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.
Answer and Explanation:
- 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...
See full answer below.
Become a member and unlock all Study Answers
Try it risk-free for 30 daysTry it risk-free
Ask a question
Our experts can answer your tough homework and study questions.Ask a question Ask a question
Learn more about this topic:
from Introduction to Management: Help and ReviewChapter 2 / Lesson 12