Case 7: The City Hotel Recovery Analysis CIS

Transcription

1 Case 7: The City Hotel Recovery Analysis CIS Danna Penaranda MARCH 29, 2015 SPRING 2015

2 TABLE OF CONTENTS The Business Situation... 2 No Change Scenario... 2 Figure Debt decreases as rented rooms decrease...3 Rent Rooms Scenario 4 Figure Debt tends to increase in the four years.4 Sell Time-Share Scenario...5 Figure second Worst scenario after no change scenario....5 Do Both Scenario...6 Figure short Run debt decreases in the most promising scenario...6 Table 1 End of year debt for 2015 for do both scenario...6 Conclusion...7 Figure debt decreases the most for do both scenario.8 Page 1 of 8

3 THE BUSINESS SITUATION Currently, the hotel city operates inefficiently in that it does not reach its $2.2 million obligation for the construction loan payment owed to the city. Although the hotel operates efficiently enough to cover its operating expenses, it falls short to meet its liability. Since its opening in 2014, it has had to borrow more from the city s fund in order to contribute to the construction loan payment. In total, the hotel currently owes more than the annual construction loan payment to the city. That amount has increased %, a total of $15 million. Because the city is financing the construction loan payment and the consequent loans, city administrators must find out whether it is best for the city to sell the hotel or find new business entries to increase its cash flows, which in return would help pay the debt owed to the city. There are four scenarios that best option reduces the most working capital debt in each of the years 2015, 2016, 2017, and These scenarios are: NO CHANGE SCENARIO With this being the second worst case scenario, it is assumed that seasonal tourists will not have much impact, and that the expected occupancy rate will remain the same. In addition, the hotel returns losses in 2015, 2016 and 2017 respectively with this scenario in its Net Income Losses after Taxes even though the hotel expects 164,250 hotel room rentals. When the Quantity does not Dominate Total Revenue: In this case, the quantity increase in hotel room rentals does not increase Total Revenue. Conversely, it is able to decrease End-of-year debt owed to the city government in all years when it expects an average of 151,439 hotel room rentals only when it engages with the college and the time-share company (See Figure 1.0.1). What numbers offset a debt of $2.3million in 2018 when the hotel does not rent and or sell timeshare rooms? Operating expenses are in part fixed and variable. Each year the hotel forecasts its Operating Expenses to increase $250,000 independently of whether the hotel rents 50 rooms to the college or sells rooms to the time-share. Management must count in both options: sell and rent to spread these expenses. It s not justifiable to maintain expenses such as Payroll (to a point fixed) when it does not attract new businesses. The advice is to distribute this expense and others along the new arrival of customers either by renting, selling or doing both. Page 2 of 8

4 . Less Number of Rental Rooms Decreases Debt $16,810,000 $16,580,000 $16,350,000 $16,299,065 $16,393,685 END OF YEAR DEBT OWED TO CITY GOVERNMENT $16,120,000 $15,890,000 $16,032,947 $15,660,000 $15,620,110 $15,430,000 $15,200, , , , , , , , , , ,900 NUMBER OF RENTAL ROOMS FIGURE DEBT DECREASES AS RENTED ROOMS DECREASE GREEN BUBBLE REPRESENTS YEAR 2018 BLUE BALL REPRESENTS YEAR 2017 RED BALL REPRESENTS YEAR 2016 ORANGE BALL REPRESENTS YEAR 2015 Page 3 of 8

5 RENT ROOMS SCENARIO The second scenario is renting 50 rooms to the neighboring college. This is the best second scenario. The average End-of-year debt owed to the city government is $1.8 million. Only in the long run will the hotel be able to report favorable Net Income after Taxes if Inflation Rate(s) maintain at 1%, 2%, 3%, and 4% respectively for each year. The hotel has 700 other rooms to which spread fixed costs, and it s in the hopes that seasonal tourists at least will surpass the total number of room rentals beyond 153,300 in How Low Prices Hurts the Borrower: In 2015, as it usually happens when the Inflation Rate is less than the Interest Rate, the prices went down 1% when the Interest Rate stayed 2%. This translates into 3% buying power to the city s funds, therefore hurting the hotel (borrower) by having to pay 1% more. The hotel s Total Interest Expense offset Income before Interest Expense by $1,073,534. Thus, the hotel reports negative Net Income after Taxes for $352,924 because a decrease in prices led to an Average Daily Room Rate of only $ With this scenario, the hotel is never able to make re-payments to the city s funds and instead its debt represents an upward trend (See Figure 1.0.2) DEBT AMOUNTS IN MILLION DOLLARS $19,500,000 $19,000,000 $18,500,000 $18,000,000 $17,500,000 $17,000,000 $16,500,000 $16,000,000 $15,500,000 Rent Rooms Scenario $16,786,842 $18,019,139 Debt in each Year End-of-year debt owed to city government 2015 End-of-year debt owed to city government 2016 End-of-year debt owed to city government 2017 End-of-year debt owed to city government 2018 $18,879,775 $19,057,772 FIGURE DEBT TENDS TO INCREASE IN THE FOUR YEARS Page 4 of 8

