Finance in Action Brownell Country Club–Lease or Purchase The Brownell Country Club is in the process of upgrading its catering management system and trying to determine whether to purchase system software or go with an online version. Company management projects the market cap rate to be 10% in Year 3, and the company’s WACC is 12%. A computer model can calculate the maximum amount of money you can borrow and still meet your lender’s debt service coverage requirement based on the proposed interest rate, amortization rate, and your cash flow projections. If you input $100 as the present value of an investment, $712.31 as the future value, and 49 years as the compounding period, you would have earned an interest rate of 4.09% per year. A Types of Capital There are two types of capital: debt and equity. Milton believes the sellers of targeted assets will include large lodging companies and smaller ones. Consider that you have won a small lottery and now have the choice of receiving $600 per year for five years or a lump sum payment today. So, Leven resigned from Holiday Inns Worldwide, and US Franchise System (USFS) was launched in October 1995. Chapters 10 and 11 focus on how to prepare a professional investment package and successfully secure the capital needed for growth. At times, a personal guarantee is also required by your lender. During the early 1970s, after receiving his BS from the School of Hotel Administration at Cornell University and his MBA from the University of Buffalo, Rushmore went to work for a hospitality real estate brokerage firm, where he learned to prepare hotel appraisals, feasibility studies, and deal structuring from his mentor, Steve Brener. If the current downturn proves more persistent, the window of opportunity may be longer resulting in a greater opportunity to acquire distressed assets. Appraisers often obtain information from public records and tax assessors. C O S T O F C A P I TA L : The amount of cash flow allocated to the provider of the capital divided by the amount of capital provided. Loan size—principal b. Chapters 8 and 9 apply these concepts and calculations to investment analysis techniques and hospitality industry scenarios. The reader of your investment package wants to learn why you believe the deal will be successful, but he also wants to be assured by an independent third party, experienced in the hospitality industry, that his investment will be safe and yield favorable financial results. When its founding dean, Dr. James Taylor, first approached Eric with his vision for a new hotel school, Eric was receptive and convinced his father to contribute $1.5 million to the development of the college. F E A T U R E S T O R Y JOSEPH L. JACKSON–OUTBACK AS A PARTNER Joseph L. Jackson is a twenty-eight-year veteran of the restaurant industry and a graduate of the Conrad N. Hilton College. However, Mr. Corcoran’s assertiveness and outstanding business experience, combined with his partner’s reputation as a hospitality mogul and experience as the first president of Embassy Suites Hotels, enabled them to convince a lender that the deal had significant upside value. Some lenders charge a fee to make the loan and deduct the fee from the loan proceeds. At the same time, this can be done via a formula: PVA n = PMT ⫻ [1– {1/(1 + r)n }] r Where PMT = payment or the annuity amount. How? Included in its portfolio were the Sheraton and Westin HOTEL FINANCING TRENDS AND SCHEMES 165 I L L U S T R AT I O N 6 - 1 1 Boykin Lodging Equity Inns Felcor Lodging Hospitality Properties Trust Host Marriott Humphrey Trust Innkeepers USA InnSuites Hospitality Trust Jameson Inns, Inc. LaSalle Hotel Properties Meristar Hospitality Corp RFS Hotel Investors Sunstone Hotel Investors Winston Hotels Hotel REITs chains and Caesar’s World casinos. As soon as [(] is typed, EXCEL displays: PV(rate,nper,pmt,[fv],[type]); the word rate is bolded to prompt you to enter the rate. [2nd] [CE/C] 3. You now have, as they say, skin in the deal. Compare the present value of the lease payments with the cost to purchase the asset. Lodging Forecast. This is a major challenge for most companies and becomes even harder the larger the company becomes. TIME VALUE OF MONEY APPLICATIONS 259 Hannah projects cash distribution to her equity investors to be $60,000 per year. A&W was established on the foundation of its famous root beer formula by founder Roy Allen. Why? It’s an annuity calculation where: PV ⫽ loan amount N ⫽ number of compounding periods I / Y ⫽ interest per compounding period With three variables, you can compute the fourth—PMT, in this case—the debt service payment you need to make each period. 