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Should the management of Phuket Beach Resort accept the offer made by Planet
Karaoke Pub to set up an outlet inside the hotel or should the management
operate a pub, Beach Karaoke Pub, by itself?
The space was located on the second floor of the main building and was very
much under-utilised. Planat Karaoke Pub offered to sign a four-year lease
agreement with the hotel for rending part of the unused space. It proposed to
pay:
a. a monthly rental fee of 170,000 baht for the first two years; and
b. thereafter, a 5% increment for the next two years.
Planet Karaoke Pub required only 70% of the unused space measuring 3,000 sq.
feet. This would allow the hotel to keep the remaining space for the creation of an
alley two years later.
Mike Campbell sought the assistance of Kornkrit Manming, the hotel’s Financial
Controller to review the offer from Planet Karaoke Pub and estimating revenues
and costs associated with an alternative project, Beach Karaoke Pub.
III. Objectives
With the given two alternatives on hand, this case aims to:
Submitted by:
R. Bagunas, S. Chua, C. De Guzman, N. Padon, D. Palmones, J. Valeros, O. Velarde 1
Submitted to:
Prof. R. Queddeng
Phuket Beach Resort Case Analysis
Graduate School of Business
De La Salle University
a. Assumptions
2. The estimated total sales amounting to 4,672,000 baht for the first year of
operation is a reasonable estimate and thus was applied with the 5% sales
growth per annum.
3. The 25% fear factor is applied on the projected annual net room revenue
representing 50% of the pub revenue – 50% from hotel guests.
6. All payments and inflows assumed to have been made at the end of the
year.
a. Areas of Consideration
7. The two projects have unequal lives: Planet Karaoke Pub to run for 4 years
while Beach Karaoke Pub to run for 6 years.
8. It was envisaged that the proposed pub would not affect the hotel’s future
expansion plans.
Submitted by:
R. Bagunas, S. Chua, C. De Guzman, N. Padon, D. Palmones, J. Valeros, O. Velarde 2
Submitted to:
Prof. R. Queddeng
Phuket Beach Resort Case Analysis
Graduate School of Business
De La Salle University
11.Staff for the karaoke pub could be recruited internally because the hotel had
excess manpower and the excess staff had long-term contracts with the
hotel.
13.The Chief Security Officer had expressed his concerns and displeasure over
the security problems that a karaoke pub might bring. This might attract
unwelcome guests from outside and might in turn be a negative factor for
the pub in terms of attracting tourists travelling with children, which
accounted for 25% of the total patronage. This risk factor will be present in
both the “lease” and “build” option.
Phuket Beach Hotel to rent out an unused space owned by the Hotel
located on the second floor of the main building.
Advantages:
Additional source of revenue
Steady source of revenue in the form of “fixed” monthly rental
Take advantage of unutilised space
Tie-up with a company that is expanding fast in the country
(“positive image”)
Company is exposed to lesser risk since it will be a third party who
will be doing majority of the investment of the pub
Disadvantages:
Will entail additional costs and investment
Limited control over overall pub operations
Problem on allocating overhead costs
Advantages:
Venture into a lucrative business spreading fast in the country
Have control over overall pub operations
Additional source of revenue
Complementary pub operation with its hotel business
Disadvantages:
Submitted by:
R. Bagunas, S. Chua, C. De Guzman, N. Padon, D. Palmones, J. Valeros, O. Velarde 3
Submitted to:
Prof. R. Queddeng
Phuket Beach Resort Case Analysis
Graduate School of Business
De La Salle University
16.Assess the economic benefits associated with each of the capital projects.
What is the initial outlay? What are the incremental cashflows over the life
of the project? What is an appropriate discount rate to use for discounting
the cashflows of the project?
The initial outlay for each alternative would depend on whether management is
willing to undertake a risk in operating a business with perceived "security"
issues. For ACA 1: Planet Karaoke Pub, it has an option of whether to invest
770,000 baht or 1,000,000
baht as initial outlay.