6 SELL TIME-SHARES SCENARIO When selling rooms to the time-share company, the hotel s Net Income after Taxes is negative in 2015 and 2016 with $796,032 and $284,700 respectively. These numbers rely in the time-share company to buy 10 rooms each year. In reality, they can buy less than 10 rooms. For instance, if only 7 rooms are bought in 2015 and increase 1% each year, Net Income after Taxes incurs losses of almost $1million and $422,303 for 2015 and 2016 respectively. How Low Prices Hurts the Borrower: In 2015, the hotel is also affected by down prices with an Interest Rate greater than an Inflation Rate. Furthermore, the hotel pays more for its Total Interest Expenses derived from a low growth in Average Daily Room Rate. Not Making Repayments Increases Debt: With this scenario the hotel cannot afford to make any payments to the city s funds in any years. Indeed, selling rooms to the time share company is not promising because this scenario, out of all four, has the biggest losses for the hotel (See Figure). If this were the only choice for the hotel, the course of action will be to sell the hotel to a national chain. Note that in 2016 Working Capital Loan increased because End-of-year debt owed to city government in 2015 did not go down. For 2015 the Working Capital Loan was only $300,000. However, because it was not able to make repayments to the city, thereby increasing its debt, 2016 had $44,599 more in Working Capital Loan. Sell Time-Shares Scenario DEBT AMOUNTS IN MILLION DOLLARS $25,000,000 $20,000,000 $15,000,000 $10,000,000 $5,000,000 $0 $17,229,950 $19,005,925 $20,340,467 $21,006,830 Debt in each Year End-of-year debt owed to city government 2015 End-of-year debt owed to city government 2016 End-of-year debt owed to city government 2017 End-of-year debt owed to city government 2018 FIGURE SECOND WORST SCENARIO AFTER NO CHANGE SCENARIO Page 5 of 8

7 DO BOTH SCENARIO Out of all the scenarios, selling rooms and renting to the college allows the hotel to report gains in its Net Income after Taxes each year. The other scenarios ran in negative Net Income after Taxes at least one year, and therefore such scenarios did not decrease End-of-year debt owed to city government. Diversification of Customers Allowed a Cushion Against Low Prices: Inflation Rate of 1% does not affect the hotel because two new entries of business are the cushion to protect the hotel from low rates in the Average Daily Room Rate. Each year the hotel borrows less from the city s funds if it rents to the college and sells to timeshare. Borrowing from the city s government decreased an average of 77% from 2015 to Long Run and Short Run Are Promising: In the long run, for 2018, the hotel will not have to borrow from the city to maintain its Minimum Cash Required. It s in the best interest of the community, the city, and employees to sell rooms to the time-share company and rent 50 rooms to the college. In the short run, this scenario provides the least End-of-year debt owed to the city government in 2015 (Y axis) in comparison to the other scenarios (X axis) (see Figure 1.4). This can also be seen in Table End-of-Year Debt for all Scenarios 18,500,000 18,000,000 17,878,227 DEBT AMOUNTS IN MILLION DOLLARS 17,500,000 17,000,000 16,500,000 16,000,000 16,786,842 17,229,950 16,241,939 15,500,000 15,000,000 No Change Rent Rooms Sell Time-Shares Do Both FIGURE SHORT RUN DEBT DECREASES IN THE MOST PROMISING SCENARIO No Change Rent Rooms 2015 Sell Time- Shares Do Both 17,878,227 16,786,842 17,229,950 16,241,939 TABLE 2 END OF YEAR DEBT FOR 2015 FOR DO BOTH SCENARIO Page 6 of 8

8 CONCLUSION The hotel must do business with both the college and the time-share company. This is the only case for which the Inflation Rate did not majorly affect Average Daily Room Rate. In the scenarios for No Change, Rent Rooms, and Sell Time-Shares, a reduction in prices led to less Total Revenue. In return the Working Capital Loan worked against the hotel when the Interest Rate was greater than the Inflation Rate, thereby increasing Total Interest Expense where Total Revenue was less. The second best scenario, Rent Rooms, is not optimal in that it has the less amount of End-ofyear debt throughout all years when compared to No Change and Sell Time-share scenarios. In 2015, the hotel will lose $352,924 in Net Income after Taxes. There are two similarities for both Rent Rooms and Sell Time-share scenarios. They are both never able to make payments to the city and struggle to make Net Income after Taxes in the million dollars. Similarly then, both scenarios go into debt to keep running their End-of-year Cash on Hand. Even though the Sell Time-share scenario does not soar the debt as much as the No Change scenario, it runs negative income in 2015 and Operating Expenses for this scenario are, in most of the years, greater than No Change and Rent Rooms scenarios. Time-share Remodeling Expense cannot be justified it if were the only option. Perhaps, a lean management approach can cut back on this expense by adopting sustainable lighting and laundry. For both Rent Rooms and Sell Time-share scenarios, advertising expense, part of Operating Expenses, is very likely to increase in order to gain new visitors to fill out 740 or 700 rooms. The No Change Scenario being the worst, struggles to make gains in Net Income after Taxes since it runs in the negative for three consecutive years. Again, it has to borrow to keep running which is not justifiable. This scenario is not promising because it soars its End-of-year debt owed to the city in an average of $2.0 million in the next four years. Therefore, management should not sell the hotel, rent 50 rooms to college only, or sell rooms to time-share company only. Rather, it should diversify its customers among tourists, the neighboring college, and the time-share company. Figure shows End-of-year debt owed to the city for Do Both scenario. Page 7 of 8

9 Do Both Scenario DEBT AMOUNTS IN MILLION DOLLARS $18,000,000 $17,500,000 $17,000,000 $16,500,000 $16,000,000 $16,241,939 $17,032,583 $17,435,316 $17,145,175 $15,500,000 Debt in each Year End-of-year debt owed to city government 2015 End-of-year debt owed to city government 2016 End-of-year debt owed to city government 2017 End-of-year debt owed to city government 2018 FIGURE DEBT DECREASES THE MOST FOR DO BOTH SCENARIO Page 8 of 8