Utilizing the cap rate method, what will be the sale price for the hotel in year three? FINANCE IN ACTION: Application Exercises at the end of each chapter reinforce student comprehension of the key concepts presented in it. ■ Return on assets (net income / total assets): A return on assets of 5.31% means that each dollar in assets generates $0.05 in net income for Gian’s. Robbins, T. ‘‘Ray Kroc Did It All for You.’’ Esquire, 100, pp. These principles are known as Generally Accepted Accounting Principles (GAAP). The servicing agent made a fee for monitoring the loan. S O U R C E S Britton, N. ‘‘1919 Pete Harris Pappas 2005: A Leader in Houston’s Restaurant Scene.’’ Houston Chronicle, December 21, 2005. While both are interested in the financial feasibility of the project, the qualifications of the project team, thirdparty confirmation of the merits of the deal, projected operating results, and the potential risk factors that could negatively impact the project, lenders focus on the following three ratios: a. Higley, J. 5. The 302-room Blackstone Hotel is a recently defranchised upscale NEGOTIATING SKILLS 343 hotel asset that has been lender-owned for several years and fallen on hard times. EXPLORING THE WEB ✶ Based on the websites mentioned in this chapter and on other websites you may find, choose one company you would want to open a franchise with and explain the financial rationale behind your choice. The primary disadvantage of the corporate entity is double taxation. Financing for new hotel projects was plentiful, as both lenders and investors sensed that the real estate cycle was taking a turn for the better. Mantle has decided to invest the remaining 30% of the project cost with its own funds; therefore, it 273 TIME VALUE OF MONEY APPLICATIONS will only be necessary to secure financing from a lender. 3. By doing so, you will obtain the following information: Principal Interest Balance 160,000 24,779.84 0 While the term of the loan and the amortization rate in the previous example were the same, in the real world the term of the loan is usually much shorter than the amortization period. In other words, if your investors’ hurdle rate is 15%, all cash flow would go to them until they achieved a 15% return on their money. ■ The loan-to-value ratio (LTV) is another important metric for lenders. Thus, 7.5% is the (I/Y), $10,000 is the (PMT), and $110,000 is the (PV). Credit and cash sales are projected to grow at 10% each month, which can be calculated by simply multiplying the previous month’s sales figure by 1.1 (26,500 ⫻ 1.1 ⫽ 29,150). If you need to pay bills, make sure you have sufficient funds in your account. B A N K R U P T C Y: Occurs when liabilities exceed assets and the business is unable to meet its current financial obligations. Management Reports: All hotel managers should be familiar with and able to read, analyze, and, in some cases, prepare the following management reports: a. http: / / www.landrysrestaurants.com / pages / news events / published news / 99cfp-021599.htm. Special thanks are also due to Randy Smith and Mark Lomanno of Smith Travel Research and Frank Wolfe of the Hospitality Financial and Technology Professionals for their generosity in sharing their knowledge and publications. The difference between your cash inflows and cash outflows represents the amount of working capital you need and becomes your working capital budget. By Year 5, the restaurant could generate $2.5 million in annual food revenue and $1.5 million in annual beverage revenue. If the business is a corporation, the investment is called common or preferred stock. The company is allowed to book the investment as an asset and avoid depreciating it on its books. SOURCE: Smith Travel Research. Ms. Brown was able to secure a loan for $1,540,000, and an equity investor agreed to invest the remaining $660,000 in exchange for 20% ownership in the project. 5. THE NEED FOR CAPITAL 155 THE REAL DEAL More and more governments, local and state, are getting into the hotel business. ➤ The statement of cash flow links the income statement and the balance sheet and provides management with a summary of the company’s cash inflows and outflows from operations, investing activities, and financing activities. 