Net Present Value Method—Annuity
Model 99 Hotels is considering the construction of a new hotel for $13,500,000. The expected life of the hotel is 5 years with no residual value. The hotel is expected to earn revenues of $14,796,000 per year. Total expenses, including straight-line depreciation, are expected to be $13,500,000 per year. Model 99 management has set a minimum acceptable rate of return of 20%.
a. Determine the equal annual net cash flows
from operating the hotel.
$
b. Calculate the net present value of the new hotel, using the present value factor of an annuity of $1 table below. If required, round to the nearest dollar. If the net present value is negative, enter the amount using a minus sign.
| Present Value of an Annuity of $1 at Compound Interest | |||||
| Year | 6% | 10% | 12% | 15% | 20% |
| 1 | 0.943 | 0.909 | 0.893 | 0.870 | 0.833 |
| 2 | 1.833 | 1.736 | 1.690 | 1.626 | 1.528 |
| 3 | 2.673 | 2.487 | 2.402 | 2.283 | 2.106 |
| 4 | 3.465 | 3.170 | 3.037 | 2.855 | 2.589 |
| 5 | 4.212 | 3.791 | 3.605 | 3.353 | 2.991 |
| 6 | 4.917 | 4.355 | 4.111 | 3.785 | 3.326 |
| 7 | 5.582 | 4.868 | 4.564 | 4.160 | 3.605 |
| 8 | 6.210 | 5.335 | 4.968 | 4.487 | 3.837 |
| 9 | 6.802 | 5.759 | 5.328 | 4.772 | 4.031 |
| 10 | 7.360 | 6.145 | 5.650 | 5.019 | 4.192 |
| Annual net cash flow | $ |
| Present value of hotel project cash flows | $ |
| Less hotel construction costs | $ |
| Net present value of hotel project | $ |
c. Which of the following statements is correct regarding this potential project?
They should build the hotel because the present value of the hotel's operating cash flows exceeds the construction costs.
They should build the hotel because the present value of the hotel's operating cash flows is less than the construction costs.
They should build the hotel because the present value of the hotel's operating cash flows is equal to the construction costs.
They should not build the hotel because the net present value is negative.
a) Annual Net cash flow : 14796000-13500000+(13500000/5) = $3996000
b) Calculate net present value
| Annual net cash flows | 3996000 |
| Present value of hotel project cash flows (3996000*2.991) | 11952036 |
| Less hotel construction costs | -13500000 |
| Net present value of hotel project | -1547964 |
c. Which of the following statements is correct regarding this potential project?
So answer is d) They should not build the hotel because the net present value is negative.
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