HOS 470 Chapter 6 Homework 2015

List some of the factors which make debt less expensive than equity. 2. Explain the tax-effect upon the cost of debt. 3. Why might a hotel project have a higher interest rate than a single-family home loan? 4. What is Internal Capital and how should it be priced when computing WACC? 5. What is the Yield Curve and what can it tell you about the stock market’s prospects? Chapter 6 – Equity Partner Return Listed below is an example of the Return on Equity calculation for a $300,000 project with $210,000 of debt @ 10% and $90,000 of equity @ 30% of net cash flow. The cash flow is $81,000. 6. Calculate the Return on Equity for an equity partner who receives 35% of the net cash flow of a $1,500,000 project with 70% of debt @ 12%. The projected cash flow is $560,000. 7. Calculate the Return on Equity for an equity partner who receives 25% of the net cash flow of a $1,200,000 project with 60% of debt @ 9%. The projected cash flow is $420,000. Chapter 6 – WACC (Known ROE) Listed below is an example of a Weighted Average Cost of Capital (WACC) calculation for a $200,000 project financed by $120,000 of debt @ 12% and $80,000 of equity at 25%. The tax rate is 33%. $ Weight % PreTax % Cost Tax Rate % AfterTax % Cost Weighted Cost Debt $1,20,000 60.0% 12.0% 33.0% 8.0% 4.8% Equity $80,000 40.0% 25.0% 33.0% 25.0% 10.0% Total $2,00,000 100.0% 14.8% 8. Calculate the WACC for a $450,000 project, 70% financed by debt @ 9% and the balance by equity at 19%. The tax rate is 28%. $ Weight % PreTax % Cost Tax Rate % AfterTax % Cost Weighted Cost Debt Equity Total 9. Calculate the WACC for a $1,600,000 project, 65% financed by debt @ 13% and the balance by equity at 24%. The tax rate is 31%. $ Weight % PreTax % Cost Tax Rate % AfterTax % Cost Weighted Cost Debt Equity Total Chapter 6 – WACC (ROE from Share of Cash Flow) 10. Calculate the Return on Equity for an equity partner who receives 27% of the net cash flow of a $2,200,000 project with 65% of debt @ 11%. The projected cash flow is $620,000. The tax rate is 32% Item Calculation Result Project Cash Flow Project Cash Flow Interest Cost Interest Cost Net Cash Flow Net Cash Flow Equity Partner Share Equity Partner $ Share Cost of Equity Return on Equity 11. Now calculate the WACC for that project. $ Weight % PreTax % Cost Tax Rate % AfterTax % Cost Weighted Cost Debt Equity Total Chapter 6: Conversion of Historic Bank to Hotel (pg 175) The Williams Bennett Hotel Development Co. has identified an historic bank building that could be converted into a hotel. The location is in the heart of downtown Smithton, a densely populated city. The structure was designed by an acclaimed architect and built in 1913. The fifteen-story will be transformed into a chic boutique hotel with the hotel lobby, meeting rooms, cafe and fitness area on the first two floors. The remaining thirteen floors will contain 130 guest rooms. The entire project will cost $35,000,000. 60% of the project will be financed with debt and $14 million is being provided by equity investors. The lender is offering a loan at a 12% interest rate and the equity investors are requiring a return of 18% on their investment. The current business tax rate is 25%. Because the structure is an historic landmark, the development company has been in discussions with government agencies to determine if there are any public incentives for redeveloping the property. The hotel market in Smithton is underserved and the city needs additional rooms to attract larger convention groups. The city would also gain additional jobs which would lower the unemployment rate and a spur to the local retail and restaurant market from the new guests. 12. Calculate the WACC for this project: $ Weight % PreTax % Cost Tax Rate % AfterTax % Cost Weighted Cost Debt Equity Total What subsidies can the government offer to the development? How would a potential real estate tax abatement of $1,000,000, evenly spread over 5 years, impact the project’s ability to service debt? Chapter 6: Turner County Luxury Mixed Use Development (pg 175-176) Frank Douglas, a real estate developer, just finalized a major deal with Turner County to develop a major hotel/luxury condominium/golf/conference center/residential mixed-use project on land owned by Turner County. The development will include a 150 room five-star hotel, 75 luxury 2,500 sq. ft. condominium units, an eighteen hole championship golf course and 360 residential golf course lots. The total development cost, exclusive of the cost of the land and financing expenses, is projected to be $250,000 per room for the hotel, $200 per square foot for the luxury condominium units, $6 million for the golf course and 10% of the projected $500,000 selling price for each residential lot. The county has agreed to contribute the land to the project at no cost. The county’s justification for this contribution is the new jobs, real estate taxes and new visitors to the area generated by the mixed-use development. Summary of the Project Data: Hotel rooms 150 Cost per room $2,50,000 Condo units 75 Condo size (square feet) 2,500 Condo cost per square foot $200 Golf course $60,00,000 Residential lots 360 Selling price per residential lot $5,00,000 Residential lot development cost (% of selling price) 10% A. Calculate the Project Costs using the above data: Hotel 75 Condominiums 360 Residential Lots Golf Course Total Project Cost B. Determine the Total Debt and Equity Needed Maximum Loan to Value Ratio 55% Debt Equity C. Possible Sources of Loans D. Possible Sources of Equity

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