13-7: Real Options – Nevada Enterprise is considering buying a vacant lot that sells for $1.2 million. If the property is purchased, the company’s plan is to spend another $5 million today (t = 0). To build a hotel on the property. The cash flows from the hotel will depend critically on whether the state imposes a tourism tax in this year’s legislative session. If the tax is imposed, h the hotel is expected to produce cash flows of $600, 000 at the end of each of the next 15 years. If the tax is not imposed, the hotel is expected to produce cash flows of $1, 200, 000 at the end of each of the next 15 years. The project has a 12% WACC. Assume at the outset that the company does not have the option to delay the project.  

a. What is the project’s expected NPV If the tax is imposed?  

b. What is the project’s expected NPV if the tax is not imposed?  

c. Given that there is a 50% chance that the tax will be imposed, what is the project’s expected NPV if management proceeds  

d. Although the company does not have an option to delay construction, it does have the option to abandon the project 1 year from now if the tax is imposed. If it abandons the project, it will sell the complete property 1 year from now at an expected price of $6 million after taxes. Once the project is abandoned, the company will no longer receive any cash flows. Assuming that all cash flows are discounted at 12%, will the existence of this abandonment option affect the company’s decision to proceed with the project today? Explain.  

e. Finally, assume that there is no option to abandon or delay the project, but that the company has an option to purchase an adjacent property in 1 year at price of $1.5 million (outflow at t =1). If the tourism tax is imposed, the expected net present value of developing this property (as of t =1) will be only $300, 000 (so it doesn’t make sense to purchase the property for $1.5 million. However, if the tax is not imposed, the expected net present value of the future opportunities from developing the property will be $4 million (as of t=1). Thus, under the scenarios, it makes sense to purchase the property for $.5 million (at t=1). Assume that these cash flows are discounted at 12%, and the probability that the tax will be imposed is still 50%. What is the most the company would pay today (t=0) for the $1.5 million purchase options (at t=1) for the adjacent property?  

Nevada Enterprises is considering buying a vacant lot that sells for $1.2 million. If the property is purchased, the company’s plan is to spend another $5 million today (t = 0) to build a hotel on the property. The cash flows from the hotel will depend critically on whether the state imposes a tourism tax in this year’s legislative session. If the tax is imposed, the hotel is expected to produce cash flows of $500,000 at the end of each of the next 15 years. If the tax is not imposed, the hotel is expected to produce cash flows of $1,400,000 at the end of each of the next 15 years. The project has a 12% WACC. Assume at the outset that the company does not have the option to delay the project.

a. What is the project’s expected NPV if the tax is imposed?

b. What is the project’s expected NPV if the tax is not imposed?

c. Given that there is a 55% chance that the tax will be imposed, what is the project’s expected NPV if management proceeds with it today?

d. Although the company does not have an option to delay construction, it does have the option to abandon the project 1 year from now if the tax is imposed. If it abandons the project, it will sell the complete property 1 year from now at an expected price of $6 million after taxes. Once the project is abandoned, the company will no longer receive any cash flows. Assuming that all cash flows are discounted at 12%, will the existence of this abandonment option affect the company’s decision to proceed with the project today? Explain.

e. Finally, assume that there is no option to abandon or delay the project, but that the company has an option to purchase an adjacent property in 1 year at a price of $1.5 million (outflow at t = 1). If the tourism tax is imposed, the expected net present value of developing this property (as of t = 1) will be only $300,000 (so it doesn’t make sense to purchase the property for $1.5 million). However, if the tax is not imposed, the expected net present value of the future opportunities from developing the property will be $4 million (as of t = 1). Thus, under this scenario, it makes sense to purchase the property for $1.5 million (at t = 1). Assume that these cash flows are discounted at 12%, and the probability that the tax will be imposed is still 55%. What is the most the company would pay today (t = 0) for the $1.5 million purchase option (at t = 1) for the adjacent property?

suppose that a hotel has 100 rooms and the hotel is accepting overbooking anticipating some cancellations. The probability for cancellation is 0.07.

a) What is the probability that somoen who made a reservation will be turned away if this hotel has allowed for 110 resevations?

b. 105 reservation

c. why did the answer to part b go down

American Movieplex, a large movie theater chain, leases most of its theater facilities. In conjunction with recent operating leases, the company spent $28 million for seats and carpeting. The question being discussed over breakfast on Wednesday morning was the length of the depreciation period for these leasehold improvements. The company controller, Sarah Keene, was surprised by the suggestion of Larry Person, her new assistant.

Required:

1. How would increasing the depreciation period affect American Movieplex’s earnings?
2. Does revising the estimate pose an ethical dilemma?
3. Who would be affected if Person’s suggestion is followed?