As for ACA 2: it could either spend 1,700,000 baht or 2,100,000 baht
depending on available funds and depending on payback period criteria.
Should management opt for a shorter payback period, then naturally, it would
have to spend
on the lower range of its option investment amount.
Factor at 10.75%
Weighted average cost of capital: 1 0.903 0.903
debt equity 2 0.815 1.718
composition 25% 75% 3 0.736 2.454
rate 10% 12% 4 0.665 3.119
= (0.25*0.10)(1-0.30)+(0.75*0.12) = 10.75% 5 0.600 3.719
6 0.542 4.261
Submitted by:
R. Bagunas, S. Chua, C. De Guzman, N. Padon, D. Palmones, J. Valeros, O. Velarde 4
Submitted to:
Prof. R. Queddeng
Phuket Beach Resort Case Analysis
Graduate School of Business
De La Salle University
/ years 4 4
250,000.0 192,500.0
annual depreciation 0 0
Submitted by:
R. Bagunas, S. Chua, C. De Guzman, N. Padon, D. Palmones, J. Valeros, O. Velarde 5
Submitted to:
Prof. R. Queddeng
Phuket Beach Resort Case Analysis
Graduate School of Business
De La Salle University
NPV of
Year(s) Amount PV factor cash flows
Annual Operating Cash Flow 1 323,750.00 0.903 292,346.25
2 300,650.00 0.815 245,029.75
3 313,162.50 0.736 230,487.60
4 251,300.00 0.665 167,114.50
Renovation costs 0 770,000.00 1.000 (770,000.00)
164,978.10
Alternative 1 (scenario two): Planet Karaoke Pub (Upper Limit)
NPV of
PV
Year(s) Amount factor cash flows
341,000.0 0.90
Annual Operating Cash Flow 1 0 3 307,923.00
317,900.0 0.81
2 0 5 259,088.50
330,412.5 0.73
3 0 6 243,183.60
268,550.0 0.66
4 0 5 178,585.75
1,000,000.0 1.00
Renovation 0 0 0 (1,000,000.00)
(11,219.15)
Submitted by:
R. Bagunas, S. Chua, C. De Guzman, N. Padon, D. Palmones, J. Valeros, O. Velarde 6
Submitted to:
Prof. R. Queddeng
Phuket Beach Resort Case Analysis
Graduate School of Business
De La Salle University
Submitted by:
R. Bagunas, S. Chua, C. De Guzman, N. Padon, D. Palmones, J. Valeros, O. Velarde 7
Submitted to:
Prof. R. Queddeng
Phuket Beach Resort Case Analysis
Graduate School of Business
De La Salle University
The appropriate discount rate to use for discounting the cashflows of the
project would be the weighted average cost of capital computed using the
provided percentages of debt and equity (25% and 75%) together with their
relevant pre-tax rates - 10% and 12%, respectively. Applying the after-tax rate
for debt, assuming the cost of equity is already after tax, would get an after-tax
rate of 7% multiplied by 25% for a total of 1.75% for debt. Likewise for equity,
multiplying its "after-tax" rate of 12% by its relevant weight, 75% and will get
9.00% for equity. Weighted average for debt - 1.75%, plus weighted
average for equity - 9.00%, and will get weighted average cost of capital
amounting to 10.75%.
Submitted by:
R. Bagunas, S. Chua, C. De Guzman, N. Padon, D. Palmones, J. Valeros, O. Velarde 8
Submitted to:
Prof. R. Queddeng
Phuket Beach Resort Case Analysis
Graduate School of Business
De La Salle University
It would seem that the measures rank the projects identifically, all points to
alternative two – own pub: Beach Karaoke Pub, with lower limit investment of
1,700,000 baht. The best criterion would be to use either NPV or IRR since both
considers time value of money.
