×




Hotel Vertu: Analyzing the Opportunity in the Boutique Hotel Industry Net Present Value (NPV) / MBA Resources

Introduction to Net Present Value (NPV) - What is Net Present Value (NPV) ? How it impacts financial decisions regarding project management?

NPV solution for Hotel Vertu: Analyzing the Opportunity in the Boutique Hotel Industry case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Hotel Vertu: Analyzing the Opportunity in the Boutique Hotel Industry case study is a Harvard Business School (HBR) case study written by Howard H. Stevenson, Michael J. Roberts. The Hotel Vertu: Analyzing the Opportunity in the Boutique Hotel Industry (referred as “Hotel Boutique” from here on) case study provides evaluation & decision scenario in field of Innovation & Entrepreneurship. It also touches upon business topics such as - Value proposition, Entrepreneurship, Joint ventures, Negotiations, Strategic planning.

The net present value (NPV) of an investment proposal is the present value of the proposal’s net cash flows less the proposal’s initial cash outflow. If a project’s NPV is greater than or equal to zero, the project should be accepted.

NPV = Present Value of Future Cash Flows LESS Project’s Initial Investment




Case Description of Hotel Vertu: Analyzing the Opportunity in the Boutique Hotel Industry Case Study


Two soon-to-be MBA graduates are considering a business opportunity in the boutique hotel industry. Having found a seemingly attractive property in Savannah, Georgia, Yvonne D'Arcy and Elisabeth Whiting face questions about career issues, planning, financing, and the possibility of unequal power dynamics. Students assess the merits of the proposed project, as well as the overall attractiveness of the boutique hotel industry and the career opportunity it presents. Exhibits include a Letter of Agreement between D'Arcy and Whiting, the hotel's historical performance data, lodging statistics for the Savannah market, and the project budget. An associated case, "Hotel Vertu: Financing the Venture in the Boutique Hotel Industry" (#917505), overlaps with this case, but delves into the issues around financial forecasts, financial returns, deal structure, equity splits, and the power dynamic between investors and entrepreneurs. Although each case can be taught on its own (i.e., students do not require data or knowledge from one case in order to benefit fully from the other), the two can be paired in order to give students a more complete sense of the challenges that aspiring entrepreneurs may face. If both cases are taught, it is recommended that instructors begin with "Hotel Vertu: Analyzing the Opportunity in the Boutique Hotel Industry."


Case Authors : Howard H. Stevenson, Michael J. Roberts

Topic : Innovation & Entrepreneurship

Related Areas : Entrepreneurship, Joint ventures, Negotiations, Strategic planning




Calculating Net Present Value (NPV) at 6% for Hotel Vertu: Analyzing the Opportunity in the Boutique Hotel Industry Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10015779) -10015779 - -
Year 1 3454396 -6561383 3454396 0.9434 3258864
Year 2 3957088 -2604295 7411484 0.89 3521794
Year 3 3939175 1334880 11350659 0.8396 3307407
Year 4 3247164 4582044 14597823 0.7921 2572058
TOTAL 14597823 12660124


The Net Present Value at 6% discount rate is 2644345

In isolation the NPV number doesn't mean much but put in right context then it is one of the best method to evaluate project returns. In this article we will cover -

Different methods of capital budgeting


What is NPV & Formula of NPV,
How it is calculated,
How to use NPV number for project evaluation, and
Scenario Planning given risks and management priorities.




Capital Budgeting Approaches

Methods of Capital Budgeting


There are four types of capital budgeting techniques that are widely used in the corporate world –

1. Net Present Value
2. Internal Rate of Return
3. Profitability Index
4. Payback Period

Apart from the Payback period method which is an additive method, rest of the methods are based on Discounted Cash Flow technique. Even though cash flow can be calculated based on the nature of the project, for the simplicity of the article we are assuming that all the expected cash flows are realized at the end of the year.

Discounted Cash Flow approaches provide a more objective basis for evaluating and selecting investment projects. They take into consideration both –

1. Timing of the expected cash flows – stockholders of Hotel Boutique have higher preference for cash returns over 4-5 years rather than 10-15 years given the nature of the volatility in the industry.
2. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Hotel Boutique shareholders have preference for diversified projects investment rather than prospective high income from a single capital intensive project.




