Value Lodges owns an economy motel chain and is considering building a new 200-u
ID: 2498961 • Letter: V
Question
Value Lodges owns an economy motel chain and is considering building a new 200-unit motel. The cost to build the motel is estimated at $8,000,000; Value Lodges estimates furnishings for the motel will cost an additional $700,000 and will require replacement every 5 years. Annual operating and maintenance costs for the motel are estimated to be $800,000. The average rental rate for a unit is anticipated to be $40/day. Value Lodges expects the motel to have a life of 15 years and a salvage value of $900,000 at the end of 15 years. This estimated salvage value assumes that the furnishings are not new. Furnishings have no salvage value at the end of each 5-year replacement interval. Assuming average daily occupancy percentages of 50%, 60%, 70%, and 80% for years 1 through 4, respectively, and 90% for the 5th through 15th years, a MARR of 12%/year, 365 operating days/year, and ignoring the cost of land, should the motel be built? Base your decision on an internal rate of return analysis.
What is the internal rate of return used to reach your decision?
Explanation / Answer
Year Building Cost Average rental Per day No Of units Occupancy Ratio No of days Revenue(Multiplication of prev.4) Annual Operating Cost Furnishing Cost Net Cash Flow PVAF @ 12% Present Value PVAF @ 14% Present Value 0 (80,00,000) 0 0 0 0 0 0 (7,00,000) (87,00,000) 1 (87,00,000) 1 (87,00,000) 1 0 40 200 50 365 14,60,000 (8,00,000) - 6,60,655 0.892857 5,89,871 0.877193 5,79,522 2 0 40 200 60 365 17,52,000 (8,00,000) - 9,52,665 0.797194 7,59,459 0.769468 7,33,045 3 0 40 200 70 365 20,44,000 (8,00,000) - 12,44,675 0.71178 8,85,935 0.674972 8,40,120 4 0 40 200 80 365 23,36,000 (8,00,000) - 15,36,685 0.635518 9,76,591 0.59208 9,09,841 5 0 40 200 90 365 26,28,000 (8,00,000) (7,00,000) 11,28,695 0.567427 6,40,452 0.519369 5,86,209 6 0 40 200 90 365 26,28,000 (8,00,000) - 18,28,695 0.506631 9,26,474 0.455587 8,33,129 7 0 40 200 90 365 26,28,000 (8,00,000) - 18,28,695 0.452349 8,27,209 0.399637 7,30,815 8 0 40 200 90 365 26,28,000 (8,00,000) - 18,28,695 0.403883 7,38,579 0.350559 6,41,066 9 0 40 200 90 365 26,28,000 (8,00,000) - 18,28,695 0.36061 6,59,446 0.307508 5,62,338 10 0 40 200 90 365 26,28,000 (8,00,000) (7,00,000) 11,28,695 0.321973 3,63,410 0.269744 3,04,458 11 0 40 200 90 365 26,28,000 (8,00,000) - 18,28,695 0.287476 5,25,706 0.236617 4,32,701 12 0 40 200 90 365 26,28,000 (8,00,000) - 18,28,695 0.256675 4,69,380 0.207559 3,79,562 13 0 40 200 90 365 26,28,000 (8,00,000) - 18,28,695 0.229174 4,19,090 0.182069 3,32,949 14 0 40 200 90 365 26,28,000 (8,00,000) - 18,28,695 0.20462 3,74,187 0.15971 2,92,061 15 9,00,000.00 40 200 90 365 26,28,000 (8,00,000) - 27,28,695 0.182696 4,98,522 0.140096 3,82,281 1,53,10,325 9,54,310 (1,59,903) At 12% Net Cash Flow = 954310 At 14% Net Cash Flow -159903 for Every 2% 1114213 Required Decrease in Cash Flow 9,54,310 Required Increase % 1.71 % (2/1114213*954310) IRR 13.71 (12+1.71) As IRR is greater than MARR, We can accept the project. 13.71>12
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