American Movieplex, a large movie theater chain, leases most of its theater facilities. In conjunction with recent operating leases, the company spent $28 million for seat and carpeting. The question being discussed over breakfast on Wednesday morning was the length of the depreciation period for these leasehold improvements. The company controller, Sarah Keene, was surprised by the suggestion of Larry Person, her new assistant.

Keene: Why 25 years? We've never depreciated leasehold improvements for such a long period.

Person: I noticed that in my review of back records. But during our expansion to the Midwest, we don't need expenses to be any higher than necessary.

Keene: But isn't that a pretty rosy estimate of these assets' actual life? Trade publications show an average depreciation period of 12 years.

Read through the dilemma. For the Original Post*, you will be arguing in favor of Larry Person's proposal to increase the depreciation period for leasehold improvements. Remember to use logic and the accounting principles you have learned thus far to develop your argument. You must include at least three points as to why this route is the best route to go (with one of those points being related to the learned accounting principles).

American Movieplex, a large movie theater chain, leases most of its theater facilities. In conjunction with recent operating leases, the company spent $28 million for seat and carpeting. The question being discussed over breakfast on Wednesday morning was the length of the depreciation period for these leasehold improvements. The company controller, Sarah Keene, was surprised by the suggestion of Larry Person, her new assistant. Keene: Why 25 years? We've never depreciated leasehold improvements for such a long period. Person: I noticed that in my review of back records. But during our expansion to the Midwest, we don't need expenses to be any higher than necessary. Keene: But isn't that a pretty rosy estimate of these assets' actual life? Trade publications show an average depreciation period of 12 years. Read through the dilemma.

For the Original Post*, you will be arguing in favor of Larry Person's proposal to increase the depreciation period for leasehold improvements. Remember to use logic and the accounting principles you have learned thus far to develop your argument. You must include at least three points as to why this route is the best route to go (with one of those points being related to the learned accounting principles).

1. PLEASE ANSWER AT LEAST ONE OF THE FOLLOWING PROBLEMS

Installment sales.

Sawyer Furniture Company concluded its first year of operations in which it made sales of $800,000, all on installment. Collections during the year from down payments and installments totaled $300,000. Purchases for the year totaled $400,000; the cost of merchandise on hand at the end of the year was $80,000.

Instructions

Using the installment-sales method, make summary entries to record:

(a)   the installment sales and cash collections;

(b)   the cost of installment sales;

(c)   the unrealized gross profit;

(d)   the realized gross profit.

2. PLEASE ANSWER AT LEAST ONE OF THE FOLLOWING PROBLEMS

Percentage-of-completion method.

Penner Builders contracted to build a high-rise for $14,000,000. Construction began in 2010 and is expected to be completed in 2013. Data for 2010 and 2011 are:

                                                                                                     2010                2011

            Costs incurred to date                                                $1,800,000      $5,200,000

            Estimated costs to complete                                        7,200,000        4,800,000

Penner uses the percentage-of-completion method.

Instructions

(a)   How much gross profit should be reported for 2010? Show your computation.

(b)   How much gross profit should be reported for 2011?

(c)   Make the journal entry to record the revenue and gross profit for 2011.

-Pick two of the principles of green chemistry, state which 2 you chose and show how they connect to your life or intended profession. Please be very clear (as in overtly) as to which two you are selecting so that I am sure to recognize the connections you are making.

-How has the Tragedy of the Commons affected you or your family? For example, when one of the creators of this course (Ted Picciotto) was younger, he and his father would see quail frequently in the state park near their home. Since then they have all but disappeared. Only recently has the population begin to rebound very slightly. If you are not old enough to remember a change in the environment, interview a parent or grandparent if possible.

-How have your studies to date prepared you for the future world in which you live? In what ways do you think your study of chemistry will prepare you?

Please use IRAC.

1. Bob, a sole proprietor, owns a well-know aquatic park in the city of Bakersfield. One day, one of Bobs worst employees was messing around with the music system set up in the back. Without acknowledgement, Bob’s worst employee tripped on a wire and accidentally cut the wire to the point were there was a dangerous shortage. John, Bob’s newest employee noticed the accident and immediately notified Bob. Without taking a second look, Bob told John, “I am sure it’s not big deal, just get back to work.” Next week, a child was playing near the pool in the back and when jumping in the pool, the child tripped on the cord and got electrocuted. The child had 3rd degree burns resulting in a hospital bill of $160,000. The child’s mother consults with you and asks whether they have a personal injury claim against Bob, even though it was Bob’s employee’s fault?

Please use IRAC.

What is the difference between a management contract, a brand, and a hotel franchise agreement? Are all three necessary to run a successful hotel?