(Replacement chains) Destination Hotels currently owns an older hotel on the bes
ID: 2787715 • Letter: #
Question
(Replacement chains) Destination Hotels currently owns an older hotel on the best beachfront property on Hilton Head Island, and it is considering either remodeling the hotel or tearing it down and building a new convention hotel, but because both hotels would occupy the same physical location, the company can only choose one projectlong dash—that is, these are mutually exclusive projects. Both of these projects have the same initial outlay of $1,000,000. The first project, since it is a remodel of an existing hotel, has an expected life of 6 years and will provide free cash flows of $ 350,000 at the end of each year for all 6 years. In addition, this project can be repeated at the end of 6 years at the same cost and with the same set of future cash flows. The proposed new convention hotel has an expected life of 12years and will produce cash flows of $210,000 per year. The required rate of return on both of these projects is 12 percent. Calculate the NPV using replacement chains to compare these two projects.
The NPV of remodeling the existing hotel is
The NPV of building a new hotel is
Destination Hotels should
Explanation / Answer
Remodel of Existing Hotel
CF0 = -1,000,000
CF1 = 350,000
CF2 = 350,000
CF3 = 350,000
CF4 = 350,000
CF5 = 350,000
CF6 = 350,000
CF6 = -1,000,000
CF7 = 350,000
CF8 = 350,000
CF9 = 350,000
CF10 = 350,000
CF11 = 350,000
CF12 = 350,000
NPV = -1,000,000 + 350,000/ (1.12)1 + 350,000/ (1.12)2 + 350,000/ (1.12)3 + 350,000/ (1.12)4 + 350,000/ (1.12)5 + 350,000/ (1.12)6 - 1,000,000/ (1.12)6 + 350,000/ (1.12)7 + 350,000/ (1.12)8 + 350,000/ (1.12)9 + 350,000/ (1.12)10 + 350,000/ (1.12)11 + 350,000/ (1.12)12
NPV = -1,000,000 + 312,500 + 279,017.86 +..............- 506,631.12 + 89,836.28
NPV = 661,399.86
New Convention Hotel:
CF0 = -1,000,000
CF1 = 210,000
CF2 = 210,000
CF3 = 210,000
CF4 = 210,000
CF5 = 210,000
CF6 = 210,000
CF7 = 210,000
CF8 = 210,000
CF9 = 210,000
CF10 = 210,000
CF11 = 210,000
CF12 = 210,000
NPV = -1,000,000 + 210,000/ (1.12)1 + 210,000/ (1.12)2 + 210,000/ (1.12)3 + 210,000/ (1.12)4 + 210,000/ (1.12)5 + 210,000/ (1.12)6 + 210,000/ (1.12)7 + 210,000/ (1.12)8 + 210,000/ (1.12)9 + 210,000/ (1.12)10 + 210,000/ (1.12)11 + 210,000/ (1.12)12
NPV = -1,000,000 + 187,500 +................+ 53,901.77
NPV = 300,818.59
Destination Hotels should remodel the existing hotel
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