Question

A nationwide motel chain is considering locating a new motel in Bigtown, USA. The cost of building a 150-room motel (excluding furnishings) is $5.3 million. The firm uses a 12-year planning horizon to evaluate investments of this type. The furnishings for this motel must be replaced every four years at an estimated cost of $1, 900, 000 (at k = 0, 4, and 8). The old furnishings have no market value. Annual operating and maintenance expenses for the facility are estimated to be $110, 000. The market value of the motel after 12 years is estimated to be 15% of the original building cost. Rooms at the motel are projected to be rented at an average rate of $45 per night. On the average, the motel will rent 60% of its rooms each night. Assume the motel will be open 365 days per year. MARR is 7% per year. Using an annual-worth measure of merit, is the project economically attractive?

Answer 1

To determine if the project is economically attractive, we need to calculate the present worth of the cash flows associated with the project.

Step-by-step explanation:

To determine if the project is economically attractive, we need to calculate the present worth of the cash flows associated with the project. The cash inflows include the room rental revenue, while the cash outflows include the building cost, furnishings replacement cost, operating and maintenance expenses, and the market value of the motel after 12 years. We need to discount these cash flows to the present using the minimum attractive rate of return (MARR) of 7% per year.

By discounting the cash flows, we can calculate the annual worth of the project. If the annual worth is positive, it means the project is economically attractive. If the annual worth is negative, it means the project is not economically attractive.

Let's calculate the annual worth of the project:

1. The initial cost of building the motel is $5.3 million. We assume this cost occurs at the beginning of year 0.
2. The furnishings replacement cost of $1,900,000 occurs at year 0, 4, and 8.
3. The operating and maintenance expenses of $110,000 occur annually.
4. The market value of the motel after 12 years is estimated to be 15% of the original building cost.
5. The room rental revenue is calculated as $45 per night, with an occupancy rate of 60% and the motel being open 365 days per year.

By calculating the present worth of these cash flows and comparing it to zero, we can determine if the project is economically attractive or not.