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25 April, 07:08

A Resort in Hawaii is now available for sale for $400 million. Hilton Hotels Corp. and Marriott International Inc. are both considering purchasing the resort. The resort is expected to deliver a free cash flow of $45 million every year for the next 20 years. S&P500 expected return is 8%, the risk-free rate is 2%, Hilton's beta is 1.1, and Marriott's beta is 1.3. Both firms have zero debt. Which one of the following statements is correct?

a. Hilton and Marriott both should try to purchase the resort.

b. Hilton should purchase the resort, but Marriott should not.

c. Hilton should not purchase the resort, but Marriott should.

d. Neither should try to purchase the resort.

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Answers (1)
  1. 25 April, 07:16
    0
    b. Hilton should purchase the resort, but Marriott should not.

    Explanation:

    given data

    Resort sale = $400 million

    free cash flow = $45 million

    time = 20 year

    return = 8%

    risk-free rate = 2%

    Hilton beta = 1.1

    Marriott beta = 1.3

    solution

    we get here first NPV of the resort when the cost of capital is

    Re = risk-free rate + beta (Rm - Rf) ... 1

    Re = 2 + 1.1 (8 - 2)

    Re = 8.6%

    and

    The NPV will be as

    cash flow to free cash flow is = 45 million

    so NPV is $22.767

    and

    as that at cost of capital of 9.8%,

    The NPV will be

    NPV = $11.6011

    so we can say that Hilton should pursue the project due to the positive NPV

    but due to the negative NPV here Marriott should not pursue the project.
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