I. Economic Benefits
The first and most obvious benefit of leasing the space is the significantly lower capital expenditure at period zero. The capital expenditure for the leasing project is more than half of that of the building a business project. This means that there are less upfront payments as well as less potential debt. Additionally, the guaranteed lease payments indicate a consistent cash flow for the hotel regardless of the success of the pub venture. In comparison, depreciation is also lower from a leasing standpoint due to the lower initial capital expenditure. As the main responsibility of running the business is outsourced to the leasing company, this initiative ...view middle of the document...
II. Initial Capital Investments
Prior to being able to lease the space to Planet Karaoke Pub, Phuket Beach Hotel will need to make some up-front renovations. The minimal renovations include setting up partitions and building a kitchen . Since the hotel will not be utilizing the space, the Planet Karaoke Pub will be solely responsible for the initial capital investment costs related to decorating and furnishing the pub. Phuket Beach Hotel’s initial capital investment for the leasing project is only $1,000,000.
Should the hotel decide to build the Beach Karaoke Pub, the same initial renovations will still need to be completed to the space. Furthermore, the hotel will need to decorate and furnish the newly renovated pub prior to opening their doors for business. The initial up-front investment for the renovations will be $1,200,000. Additionally, the cost of furnishing the pub amounts to $900,000. The initial capital investment for building the Beach Karaoke Pub totals $2,100,000.
III. Cost of Capital
In evaluating the cost of capital, KornKrit revealed a savings account which had been earning accumulative interest at 5%. This savings account would be used to provide the cost of debt which totals 25% of the cost of capital. Kornkrit also believed that in the recent past the project discount rate was too high and that maybe an adjustment would help. The original plan was to discount the projects at 75% equity and 25% debt, the debt bearing an interest rate of 10% and equity sold off at 12%. This would have concluded a cost of capital at (0.75 x 0.12) + (0.25 x 0.10 x 0.70) = 10.75%.
IV. Project Evaluations
With regards to payback on capital expenditure, the building a business project proves to be more lucrative than the leasing project. Although Phuket Beach Hotel’s initial capital expenditure for building a business is double that of the leasing option, it is projected to earn that amount back in three years of operation. After three years, the hotel would then be able to operate on a profit for the remaining life of the project. In comparison, it would take all four years of the set leasing contract to earn back the initial capital expenditure set forth in the leasing option.
Net present value
Similar to the payback evaluation, when taking into account the net present value of both projects, building a business proves to be more a profitable venture. By comparing the net present value of both projects, the leasing option’s net present value ($34,901.66) is only 3% of that of the building a business option’s net present value ($1,142,755.43).
Internal Rate of Return
When comparing the ventures...