Evaluation Of Anilana Hotel’s Proposed Hotel Expansion In Tangalle, Sri Lanka

Non-Financial Grounds for the viability of the project

The organisation chosen is Anilana Hotels, which is operating in Sri Lanka and it is planning to open a new hotel in Tangalle, Sri Lanka. The project is deemed to be viable on certain non-financial grounds, which are enumerated briefly as follows:

Customer satisfaction:

An organisation could not conduct its business operations in the absence of customers. This is because the existing financial measures carry limited value to future profitability, as it has with customer satisfaction (Damodaran 2016). It has been observed that there is relationship between the stock price of an organisation and customer satisfaction. Hence, before undertaking the project of opening a new hotel, Anilana Hotels could use customer perception as a primary basis for ascertaining the viability of the project. This could be carried with the help of market research like questionnaire and surveys. One of the significant financial measures, which could be used for linking with customer satisfaction, is staff turnover (Daunfeldt and Hartwig 2014). Staff turnover is associated with the productivity of the hotel in terms of providing services and increased productivity would increase the satisfaction level of the customers, since their needs are fulfilled. As a result, increased customer satisfaction would lead to more revenue generation of Anilana Hotels.

Competitive edge:

In the recent times, Sri Lanka has attracted 2.1 million global visitors in 2018 with tourists expressing interest to visit Tangalle (Sundaytimes.lk 2019). This denotes the presence of sound market potential for the new project. Hence, opening a new hotel in this area would provide competitive advantage to Anilana Hotels in the long-run, as it would generate positive cash flows for a number of years.

Company overview:

Anilana Hotels is involved in operating resorts and hotels in Sri Lanka. In addition, it develops as well as invests in properties and it is incorporated in 2010 based on Colombo, Sri Lanka. The hotel aspires to be realised for stylish, comfortable and modern properties along with providing greater quality services, congenial hospitality and concentrating on fulfilling the needs of the guests. By maintaining sound growth, the hotel intends to provide above average profitable returns to the shareholders and owners by enhancing the investment values and worth of the organisation (Anilana.com 2019). The profit and cash flows generated by the hotel over the last five years are presented in the form of a table as follows:

Table 1: Net income and cash flows of Anilana Hotels for the years 2013-2017

Cashflows of the project

(Source: Anilana.com 2019)

In order to initiate this project, Anilana Hotels has to incur LKR 35,750,000, out of which 35,000,000 would be needed for purchasing the building, in which the new hotel would be opened. The remaining outflows would be required for initial market research, legal and secretarial fees and staff training. Anilana Hotels would offer three types of hotel rooms for the guests, which include standard, deluxe rooms. The number of standard rooms, deluxe rooms and superior rooms would be 125, 85 and 70 respectively. The occupancy rate is expected increase after every four months in each year and in the final year, it is projected that the hotel would have full occupancy rate. This would help the hotel in maximising their overall profit margin (Fracassi 2016).

The relevant expenses that would be incurred every year include staff salaries, material costs, marketing expenses and depreciation on building. It is projected that the hotel would not employ above 30 staffs in the hotel in the five-year period in order to keep control of its expenses owing to the net loss it suffered in the previous years. It is assumed that the building would depreciate by 8% each year by following the straight-line method. The corporate tax rate of 28% is applied on operating income to calculate the net income after which depreciation amount has been added back to each of the respective years in order to arrive at the net cash inflows (Refer to Appendices, Appendix 2 for detailed calculations).

In order to calculate the weighted average cost of capital for the new hotel initiation in Tangelle, Sri Lanka, certain assumptions have been made. After evaluating the latest annual report of Anilana Hotels in 2017, it has been found that the hotel has not paid any dividend to its shareholders in the mentioned year owing to the net loss it has incurred over the years. However, it is assumed that the opening of the new hotel would help in covering the loss to a large extent by generating increased revenue and the hotel is expected to minimise its operating expenses significantly by 50% in its current business operations. This would create the ability of the hotel to pay out dividends to its shareholders (Ferran and Ho 2014).

