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BHCs major competitors in India are two other major Indian hotel
chains and a host of other five star hotels which operate in the
metropolises as an extension of multinational hotel chains.
The foreign hotel majors are considerably stronger than the Indian
hotels in terms of financial resources, but their presence in the
country has historically been small.
With the government committed to developing India as a
destination for business and tourism, several hotel majors have
announced their intention to establish or expand their presence in
the country.
BHCs assets and liabilities (in million rupees) at the end of year 0 were as
follows:
Owners Equity and Liabilities
Assets
Net worth
1126
Net fixed assets
1510
Debt
900
Gross Block: 2110
Accumulated Depreciation 600
Current Assets
516
2026
2026
BHC had no operating assets.
At the end of year 0, BHC owned 2190 rooms.
It has planned the following additions for the next 7 years.
Most of the land needed by the company for these additions has been
already acquired.
Year
Rooms
Investment (in million
rupees)
1
90
200
2
130
300
3
80
240
4
130
500
5
186
800
6
355
1400
7
150
800
For the sake of simplicity assume that the addition will take place at the
beginning of the year.
For developing the financial projections of BHC, the following assumptions may be made.
The occupancy rate will be 60% for year 1. Thereafter, it will increase by 1% per year for
the next 6 years.
The average room rent per day will be Rs. 2500 for year 1. it is expected to increase at
the rate of 15% per year till year 7.
Food and beverage revenues are expected to be 65 per cent of the room rent.
Material expenses, personnel expenses, upkeep and services expenses, and sales and
general administration expenses will be, respectively, 15, 15, 18, and 18 per cent of the
revenues (excluding the management fees).
Working capital (current assets) investment is expected to be 30 percent of the revenues.
The management fees for the managed properties will be 7 percent of the room rent. The
room rent from managed properties will be more or less equal to the room rent from
owned properties.
The depreciation is expected to be 7 percent of the net fixed assets.
The after-tax non-operating cash flows (in million rupees) will be as follows: 300 (year 2),
600 (year 5), 800 (year 6).
Given the tax breaks it enjoys, the effective tax rate for BHC will be 20 percent.
There will be no change in deferred taxes.
Financial Projections
1
7
PANEL I*
A.
B.
C.
Rooms
Occupancy rate
Average room rent
(in rupees)
228
0
0.60
250
0
241
0
0.61
287
5
2490
0.62
3306
2620
0.63
3802
2806
0.64
4373
316
1
0.65
502
8
3311
0.66
5783
377
1
4613
PANEL II *
D.
E.
F.
G.
H.
124
8
811
205
9
87
214
154
3
1863
2291
2867
1211
1489
1864
100
3
3074
3780
254
6
130
3204
160
3940
108
2998
4731
245
1
7611
200
4931
622
2
323
7934
264
Financial Projections
Year
1
5
7
PANEL III*
I.
J.
K.
L.
K.
Material
expenses
Personnel
expenses
Upkeep and
service expenses
Sales and
general admn
expenses
Total operating
expenses
309
309
382
382
461
461
567
567
710
710
933
933
1142
1142
371
458
553
680
852
1120
1370
371
458
553
680
852
1120
1370
1360
1680
2028
2494
3124
4106
5024
Financial Projections----Year
4
1
5
7
PANEL IV*
L.
M.
N.
O.
P.
Q.
R.
S.
T.
EBDIT(H-K)
786
Depreciation
120
EBIT
666
NOPLAT
533
Gross cash flow
653
Gross
investments
(Fixed assets +
302
current assets)
Free cash flow
351
from operations
(P-Q)
Non-operating
351
*(All flow
figures are in million
cash
974
132
842
674
806
1176
140
1036
829
969
446
398
360
571
300
660
571
rupees)
144
6
166
128
0
102
4
119
0
1807
210
1597
1278
1488
1085
238
0
293
208
7
167
0
196
3
291
0
329
258
1
206
5
239
4
184
8
121
6
403
712
478
600
1033
Year
4
A.
B.
C.
D.
E.
F.
G.
1
5
Current assets*
Current assets
addition*
Gross block*
Capital exp.*
Acc. deprn.*
Net block (C+D-E)
Depreciation
7
516
618
764
924
1134
102
2110
200
600
1710
120
146
2310
300
720
1890
132
158
2610
240
852
1998
140
212
285
0
500
984
236
6
166
285
3350
800
1150
3000
210
141
9
186
7
448
415
0
140
0
136
0
419
416
555
0
800
165
3
469
7
Cost of capital : BHC has two sources of finance, equity and debt.
The cost of capital for BHC is
Cost of capital = (weight of equity x cost of equity) + (weight of debt
x cost of debt)
The weights of equity and debt, based on market values, are as
follows:
Weight of equity = 17100/18000 = 0.95
Weight of debt = 900/18000 = 0.05
The cost of debt is given to be 9 %. The cost of equity using the
capital asset pricing model is calculated below:
Cost of equity of BHC = Risk-free rate + Beta of BHC (Market Risk
Premium)
= 12 + 0.6775(8) = 17.42%
Given the component weights and costs, the cost of capital for BHC is:
(0.95)(17.42) + (0.5)(9) = 17.00%
12
75
80
150
12.5
2.0
1.9
15
80
100
240
16.0
3.0
2.4
20
100
160
360
18.0
3.6
2.3
Value of Assets
The first step in the adjusted book value approach is to value the assets of
the firm.
