Hospitality Uses and Mineral Leases Practice Problem Aiming to bring the most jo

Question

Hospitality Uses and Mineral Leases

Practice Problem

Aiming to bring the most jobs and economic development to the county,

the San Luis Obispo County Council commissioned a study which evaluated the

highest and best use for land at the end of Avila Beach and Lighthouse Road.

There are potential energy reserves on the publicly owned land nearby and within

the countys boundaries. The reserve report found that substantial oil reserves

exist on the county-owned land adjacent to Port Harford. Several oil companies

have submitted bids for exploration leases on the land adjacent to the port.

The owners of Obispo Convention Center, a 320-room hotel farther inland

near the Pacific Golf Courses would rather see an expansion of the hospitality

uses in the county. The existing harbor building could expand recreational

boating. It already encompasses an outdoor pool deck, concession businesses

such as food and beverage outlets, and a parking area, which the owners believe

could be expanded for further recreational use.  

The county is considering granting a mineral lease to Energy Development

Co. (EDC), to begin extracting the oil over the next ten years from the adjacent

land. The owners of Oxnard Convention Center are concerned that oil drilling will

interfere with the tourism industry in San Luis Obispo.   They would rather see the

development of a new 280-room hotel and golf course at the location.

This is an arial photograph of the location.

PROPOSED NEW HOTEL INFORMATION

County annual averages:

Daily room rate: $220

Countys Occupancy rate: 75%

Operating expenses: $175 per room per day

General Market Conditions:

Occupancy began to show positive yearly growth and hotel capitalization

rates began to decline. Capitalization rates for new hospitality uses derived from

select lodging REIT data for the county averaged 11.5%.  

PROPOSED MINERAL LEASE INFORMATION

There is presently one working oil well on the land. In estimating reserves,

EDCs engineer estimates that the proved developed producing (PDP) reserves

at the site are a total of 1.7 million barrels of oil, with an annual decline rate of

30%. The company is considering a 15-year lease. The average price of oil for the

last year has been $95 per barrel. The county has indicated it will require that a

discount rate of 15% be used for valuing mineral leases in San Luis Obispo County.

EDC expects to pay a tax rate of 10%. Exploration costs will be 7% of

revenues. Production expenses are projected to be approximately 42% of the

leases gross revenue and management costs are less than 5% of gross income

due to recent modernization measures the company has undertaken. The county

would require that the land be returned in the same condition as it was when

leased. EDC budgets 9% of gross revenue to cover the expense of restoring the

property when extraction operations cease.    

Questions:

Estimate the total value of both projects, if done together, and whether
they are compatible with each other.

Explanation / Answer

Below is the calcuation for both the project

Project A

Project B

Since the total value of the project is possitive both the project can be dpne together and they are compabtible with each other.

Numbers of room 280 Operating cost per room $           175 County's Occupancy rate 75% Daily Occupancy = Number of Rooms * County's occupancy rate 210 Daily Room Rate $           220 Total revenue per day = Number of occupied room per day * Daily room rate $      46,200 Total Cost per day = Number of occupied room per day * operating cost per room $      36,750 Net Income per day - Total Revenue per day - Total Cost per day $        9,450 Capitalization rate 11.50% Yearly Income $ 3,449,250 Total Value = Yearly income / capitlization rate $29,993,478

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