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CHAPTER 13
FEASIBILITY STUDIES — AN INTRODUCTION
INTRODUCTION
In many ways, this chapter can be considered a continuation of Chapter 12. While Chapter 12
covered various methods for evaluating investments in long-term assets for periods up to five or
so years, this chapter takes a look at what is required for very long-term investments in land and
buildings. The chapter describes what is included in a feasibility study for a proposed new hotel,
and in particular discusses the financial aspects of such a study.
TRUE OR FALSE QUESTIONS
(Correct answer indicated by T for True and F for False answers)
1. A feasibility study is designed to guarantee to a lender that a new hotel project will be
financially successful.
F
2. A feasibility study can have either a positive or a negative recommendation.
T
3. A feasibility study may reduce the risk of a particular investment but does not
eliminate the risk.
T
4. Most feasibility studies begin with a financial analysis of the proposal and conclude
with other matters such as site evaluation.
F
5. The general market characteristics section of a feasibility study covers matters such as
the proposed advertising budget.
F
6. The general market characteristics section of a feasibility study covers both
descriptive and statistical data where these are relevant.
T
7. Auto access routes are an important part of the site evaluation section of a feasibility
study for a downtown restaurant.
F
8. A hotel feasibility study should include in its supply and demand section local hotel
occupancy trends broken down by class of hotel.
T
9. The major source of demand for all downtown city hotels is the tourist.
F
10. Business travel growth can often be correlated to growth in local office space
occupancies.
T
11. The business traveler component of demand for hotel rooms in an area is 80% and has
been growing at 7% a year. Composite growth rate is 56%.
F
12. Business travel demand for hotel rooms in an area is 80% and vacation travel demand
20%. Annual compound business travel growth is 7% and vacation travel 10%. Total
composite growth rate is 7.6%.
T
13. Current average nightly demand for hotel rooms in an area is 1,796 and composite
growth rate of demand is 5.5%. Next year’s (year 1) demand for rooms will be 1,895
(to the nearest whole number).
T
14. Current average nightly demand for hotel rooms in an area is 1,796 and composite
growth rate of demand is 5.5%. Two years from now (year 2) demand for rooms will
be 2,095.
F
15. Average nightly demand for hotel rooms is 1,796 in a particular area and hotels in that
area are averaging 75% occupancy. Total number of rooms presently available in that
area is 2,395.
T
16. Average nightly demand for rooms in an area is 3,598 and hotels are averaging
75% occupancy. Total number of rooms presently available in that area is 4,568.
F
17. Average nightly demand for rooms in an area is 3,598 and area hotels are averaging
an occupancy rate of 75%. A new hotel is to be built that will cause all hotels
(including the new one) to operate at a 70% occupancy in the first year. The new
hotel will have 496 rooms.
F
18. Interim financing is temporary financing while a property is being built, whereas
bridge financing is used for post-opening working capital.
F
19. A long-term mortgage on a building is also referred to as a permanent mortgage.
T
20. A permanent mortgage is one on which interest only has to be paid.
F
21. A chattel mortgage is a mortgage taken out to finance chattels such as food and
beverage inventories.
F
22. A pro-forma income statement is an income statement calculated on a cash basis.
F
23. Feasibility study sales revenue projections are usually prepared for one possible level
of sales revenue only.
F
24. The best way to evaluate feasibility study financial projections is to convert the
projected cash flow figures using net present value (NPV) or internal rate of return
(IRR).
T
MULTIPLE CHOICE QUESTIONS
(Correct answer indicated by asterisk)
1. One of the following statements is not correct. A feasibility study:
(c) Can indicate either a positive or a negative outcome of an investment
(d) Should be independently prepared by an impartial third party
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2. Which of the following items would not be included in the general market characteristics
section of a feasibility study?
(a) Industrial growth trends
(b) Employment and economic trends
3. Which of the following would not be part of the site evaluation section of a feasibility study?
(c) Transportation routes to and from the site
(d) Site dimensions
4. Which of the following would not be part of the supply and demand information section of a
hotel feasibility study?
(a) Hotel occupancy trends in the local area for the past five years
(b) A list of competitive hotels currently serving that market
5. Business travel demand is estimated to comprise 80% and convention delegate demand 20%
for a proposed new hotel. The annual average growth rate in business travel is 4% and
convention delegates 5%. Composite overall average growth rate of demand is:
(c) 1.0%
(d) 4.8%
6. In a particular area, demand for hotel rooms is 60% from business travel, 30% from
convention delegate travel, and 10% from vacation travel. These three markets have been
growing at 8%, 6%, and 5%, respectively. Composite growth rate of demand is:
(c) 1.8%
(d) 0.5%
7. Current average nightly demand for hotel rooms in an area is 898 and composite total growth
rate of demand is 5.5%. Next year’s (Year 1) demand for rooms will be (to the nearest whole
number):
(a) 945
(b) 953
8. Current average nightly demand for hotel rooms in an area is 1,260 and composite total
growth rate of demand is 6%. The demand for rooms in each of the next 3 years (years 1, 2,
and 3), respectively, will be:
(a) 1,336 / 1,416 / 1,521
(b) 1,416 / 1,501 / 1,591
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9. Average nightly demand for hotel rooms in an area is 2,635. The hotels in that area are
presently averaging 72% occupancy. The total number of rooms available is:
(c) 3,416
(d) 3,201
10. Average nightly demand for rooms in an area is 2,635. The hotels in that area are presently
averaging 72% percent occupancy. Assume a new hotel is to be built that will cause
occupancy for all hotels (including the new one) to drop to 65% in the first year (Year 1).
