# Kim hotels is interested in developing a new hotel in Seoul . The company estimates that the...

## Question:

Kim hotels is interested in developing a new hotel in Seoul . The company estimates that the hotel would requires an initial investment of $20 million. Kim expects that the hotel will produce positive cash flows of$3 million a year at the end of each of the next 20 years. The project's cost of capital is 13%.

a. What is the project's net present value?

b. Kim expects the cash flows to be $3 million a year, but it recognizes that the cash flows could actually be much higher or lower, depending on whether the Korean government imposes a large hotel tax. one year from now.There is a 50% chance that the tax will be imposed in which case the yearly cash flows will be only$.2.2 million. At the same time there is a 50% chance that the tax will not be imposed, in which case the yearly cash flows will be $3.8 million. Kim is deciding whether to proceed with the hotel today or to wait a year to find out whether the tax will be imposed. If Kim waits a year, initial investment will remain at$20 million. Assume that all cash flows are discounted at 13%.

Use decision tree analysis to determine whether Kim should proceed with the project today or wait a year before deciding.

## Decision Tree Analysis:

A decision tree analysis involves making decisions over several periods. Since these decisions result in particular outcomes, the analysis usually branches out in the shape of a tree.

a.

Let,

• NPV = net present value
• CF = the periodic cash flow,
• n = the number of periods,
• r = the interest rate.

The NPV of the project can found as...

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