Question

Net Present Value Method—Annuity for a Service Company

Welcome Inn Hotels is considering the construction of a new hotel for $72 million. The expected life of the hotel is 7 years with no residual value. The hotel is expected to earn revenues of $22 million per year. Total expenses, including depreciation, are expected to be $15 million per year. Welcome Inn management has set a minimum acceptable rate of return of 13%. Assume straight-line depreciation.

a. Determine the equal annual net cash flows from operating the hotel. Round to the nearest million dollars.
$ _______million

Present Value of an Annuity of $1 at Compound Interest
Periods	8%	9%	10%	11%	12%	13%	14%
1	0.92593	0.91743	0.90909	0.90090	0.89286	0.88496	0.87719
2	1.78326	1.75911	1.73554	1.71252	1.69005	1.66810	1.64666
3	2.57710	2.53129	2.48685	2.44371	2.40183	2.36115	2.32163
4	3.31213	3.23972	3.16987	3.10245	3.03735	2.97447	2.91371
5	3.99271	3.88965	3.79079	3.69590	3.60478	3.51723	3.43308
6	4.62288	4.48592	4.35526	4.23054	4.11141	3.99755	3.88867
7	5.20637	5.03295	4.86842	4.71220	4.56376	4.42261	4.28830
8	5.74664	5.53482	5.33493	5.14612	4.96764	4.79677	4.63886
9	6.24689	5.99525	5.75902	5.53705	5.32825	5.13166	4.94637
10	6.71008	6.41766	6.14457	5.88923	5.65022	5.42624	5.21612

b. Calculate the net present value of the new hotel, using the present value of an annuity of $1 table above. Round to the nearest million dollars. If required, use the minus sign to indicate a negative net present value.
Net present value of hotel project: $ _______million

Answer 1

a.	Net Cash flows	=	$                    17	million
b.	Net Present Value of Hotel Project	=	$                      3	million
	Workings:
a.	Revenues	=	$                    22	million
	Expenses, excluding depreciation	=	$                      5	million
	Net Cash flows	=	$                    17	million
	Depreciation	=	(Initial cost - salvage value) / useful life
		=	($72 million - 0) / 7 years
		=	$                    10	million
	Expenses , excluding depreciation	=	$15 miliion - $10 million
		=	$                      5	million
b.		Year	Value Flows	Present Factor @ 13%	Present Value
	Initial Cost	0	$                  -72	1	$                   -72
	Cash Inflows	1 - 7	$                    17	4.4226	$                     75
	Net Present Value				$                       3