The key considerations in valuing various assets are discussed below:
Cash
Cash is cash.
Hence there is no problem in valuing it.
Indeed it is gratifying to have an asset which is so simple to value.
Instead of computing the value of the enterprise as the present value of all future
free cash flows, as in the DCF model, one can instead calculate a return ratio that
expresses the companys current or future ability to produce free cash flow.
A popular method for this is known as cash flow return on investment (CFROI).
Originally designed by the Holt Value Consultants, CFROI can be defined as the
sustainable cash flow a business generates in a given year as a percentage of
the cash invested in the companys assets.
You can think of CFROI as a weighted average internal rate of return (IRR) of all
the projects within the company.
Usually, it is expressed as:
Gross Cash Investment =
CF1 / (1+CFROI) + CF2/(1+CFROI)2 +----- + CFn /(1+CFROI)n + TV/
(1+CFROI)n
Since the publication of Fisher Black and Myron Scholes groundbreaking article The pricing of options and corporate liabilities in
1973, option valuation has been used frequently by investors,
traders and others to calculate the theoretical value of stock
options, interest rate options, and all other kinds of options traded
all over the world.
It is only in the last few years that option valuation has been
recognized as an alternative to standard net present value
calculations in the valuation of investment opportunities in real
markets and as a company or project valuation tool.
A financial option gives its owner the right to buy (call option) or
sell (put option) a certain specified underlying asset (a stock, bond,
amount of gold, etc,) at a specified price (the exercise price) within
a certain period of time (the exercise period), but with no obligation
to do so. For this right the owner pays a premium (the price of the
option).
The idea behind real options is similar to the idea of financial options.
Consider for example a company that has identified an opportunity (an
option), a project with a certain required investment today and a certain
additional investment in six months time (the exercise price).
In six months time, if the opportunity looks promising, i.e. the expected net
present value of the project is higher than the exercise price (the investment)
of the option, the option is exercised and the project goes ahead.
If the project does not look promising, i.e., the net present value of the project
is lower than the exercise price (the investment) of the option, the option is
not used and the only loss is the price of the option paid, the premium.
The point of real options valuation is that it takes into consideration the
flexibility that is inherent in many projects (or in entire companies) in a way
that a DCF valuation does not.
With real options, management possibilities to expand an investment or to
abandon a project are given a correct value.
Or, stated differently, real option valuation might produce positive net present
values where standard net present value calculations produce negative ones.
This is because the flexibility of the project or the investment is given a value.
Specifically, real options valuation is a powerful tool in investmentintensive industries where companies make investments in sequences
involving a high degree of uncertainty.
A small investment today that gives the opportunity to either continue
with a larger investment later or abandon the project altogether is much
like a stock option where a small premium is paid today in order to have
the opportunity, but not the obligation, to buy the stock later.
Examples of such industries include energy (particularly oil and gas), all
R&D-intensive industries such as biotechnology, pharmaceutical and hightech, as well as industries with high marketing investments.
Recently, a number of financial authorities have argued that real options
valuation is a valuable tool for the valuation of almost any type of
company.
The idea is that all unexplored avenues for future cash flow, for example
possible new products, new segments or new markets, could or even
would be best valued through real options valuation.
They want to divide the valuation of a company in the following manner :
Where
Where EVA is economic value added for year one, ROIC is the
return on invested capital for year one, WACC is the weighted
average cost of capital, K is the capital stock in the company at
the beginning of year one and NOPAT is net operating profit after
taxes for year one.
The result of these calculations states whether the company has a
positive or a negative EVA, in other words whether the company is
creating or destroying value.
ROIC = NOPAT / K
A specific form of valuation often used when valuing young firms is called
VC valuation or target ownership approach.
The approach starts from the end by estimating an exit valuation and then
calculating a value today based on the required returns for the investor.
In its simplest form, the approach uses the following formula:
Post-money valuation = Terminal value at exit year n / Required ROI
Where
Post-money valuation is the company value after the investment is made
(Post-money valuation = Pre-money valuation + the capital invested),
Terminal value is the expected value of the company at an exit date at
some point in the future and
Required ROI is the return investor demands from investing in the specific
company at the specific time.
The terminal value is the value you could expect the company to
be worth at exit (an IPO or trade sale) in a few years from now.
The terminal value can, in theory, be calculated using any
valuation approach but in practice, one or several multiples are
often used and applied to the companys sales, earnings, etc.
Let us say that a company is expected to have sales of 30 mio in
five years time (usually, the investors discount the revenues
forecasted by management by 40-70%) and that well-managed
companies in the same industry have net margins of 10%.
If we assume the company will be able to reach the same margins
then this would give net earnings of 3mio in five years time.
If the most similar company has an earnings multiple ( P/E) of 20
and if we apply this to the company being valued, we get a
terminal value in five years time of 60mio (P/E 20 X 3mio).