1.With the assistance of firm management consultants, the directors of Ocean Blue Hotel, a profitable company in the hotel and leisure industry, are currently considering an expansion project to build a new country club and conference centre next to the existing hotel. The new complex will provide a wide range of leisure and business facilities for members, guests and business community.

The initial investment in land, buildings and equipments is estimated at Rs880,000, although grant aid of 10% of this capital cost will be received in the project's first year of operation. Annual operating costs (salaries, wages, overheads, etc.) associated with the project are estimated at Rs265,000 (which include depreciation of Rs58,000 and an allocation of the hotel's existing fixed overheads of Rs22,000). The cost of the consultants' report on the project was Rs12,000.

In the business plan the consultants' estimate of club membership is as follows:

No of membersProbability

Year 1Year 2 onwardsof occurrence

3006000.15

4007000.20

5008000.30

6009000.20

7001,0000.15

The consultants also estimate membership fees as follows:

No of membersProbability

Year 1Year 2 onwardsof occurrence

Rs200Rs3000.15

Rs250Rs3500.20

Rs300Rs4000.30

Rs350Rs4500.20

Rs400Rs5000.15

Additional revenues from other related activities (bar and restaurant sales, conferences and functions, etc.) are estimated at Rs45,000 per year. The business plan also assumes a ten-year economic life for the project.

Ocean Blue's current cost of capital is 10% and the directors wish to add a risk premium of 2% for this project. The directors require a maximum acceptable payback period of six years for this project.

As a member of the management consultancy team you are required to:

1. Calculate the payback period (PPB) for the project;

2. Calculate the net present value (NPV) for the project;

3. Calculate the internal rate of return (IRR) for the project;

4. Identify, and briefly explain, two techniques you would consider appropriate for the assessment of risk in this particular project.

5. What other factors (financial and non-financial) should the directors consider in evaluating this project?

Ignore taxation and residual values.