Due to no payment of dividend, the dividend per share of a competitor hotel has been used, which is $0.10 per share and the growth rate of dividend is expected at 4% over the next five years. Similar, the yield to maturity is taken as 16.08%. The intention here is to maintain the cost of capital at 10%. Moreover, it is assumed that in order to fund the necessary plant and equipment, the hotel would raise 50% of the funds through debt and the remaining 50% by equity. By considering all this data, the WACC of the desired project has been computed (Refer to Appendices, Appendix 2 for WACC calculation).

Weighted average cost of capital (WACC) calculation

For evaluating the new expansion project of Anilana Hotels, the two investment appraisal techniques used include net present value (NPV) and internal rate of return (IRR) (Refer to Appendices, Appendix 3 for detailed calculations). From the table, it could be observed that the NPV of the expansion project is computed as LKR 6,520,780, while the internal rate of return is calculated as 17.19%. With the help of NPV, it becomes possible to determine the profitability of a proposed investment based on which final decision could be undertaken (Andor, Mohanty and Toth 2015). A higher and positive NPV is always desirable and in this case, the NPV is found to be positive, which states the project would be viable for the hotel in order to maximise its overall profit margin.

On the other hand, IRR denotes the rate at which an investment project promises in generating a return during its economic life. If the value of IRR is higher than the cost of capital, the project would be profitable for the organisation and vice-versa (Clancy and Collins 2014). In this case, IRR is higher than the required rate of return of 10%, which implies the feasibility of the project. Hence, undertaking the hotel expansion project would help Anilana Hotels in offsetting the net losses to a certain extent that it has encountered in the past four years.

By critically analysing the annual reports of Anilana Hotels for the past five years, it has been found that the hotel has suffered significant losses in the last four years. Moreover, there has been no dividend payment made by the hotel in these years as well. Thus, it clearly states the market sentiment about the hotel would not be positive among its shareholders. In this situation, when the hotel announces a new project, the investors might have concerns regarding the project viability. However, as the project is expected to yield long-term benefits in future, the perceptions of the investors might change in future as well (De Andrés, De Fuente and San Martín 2015). Therefore, the share price is expected to decline in the initial stage, which would increase in future, as soon as it starts to generate benefits.  

For the new hotel project, Anilana Hotels is planning to raise 50% of its funds through debt and 50% of its funds through equity. Since the hotel is planning to raise funds for opening a new hotel in Tangalle, Sri Lanka and the concerned expansion would result in increased profit margin for the hotel, the share price is expected to rise in future. However, there would be decline in earnings per share in the short-term because of additional shares in circulation, which tend to minimise the overall market value (Gullifer and Payne 2015).

Evaluation of the Project using Investment Appraisal Techniques

After the completion of the hotel expansion project of Anilana Hotels, it is already projected that the hotel would provide dividend payments to its shareholders, since the same is expected to grow by 4% throughout the entire project life. Moreover, the net losses would be offset largely by the expansion project, which would be a favourable indication to the market (Kengatharan 2016). Such increase in dividend and profit margin would boost the share price of the hotel in the market in the long-run.

The three potential sources of finance for funding the hotel expansion project are listed as follows:

Equity finance:

Equity finance is the technique of obtaining funds by issuing new equity shares and selling them in the market for funding new projects and business expansions. By using financing, Anilana Hotels would have no loan to repay, which would provide the freedom of channelling additional money for business growth. Moreover, even if there is absence of creditworthiness like net losses suffered by Anilana Hotels, equity is preferable over debt finance. However, the hotel would have loss of control, since they need to involve the shareholders in management decision-making process. This might result in some conflict of interest, if differences could be found in management style, vision and methods of running hotel operations (Nurullah and Kengatharan 2015).

Debt finance:

Debt finance is the amount borrowed to be repaid with interest within a stipulated period. With the help of this financing, Anilana Hotels could maintain complete control of ownership without answering to the investors and the amount to be paid as interest is tax deductible. However, the disadvantages include maintenance of sound credit history, financial discipline to make timely repayments and placing assets at risk by providing collateral to the lender.

Government grants:

Although Anilana Hotels would use an equal proportion of debt and equity for funding its hotel expansion, it could use government grants for funding future projects. The main advantage of this funding is that the organisation does not have to repay any amount and thus, it could increase its focus on improving its existing services. However, the amount obtained from government grants has to be used by staying in line with the initial plan provided along with tracking progress and submitting reports regularly to the particular agency (Rossi 2014).

