Task 2: Capital Investment

A company has planned to invest in a new hotel for a negotiated price of $ 15,000,000 which
includes a purchase price of $ 12,000,000 and other costs i.e. legal fees and stamp duty of $
3,000,000.
The Cash inflows and Outflows for the next 10 years were as under:
Year Cash Inflows Cash Outflows
1 $2,000,000 $1,500,000
2 $2,100,000 $1,600,000
3 $2,200,000 $1,700,000
4 $2,300,000 $1,800,000
5 $2,000,000 $10,000,000
6 $3,000,000 $2,000,000
7 $3,000,000 $2,000,000
8 $3,000,000 $2,000,000
9 $3,000,000 $2,000,000
10 $3,000,000 $2,000,000

The Net Present Value for the investment is required to be calculated considering a cost of
capital of 8%
Part a)
One of the most widely used technique of capital budgeting is the Net present value method. For
the purpose of calculating the NPV of the project, the concept of time value of money is
considered. For calculation, the present value of cash inflows and cash outflows are calculated
and the PV of outflows is deducted from the PV of inflows for estimating the NPV of the project.

NPV = PV of Cash Inflows – PV of Cash Outflows

The NPV for the investment in the Hotel so calculated is $ (1,6071,205). (Refer excel sheet
named “Task 2 Capital Investment”).
Part b)
Based on the NPV so calculated, it is not recommended to invest in the hotel business. A
negative NPV indicates the project will not create value and the business will be loss-making.
When we have reduced the investment value to 40%, with 6% discount rate the NPV is still
negative and the hence, it is recommended not to invest in this hotel business. The initial
investment and cost of business is quite high in comparison to the cash inflows generated. If the
company still wants to invest in the hotel project following steps can be taken:
 Improving the cash inflows by segmenting the target market, using dynamic pricing,
doing digital marketing, offering discounts and substantial credit period, etc.
  Replacing the finance sources with sources that are cheaper. For example, using equity
financing in comparison to debt.
 Negotiating for a longer credit period from suppliers. The cash outflows are quite high as
evident from the cash flows in the table above, hence, steps should be taken to reduce the
costs by looking for suppliers providing products at prices lower than market rate.

The practical issues that should be taken into consideration are as under:
 Changes in price of products
 Changes in government policies, laws and regulations
 Changes in policies of funding sources
 Market risk, inflation and volatility
 Improper estimation of costs and revenue