Investment Appraisal and Shareholders’ Wealth

Running head: INVESTMENT APPRAISAL AND SHAREHOLDERS’ WEALTH
Investment Appraisal and Shareholders’ Wealth
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1INVESTMENT APPRAISAL AND SHAREHOLDERS’ WEALTH
Table of Contents
1.0 Justification of the viability of the project:................................................................................2
2.0 Introduction of the company and identification of cash inflows and outflows related to the
project:.............................................................................................................................................3
3.0 Calculation of the weighted average cost of capital:.................................................................4
4.0 Evaluation of the project using investment appraisal:...............................................................5
5.0 Impact of share price by announcing the new project:..............................................................6
6.0 Impact of share price by raising capital for the new project:....................................................6
7.0 Impact of share price by the completion of the new project:....................................................7
8.0 Discussion of three potential sources of finance:......................................................................7
9.0 Discussion of three shareholders’ wealth valuation methods:...................................................8
10.0 Discussion about the signalling effect of dividend:.................................................................9
References:....................................................................................................................................10
Appendices:...................................................................................................................................12

2INVESTMENT APPRAISAL AND SHAREHOLDERS’ WEALTH
1.0 Justification of 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

3INVESTMENT APPRAISAL AND SHAREHOLDERS’ WEALTH
provide competitive advantage to Anilana Hotels in the long-run, as it would generate positive
cash flows for a number of years.
2.0 Introduction of the company and identification of cash inflows and outflows related to
the project:
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:
Particulars 2013 (in LKR) 2014 (in LKR) 2015 (in LKR) 2016 (in LKR) 2017 (in LKR)
Profit/(Loss)
for the year
10,555,320 (309,064,216) (456,804,005) (243,213,092) (276,052,460)
Cash and cash
equivalents at
the end of the
year
(281,791,206) (80,533,769) (91,981,449) (109,839,719) (97,836,054)
Table 1: Net income and cash flows of Anilana Hotels for the years 2013-2017

4INVESTMENT APPRAISAL AND SHAREHOLDERS’ WEALTH
(Source: Anilana.com 2019)
Identification of cash inflows and outflows:
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).
3.0 Calculation of the weighted average cost of capital:
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

5INVESTMENT APPRAISAL AND SHAREHOLDERS’ WEALTH
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).
4.0 Evaluation of the project using investment appraisal:
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.