Assignment: Capital Prioritization

This assignment is due via the Assignment Link by 11: 59 PM Eastern, on the due date.

This assignment is worth 50 points, and will be graded based on the rubic. You may view the rubric by clicking on the assignment link.

Late work will not be accepted.

The Case

You are working as an Asset Manager for a major hotel ownership group. You have been tasked with reviewing several alternatives for improving the value of one of the hotels in your portfolio.

Your analyst has provided you with information about these alternatives in the attached Excel spreadsheet.

Background

Improving the value of a hotel asset is the goal of ownership, management, and the Franchisor. Every party benefits when this is done. Improved valuations create attractive investment returns for ownership, and over time attract additional investment into hotel real estate creating growth and career opportunities for all involved.

The valuation of a hotel is based on two things. Cash flow and the market capitalization rate. Cash flow is simply the cash flow before Interest, Depreciation, Amortization, and Income taxes. These items are the result of the capital structure of the asset – and that structure always changes with new ownership.

The market capitalization rate is based on the return requirements or investors in the market at the time the hotel transaction occurs. Generally, the capitalization rate increase when risk increases, and decreases when risk decreases. Individual owners cannot control the capitalization rate. It is function of market forces.

The focus of Asset Management, therefore, is to improve Cash Flow. This is done in one of two ways. Improving revenue or decreasing costs. Or both Revenue can be increased by improving market share, or maintaining market share in a market with improving demand, or adding facilitites that will generate revenue. Cost reductions can be achieved by identifying benchmark performance and moving the hotel asset to those benchmarks, or by the elimination of services, energy conservation, outsourcing, tightening up inventory controls, etc.

You tasked the management team at your hotel with suggesting 3 ways to improve cash flow. You have received this information, and your analysist has prepared an Excel spreadsheet with this information.

In these analysis, your company has a policy of taking the information that is received by the properties and discounting their improvement calculations using the following discount rates:

· Low risk of not achieving the proforma results: 10% Discount

· Moderate risk of not achieving the proforma results: 25% Discount

· High risk of not achieving the proformat results: 75% Discount.

These rates are applied to the hotel projection. So, for example, if the hotel forecast a $50,000 increase in cash flow and you assessed the risk of achievement as moderate, you would reduce their estimate by 25%. The cash flow you would use for your valuation assessment would be ($50,000 – ($50,000 X 25%)) or $37,500.

Your company monitors the capitalization rates achieved in consummated transactions across all markets. This rate is updated periodically – and is currently 7%. You will use this capitalization rate in your valuation improvments.

As a reminder, the value of a hotel is:

Cash Flow Capitalization Rate.

Requirements:

1. For each of the 3 cash flow improvements suggested, calculate the improvement in value that will result – based on the information presented AND the application of a risk discount.

2. Prepare a memo to your CEO that

· Describes each improvement suggestion

· Indicate which level of risk discount you used and why you chose that rate.

· Shows the valuation improvement if all three suggestions were implemented.

3. Submit your memo in a WORD document.

This assignment is worth 50 points and will be graded based on the assignment rubric.