Shareholder wealth value is a business term, which states that the final measure of the success of an organisation is the degree to which it enriches the shareholders by providing increased dividends and return on invested capital. The three methods of valuing shareholders’ wealth include the following:

Market Sentiment and Share Price

Earnings per share valuation method:

When decisions are undertaken to increase net profit every year, the organisation could either increase its retained earnings base or pay increased dividends to the shareholders. Earnings per share are a key indicator related to shareholders’ wealth and with the rise in earnings, there is increase in this ratio as well. This would make the investors to view the organisation as valuable.

Asset-based valuation method:

The main reason that an organisation obtains funds is to purchase assets so that the same could be used for revenue generation or investment in new projects with a positive return. An effectively-managed organisation increases the utilisation of its assets in order to operate within a smaller asset investment (Rossi 2015).

Cash flow-based valuation method:

It is possible for an organisation to increase cash flows by conversion of inventory and trade receivables quickly into cash collections. With an increased rate of receivables turnover and inventory turnover, shareholder value could be increased.

According to the theory of asymmetric dividend, asymmetry could be observed in financial information and the managers have additional information than the shareholders regarding the financial prospects of an organisation (Vernimmen et al. 2014). Due to this, the shareholders would find signals regarding the dividend decision that the managers attempt for obtaining additional knowledge. Thus, asymmetric information mainly takes place at the time the management possesses additional information of the organisation in contrast to its shareholders.

References:

Andor, G., Mohanty, S.K. and Toth, T., 2015. Capital budgeting practices: A survey of Central and Eastern European firms. Emerging Markets Review, 23, pp.148-172.

Anilana.com., 2019. Anilana | a touch of paradise | Passikudah Nilaveli Nuwara Eliya Dambulla. [online] Available at: https://www.anilana.com/index.html#about [Accessed 12 Feb. 2019].

Anilana.com., 2019. Anilana | Investor Information. [online] Available at: https://www.anilana.com/investors.html [Accessed 12 Feb. 2019].

Clancy, D.K. and Collins, D., 2014. Capital budgeting research and practice: The state of the art. In Advances in Management Accounting (pp. 117-161). Emerald Group Publishing Limited.

Damodaran, A., 2016. Damodaran on valuation: security analysis for investment and corporate finance (Vol. 324). John Wiley & Sons.

Daunfeldt, S.O. and Hartwig, F., 2014. What determines the use of capital budgeting methods?: Evidence from Swedish listed companies. Journal of Finance and Economics, 2(4), pp.101-112.

De Andrés, P., De Fuente, G. and San Martín, P., 2015. Capital budgeting practices in Spain. BRQ Business Research Quarterly, 18(1), pp.37-56.

Ferran, E. and Ho, L.C., 2014. Principles of corporate finance law. Oxford University Press.

Fracassi, C., 2016. Corporate finance policies and social networks. Management Science, 63(8), pp.2420-2438.

Gullifer, L. and Payne, J., 2015. Corporate finance law: principles and policy. Bloomsbury Publishing.

Kengatharan, L., 2016. Capital budgeting theory and practice: a review and agenda for future research. Applied Economics and Finance, 3(2), pp.15-38.

Nurullah, M. and Kengatharan, L., 2015. Capital budgeting practices: evidence from Sri Lanka. Journal of Advances in Management Research, 12(1), pp.55-82.

Rossi, M., 2014. Capital budgeting in Europe: confronting theory with practice. International Journal of Managerial and Financial Accounting, 6(4), pp.341-356.

Rossi, M., 2015. The use of capital budgeting techniques: an outlook from Italy. International Journal of Management Practice, 8(1), pp.43-56.

Sundaytimes.lk., 2019. Tangalle: Paradise lost . [online] Available at: https://www.sundaytimes.lk/120101/News/nws_22.html [Accessed 12 Feb. 2019].

Vernimmen, P., Quiry, P., Dallocchio, M., Le Fur, Y. and Salvi, A., 2014. Corporate finance: theory and practice. John Wiley & Sons.

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