Question

Kim Hotels is interested in developing a new hotel in Seoul. The company estimates that the hotel would require an initial investment of $15 million. Kim expects the hotel will produce positive cash flows of $2.4 million a year at the end of each of the next 20 years. The project's cost of capital is 14%. What is the project's net present value? Negative value, if any, should be indicated by a minus sign. Enter your answers in millions. For example, an answer of $10,550,000 should be entered as 10.55. Do not round intermediate calculations. Round your answer to two decimal places. $ million Kim expects the cash flows to be $2.4 million a year, but it recognizes that the cash flows could actually be much higher or lower, depending on whether the Korean government imposes a large hotel tax. One year from now, Kim will know whether the tax will be imposed. There is a 50% chance that the tax will be imposed, in which case the yearly cash flows will be only $1.5 million. At the same time, there is a 50% chance that the tax will not be imposed, in which case the yearly cash flows will be $3.3 million. Kim is deciding whether to proceed with the hotel today or to wait a year to find out whether the tax will be imposed. If Kim waits a year, the initial investment will remain at $15 million. Assume that all cash flows are discounted at 14%. Use decision-tree analysis to determine whether Kim should proceed with the project today or wait a year before deciding.

Answer 1

Initial Investment = $15 Million

Cash Flow per year = 2.4 Million

WACC = 14%

NPV= $0.9 Million

Therefore, he should invest today.