9. $ 4,724,650 divided by $6,500,000 ⫽ LTV of 73% 3. While the low initial rate may look attractive, remember that as interest rates increase, your business’s cash flow must grow at a higher rate than the increase in the interest rate over time in order for you to stay ahead of the game. If any of the cash flows change, including the cash outflow (for example, $600), you need change one value INVESTMENT ANALYSIS 231 Scenario You are looking to invest in a deal and are considering several investment alternatives. In addition, the termination rights of the hotel owner are limited. E Q U I T Y K I C K E R : Provides the deal sponsor with a portion of the profit on sale after the loan balance is paid and the outside investors receive all of their initial equity back. 362 CHAPTER 12 䡲 TYING IT ALL TOGETHER In addition to evaluating the overall feasibility of the project, the qualifications of your project management team, and the risk associated with achieving your financial projections, prospective equity investors are also interested in the answers to the following questions: 1. 6. To ensure complete market coverage, Milton will employ a three-level strategy: 1) as a nationally prominent owner of premium limited service and upscale hotel properties in the United States, Milton maintains an extensive network of contacts among owners and operators of similar assets, and thus enjoys broad access to potential transactions; 2) Milton has engaged W&S Consulting to exclusively provide the Venture with access to potential transactions through its nationwide client base and network of relationships within the lodging industry; and 3) Milton will employ its team approach to sourcing transactions where it will identify a qualified regional or local partner to source potential transactions within a given geographic region and perform daily operational activities with the acquired property. . EXPLORING THE WEB ✶ Visit www.governmentguide.com and look under the heading ‘‘Small Business.’’ Identify at least two sources from which a small business can obtain a business loan. Take the latest edition of the Uniform System of Accounts for the Lodging Industry (USALI) as an example. The software ranges in price from $10 to a few hundred dollars. Personal financial data: This is required only in situations where the lender requires the loan be guaranteed. While the payback period method has its advantages, it also has its disadvantages. Smaller organizations may employ a single manager to oversee operations and hospitality financial management for the company. It is almost an art. SBA 7(a) loans can be either short term or long term and offer a below-market interest rate, as a large portion of the money is loaned to the local bank by the federal government at a very low interest rate. ‘‘About Pizza Hut: Our Story.’’ http: / / www.pizzahut.com / about / (accessed January 22, 2006). 5. If you are able to maximize the amount of the loan and minimize your monthly debt service payments by negotiating a favorable amortization rate, you will have succeeded in using other people’s money to make money for yourself. A tax abatement is a written authorization given to a developer by a local taxing authority that exempts the property from having to pay property or other taxes for a specified period. ■ NPV is equal to or greater than zero. Points Charged As noted earlier, a point is equal to 1% of the loan. ■ Your business plan and story therefore must be persuasive and should be confirmed by a credible third-party source. Brown. The cash sales and credit sales projected for Sarah’s Kitchen are as follows: January February March April May Cash $17,000 $19,640 $16,200 $15,380 $17,390 Credit 40,000 42,000 48,000 50,000 49,500 If collections of credit sales are 70% the first month and 30% the second month, what would be the cash receipts for March, April, and May? THE REAL DEAL Effective October 28, 2004, a new federal law known as the Check Clearing for the Twenty-first Century Act—or, more commonly, Check 21—was passed to enable banks to process checks faster. ➤ Real estate investment conduits, REITs, timeshares, condominium hotels, and hotel mixed-use developments are examples of current hotel financing schemes. A good example of how cost control may benefit the lodging industry is the occupancy versus average room rate debate. This is a written promise from the take-out lender that he will repay the construction loan at the end of its term as long as the project meets the specifications the borrower and construction lender agree to in advance of the funding of the loan. The cost? Electric companies are also helping by offering free inspection and advice. The $110,000 loan amount is the present value (PV), the $10,000 annual debt service is the payment (PMT), and the twenty-year amortization rate the debt service payment is based on is the (N). NEW HOTEL FINANCING VEHICLES a. In 1954, Barron assumed the position of president and chief executive officer of Hilton Hotels Corporation, and in February 1979 he became chairman of the board. 