Question

НСМ Ноels Compогation Suppose you have recently been appointed as the financial analyst to work for the HCM Hotel Corporation, an international hotel corporation which owns and operate renowned hotel brands all over the world. Your direct supervisor, the regional financial director (RFD) for the Asian-Pacific region has just handed you the estimated cash flows for two proposed investment projects regarding budget hotels. Project M involves constructing a new hotel in a developing area; it would take some time to build up the cdientele for this hotel, and so the cash inflows would increase over time. Project P involves renovating of an old hotel building in an economically saturated market, and its cash flows would decrease over time. Both projects have 3-year project lives, because HCM Hotels Corporation is planning to give up the budget hotel segment and enter the upmarket hotel segment after 3 years. Here are the two hotel projects' net cash flows expected in the next 3 years:- Expected Net Cash Flow Project M Project P Year ($100 000) (S100 000) $10 000 $70 000 $60 000 $50 000 S80 000 $20 000 Depreciation, trade-in values, net working capital requirements, and tax effects are all included in these cash flows. The regional financial director also made subjective risk assessments of each hotel project, and he concluded that both projects have risk characteristics which are similar to the company's average project. HCM Hotels Corporation's weighted average cost of capital is 10 percent. As the company's financial analyst, you are now instructed by the regional financial director to determine whether one or both of these two hotel investment projects should be accepted. What is the payback periodFind shananhaekmarigd of Projects M and P. (Show your workings clea E(Alt + Á) What is the rationale for the payback method? According to the payback (a) (b) criterion, which project or projects should be accepted if HCM Hotels Corporation's maximum acceptable payback is 2 years, and if Projects M and Pare independent? What if they are mutually exclusive? Justify your answers. What are the main disadvantages of the 'payback method"? (c) (d) Is 'payback method' of any real usefulness in capital budgeting decisions? Elaborate your answers with appropriate examples.

Answer 1

Here I provide all explanation in following image

a) When cash flows are expected to vasry in Subsequent years, then Substraction method would be used to find out the pay back period. in this method each annual cash flow Will be. Subtracted from initial cash outflow, untill The pay back period (recovery of initial Investment). achieved. Computation of payback period For Project M :- Year Cash flow C$ 100 000 ). 10.000 60,00D 80.000 ما لا 190.000) (30000) 50,000 pay back period - 2 years + 30.000 80.000 2:375 years For project P - year Cashflow. C & 100ooo) 70.000 50.000 (30,000) 20.000 - pay back period - I year of 50.000 - 1.6 years

b pay back period is the time period that required to recover the initial investment in a project - The rationale behind this is that the Shorter the pay back period, the greates the liquidity and the less risk in project. fence, HCM Hotels cosporation's maximum acceptable pay back period is 2 years. Even if project M and project P are independent projects Only_project p would be Selected to investment, Since, it's pay back period C1 6 years) is less than HOM's acceptable pay back period of 2 years. (*) of projects one M and project p are mutually exclusive project P would be selected hence, it has lower payback period than project 'P. co Disadvantages of pay back pered 1. pay back period ignores time value of Money. 2. E' does not consider the future cash flows - after payback period 3. E ignoves profitability of project. perted D) Generally, pay back method is used to choose projects in capital budgeting decisions.. pay back period melhod is Suitable for projects of Smal) Ynvestments_Hence, iti not. Wouthg Spending much time and effat on economic analysis in Such projects It can be used by homeowners and businesses to calculate return on energy efficient technologies_such as Solar panels and insulation, as well as maintenance and upgrades