Question

Concept Check A Bank to a Hotel The Williams Bennett Hotel Development Co. has identified a historic bank building that could be converted into a hotel. The location is in the heart of downtown Smithton, a densely popu- lated metropolitan city. The structure was designed by an acclaimed architect and built in 1913. The fifteen-story building will be transformed into a chic boutique hotel with the hotel lobby, meeting rooms, café, and fitness area on the first two floors. The remaining thirteen floors will contain 130 guest rooms. The entire project will cost $35,000,000. Sixty percent of the project cost ($21,000,000) will be financed through debt, and $14,000,000 is being provided by equity investors. The lender is offering a favorable 12% interest rate on the $21,000,000, and the equity investors are re- quiring a return of 18% on their investment. The current business tax rate is 25%. Because the structure is historic, the Williams Bennett Hotel Development Co. has been in discussions with the city government to determine if there are any public incentives for redeveloping this property. The development company knows the hotel supply in Smithton is underserved and that the city needs additional rooms to attract larger convention groups. The city would also gain from additional jobs, which would lower the unemployment rate. There are obvious benefits for both the City of Smithton and the Williams Bennett Hotel Develop- ment Co.

Answer 1

Answer 1

WACC

Cost of entire Project	35000000
	Amount	Rate	Weight
Debt	21000000	12%	0.6	Debt / Cost of Project
Equity	14000000	18%	0.4	Equity / Cost of Project
Business Tax Rate		25%

WACC = We*Re + Wd*Rd*(1-Tc)
Where,
We - Weight of Equity	0.6
Re - Rate of Interest on Equity	0.18
Wd - Weight of Debt	0.4
Rd - Rate of Interest on Debt	0.12
Tc - Tax Rate	0.25
WACC = 0.6*0.18 + 0.4*0.12*(1-0.25)
WACC = 0.816 or 8.16%

Answer 2

The company is liable to pay taxes at 25%, when we take a debt, we have to pay interest on the same and the given rate in this case is 12%, Interest paid is an expense to the company and expenses are deducted from income that is taxed. Therefore in the given formulae we have deducted the tax from the net interest payable to arrive at the net cost of debt.

Answer 3

Since the said hotel is going be buit in a historic building, the city government can provide funding and other help to reinstate the building to be used as the bank. The hotel will also provide employment and reduce the unemployment rate, the government can subsidise by compensating the employess. Since the Hotel is going to provide obvios benefits to the government and the company, the government acn also subsidise the business tax rate for the company for this project

Answer 4

The total interest company will be liable to pay each year 2520000 (21000000 * 12%)

With the total abatement of 1000000 spread evenly over 5 years ,implies 200000 (1000000 / 5) each year, will help in payment of interest, that means approximately, 8% (200000 /2520000 ) of the total interest payable will be borne by the city government