244 CHAPTER 8 䡲 INVESTMENT ANALYSIS 9. Mr. Cruz would want to renovate the property and convert it to a Brownbark Restaurant, which is a familyfriendly gourmet hamburger restaurant. TWL Research believes that this RevPAR decline will have a substantially greater impact on those hotels experiencing declining occupancies prior to the macroeconomic downturn. 2. Scenario A: CF ⴝ $10,000 and CR ⴝ 10% Scenario B: CF ⴝ $10,000 and CR ⴝ 20% Scenario A is the correct answer, as $10,000 divided by 0.10 equals $100,000, while Scenario’s B value is $10,000 divided by 0.20, or $50,000. The Uniform System of Financial Reporting for Spas, the newest uniform system of accounts, was published in 2005 to better monitor spa services for upscale hotels and resorts. Identify the factors that impact market value. Since the 1980s, hotel lenders have become more sophisticated, take fewer risks, and lend a smaller percentage of the total project cost. These companies make their profit from the individual cardholder or the merchant—or in some cases, from both. While insurance companies and pension funds make loans, they also invest equity. Bill focused the company’s attention on the growth of hotels and originated the concept of brands within a brand, now known as market segmentation. Again, it is more practical and accurate to perform these calculations using a business calculator or a spreadsheet such as Excel. Like insurance companies, pension funds specialize in mini-perm and permanent loans. In many cases, the CEO and CFO have only ten minutes to tell the company’s story and get the prospective buyer excited about buying the stock. ➤ The three primary financial statements you should be familiar with are the income statement, balance sheet, and statement of cash flow. She is a senior lecturer in accounting in the Oxford School of Hospitality Management at … Alternatively, you can use the cash flow function key on your business calculator, enter each year’s cash flow as instructed, and compute the present value a little faster. 10. Years ago, complicated mathematical formulas were used to analyze financial transactions. You also need to select the best form of business entity, decide on the proper mix of debt and equity, and successfully negotiate your loan agreement with your lender and your equity agreement with your investor. The degree of sophistication is dictated by the type and size of the operation and the needs of management and ownership. Hilton Promus Landry’s Golden Nugget Las Vegas and Laughlin Marriott Ritz-Carlton and Renaissance Starwood Westin and Sheraton Wendy’s Tim Hortons, Café Express, Baja Fresh, Yum! A hotel is a focal point for the exchange of knowledge between millions of people who want to know each other better, trade with each other and live with each other in peace. Illustration 9-13A shows the Excel formula for the spreadsheet calculations. The main aim of this paper is to investigate the implementation of risk management in Croatia’s hospitality industry. Project B costs $11,000,000 and has a present value of $12,000,000 and an NPV of $1,000,000. OFF-BALANCE-SHEET FINANCING Off-balance-sheet financing is a clever method that is legal as long as you strictly follow the rules. Analyze potential investment opportunities using NPV and IRR. To assist the reader in evaluating and becoming comfortable with the cost of your deal, a detailed line item project budget is recommended. A N N U I T Y D U E : Same as a regular annuity except the payments occur at the beginning of the compounding period rather than at the end. He jokingly admits, ‘‘Unlike my great friend, Bill Marriott, I have never checked the temperature of the hot water in the chafing dish that keeps the bacon warm. . While the operation of all business calculators and computer spreadsheets is not exactly the same, each is similar enough for you to understand and calculate using your particular business calculator and computer spreadsheet. ‘‘Finance Sources.’’ Restaurant Finance Monitor 15(5) (May 20, 2004): 4. Food and beverage costs are calculated in the same manner. Because the risk of a mezzanine loan is much higher than the risk of a first mortgage loan, the associated interest rate is also much higher. The Millennium approach to mixed-use development is to offer a range of products, all of which capitalize on a luxury brand to create synergies that provide a tremendous premium to their real estate. If it is the latter case, the lender is raising an objection. As the deal is analyzed by the potential buyer, she compares the asking price of the seller with both the current market value, based on the capitalization of the trailing twelve months’ cash flow, and the potential present value of the asset, assuming the successful execution of 266 CHAPTER 9 䡲 HOSPITALITY INDUSTRY APPLICATIONS OF TIME VALUE the action plan. As seen in Illustration 8-7, the function can be invoked by ‘‘⫽mirr(’’. While the car loan may be an annuity, the entire car purchase transaction is more like an uneven cash flow, especially if you are leasing a car with a purchase option and have a balloon payment to make at the end of the lease. His fishing companion, the late Houston oil and real estate tycoon, R.E. An additional benefit of cost control is that for every dollar of cost reduction, 100% falls to the bottom line, while in the case of sales growth, expenses required to generate the new sales must be deducted from the increase in gross sales. IMPORTANCE TO THE HOSPITALITY MANAGER As a hospitality manager, understanding the time value of money concept, the concept of market value, and learning the investment analysis skills based on these concepts is important to your success. If Sarah’s business falls in the 30% tax bracket, what is her cost of debt after tax? A financially oriented hospitality manager will take the time to estimate all the costs involved and include them in his pricing decision. Following his costly mistake, Sternlicht left JMB and struck out on his own. A corporation is a separate legal entity that can act on its own or on behalf of the shareholders. Conversely, if you doubt your lender will lower his interest rate below 7.5%, what amortization rate would you need to negotiate in order to borrow $110,000 at an interest rate of 7.5%? 5. The cost of debt and equity is usually stated as a percentage and is calculated by dividing the projected annual payment to the lender or investor by the amount of capital it provides. ANALYSIS OF FINANCIAL STATEMENTS 87 Ms. Sarah Blackwell is a financial analyst who specializes in restaurant companies, and one of the companies in her portfolio is Larry’s Luncheon Spot. 9. You may be surprised; he may say, ‘‘Okay, let’s have lunch and close the deal today. Weighted average cost of capital (WACC) b. S O LV E N C Y R A T I O : Measures a business’s ability to meet long-term financial obligations (over one year). Food and beverage are combined, as many of the same employees sell and service both food and beverage items. Your loan, of course, must conform to the standards of the banking industry, which bank examiners monitor. Of course, there have been years when the inflation rate has been higher, sometimes in double digits, and years when the inflation rate has been very low. Year Payment Principal Interest Balance 1 2 3 4 5 36,956 36,956 36,956 36,956 36,956 28,956 30,404 31,924 33,520 35,196 8,000 6,552 5,032 3,436 1,760 131,044 100,640 68,716 35,196 0 Note that while the debt service payment remains fixed over the amortization period, the amount of the principal repayment component increases while the amount of the interest component decreases. In the real world, not everything comes in neat packages. Marriott Jr. in 1972. Her investor’s hurdle rate, which equates to her cost of equity, is 15%, with NPV computing to negative ($1,928). At the beginning of each month, estimate your cash inflows and outflows for the next ninety days. Brownstone Restaurants, Inc. owns and operates over 20 restaurants on the east coast of the United States. ■ Managers: Compare actual results with the budget for the period, the prior year, competitors, 57 and industry norms, and flag problem areas for follow-up actions. 3. ➤ The income statement, or profit and loss statement, presents a company’s operating results over a specific period, usually a month, a quarter, or a year. Samuel has requested a copy of the most recent income statement and balance sheet to help determine if the property would fit into his company’s portfolio of restaurants. $ PAR $ POR REVENUES Rooms Food Beverage Telephone Other Operated Dept. The Mason Hotel, a franchised property, is on the market, and the owners are looking to sell the asset quickly because they need cash to invest in other projects they currently own and operate. Private companies look at the total value of the company in terms of increasing profits, increasing cash flow, and increasing its return on investment. 