Value Lodges owns an economy motel chain and is considering building a new 200-unit motel. The cost to build the motel is estimated at $6,800,000; Value Lodges estimates furnishings for the motel will cost an additional $200,000 and will require replacement every 5 years.
Annual operating and maintenance costs for the motel are estimated to be $540,000. The average rental rate for a unit is anticipated to be $25/day. Value Lodges expects the motel to have a life of 15 years and a salvage value of $900,000 at the end of 15 years. This estimated salvage value assumes that the furnishings are not new. Furnishings have no salvage value at the end of each 5-year replacement interval.
Required:
1. Assuming average daily occupancy percentages of 50 percent, 60 percent, 70 percent, and 80 percent for years 1 through 4, respectively, and 90 percent for the fifth through fifteenth years, a MARR of 12 percent/year, 365 operating days/year, and ignoring the cost of land, should the motel be built? Base your decision on an internal rate of return analysis.

Question

02-06-2020
Business

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Value Lodges owns an economy motel chain and is considering building a new 200-unit motel. The cost to build the motel is estimated at $6,800,000; Value Lodges estimates furnishings for the motel will cost an additional $200,000 and will require replacement every 5 years.
Annual operating and maintenance costs for the motel are estimated to be $540,000. The average rental rate for a unit is anticipated to be $25/day. Value Lodges expects the motel to have a life of 15 years and a salvage value of $900,000 at the end of 15 years. This estimated salvage value assumes that the furnishings are not new. Furnishings have no salvage value at the end of each 5-year replacement interval.
Required:
1. Assuming average daily occupancy percentages of 50 percent, 60 percent, 70 percent, and 80 percent for years 1 through 4, respectively, and 90 percent for the fifth through fifteenth years, a MARR of 12 percent/year, 365 operating days/year, and ignoring the cost of land, should the motel be built? Base your decision on an internal rate of return analysis.

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jepessoa jepessoa · Answer 1 · 2020-06-03T04:09:35+02:00

Answer:

The motel should not be built because the IRR is 9.31%, which is lower than the company's MARR (12%).

Explanation:

cost to build the new 200 unit motel $6,800,000 + $200,000 = $7,000,000

the furnishing must be replaced every 5 years

annual operating costs $540,000

average rental rate

useful life 15 years with a salvage value of $900,000

expected cash flows:

year total revenue costs furnishing total

0 -$6,800,000 -$200,000 -$7,000,000

1 $912,500 -$540,000 $372,500

2 $1,095,000 -$540,000 $555,000

3 $1,277,500 -$540,000 $737,500

4 $1,460,000 -$540,000 $920,000

5 $1,642,500 -$540,000 $1,102,500

6 $1,642,500 -$540,000 -$200,000 $902,500

7 $1,642,500 -$540,000 $1,102,500

8 $1,642,500 -$540,000 $1,102,500

9 $1,642,500 -$540,000 $1,102,500

10 $1,642,500 -$540,000 $1,102,500

11 $1,642,500 -$540,000 -$200,000 $902,500

12 $1,642,500 -$540,000 $1,102,500

13 $1,642,500 -$540,000 $1,102,500

14 $1,642,500 -$540,000 $1,102,500

15 $2,542,500 -$540,000 $2,002,500

now using an excel spreadsheet I calculated both the NPV and IRR:

NPV = -$1,113,875
IRR = 9.31% < 12% (MARR)

andromache andromache · Answer 2 · 2022-02-03T14:35:53+01:00

The model should not be built because the IRR is 9.31%, which is lower than the company's MARR (12%).

The calculation is as follows:

cost to build the new 200 unit motel should be

= $6,800,000 + $200,000

= $7,000,000