31 Dec The owners have?decided to renovate the Hungerford Hotel, with the intention of selling the property when the marginal rate of return peaks two years after the renovation. Before acting on

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SHA613: Developing an Asset Management Strategy

School of Hotel Administration, Cornell University

Project: Renovating the Hungerford Hotel

Instructions:

The owners of the Hungerford Hotel are considering whether they should hold the hotel or renovate it, as well as when they should consider selling the hotel. Answer the following questions based on two scenarios for the Hungerford Hotel that are shown on the last page in this document. The first scenario is the base case, which Professor deRoos analyzed in the video on the previous page “Case Study: The Hungerford Hotel.” The second scenario is the renovation case, which assumes that the renovation has been completed. You can assume that the hurdle rate is 14%.

To submit this assignment, please refer to the instructions in the course.

1. In what year or years does the holding period IRR for the renovation exceed the holding period IRR for the base case? Provide evidence for your answer.

From the analysis presented for the case, the holding period IRR for the renovation case is above the base case from year 1 to year 5. For the base case, the IRR for the first year is 15.6% which is significantly lower compared to 38.2% in the renovation case, which is in excess of the base case by 22.6%. In year 2, the renovation case has an IRR of 32.0% which is more than the 15.4% presented for the base case. In the third year, the base case has an IRR of 15.1% while the renovation case has a significantly higher IRR of 28.1%.

The fourth year also presents a lower IRR of 14.8% in the base case compared to the renovation case with an IRR of 24.4%. In the fifth year, the base case has an IRR of 14.6%, which is lower than the renovation case’s IRR of 22.2%. therefore, over the five years the holding period IRR for the base case was lower than the renovation case IRR. This indicates that the hotel was performing exemplarily well after renovation than before.

2. The renovation case shows a significant increase in both occupancy and average daily rate (ADR) from the base case. For example, in year 4, the renovation case has a 72.5% occupancy rate and an ADR of $199.39, while the base case has an occupancy rate of 71.0% and an ADR of $190.02. Provide a rationale for how the renovation could result in increases in both the occupancy and the ADR given that these two-revenue metrics are frequently in tension with each other.

The hotel must consider the impact of renovation on the marketability of the hotel and profitability. In this case, the average daily rate is slightly lower for the base case than for the renovation case. This could be attributed to marketability of the hotel leading to increased returns after renovation compared to the period before presented in the base case. Therefore, renovation of the hotel has a implication on financial performance of the hotel, which is indicated by the performance average daily rates of the hotel over the five years period.

A similar case is reported for the occupancy rate being higher for the renovation case than for the base case. Increased occupancy is a result of the hotel being more attractive to the customers. In addition, the marketability of the hotel increases leading to more customers per day. The increased performance could also be attributed to improved competitiveness of the hotel in the hospitality market compared to rivals. Renovation could also lead to installation of new features that are latest in the market and attractive to customers, thus the increased occupancy rate and average daily rates. Although the two metrics are in tension with each other, it evident that renovating the hotel has a direct impact on the average daily rates and occupancy rates.

3. Consider the base case and the renovation case separately. For each case, when would you advise a sale, assuming that the goal was to sell the hotel as long as the marginal rate of return (MRR) is above the hurdle rate of 14%? Provide a brief explanation of your answer.

Marginal rate of return describes the amount of revenue that a company generates for every extra expense incurred on production costs. On the other hand, hurdle is the minimum return expected from an investment project. Considering the base case, it would be prudent to advise for a sale when the marginal rate of return is above the hurdle as the criteria for selling the hotel. Therefore, I would advise the hotel owners to make sale on years one, two, and three. The marginal rate of return in year one is 15.6%, in year two MRR is 15.1%, and 14.4% in year three, which are all above the hurdle rate of 14%. Therefore, it would be prudent to advise for a sale decision when the MRR is above the hurdle rate, that is, in first, second and third years.

Similarly, for the renovation case it would be prudent to advise for a sale when the MRR is above the hurdle rate. It would be advisable to make a sale on years one to three. In year one, the MRR is 38.2%, in year two the MRR is 25.8%, while MRR in year three is 19.9%. Nonetheless, years four and five do not meet the threshold of 14% since they are lower than the hurdle rate meaning it would not be prudent for a sale based on the decision criteria.

4. For the base case scenario, given that the holding period IRR is maximized in year 1, does it makes sense to sell, then? Assume the hurdle rate is 14%. Provide a brief explanation of your answer.

If the hurdle rate is maximized in year 1, it does not make sense to sell the hotel unless the main aim is to sell the hotel. The primary aim of a any project is to maximize returns. Therefore, if the primary aim of the project was to maximize profitability, the initial increase in profitability makes it irrational to make the sale.

On the other hand, the hurdle rate of 14% means that internal rate of return must be above it. However, the management would consider holding the hotel, renovate, or selling based on the potential returns expected from the investment. It would be prudent to consider selling the hotel when the project fails to meet the returns expectations, but as long as the project is meeting the returns expectations the decision to sell the hotel is not prudent.

5. Assume the Hungerford is renovated. When might it make sense to think about selling the hotel? Provide a brief explanation of your answer.

The management of the hotel should not make decision of selling the hotel as long as the hotel is making returns above the hurdle rate of 14%. If the hotel maintains an internal rate of return that is above the hurdle rate, it is not prudent to sell it. However, as the time progresses, the marginal rate of return declines as the internal rate of return falls over time. When the internal rate of return falls below the hurdle rate, it would be prudent to sell the hotel because holding the hotel would not have any gains to the investors.

If the primary objective was to make a sale of the hotel on renovation, then it would be prudent to make sale when the internal rate of return and marginal rate of return are the highest. However, if the primary objective was to generate profit it would be prudent to hold it until the returns starts declining below the hurdle rates.

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