Submitted by:
R. Bagunas, S. Chua, C. De Guzman, N. Padon, D. Palmones, J. Valeros, O. Velarde 9
Submitted to:
Prof. R. Queddeng
Phuket Beach Resort Case Analysis
Graduate School of Business
De La Salle University
Submitted by:
R. Bagunas, S. Chua, C. De Guzman, N. Padon, D. Palmones, J. Valeros, O. Velarde 10
Submitted to:
Prof. R. Queddeng
Phuket Beach Resort Case Analysis
Graduate School of Business
De La Salle University
Submitted by:
R. Bagunas, S. Chua, C. De Guzman, N. Padon, D. Palmones, J. Valeros, O. Velarde 11
Submitted to:
Prof. R. Queddeng
Phuket Beach Resort Case Analysis
Graduate School of Business
De La Salle University
Submitted by:
R. Bagunas, S. Chua, C. De Guzman, N. Padon, D. Palmones, J. Valeros, O. Velarde 12
Submitted to:
Prof. R. Queddeng
Phuket Beach Resort Case Analysis
Graduate School of Business
De La Salle University
Submitted by:
R. Bagunas, S. Chua, C. De Guzman, N. Padon, D. Palmones, J. Valeros, O. Velarde 13
Submitted to:
Prof. R. Queddeng
Phuket Beach Resort Case Analysis
Graduate School of Business
De La Salle University
18.Are the projects comparable based on the standard NPV measure, given that
they have unequal lives? What adjustment or alternative method is required
in comparing such projects?
The projects are comparable based on the standard NPV measure even though
they have unequal lives. In NPV, cash flows are discounted into the present
time.
All are put on "equal" footing, as if all the "inflows" would be received today,
and as if all the
"outflows" would be spent today. Thus, the relevant time value of money being
considered, evaluation is comparable. The only adjustment required would
have to be in terms determining and evaluating the most effective cost of
capital in decision-making.
Submitted by:
R. Bagunas, S. Chua, C. De Guzman, N. Padon, D. Palmones, J. Valeros, O. Velarde 14
Submitted to:
Prof. R. Queddeng
Phuket Beach Resort Case Analysis
Graduate School of Business
De La Salle University
Submitted by:
R. Bagunas, S. Chua, C. De Guzman, N. Padon, D. Palmones, J. Valeros, O. Velarde 15
Submitted to:
Prof. R. Queddeng
Phuket Beach Resort Case Analysis
Graduate School of Business
De La Salle University
19.How sensitive is your ranking to changes in the discount rate? What other
“key value drivers” would affect the attractiveness of the projects? Estimate
the sensitivity of your result to a change in any of the key value drivers.
at 8%
Alternative 1 : Planet Karaoke Pub (Lower Limit)
NPV of
Year(s) Amount PV factor cash flows
Annual Operating Cash Flow 1 323,750.00 0.926 299,792.50
2 300,650.00 0.857 257,657.05
3 313,162.50 0.794 248,651.03
4 251,300.00 0.735 184,705.50
Renovation costs 0 770,000.00 1.000 (770,000.00)
220,806.08
Alternative 1: Planet Karaoke Pub (Upper Limit)
NPV of
Year(s) Amount PV factor cash flows
Annual Operating Cash Flow 1 341,000.00 0.926 315,766.00
2 317,900.00 0.857 272,440.30
3 330,412.50 0.794 262,347.53
4 268,550.00 0.735 197,384.25
Renovation 0 1,000,000.00 1.000 (1,000,000.00)
47,938.08
Submitted by:
R. Bagunas, S. Chua, C. De Guzman, N. Padon, D. Palmones, J. Valeros, O. Velarde 16
Submitted to:
Prof. R. Queddeng
Phuket Beach Resort Case Analysis
Graduate School of Business
De La Salle University
NPV of
Year(s) Amount PV factor cash flows
Initial investment 0 1,200,000.00 1.000 (1,200,000.00)
Other capital investment 0 900,000.00 1.000 (900,000.00)
Annual Operating Cash Flow 1 676,312.00 0.926 626,264.91
