Value Lodges owns an economy motel chain and is considering building a new 200-unit motel. The cost to build the motel is estimated at $6,800,000; Value Lodges estimates furnishings for the motel will cost an additional $200,000 and will require replacement every 5 years.
Annual operating and maintenance costs for the motel are estimated to be $540,000. The average rental rate for a unit is anticipated to be $25/day. Value Lodges expects the motel to have a life of 15 years and a salvage value of $900,000 at the end of 15 years. This estimated salvage value assumes that the furnishings are not new. Furnishings have no salvage value at the end of each 5-year replacement interval.
Required:
1. Assuming average daily occupancy percentages of 50 percent, 60 percent, 70 percent, and 80 percent for years 1 through 4, respectively, and 90 percent for the fifth through fifteenth years, a MARR of 12 percent/year, 365 operating days/year, and ignoring the cost of land, should the motel be built? Base your decision on an internal rate of return analysis.

The motel should not be built because the IRR is 9.31%, which is lower than the company's MARR (12%).

Explanation:

cost to build the new 200 unit motel $6,800,000 + $200,000 = $7,000,000

the furnishing must be replaced every 5 years

annual operating costs $540,000

average rental rate

useful life 15 years with a salvage value of $900,000

expected cash flows:

year      total revenue         costs                furnishing        total

0                                      -$6,800,000       -$200,000  -$7,000,000

1               $912,500           -$540,000                                $372,500

2           $1,095,000           -$540,000                                $555,000

3            $1,277,500           -$540,000                                $737,500

4           $1,460,000           -$540,000                                $920,000

5           $1,642,500           -$540,000                               $1,102,500

6           $1,642,500           -$540,000       -$200,000      $902,500

7           $1,642,500           -$540,000                               $1,102,500

8           $1,642,500           -$540,000                               $1,102,500

9           $1,642,500           -$540,000                               $1,102,500

10          $1,642,500           -$540,000                               $1,102,500

11           $1,642,500           -$540,000       -$200,000      $902,500

12          $1,642,500           -$540,000                               $1,102,500

13          $1,642,500           -$540,000                               $1,102,500

14          $1,642,500           -$540,000                               $1,102,500

15         $2,542,500           -$540,000                             $2,002,500

now using an excel spreadsheet I calculated both the NPV and IRR:

NPV = -$1,113,875IRR = 9.31% < 12% (MARR)

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