260 CHAPTER 9 䡲 HOSPITALITY INDUSTRY APPLICATIONS OF TIME VALUE THE REAL DEAL Sensitivity analysis helps entrepreneurs, lenders, and equity investors determine how key variables will affect the projected cash flow of an investment opportunity. Is any information missing that should go into an equity investment package? Collateral is an asset that is offered to the lender as loan insurance. Management is also now required to report to a board of directors at least four times a year and hold an annual stockholder’s meeting to answer any questions shareholders may have, even if they own only one share of the company’s stock. V A R I A B L E - R A T E L O A N : Loan that starts out with a low interest rate that escalates over time. returned to his Utah hometown to marry his college sweetheart, Alice Sheets. QUESTIONS 1. Major hotel companies are now developing computerized systems of their own. MANAGEMENT REPORTS a. Expand facilities: Add to the company’s present facilities, construct new facilities, or acquire existing facilities. That led to ownership of the international restaurant chain Kentucky Fried Chicken, today known as KFC. The lower the cap rate used to calculate the terminal sale price of the asset at the end of the analysis period, the higher the sale price and the higher the PV, NPV, and IRR. At the end of the five-year period, Maui Ocean expects the subject hotel’s cash flow to have stabilized and will cap the fifth-year cash flow at the market cap rate of 10% to calculate a sale price for the hotel. B A L A N C E S H E E T: A financial statement that reports a snapshot of the financial condition of an operation in terms of assets, liabilities, and equities. Wall Street’s strategy was to identify a small portfolio of hotels that could be acquired, create new companies structured as REITs to purchase these portfolios, orchestrate initial public offerings to raise equity from their largest institutional and high-net-worth clients, and lease the hotels to a qualified management company, often owned by the sponsor of the REIT. Let’s drink to his continued success! We all contribute a percentage of our income to Social Security now so that when we retire we will have an annuity coming back to us from the government. As part of the settlement, Archie was awarded two of the Holiday Inns he had developed, and he continued to manage them under the Mariner name. C H A P T E R 9 HOSPITALITY INDUSTRY APPLICATIONS OF TIME VALUE OF MONEY CONCEPTS AND SKILLS F E A T U R E S T O R Y BILL KIMPTON AND TOM LATOUR– THE DREAM TEAM In 30 seconds, I knew he was the guy. A non-recourse loan limits the lender’s repayment options to the assets of the business and the collateral at risk, as opposed to a recourse loan, which allows the lender to also seek repayment from the borrower’s personal assets. 5 [N] 12 [I/Y] [CPT] [FV] Display will show FV = 1,762.3417* 4. 5. Illustration 4-2 shows how a cash budget can easily be prepared using an Excel spreadsheet. The cafe´ patrons were also part of the show, chatting away and having a good time while enjoying their coffee in an elegant setting with Italian opera playing in the background. [2nd] [CE/C] [2nd] [FV] 3. During his high school years he played the stock market; during college he started his own sales and marketing firm; and after graduation he became a real estate developer building million-dollar ‘‘spec’’ homes and developing restaurants and hotels. While Westin’s management was pleased with the existing data provided by the STAR Report, what they really wanted was to select the five or six hotels in the markets where their Westin Hotels were located and measure their hotel’s performance against their competition. 128 CHAPTER 5 䡲 GROWING THE BUSINESS Managing a public company is significantly different than managing a small start-up company. A B C D E 1 I / Y (WACC) N (Year) 2 8.925% 1 FV (Annual Cash Flow) CPT PV Calculations $ 2,750,000 $2,524,672.94 ⫽PV(A2,B2,0,-C2) 3 8.925% 2 4 8.925% 3 $ 3,500,000 $2,949,938.13 ⫽PV(A3,B3,0,-C3) $ 4,000,000 $3,095,118.53 ⫽PV(A4,B4,0,-C4) 5 8.925% 6 8.925% 4 $ 4,500,000 $3,196,702.64 ⫽PV(A5,B5,0,-C5) 5 $ 5,000,000 $3,260,860.06 ⫽PV(A6,B6,0,-C6) 7 8 8.925% 6 $ 5,500,000 $3,293,042.06 ⫽PV(A7,B7,0,-C7) 8.925% 7 $ 6,000,000 $3,298,057.86 ⫽PV(A8,B8,0,-C8) 9 8.925% 8 $ 6,000,000 $3,027,824.52 ⫽PV(A9,B9,0,-C9) 10 8.925% 9 $ 6,000,000 $2,779,733.32 ⫽PV(A10,B10,0,-C10) 11 8.925% 10 $ 6,000,000 $2,551,970.00 ⫽PV(A11,B11,0,-C11) Step #3 Add the present value of all cash flows, and you will get $55,497,620. PMT? Interior designer c. Contractor 8. S E N S I T I V I T Y A N A LY S I S : Method of analyzing investment opportunities by conservatively altering the assumptions on which the projections are based. 5. A mere $735 million. Restaurants, ballrooms, meeting rooms—that stuff is outrageously expensive from a realestate perspective of hotels. ‘‘Company’s Heritage: Alice Sheets Marriott.’’ http: / / marriott.com / corporateinfo / culture / heritageAliceSMarriott.mi. Based on current market conditions, banks are willing to fund up to 70% of the total project cost to start a new restaurant. He expects business to pick up a bit in the second year, really take off in Year 3, and then stabilize and earn around $300 annually thereafter. The average or mean is the middle of the bell-shaped curve. Clearly, Clayton Bank is offering a better option for the Clover Hotel Company. Closer inspection of the statement reveals: £ Sales revenues 300,000 Less: direct For the baby boomers, or those who were born in 1955, $100 in 1955 would have been worth $712.31 in 2004. Basically, he was unhappy being an auditor. A 2004 study shows the maximum allowable payback period for an asset depends on the expected number of years the asset will last. Boatman, Inc. is an internationally franchised chain of midscale full-service hotels. Using debt also does not dilute ownership like equity does. Growth provides financial rewards to its shareholders and other benefits and advantages to its management and employees. ■ Where is the remaining capital to finance the project coming from besides my money? Other companies may hire illegal immigrants and therefore need money on the side to pay these workers off the books. The Business Entity When embarking on a new venture, the first task is to decide which form of business entity is right for the venture. A walk down the main thoroughfare of a city such as Las Vegas can cast a very bright light on this issue. Consider the following aging table. ➤ Four factors impact the present value, net present value, and internal rate of return of an investment opportunity. 342 CHAPTER 11 䡲 CRAFTING AND NEGOTIATING THE DEAL Concept Check Expanding Gregory's Fergus and Freya Eneas have owned Gregory’s Greek Restaurant for over thirty years in Gregorytown, a small scenic town in the country. Because we have entered all variables, the operation can be completed by typing [)], then hit the enter key The cell will now display the value of –$39.49. Type the open bracket [(]. If an independent third party valued your project at $1,000,000 and you are requesting an $800,000 loan, what is the loan-to-value ratio? Floor Concierge Total Conf. During economic downturns, equity markets are more stable and provide a good source of funding for entrepreneurs. It is also expected that the aggregate portfolio will be large enough and of sufficient quality to attract primarily institutional buyers such as hotel REITs and C-corporations. To see how to calculate the present value using the formula and table method, please take a look at Illustration 7-3. Your ability to maximize the amount of debt you can raise reduces the amount of equity required. By then, his hotels had acquired a cult following and frequently experienced full occupancy in spite of the high room rates. Don’t worry. In addition, by attaching new creative signature restaurants to their hotels and leasing them to well-known local chefs, they created the perception of being a full-service hotel without the costs associated with one. Knowing that he has future contracts coming in with a few long-time corporate customers, he hopes he will be able to achieve higher sales next year. A luxury-type car would probably also carry a huge insurance premium. Enter the following: 1762.34 [FV] 60 [N] 1 [I/Y] [CPT] [PV] Display will show PV = –970.0794* 3. Understand the concept of risk and return, and how to measure it. Discuss the financial challenges presented by the hospitality industry. A more thorough and skilled interpretation and analysis of these statements, however, can provide the reader with a great deal more information on the company’s operating performance, financial health, and likelihood of future success. 4. Capitalization Request Milton is seeking joint venture programmatic equity capital to execute the Venture set forth in this proposal. R E A L E S TAT E M O R T G A G E I N V E S T M E N T C O N D U I T S ( R E M I C s ) : These conduits made mortgage loans and sold them as commercial mortgage-backed securities primarily to financial institutions that formerly made real estate loans directly to real estate developers. S O U R C E S ‘‘Life After Studio 54.’’ http: / / sumagazine.syr.edu / summer01 / features / enterprisezone / index.html, 2001. When requesting capital, you must demonstrate that the money you are asking for will generate a favorable return on investment for your company. This skill will be invaluable to you in preparing operating budgets, profit flexing, and computer modeling of alternative business strategies. The purchase process begins with a purchase order request, initiated by a department head who wants to purchase a product or service. The cap rate approach to value capitalizes or values the asset’s prior twelve months’ cash flow by dividing the cash flow by the market cap rate to arrive at the asset’s approximate market value. If the market rate of interest is 6%, how much will this investment be worth at the end of ten years? While venture capital funds occasionally provide debt financing, equity investments in businesses are their primary objective. Only time will tell, as the brothers aren’t talking. C A P I TA L I Z I N G C U R R E N T O P E R A T I N G E X P E N S E S : Application Exercises Use the following sets of financial statements to complete Exercises 1 through 8: The T Resort Income Statement For the year ended December 31, 2008 Revenues Cost of Goods Sold Salaries and Wages Employee Benefits Other Expenses Depreciation $600,000.00 192,000.00 210,000.00 58,800.00 118,520.00 2,000.00 Net Income $ 18,680.00 The T Resort Balance Sheets As of December 31, 2007, and 2008 Cash Accounts Receivable Marketable Securities Inventory Prepaid Rent Total Current Asset 2007 $7,000.00 10,000.00 3,000.00 8,000.00 10,000.00 38,000.00 2008 $12,980.00 12,000.00 3,000.00 9,500.00 8,500.00 45,980.00 Furniture, Fixtures and Equipment (FF&E) Accumulated Depreciation (FF&E) Building Long-term Investments 20,000.00 (3,000.00) 20,000.00 30,000.00 20,000.00 (5,000.00) 20,000.00 45,000.00 67,000.00 80,000.00 $105,000.00 $125,980.00 Long-term Assets Total Assets 86 CHAPTER 3 䡲 ANALYZING FINANCIAL STATEMENTS Accounts Payable Accrued Payroll Accrued Taxes Total Current Liabilities $ 14,000.00 9,450.00 8,560.00 32,010.00 $ 12,460.00 8,000.00 6,980.00 27,440.00 Long-term Debt 12,500.00 20,000.00 Owner’s Equity Retained Earnings 30,490.00 30,000.00 29,860.00 48,680.00 60,490.00 78,540.00 $105,000.00 $125,980.00 Total Owner’s Equity Total Liabilities and Owner’s Equity 1. M U LT I P L E : The current market price of a company’s common stock divided by its EPS. While the actual dollar amount of each expense should increase with sales, the percentage relationship between the expense and revenue should remain approximately the same. Uniform systems of accounts for lodging, restaurants, clubs, and spas 2. Now pretend you are Ms. Samuelson and the owner requests that you increase net operating profit to $300,000. 600,, 7. Byrne, J. Calculating Time Value of Money The analysis of time value of money has changed dramatically over time. Equity Questions The process of raising equity is similar to the process of raising debt. This data allowed the chain to market room availability to customers who were likely to experience flight cancellations. Do the math: If your vendor delivers food to you on May 1 and invoices you at the end of the month, by the time you write him a check, he has actually financed your food purchase for thirty days. S O U R C E S Deady, Tim. While this approach may appear easy, if there have been few comparable sales in recent months, comparisons can be difficult. This proved to be a wise business decision on the Colonel’s part; in less than ten years, the Kentucky Fried Chicken franchise network grew to a chain of more than 600 franchises. As you advance professionally within a company or form a company of your own, the more you will need to know about debt and how to secure it. 3. If your prospective lender is comfortable with the answers to the three questions noted above, your chances of receiving the debt financing you are seeking are excellent. 2. Remember that when a lender applies its loan-to-value (LTV) formula to the present value of your project, the higher the present value, the more money it will likely allow you to borrow. This does not even include maintenance work such as oil changes. THE IPO PROCESS While going public sounds exciting and can be lucrative to everyone involved, owning and managing a public company is much different than owning and managing a private company. (2000, May 25). If you wait until you are thirty, you will only have thirty years or 360 months to save. THE REAL DEAL REITs are still going strong in 2006. The present value of a business venture is very important in borrowing money. In analyzing a balance sheet, total assets, total liabilities, or total equity serves as the base. We address objections later in the chapter. BRANDS: EVOLUTION OF QUICK-SERVICE RESTAURANTS IN THE TWENTY-FIRST CENTURY The form of a company’s ownership often changes as the company grows and enjoys financial success. ‘ Fertitta looks to the early 1990s thorough, and 9 apply these and... With 901 portions sold, food cost percent between 30 % wait to receive exclusive offers and the investor s! 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