Said Al Hamli and his friend Khaled Al Masri are the owners of asmall hotel, the Sun Star, in the Red Sea town of Hurghada. Closeto Cairo, the resort town has grown from a fishing village to oneof Egypt’s famous vacation spots. Hurghada is the gateway to manysmall islands and offshore reefs favored by recreational snorkelersand divers and many tourists combine their stay with excursions tothe Nile Valley, the Great Pyramids and Luxor.
To take advantage of the growing numbers of tourists,particularly from Europe and the Middle East, Said and Khaled areplanning to double the room capacity of their hotel by adding asecond building to the already existing structure. Fortunately,Said recognized the great potential of Hurghada ten years ago, wellbefore the town became a hub for recreational tourism, and boughtthe land adjacent to the hotel for relatively little money when itwas still under construction.
Now, Said and Khaled are studying the new layout and trying todetermine if the expected revenues justify the substantial initialinvestment of EGP 70 million ($11.8 million). According to theircalculations, operating cost would rise by EGP 23.8 million ($4million) in the first year, which would include hiring and trainingof new personnel, maintenance of facilities and equipment etc., andlikely increase by about 5 percent per year thereafter. With anaggressive marketing strategy, Said and Khaled believe that arevenue enhancement of EGP 20.8 million in the first year isrealistic and that a subsequent annual increase of about 15 percentfor eight to nine years, with revenues leveling off thereafter, canbe achieved. Ideally, Khaled would like to retire in ten years.Seeking advice from you, a knowledgeable friend, they share theirdetailed cost and revenue projections with you.
Year | Cash (EGP) | Revenue (EGP) |
0 | ?70,000,000 | |
1 | ?23,800,000 | 20,825,000 |
2 | ?24,990,000 | 23,949,000 |
3 | ?26,239,000 | 27,541,000 |
4 | ?27,551,000 | 31,672,000 |
5 | ?28,929,000 | 36,423,000 |
6 | ?30,375,000 | 41,887,000 |
7 | ?31,894,000 | 48,169,000 |
8 | ?33,489,000 | 55,395,000 |
9 | ?35,163,000 | 63,704,000 |
10 | ?36,922,000 | 73,259,000 |
QUESTIONS
1. | Determine the resulting net cash flow for each year; and compute: a. | the net present value, | b. | the simple payback period, | c. | and the profitability index. |
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2. | Give your decision on each result in terms of the project’sexpected profitability and Khaled’s ten-year investment horizon |
