Question

EX 26-9 Net present value method—annuity for a service company OBJ. 3 Welcome Inn Hotels is considering the construction of a new hotel for $90 million. The expected life of the hotel is 30 years, with no residual value. The hotel is expected to earn revenues of $26 million per year. Total expenses, including depreciation, are expected to be $15 million per year. Welcome Inn management has set a minimum acceptable rate of return of 14%a. Determine the equal annual net cash flows from operating the hotel. Round to the nearest million dollars.$ millionb. Calculate the net present value of the new hotel. Use 7.003 for the present value of an annuity of $1 at 14% for 30 periods. Round to the nearest million dollars.Net present value of hotel project: $ millionc. Does your analysis support construction of the new hotel?, because the net present value is .

Answer 1

a. $14 million

b. $8 million

c. Yes

Step-by-step explanation:

a. The computation of the equal annual net cash flows is shown below:

Annual net cash flows = Net Income after tax + Depreciation expense

where,

Depreciation equal to

= (Original cost - residual value) ÷ (useful life)

= ($90 million - $0) ÷ (30 years)

= ($90 million) ÷ (30 years)

= $3 million

And, the Net Income after tax would be

= $26 million - $15 million

= $11 million

Now put these values to the above formula

So, the value would equal to

= $11 million + $3 million

= $14 million

b. The net present value would be

= Present value of all yearly cash inflows after applying discount factor - initial investment

where,

Present value of all yearly cash inflows = Annual cash flows × PVIFA at 14% for 30 years

= $14 million × 7.0027

= $98.04 million

Refer to the PVIFA table

And, the initial investment would be $90 million

Now put these values to the above formula

So, the value would equal to

= $98.04 million = $90 million

= $8.04 million

c. Yes, the net present value comes in positive.