Phuket Beach Hotel: Valuing Mutually Exclusive Capital Projects Harvard Case Solution & Analysis

1.      Calculate and rank the projects according to payback, internal rate of return, net present value, profitability index, and equivalent annual annuity.

Answer # 3:

Capital Budgeting, Profitability Index and Annual annuity:

The company can go for various projects in determining the value of the projects. However, this projects is based on two options or events that are mutually exclusive and can be done one time i.e. either a company can go for option one, or they can go for option two. For instance discounted payback and payback period method help companies to identify the time required by the company to cover its initial cost or outlays. The payback period is found to be 2.46 and 3.84 for Planet Karaoke and Beach Karaoke Pub respectively. In addition to this, profitability index it is an additional measure through which companies can calculate the profits on a unit level, and it is based on considering all the cash flows of the company. Profitability index of both the that are Planet Karaoke Pub and Beach Karaoke Pub is found to be 1.27 and 0.23 respectively. Moreover, another measure through which one can identify the attractiveness of the projects is through identifying Return on Investment the ROI for the projects are found to be 64.1% and 77.2% respectively.

Attractiveness of a project can also be determined through identifying NPV and IRR of the project. However, IRR is not as much reliable as NPV as the cash flows are non-conventional and the projects are based on mutually exclusive property. In the case of Planet Karaoke Pub and Beach Karaoke Pub, NPV along with IRR is found to be214,849 and 373, 043 respectively with 23.2% and 17.3% IRR respectively. As seen that NPV for alternative two is more than alternative one, but the company can also use equivalent annual annuity that can be calculated through dividing net present value from the annuity factor. Annuity factor for both the projects is found to be 3.11 and 4.26 correspondingly.

  • 2.      How sensitive is your ranking to changes in the discount rate? Create a net present value profile graph with NPV on the vertical axis and cost of capital on the horizontal axis.

Answer # 4:

With the help of sensitivity analysis, one can explain the sensitivity of the project in terms of making changes in its discount rates. It explains the change in the value of because of making changes in the discount rate of projects. The calculations for the sensitivity analysis have been done in the spreadsheet attached. Doing sensitivity analysis is important, however, there are various other factors as well that the company needs to consider. One such factor is mentioned in the case, and that was based on the threat from guest room revenue erosion. The manager of the hotel was worried about those guests that are not welcomed by the hotel that in turn decrease the patronage for about 25%. The threat will cost around loss of $500 million to the hotel in terms of choosing both the projects. However, the Plant Project is able to survive because the cash flows of the company will be regular, and there will be no disruptions in it.

3.      Which project should the hotel undertake?

Answer # 5:

As mentioned in the case that both the options, the company has right now is mutually exclusive, it means that two events cannot take place at the same time. Same like the two alternatives available to the Phuket hotel cannot be implemented at the same time. The analysis done in the spread sheet has sthat the company should go for alternative number that is leasing the property to Planet karaoke Club. The net present value and internal rate of return of a project can be increased if the life of the project can be increased to at least 12 years. In addition to this, better result will be found if the company can wait and give time to progress. As of now, the management of the company came to a solution that indicates that opening its own pub is not a profitable and wise alternative to implement and it will end up as a worst investment for the company. Apart from these financial factors, there are certain side effects of choosing this alternative as well. It can have a drastic impact on the overall reputation of the company as well. Moreover, the reputation of the hotel is dependent on the places that are running inside their building. If the Planet Karaoke failed to manage properly then, it will impact the beach hotel in a negative way. Moreover, leasing the unused space to the Planet Karaoke will lead to legal work along with installation of special clauses for the lease............................

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