4. ➤ Horizontal analysis tracks the performance of a company over time and identifies meaningful trends in the accounts shown on both the balance sheet and the income statement. 1) 8. For example, if the business is not doing well, the sole proprietor bears all the losses. Mr. Cruz would want to renovate the property and convert it to a Brownbark Restaurant, which is a familyfriendly gourmet hamburger restaurant. As long as the borrower perseveres and is not afraid of rejection, she can approach many lenders seeking sound, financially feasible projects for investment of their funds. High-end establishments, such as resorts and fine dining restaurants, normally feel the effects of a weak economy first, but eventually, the entire industry feels the financial pain. The report could take the form of either a market study or an appraisal. This indicates that in November, for every $1.00 of current liabilities, Gian’s has $2.63 in current assets to cover these debts. While this ratio is of some value for a hospitality asset, the more important ratios measure how much cash flow the fixed asset generates. The matching principle, following the revenue recognition principle, requires that all expenses incurred in order to generate a particular revenue are recorded in the period the revenue is earned, even if the expense has not yet been paid. A C T I V I T Y R AT I O S . WORKING WITH AN INVESTMENT BANKER The role of an investment banker in the IPO process is twofold. Future value of an uneven stream of cash flow j. PRIVATE CREDIT COMPANIES Private credit companies specialize in mini-perm, permanent, mezzanine, and convertible loans. 3. Understand how credit cards are processed and the range of transaction fees charged. The operation can be completed by typing [)], then hit the enter key. ➤ The five types of equity are cash, land, leases, existing buildings and government subsidies. Year 3 Year 4 Year 5 75 65% 17794 $65.00 $1,156,594 $312,280 $844,313 75 70% 19163 $65.00 $1,245,563 $336,302 $909,261 75 75% 20531 $65.00 $1,334,531 $360,323 $974,208 $277,583 $566,731 $104,093 $462,638 $34,698 $427,940 $298,935 $610,326 $112,101 $498,225 $37,367 $460,858 $320,288 $653,920 $120,108 $533,813 $40,036 $493,777 Calculate the project’s ROI, NPV, and IRR. Learn how unethical companies can manipulate financial statements to mislead readers. The Golf Course Superintendent, who is in charge of maintaining the golf course, has advised the members that the system must be replaced within the next year because the system is beginning to fail. 10. Key Points ➤ When analyzing an investment opportunity, the key value is an asset’s present or market value. MAIs are to the valuation profession as CPAs are to the accounting profession. A key to his early success in outbidding others for these targeted hotel assets was his 1995 acquisition of Hotel Investors Trust, a troubled real estate investment trust (REIT) with a grandfathered paired-share structure. The airport market has seen a slight drop in occupancy and ADR over the past couple of years due to the struggling economy. ➤ Minimizing the need for working capital allows management to use available cash capital to expand the business and fund projects that generate cash flow. The young man seems to have done his homework and presents Bernard with a five-year pro forma showing cash flows of $128,000, $138,900, $141,250, $142,870, and $146,780 respectively. The equity investors are usually rewarded with the first cash-out, which is called a preferred return, until they reach their return-on-investment goal. A C C O U N T R E C O N C I L I AT I O N : Application Exercises 1. *** Payroll and Costs of Sales are included in expenses. Key Terms The amount of money borrowed. He even grows his own herbs in a garden behind the restaurant so he can serve the freshest food possible. He is loaning you the points. CHAPTER 3 䡲 ANALYZING FINANCIAL STATEMENTS Instead of following GAAP rules by