Formula and Steps to Calculate Net Present Value (NPV) of Hotel Vertu: Analyzing the Opportunity in the Boutique Hotel Industry

NPV = Net Cash In Flowt1 / (1+r)t1 + Net Cash In Flowt2 / (1+r)t2 + … Net Cash In Flowtn / (1+r)tn
Less Net Cash Out Flowt0 / (1+r)t0

Where t = time period, in this case year 1, year 2 and so on.
r = discount rate or return that could be earned using other safe proposition such as fixed deposit or treasury bond rate. Net Cash In Flow – What the firm will get each year.
Net Cash Out Flow – What the firm needs to invest initially in the project.

Step 1 – Understand the nature of the project and calculate cash flow for each year.
Step 2 – Discount those cash flow based on the discount rate.
Step 3 – Add all the discounted cash flow.
Step 4 – Selection of the project

Why Innovation & Entrepreneurship Managers need to know Financial Tools such as Net Present Value (NPV)?

In our daily workplace we often come across people and colleagues who are just focused on their core competency and targets they have to deliver. For example marketing managers at Hotel Boutique often design programs whose objective is to drive brand awareness and customer reach. But how that 30 point increase in brand awareness or 10 point increase in customer touch points will result into shareholders’ value is not specified.

To overcome such scenarios managers at Hotel Boutique needs to not only know the financial aspect of project management but also needs to have tools to integrate them into part of the project development and monitoring plan.

Calculating Net Present Value (NPV) at 15%

After working through various assumptions we reached a conclusion that risk is far higher than 6%. In a reasonably stable industry with weak competition - 15% discount rate can be a good benchmark.

Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 15 %
Discounted
Cash Flows
Year 0 (10015779) -10015779 - -
Year 1 3454396 -6561383 3454396 0.8696 3003823
Year 2 3957088 -2604295 7411484 0.7561 2992127
Year 3 3939175 1334880 11350659 0.6575 2590072
Year 4 3247164 4582044 14597823 0.5718 1856577
TOTAL 10442598


The Net NPV after 4 years is 426819

(10442598 - 10015779 )






Calculating Net Present Value (NPV) at 20%


If the risk component is high in the industry then we should go for a higher hurdle rate / discount rate of 20%.

Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 20 %
Discounted
Cash Flows
Year 0 (10015779) -10015779 - -
Year 1 3454396 -6561383 3454396 0.8333 2878663
Year 2 3957088 -2604295 7411484 0.6944 2747978
Year 3 3939175 1334880 11350659 0.5787 2279615
Year 4 3247164 4582044 14597823 0.4823 1565955
TOTAL 9472211


The Net NPV after 4 years is -543568

At 20% discount rate the NPV is negative (9472211 - 10015779 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Hotel Boutique to discount cash flow at lower discount rates such as 15%.



Acceptance Criteria of a Project based on NPV

Simplest Approach – If the investment project of Hotel Boutique has a NPV value higher than Zero then finance managers at Hotel Boutique can ACCEPT the project, otherwise they can reject the project. This means that project will deliver higher returns over the period of time than any alternate investment strategy.

In theory if the required rate of return or discount rate is chosen correctly by finance managers at Hotel Boutique, then the stock price of the Hotel Boutique should change by same amount of the NPV. In real world we know that share price also reflects various other factors that can be related to both macro and micro environment.

In the same vein – accepting the project with zero NPV should result in stagnant share price. Finance managers use discount rates as a measure of risk components in the project execution process.

Sensitivity Analysis

Project selection is often a far more complex decision than just choosing it based on the NPV number. Finance managers at Hotel Boutique should conduct a sensitivity analysis to better understand not only the inherent risk of the projects but also how those risks can be either factored in or mitigated during the project execution. Sensitivity analysis helps in –

What are the uncertainties surrounding the project Initial Cash Outlay (ICO’s). ICO’s often have several different components such as land, machinery, building, and other equipment.

What are the key aspects of the projects that need to be monitored, refined, and retuned for continuous delivery of projected cash flows.

Understanding of risks involved in the project.

What will be a multi year spillover effect of various taxation regulations.

What can impact the cash flow of the project.

Some of the assumptions while using the Discounted Cash Flow Methods –

Projects are assumed to be Mutually Exclusive – This is seldom the came in modern day giant organizations where projects are often inter-related and rejecting a project solely based on NPV can result in sunk cost from a related project.

Independent projects have independent cash flows – As explained in the marketing project – though the project may look independent but in reality it is not as the brand awareness project can be closely associated with the spending on sales promotions and product specific advertising.




References & Further Readings

Howard H. Stevenson, Michael J. Roberts (2018), "Hotel Vertu: Analyzing the Opportunity in the Boutique Hotel Industry Harvard Business Review Case Study. Published by HBR Publications.