2 739,877.60 0.857 634,075.10
3 771,988.98 0.794 612,959.25
4 805,675.30 0.735 592,171.35
5 880,101.57 0.681 599,349.17
6 958,931.65 0.630 604,126.94
1,568,946.72
Alternative 2 : Beach Karaoke Pub (Lower Limit)
NPV of
Year(s) Amount PV factor cash flows
Initial investment 0 800,000.00 1.000 (800,000.00)
Other capital investment 0 900,000.00 1.000 (900,000.00)
Annual Operating Cash Flow 1 656,312.00 0.926 607,744.91
2 719,877.60 0.857 616,935.10
3 751,988.98 0.794 597,079.25
4 785,675.30 0.735 577,471.35
5 860,101.57 0.681 585,729.17
6 938,931.65 0.630 591,526.94
1,876,486.72
at 10%
Alternative 1 : Planet Karaoke Pub (Lower Limit)
NPV of
Year(s) Amount PV factor cash flows
Annual Operating Cash Flow 1 323,750.00 0.909 294,288.75
2 300,650.00 0.826 248,336.90
3 313,162.50 0.752 235,498.20
4 251,300.00 0.683 171,637.90
Renovation costs 0 770,000.00 0.621 (478,170.00)
471,591.75
Alternative 1: Planet Karaoke Pub (Upper Limit)
NPV of
Year(s) Amount PV factor cash flows
Annual Operating Cash Flow 1 341,000.00 0.909 309,969.00
2 317,900.00 0.826 262,585.40
3 330,412.50 0.752 248,470.20
4 268,550.00 0.683 183,419.65
Renovation 0 1,000,000.00 1.000 (1,000,000.00)
4,444.25
Submitted by:
R. Bagunas, S. Chua, C. De Guzman, N. Padon, D. Palmones, J. Valeros, O. Velarde 17
Submitted to:
Prof. R. Queddeng
Phuket Beach Resort Case Analysis
Graduate School of Business
De La Salle University
at 14%
Alternative 1 : Planet Karaoke Pub (Lower Limit)
NPV of
Year(s) Amount PV factor cash flows
Annual Operating Cash Flow 1 323,750.00 0.877 283,928.75
2 300,650.00 0.769 231,199.85
3 313,162.50 0.675 211,384.69
4 251,300.00 0.592 148,769.60
Renovation costs 0 770,000.00 1.000 (770,000.00)
105,282.89
Alternative 1: Planet Karaoke Pub (Upper Limit)
NPV of
Year(s) Amount PV factor cash flows
Annual Operating Cash Flow 1 341,000.00 0.877 299,057.00
2 317,900.00 0.769 244,465.10
3 330,412.50 0.675 223,028.44
4 268,550.00 0.592 158,981.60
Renovation 0 1,000,000.00 1.000 (1,000,000.00)
(74,467.86)
Submitted by:
R. Bagunas, S. Chua, C. De Guzman, N. Padon, D. Palmones, J. Valeros, O. Velarde 18
Submitted to:
Prof. R. Queddeng
Phuket Beach Resort Case Analysis
Graduate School of Business
De La Salle University
at 16%
Alternative 1: Planet Karaoke Pub (Lower Limit)
NPV of
Year(s) Amount PV factor cash flows
Annual Operating Cash Flow 1 323,750.00 0.862 279,072.50
2 300,650.00 0.743 223,382.95
3 313,162.50 0.641 200,737.16
4 251,300.00 0.552 138,717.60
Renovation costs 0 770,000.00 1.000 (770,000.00)
71,910.21
Alternative 1: Planet Karaoke Pub (Upper Limit)
NPV of
Year(s) Amount PV factor cash flows
Annual Operating Cash Flow 1 341,000.00 0.862 293,942.00
2 317,900.00 0.743 236,199.70
3 330,412.50 0.641 211,794.41
4 268,550.00 0.552 148,239.60
Renovation 0 1,000,000.00 1.000 (1,000,000.00)
(109,824.29)
Submitted by:
R. Bagunas, S. Chua, C. De Guzman, N. Padon, D. Palmones, J. Valeros, O. Velarde 19
Submitted to:
Prof. R. Queddeng
Phuket Beach Resort Case Analysis
Graduate School of Business
De La Salle University
As the rate increases, the amount of discounted cash flows decreases. The key
value driver would be the present value factor used and the length of time for
the project to be finished. Since a dollar today is not worth a dollar tomorrow,
the shorter the project is, the more attractive it would seem. However, care
should be taken especially for projects involving unequal cash flows.
