# Kim Hotels is interested in de

Kim Hotels is interested in developing a new hotel in Seoul. Thecompany estimates that the hotel would require an initialinvestment of \$25 million. Kim expects the hotel will producepositive cash flows of \$4 million a year at the end of each of thenext 20 years. The project’s cost of capital is 14%.

1. What is the project’s net present value? Do not roundintermediate calculations. Enter your answer in millions. Forexample, an answer of \$1.23 million should be entered as 1.23, not1,230,000. Round your answer to two decimal places.

\$    million

2. Kim expects the cash flows to be \$4 million a year, but itrecognizes that the cash flows could actually be much higher orlower, depending on whether the Korean government imposes a largehotel tax. One year from now, Kim will know whether the tax will beimposed. There is a 50% chance that the tax will be imposed, inwhich case the yearly cash flows will be only \$2.9 million. At thesame time, there is a 50% chance that the tax will not be imposed,in which case the yearly cash flows will be \$5.1 million. Kim isdeciding whether to proceed with the hotel today or to wait a yearto find out whether the tax will be imposed. If Kim waits a year,the initial investment will remain at \$25 million. Assume that allcash flows are discounted at 14%. Use decision-tree analysis todetermine whether Kim should proceed with the project today or waita year before deciding.

PART A

 Cost of Capital 14% Years Outflow Inflows Initial Investment Year 0 -25 Year 1 4 Year 2 4 Year 3 4 Year 4 4 Year 5 4 Year 6 4 Year 7 4 Year 8 4 Year 9 4 Year 10 4 Year 11 4 Year 12 4 Year 13 4 Year 14 4 Year 15 4 Year 16 4 Year 17 4 Year 18 4 Year 19 4 Year 20 4 Net Presnet Value \$1.49

Conclusion : Thus in the first senario the net present value ofthe project would \$1.49 million and the NPV is calcuated usingexcel NPV formula which =NPV(14%,E5:E24)+D4 , refer to the screenshot of the excel sheet I have attached.

PART B

 Cost of Capital 14% If Tax is Imposed If Tax is not imposed Years Outflow Inflow Outflow Inflow Initial Investment Year 0 -25 -25 Year 1 2.9 5.1 Year 2 2.9 5.1 Year 3 2.9 5.1 Year 4 2.9 5.1 Year 5 2.9 5.1 Year 6 2.9 5.1 Year 7 2.9 5.1 Year 8 2.9 5.1 Year 9 2.9 5.1 Year 10 2.9 5.1 Year 11 2.9 5.1 Year 12 2.9 5.1 Year 13 2.9 5.1 Year 14 2.9 5.1 Year 15 2.9 5.1 Year 16 2.9 5.1 Year 17 2.9 5.1 Year 18 2.9 5.1 Year 19 2.9 5.1 Year 20 2.9 5.1 Net Present Value (\$5.79) \$8.78 Net Present value after 1year \$4.39

Conclusion : He should accept the project if the tax is notimposed as it will have a positive NPV. The

NPV of the same after 1 year would be \$4.39 million ( as it has50% probablity of happening i.e.50% iof \$8.78).

 Expected NPV after 1 year \$4.39 Expected NPV today \$1.49

Thus Kim should wait for 1 year and see if the tax is imposed ornot. { NPV values are calcuated in excel =NPV(14%,J5:J24)+I4 and=NPV(14%,L5:L24)+K4 }

I have attached the excel sheet for your reference.

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