The number of rooms in that new hotel will be:
(c) 368
(d) 386
11. Interim financing is the same as:
(a) A bank loan for working capital
(b) A permanent mortgage
12. A chattel mortgage is a:
(a) Type of interim financing
(b) Type of bridge financing
PROBLEM SOLUTIONS
P13.1 a. Calculate the current average occupancy of 5 motels:
Motel
Rooms
Available
Occupancy %
Rooms
Occupied
A
74
82%
=
61
B
45
73%
=
33
C
58
85%
=
49
D
48
70%
=
34
E
52
75%
=
39
277
216
Composite occupancy: (216 / 277) = 78.0%
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b. Composite growth rate:
c. Composite growth rate and projected demand for the next 4 years
Vacation travel
×
=
Other travel
10%
×
1%
=
0.1%
Rooms
Composite
Future
Year
Demand
Growth %
Demand
0
216
1
216
107%
=
231
2
231
107%
=
247
3
247
107%
=
264
4
264
107%
=
282
d. Assume a 70% occupancy and calculate the rooms that could be supplied for the
next 4 years:
Rooms
Occupancy
Supply
Current
New Rooms
Year
Demand
@ 70%
Required
Supply
Required
Current
216
/
70%
=
309
−
277
32
1
231
/
70%
=
330
−
277
53
2
247
/
70%
=
353
−
277
76
3
264
/
70%
=
377
−
277
100
4
282
/
70%
=
403
−
277
126
P13.2 a. Determination of rooms demand:
Motel
Rooms
Available
×
Occupancy
%
Rooms
Demand
#1
150
×
80%
120
#2
140
×
90%
126
#3
90
×
70%
63
#4
110
×
80%
88
#5
66
×
75%
50
(49.5 50)
#6
120
×
75%
90
Totals
676
537
Total rooms available in 6 motels: 676
Composite occupancy: (537 / 676) = 79.4%
Sources of
Demand
Sources of
Demand %
Growth
Rate %
Composite
Percentage
Business travel
10%
×
5%
=
0.5%
Total composite growth rate percentage
7.0%
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b. Composite growth rate:
c. Composite growth rate and projected demand for the next 4 years:
Rooms
Composite
Future
Year
Demand
Growth %
Demand
0
537
1
537
105.5%
=
567
2
567
105.5%
=
598
3
598
105.5%
=
631
4
631
105.5%
=
666
d. Assume a 75% occupancy and calculate the rooms that could be supplied for the
next 4 years:
Rooms
Occupancy
Supply
Current
New Rooms
Year
Demand
@ 75%
Required
Supply
Required
Current
537
/
75%
=
716
676
=
40
1
567
/
75%
=
756
676
=
80
2
598
/
75%
=
797
*586
=
211
3
631
/
75%
=
841
586
=
255
4
666
/
75%
=
888
586
=
302
*Motel 3 to be closed in Year 2 and current supply adjusted to 586 (676 – 90).
Sources of
Demand
Sources of
Demand %
Growth
Rate %
Composite
Percentage
Business travel
60%
×
6%
=
3.6%
Vacation travel
30%
×
5%
=
1.5%
Other travel
10%
×
4%
=
0.4%
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P13.3 Pro-forma Income Statement
Food sales revenue
Monday through Saturday:
Lunch [120 × 1.5 × 6 × 52 × $5.60] $ 314,496
Dinner [120 × 1.25 × 6 × 52 × $10.50] 491,400
Beverage sales revenue
Lunch [12% × $314,496] $ 37,740
Dinner [30% × ($491,400 + $141,960)] 190,008
Banquets [40% × $168,000] 67,200 294,948
Total Sales Revenue $1,410,804
Operating expenses
Food cost [38% × $1,115,856] $424,025
Total expenses (1,368,689)
Operating income [BT] $ 42,115
P13.4 a. Total Debt Equity
Land $150,000 $150,000
Building 900,000 $630,000 270,000
b. Building Mortgage Repayment
Year Total Interest Balance
0 $630,000
1 $63,000 $50,000 $13,000 617,000
c. Chattel Mortgage Payment
Year Total Interest Balance
0 $225,000
1 $61,000 $25,000 $36,000 189,000
* The final year payment is reduced due to rounding.
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P13.5 Building Depreciation
Year Expense Balance
0 $900,000
1 $54,000 846,000
Furniture & Equipment Depreciation
Year Expense Balance
0 $300,000
1 $75,000 225,000
P13.6 Year Sales Revenue Calculation
1 50 rooms × 70% × 365 × $30 = $383,000
2 50 rooms × 75% × 365 × $30 = $411,000
Year 1 Year 2 Year 3 Year 4 Year 5
Sales revenue $383,000 $411,000 $452,000 $479,000 $511,000
Op. Costs 60% $230,000 $247,000 $271,000 $287,000 $307,000
Indirect exp. 40,000 44,000 48,000 52,000 56,000
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P13.7
Year 1
Year 2
Year 3
Year 4
Year 5
Net income (or loss)
($111,000)
($ 77,000)
($ 41,000)
($15,000)
$10,000
Add:
Depreciation
$129,000
$107,000
$ 90,000
$77,000
$66,000
Prepaid expenses
20,000
20,000
20,000
20,000
20,000
Total add-backs
$149,000
$127,000
$110,000
$97,000
$86,000
Subtotal
$ 38,000
$ 50,000
$ 69,000
$82,000
$96,000
Deduct: Principal
( 49,000)
( 54,000)
( 60,000)
(66,000)
( 71,000)
Net cash flow
($ 11,000)
($ 4,000)
$ 9,000
$16,000
$25,000
The above financial projections show no net income until Year 5 and cash flow is
negative until Year 3. The accumulated cash flow over the 5 years is positive $35,000
CASE 13 SOLUTION
No solution is offered because each student’s report will differ depending on the location chosen.