rate paid by women in targeted demographics staying at the hotel

b. cleaning supplies and housekeeping wages

c. the salary of the hotel manager

d. the rent for a parking garage used by employees

e. the price charged for renting a ballroom in the hotel

4. Uber and Lyft customers often complain about the practice of “surge” or “prime-time” pricing used by these companies during periods of peak demand. This is an example of a __________ pricing policy.

a. promotional

b. competitive

c. discount

d. dynamic

e. customer

For a live play like The Tempest or any play similar hat does the performance suggest about the role of theater in contemporary culture?

How much time do Americans living in or near cities spend waiting in traffic, and how much does waiting in traffic cost them per year? The file “congestion.xlsx” includes this cost for 31 cities. For the time Americans living in or near cities spend waiting in traffic and the cost of waiting in traffic per year: c. Construct a boxplot. Are the data skewed? If so, how? d. Compute the correlation coefficient between the time spent sitting in traffic and the cost of sitting in traffic. e. Based on the results of (a) through (c), what conclusions might you reach concerning the time spent waiting in traffic and the cost of waiting in traffic?

A hotel rental service needs to have clean towels for each day of a three-day period. Some of the clean towels may be purchased new and some may be dirty towels from previous days that have been washed by a laundry service. The cost of new towels is $1 per towel, the cost of a fast one-day laundry serice is 40¢ per towel, and the cost of a slow two-day laundry service is 25¢ per towel. If the rental service needs 300,200, and 400 clean towels for each of the next three days (respectively), how many towels should the rental service buy new and how many should the rental service have washed by the different laundry services so as to minimize total costs?

The solution is minC=570 at (x,y,z,w)=(400,100,200,200), please use hand-writing for the process.

1. The National Park Service has asked you to construct a value of the Grand Canyon. Explain the pros and cons of using the travel cost method to do this. Would you prefer the hedonic method or the stated preference method? Why or why not?

1. The National Park Service has asked you to construct a value of the Grand Canyon. Explain the pros and cons of using the travel cost method to do this. Would you prefer the hedonic method or the stated preference method? Why or why not?

Q1. You are an audit manager of Morline & Co, a Public Accounting firm. The audit engagement partner, Joe Tan, has called you into his office to discuss a new audit client. You have been assigned to take charge of the audit for the financial year end, 31 December 2019 of Crown Hotel Group Bhd. (Crown Group) a listed company. The Group operates a chain of luxury hotels across Malaysia. As part of the expansion strategy, Crown Group has recently acquired a new hotel in Melbourne. You are very excited about auditing this luxury group of hotels, and are hoping that you may get to stay in one of the hotels during the audit.

Recently you had a meeting with Joe Tan, Datuk Paul Wong, the managing director of Crown Group, and Lisa Goh, the finance director of Crown Group. From detailed discussions with them, you note the following information:

Background information:
Crown Group owns four hotels in Malaysia namely Dolce, Corus, Korma, Morib, one hotel, Belux in Singapore and a newly acquired hotel in Melbourne namely Aston, which was acquired in September 2019. Each hotel operates through a separate legal entity, and Crown Group owns 100% of each entity. The Group prepares consolidated financial statements on an annual basis. The Head Office is located in Petaling Jaya, Malaysia.

In 2019, the Crown Group had total revenues of RM 90 million (2018: RM 80 million), and operating profits of RM 8,500,000 (2018: RM 11,000,000).

Lisa Goh explained that all the hotels have been performing well over the last year, with the exception of Hotel Belux. See notes below

Information Technology (IT)

Lisa Goh highlighted that the Crown Group relies heavily on the use of information technology (IT) and noted that approximately 96% of bookings are made online via its website. The Group invested significantly in IT over the last six months, which resulted in an extensive upgrade of its website and the development of a user-friendly app. Datuk Paul Wong said, “We have spent a significant amount of money developing our IT systems and ensuring they are secure, as the rapid increase in cybercrime in Malaysia is frightening.” This development cost was capitalised in Financial Year 2019.

Finance team

Each hotel has a finance team, including a financial controller. At the end of every month, a reporting pack is prepared by the financial controller, including a copy of the management accounts, key completed reconciliations and detailed commentary on how the hotel has met the key performance indicators for that particular month. Each reporting pack is submitted to the head office, and the group financial controller reviews them and performs additional reconciliations. The group financial controller also prepares the year-end consolidated financial statements. Lisa Goh has, however, informed you that the group financial controller resigned in November 2019 because he could not cope with the pressure of the job. She has not been able to find a suitable replacement as to date. Lisa has asked if your firm would be able to help with the finalisation of the consolidated financial statements for the year ended 31 December 2019, as her team is currently struggling to find the time needed.

New acquisition

The hotel in Melbourne, Aston was acquired in September 2019 for RM 8,500,000, and will be included in the consolidated financial statements at 31 December 2019. The purchase of the hotel was financed by a bank loan. Datuk Paul Wong explained this was a significant investment for the Crown Group and that a further RM 2 million has since been spent on capital expenditure to ensure it meets the exceptionally high standards of the Group. Datuk Paul Wong has invited the entire audit team to travel to Melbourne for the opening of the hotel in June 2020 as his guests. He has also assured the team will be treated very well while there.

Valuation of the hotel properties

The group policy is to value Land and Buildings at fair value. The calculation of fair value and the allocation of fair value to Land and Buildings requires significant judgement. Datuk Paul Wong confirmed professional valuation experts were appointed to value Land and Buildings at 31 December 2019. Land and Buildings at that date were valued at RM 110 million, representing a revaluation increase of RM 12 million.

Loans and Borrowings
During the financial year to 31 December 2019, the Group borrowed RM 10,500,000 in order to finance the purchase of the Aston, and to complete the renovation work required. The loan is repayable over 10 years and the Group must adhere to strict loan covenants. The bank requires the Group to provide management accounts on a quarterly basis, if a loan covenant is breached, the loan may be due for repayment immediately. Lisa Goh has informed you that the group is also struggling to ensure management accounts for the quarter ended 31 December 2019 will be submitted within the allocated timeframe. The amount of interest paid was extremely significant

Bonus
During the year, a new bonus scheme was introduced for both managers and directors for all the hotel within the group in order to increase revenue. The bonus is directly linked to revenue.

Advance payment
Advance deposits of 50% are collected for those booking for conferences and wedding packages.

Hotel Belux
The hotel Belux is one of the biggest in the Group, and contributes 25% of total revenue is located in Singapore. Although revenue has increased in 2019, profit has fallen significantly due to a number of “special offers” in both accommodation rates and the restaurant. Datuk Paul Wong believes the main causes for this fall are reduced gross margins (due to the successful uptake of the various special offer promotions during the year) and increasing costs (mainly driven by payroll). The number of special offers were approved by management in a bid to counter the tough economic environment within which the hotel operates and thereby increase revenue.

Required:
(i) Identify and explain to the audit partner SEVEN (7) key audit risks in respect of Crown Group.
(ii) Describe the matters Morline & Co should consider in the context of ISA 620 in order to evaluate the adequacy of the expert’s work in relation to engaging the services of a property expert to value Land and Buildings.
(iii) Evaluate the ethical issues(s) if any in respect of the Crown Group audit engagement and recommend appropriate safeguard(s).