IV. Conclusion
Based on the computations done by the group given the current and projected
financial data of the two alternatives, the group recommends that Phuket Beach
Resort builds its own pub because of the figures that we derived from the
computations of IRR, ROI, Payback Period, and NPV.
Submitted by:
R. Bagunas, S. Chua, C. De Guzman, N. Padon, D. Palmones, J. Valeros, O. Velarde 20
Submitted to:
Prof. R. Queddeng
Phuket Beach Resort Case Analysis
Graduate School of Business
De La Salle University
Although it is financially attractive for Phuket Beach Resort to build and operate its
own pub, there are also other factors that the management needs to look into before
venturing into this business:
a. Current Financial Standing of the Resort:
Are the owners financially capable of supporting such venture?
d. Competitors
How many competitors are there in the market?
How are the financial muscles of the competitors?
How is the market situation for pub?
What is the foreseen growth of the industry?
e. Market Size
Is the market big enough to welcome another competitor?
What is the projected market growth in the next 5 years?
Submitted by:
R. Bagunas, S. Chua, C. De Guzman, N. Padon, D. Palmones, J. Valeros, O. Velarde 21
Submitted to:
Prof. R. Queddeng
Phuket Beach Resort Case Analysis
Graduate School of Business
De La Salle University
V. Recommendation
Annual returns for each investment alternative are related to the net investment
to arrive at a certain rate which in turn are compared with the minimum standard
established based on the lowest acceptable rate of return. Generally, the
investment rating procedures are classified into two categories: (1) methods that
do not consider the time value of money; and (2) methods that consider the time
value of money. Although not any one of these methods serves every purpose,
nevertheless, the determination of the most appropriate method to be used would
be dependent upon the circumstances and needs of a particular situation.
The existing capital budgeting system at Phuket Beach Hotel ranks projects
according to their average return on investment and payback period; neglecting
the fact that both investment ranking alternatives do not consider time value of
money. This does not present an accurate measurement of investment
profitability especially since a dollar today is worth more than a dollar a year from
now. Recognition of time value of money is important in capital budgeting
decisions. Business investments commonly promise returns that extend over
fairly long periods of time and therefore it is necessary to employ techniques that
recognize the time value of money.
The Payback Period is the length of time necessary to recover the entire cost of
an investment from the resulting annual net cash flows. Payback period is not a
true measure of the profitability of an investment. It simply tells the manager
how many years will be required to recover the original investment. A shorter
payback period does not always means that one investment is more desirable
than another. It has not inherent mechanism for highlighting differences in useful
life between investments. Such differences can be very important, and relying on
payback alone may result in incorrect decisions. It does not consider time value
of money. Cash inflow to be received several years in the future is weighted
equally with cash inflow to be received right now. Although it can be also be very
useful under certain conditions since it can be used as a screening tool and is
often of great importance to new firms that are “cash poor.”
Submitted by:
R. Bagunas, S. Chua, C. De Guzman, N. Padon, D. Palmones, J. Valeros, O. Velarde 22
Submitted to:
Prof. R. Queddeng
Phuket Beach Resort Case Analysis
Graduate School of Business
De La Salle University
Discounting future cash flows is a technique that does into account cash flow
timing issues. The present value of the future cash flow is the amount that a
knowledgeable investor would pay today for the right to receive that future
amount. Arriving at a present value depends on - the amount of future cash flows,
the length of time that the investor must wait to receive the cash flow, and the
rate of return required by the investor. Discounting is the process by which the
present value of cash flows (the discounted cash flows) is determined.
Submitted by:
R. Bagunas, S. Chua, C. De Guzman, N. Padon, D. Palmones, J. Valeros, O. Velarde 23
Submitted to:
Prof. R. Queddeng