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Sleepon Hotels Inc (DEC 05 ADAPTED)
In the question, there is a working capital requirement of 50 million from the end of year one. It is also stated in the question that all receipts and costs will increase by 3%. The 50 million is used at year 1, operations are for 4 years and start at year 2 (when the construction of the project will be completed.
The solution uses working capital at 51.5 million (3% increase) and then the 1.5 million is also added every year and increased by 3% every year until year. My question is how come there is additional working capital every year and how come it is recovered in year 6 and not year 5 when the project is completed?
The question says that all costs and revenues are expected to increase by 3% a year. So given that the working capital is needed to cover the inventory, receivables, etc.., as they increase by 3% so too will the need for working capital.
As far as the recovery is concerned, the examiner should have shown it as recovered at time 5, not at time 6.
(The examiner has changed twice since this question was set. All questions set by the current examiner show the recovery to be at the end of the project (in this case time 5) – I have no idea why this previous examiner decided to show it differently in his answer 🙂 )
Dear Sir, thank you very much for your quick reply, I feel more relieved. Similarly for Blipton International (Dec 08 Adapted), the hotel investment disposal recovery is subject to both inflation and market value appreciation; the recovery consists of the open market value less the repair and maintainance costs incurred at the year of the disposal. The market value appreciates and inflates to the power of 5 (the duration of the cash flows ad project while the repair costs to the power of 6. Is the reason the same as your answer above if you are familiar with the question. Should I not take it for granted that you are familiar with all the questions?
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