A Resort in Hawaii is now available for sale for $400 million. Hilton Hotels Corp. and Marriott International Inc. are both considering purchasing the resort. The resort is expected to deliver a free cash flow of $45 million every year for the next 20 years. S&P500 expected return is 8%, the risk-free rate is 2%, Hilton’s beta is 1.1, and Marriott’s beta is 1.3. Both firms have zero debt. Which one of the following statements is correct?
a. Hilton and Marriott both should try to purchase the resort.
b. Hilton should purchase the resort, but Marriott should not.
c. Hilton should not purchase the resort, but Marriott should.
d. Neither should try to purchase the resort.

b. Hilton should purchase the resort, but Marriott should not.

Explanation:

given data

Resort sale = $400 million

free cash flow = $45 million

time = 20 year

return = 8%

risk-free rate = 2%

Hilton beta =1.1

Marriott beta = 1.3

solution

we get here first NPV of the resort when the cost of capital is

Re = risk-free rate + beta( Rm - Rf)    1

Re = 2 + 1.1 ( 8 - 2 )

Re = 8.6%

and

The NPV will be as

cash flow to free cash flow is = 45 million

so NPV is $22.767

and

as that at cost of capital of 9.8%,

The NPV will be

NPV = $11.6011

so we can say that Hilton should pursue the project due to the positive NPV

but due to the negative NPV here Marriott should not pursue the project.

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