recognizing revenues when they are earned, he records the full value of the contract as a current revenue. Preview of Chapter 1 1. Because the cost of debt is almost always lower than equity, applying financial leverage to a deal can significantly increase its ROI. What would be the MIRR of Bernard’s proposal in the preceding question? All rights reserved. Daily payroll cost report c. Rooms revenue forecast d. Food and beverage menu abstract e. Accounts receivable aging schedule 4. Occupancy percentages and ADRs are two of these key variables. If you already input the cash flows while calculating NPV, you are a step ahead. What are three key items that investors focus on when evaluating an investment package? Define modified internal rate of return, and explain how lenders and investors make investment decisions using this financial analysis tool. Equity Questions The process of raising equity is similar to the process of raising debt. When General Mills acquired the fledgling chain of three seafood restaurants two years later, he elected to stay with the restaurant. Today, NASDAQ is the largest electronic market in the United States, processing about 1.8 million transactions per day. 2. 3. If you refer to Illustration 2-4, you will see why this is its name. INSURANCE COMPANIES While many people don’t think of insurance companies as sources of financing, the money insurance companies receive as premiums must be wisely invested to generate funds to pay insurance claims. PENSION FUNDS Much like insurance companies, pension funds also need to invest the money employees contribute so that when the individuals retire, there is sufficient money to provide for their retirement. The company’s first investment was in a branded hotel that had been suffering from neglect and mismanagement. Always be alert to any objections raised. The more debt you can borrow, the less equity you will need, and the higher your return on investment (ROI) will be. While the U.S. Congress is reviewing this apparent unfairness, double taxation of corporations is still the law of the land today (see Illustration 11-3). Do not be afraid of taking a chance. Larry’s Luncheon Spot Income Statement For the Month Ended September 30, 2008 Percent Revenues: Food $412,000,000 100.0 Cost of Sales: Food $101,352,000 24.6 Gross Profit $310,648,000 75.4 $107,120,000 26.0 23,484,000 5.7 Operating (Controllable) Expenses Salaries and Wages Employee Benefits 88 CHAPTER 3 䡲 ANALYZING FINANCIAL STATEMENTS Direct Operating Expenses 76,045,230 18.5 Marketing 13,678,400 3.3 Utilities 12,318,800 3.0 Administrative and General 17,950,000 4.4 5,850,400 1.4 $256,446,830 62.2 $ 54,201,170 13.2 Repairs and Maintenance Total Operating Expenses Operating Income Other (Noncontrollable) Expenses Rent $ 22,660,000 5.5 16,502,000 4.0 Depreciation Interest 8,450,000 2.1 Total Other Expenses $ 47,612,000 11.6 Income Before Income Taxes $ 6,589,170 1.6 Less: Income Taxes $ 4,944,000 1.2 Net Income $ 1,645,170 0.4 Larry’s Luncheon Spot Balance Sheets As of Month Ended September 30, 2xx* 2007 2008 Cash $ 1,502,153 $ 1,265,105 Change $ 237,048 Accounts Receivable 2,985,000 2,895,800 89,200 Short-term Investments 3,850,000 468,500 3,381,500 Food Inventory 2,034,000 1,810,000 224,000 Prepaid Rent 1,100,000 2,850,000 (1,750,000) Total Current Assets Furniture, Fixtures, and Equipment (FF&E) $ 11,471,153 $ 9,289,405 $ 2,181,748 $ 120,300,000 $ 105,050,000 $ 15,250,000 Accumulated Depreciation (FF&E) (160,000,000) (158,600,000) (1,400,000) Buildings 190,290,000 195,890,000 (5,600,000) 495,600 637,000 (141,400) $ 151,085,600 $ 142,977,000 $ $162,556,753 $152,266,405 $10,290,348 Long-term Investments Long-term Assets Total Assets 8,108,600 ANALYSIS OF FINANCIAL STATEMENTS Accounts Payable $ Accrued Payroll Accrued Taxes Total Current Liabilities 12,500,000 $ 14,500,000 $ (2,000,000) 23,900,500 25,008,000 (1,107,500) 118,050 173,000 (54,950) $ 36,518,550 $ 39,681,000 $ (3,162,450) Long-term Debt $ 28,000,000 $ 21,000,000 $ 7,000,000 Shareholder’s Equity $ 8,771,000 $ 8,769,000 $ Retained Earnings Total Shareholder’s Equity 89,267,203 $ 98,038,203 Total Liabilities and Shareholder’s Equity $162,556,753 82,816,405 $ 91,585,405 $152,266,405 89 2,000 6,450,798 $ 6,452,798 $10,290,348 Concept Check The Crescendo The Crescendo is a full-service hotel located in a city with a population of 450,000. 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