CASE STUDY – G Plc

ABRO
Plc
owns the ‘Seasons Hotel’, a four star establishment located in the Wicklow
mountains. The owners of the hotel have recently spent €30,000 on market
research into the potential for improving the hotel’s image, customer base and
profitability.

The market research concluded that if the hotel could
achieve five star status, then the occupancy rate would increase from 60% to 70%
for each of the 350 nights that the hotel opens for per year. To achieve five
star status the hotel would have to add a leisure complex to its customer
offering. The estimated cost of this project is €13,000,000.

The average casual spend per room (food and beverage) is
currently €75 per occupied room at a contribution margin of 50%. This is
expected to increase by €30 per occupied room if five star status is achieved.
This is in part due to increased prices which improve the contribution margin
to 60%.

The Seasons Hotel has 150 bedrooms which are charged at
an average nightly rate of €150. Given the difficult trading conditions this
average rate is not expected to change for the next three years, at least. If
five star status is achieved the average room rate per night would increase by
€75 per night in the first year and settle at an average nightly rate of €300
per room for the next two years.

As a result of the hotel upgrade it is expected that the
annual local council rates will increase from €90,000 per annum to €150,000 in
the first year, increasing by €15,000 per annum thereafter. The pool will cost
€15,000 to heat each month. The Seasons Hotel has agreed that this cost will
remain fixed for three years.

The business plan for the new leisure facility forecasts
a profile of four different users of the facility, namely:

•Hotel
guests who avail of the leisure facility at no charge.

•Casual
guests – paying €15 per visit.

•Family
memberships – paying €1,500 per family per year.

•Single
memberships – paying €750 per year.

The above are year one prices. Family memberships will be
increased by €150 per year commencing in year three. Single memberships will
remain at €750 for the next four years whilst the casual charge will increase
by €1.50 per guest per year commencing in year 2.

The indicative charges and trading volumes of each type
of customer has been advised by the market research company. A summary of its
volume projections read as follows:

SEASONS HOTEL – GUEST
PROJECTIONS:

The
leisure facility will incur the following annual salary costs in its first year:

•General
Manager – €75,000

•Cleaner
– €30,000

•Life
Guards – €30,000 each. Three lifeguards will be employed to provide the
necessary level of service.

•All
salaries will be uplifted for inflation at 3% commencing in year three of the
proposal.

Other
relevant information:

•For
the purpose of financing the proposal the company intends to raise irredeemable
debt finance of €13,000,000 at a rate of 11%, which attracts tax relief at
12.5%.

•The
most recent dividend declared was €0.50 per ordinary share. This dividend will
be paid on 20 September 2013. You have calculated that the average compound
rate of growth in dividends over the last five years has been 5%. This growth
rate is expected to continue.

•ABRO
Plc’s ordinary shares presently trade at €5.50 cum div.

•ABRO
Plc’s preference dividends are trading at €0.75 ex dividend.

•ABRO
Plc’s 2014 redeemable debentures are presently valued at 98% of their par
value. All interest due on debentures to 31 March 2013 has been paid in full.

•Short-term
borrowings consist of a permanent bank overdraft facility.

•Investments
in hotel buildings attract 4% capital allowances on a straight-line basis and
the prevailing corporation tax rate is 12.5%.

Investment
criteria:

ABRO Plc expects all capital investments to achieve a
positive Net Present Value after three years with a discounted payback period
of 2.5 years, when discounted at the firms weighted average cost of capital.

Extracts
from the most recent audited accounts of ABRO Plc are as follows:

ABRO PLC

Statement of Financial Position as at 31 March
2013

Assets

Non Current Assets €Ms
€Ms

Land and Buildings 790

Fixtures and Fittings 40 830

Current Assets

Inventories 60

Trade Receivables 90

Cash and Cash Equivalents 125 275

____

Total Assets 1,105

Equity and Liabilities

€2 ordinary shares 250

€1 preference shares at 10% 100

Accumulated Profits 100 450

Non Current Liabilities

10% Debentures Redeemable 2014 250

Current Liabilities

Trade Payables 200

Accruals/Other 80

Short Term Borrowings @ 8% 125 405

____

Total Equity and Liabilities 1,105

CASE STUDY – ABRO Plc

REQUIREMENTS:

Prepare a briefing paper for the board
of management of ABRO Plc that:

(a)
Advises on the acceptability of the proposed
investment in the leisure facility. Your evaluation should consider both financial
and non-financial issues and any assumptions made should be clearly stated.

(40
Marks)

(b)
Critically evaluates the investment criteria
used to assess the investment proposal.

(15
Marks)

(c)
Discusses, with supporting calculations, how
risk assessment could be incorporated into the investment analysis of the
proposed leisure facility.

(25
Marks)

(d)
Critically discusses whether companies, by
integrating a sensible level of gearing into their capital structure, can
minimise their weighted average cost of capital.

(10
Marks)

Layout
and writing quality (10
Marks)