Maximizing Profit with Athenia Hotel Investment

What are the NPV and IRR of converting Matthew's Ottawa office building into the Athenia Hotel?

Calculate the initial investment, cash flows, NPV, and IRR to determine the potential profitability of this investment.

NPV and IRR Calculation:

To calculate the NPV (Net Present Value) and IRR (Internal Rate of Return) of converting Matthew's Ottawa office building into the Athenia Hotel, we need to consider the cash flows and the required rate of return.

Step 1: Calculate the Initial Investment

The initial investment includes the cost of disposing of the old office equipment and the cost of the furniture and masonry for the Athenia hotel.

Cost of disposing old office equipment = $2 million

Current selling price of old office equipment = $400,000

Net disposal cost = Cost of disposing - Selling price = $2 million - $400,000 = $1.6 million

Cost of furniture and masonry for the Athenia hotel = $10 million

Initial investment = Net disposal cost + Cost of furniture and masonry = $1.6 million + $10 million = $11.6 million

Step 2: Calculate the Cash Flows

The cash flows include the increased pre-tax profits generated by the Athenia hotel and the salvage value of the furniture and masonry.

Annual pre-tax profit from the Athenia hotel = $2.4 million

Number of years = 15

Salvage value of furniture and masonry = $1,000,000

Step 3: Calculate the NPV

NPV is the present value of all the cash flows over the life of the investment, discounted at the required rate of return.

Step 4: Calculate the IRR

IRR is the rate at which the NPV of the investment becomes zero. It represents the annualized rate of return that the investment is expected to generate.

By analyzing and calculating the NPV and IRR, Matthew can make an informed decision on whether converting his office building into the Athenia Hotel will lead to maximizing profits.