Hospitality Financial Management Ch.4 Feasibility Study

CHAPTER 4: FEASIBILITY STUDY
Feasibility study is an analysis of the attractiveness of the location and the financial situation of
a property development. It is carried out to assess whether a business can be opened at a new
location or to be expanded in the existing location. A feasibility study may reduce the risk of a
particular investment but not eliminate the risk.
4.1 Feasibility Study Format

4.1.1 Front Matter
Introduction to the business, types of business, organization information, and the reason
of the feasibility study being carried out
4.1.2 General Market Characteristics

Population growth, industrial growth, disposable incomes, attractions, facilities,
accessibility of the location, employment and economic trends, housing areas, special
factors for example location near to beach or public university
4.1.3 Site Evaluation

Detailed maps of the location, business activities surrounding, possible future expansion,
financial value of the chosen site, ability of the future expansion
4.1.4 Supply and Demand Information

For a property development, factors that need to be considered are the ability of demand
to exceed supply (dd > ss), demand in the new market that is not served with the
existing supply, and the supply is inferior/superior in quality that lead to the needs of
demand for the new supply.
4.2 Basic information of the supply and demand information:

• Occupancy trends in the local area for the past 5 years
• A list of hotels currently serving the local market
• Competitive information (Occupancy rates, F&B facilities, composition of market for
rooms and F&B)
• The principle sources of demand (travelling business person, the convention
delegate, vacationer)
4.3 Supply and Demand Analysis

Step 1: Calculate the most recent 12-month Average Occupancy of the most competitive
hotels
Step 2: Calculate the composite growth rate of demand from the various sources
Step 3: Calculate future room demand year by year
Step 4: Calculate the future supply of rooms required
Example:
There are five competitive hotels in a resort area with the following number of rooms and current
occupancy rates:
Hotel Rooms Occupancy
A 74 82%
B 45 73%
C 58 85%
D 48 70%
E 52 75%
Demand for rooms in the area is broken down into the following sources and growth rates:
Source Percentage Growth rate
Business traveler 10% 5%
Vacation traveler 80% 8%
Other travelers 10% 1%
You are required to calculate the following:

a) Calculate the current average occupancy of the six hotels
b) Calculate the composite rate of growth in demand
c) Apply the composite growth rate to the demand figures to obtain projected demand for
each of the next four years
d) Assume that 70% average room occupancy for the hotels is profitable. Calculate the
future supply of rooms that could be supported for each of the next four years.
e) If hotel E is due to be demolished at the end of year 2 to make way for development of a
new shopping complex, calculate the future supply of rooms that could be supported for
each of the next four years by using average occupancy in (a).
Solution:
a. Determination of rooms demand:
Rooms Occupancy = Rooms
Motel Available × % Demand
A 74 × 82% = 61
B 45 × 73% = 33
C 58 × 85% = 49
D 48 × 70% = 34
E 52 × 75% = 39
Totals 277 216
Total rooms available in 5 hotels: 277

Composite occupancy: (216 / 277) = 78%
b. Composite growth rate:

Sources of Sources of Growth Composite
Demand Demand % Rate % Percentage
Business travel 10% × 5% = 0.005
Vacation travel 80% × 8% = 0.064
Other travel 10% × 1% = 0.001
Total composite growth rate percentage 7%
c. Composite growth rate and projected demand for the next 4 years:
Rooms Composite Future
Year Deman Growth % Demand
d
0 216
1 216 × 107% = 231
2 231 × 107% = 247
3 247 × 107% = 264
4 264 × 107% = 282
d. Assume a 70% occupancy and calculate the rooms that could be supplied for the next 4
years:
Rooms Occupancy Supply Current New Rooms

Year Demand @ 70% Require Supply Required
d
Current 216 / 70% = 309 − 277 = 32
1 231 / 70% = 330 − 277 = 53
2 247 / 70% = 353 − 277 = 76
3 264 / 70% = 377 − 277 = 100
4 282 / 70% = 403 − 277 = 126
Comment:
A project to develop a hotel in this area is feasible because there are rooms required in year 4
of 126 rooms. If the construction starts now, a 126-room hotel can be operated in year 4 to cater
the demand in this area.
e. Assume a 78% occupancy and Hotel E is due to be demolished in year 2 calculate the
rooms that could be supplied for the next 4 years:
Rooms Occupancy Supply Current New Rooms

Year Demand @ 78% Require Supply Required
d
Current 216 / 78% = 277 − 277 = 0
1 231 / 78% = 296 − 277 = 19
2 247 / 78% = 317 − 277 = 40
3 264 / 78% = 338 − 225 = 113
4 282 / 78% = 362 − 225 = 137
Comment:
As compared to answer in (d), a project to develop a hotel in this area is still feasible because
there are rooms required in year 4 of 137 rooms. Furthermore, there is one hotel will cease
operation at the end of year 2. If the construction starts now, a 137-room hotel can be operated
in year 4 to cater the demand in this area.
PAST SEMESTER QUESTIONS
QUESTION 1
Quiz 2 APR 2009

Six competitive hotels have the following number of rooms and current occupancy percentage

1 200 80%
2 220 90%
3 80 70%
4 130 80%
5 90 75%
6 150 75%
Demand for rooms in the area where the hotels are located I broken down into the following
sources and growth rates:


d) Assume the average room occupancy is 70% for the hotels in this area and is
considered profitable. Assume also that hotel 3 is due to be demolished in Year 2 to
make way for a new highway. Calculate the future supply of rooms that could be
supported for each of the next four years.
QUESTION 2
Test 2 OCT 2008


Armada 200 80%
Plaza 220 90%
Crowne 80 70%
Malaya 130 80%
Murahan 90 75%
Kelas 150 75%


d) Assume that a 100-room Grand Hotel will be opening at the end of year 2. By using the
average room occupancy that you have calculated in (a), calculate the future supply of
rooms that could be supported for each of the next four years.
e) Advice the future entrepreneur that would like to venture in the hotel industry in this
particular area with the answer from (d). What if to get the profit, the average occupancy
is 75%. How do you change your advice to the future entrepreneur about opening a
hotel in this site?
QUESTION 3
Test 2 APR 2009


Mahal 300 80%
Murah 140 90%
Bajet 80 70%
Diskaun 140 80%
Kelas 100 75%
Darjah 120 75%


d) Assume that Darjah Hotel will be closed at the end of year 2. By using the average room
occupancy that you have calculated in (a), calculate the future supply of rooms that
could be supported for each of the next four years.
e) Advice the future entrepreneur that would like to venture in the hotel industry in this
particular area with the answer from (d). What if to get the profit, the average occupancy
is 75%. How do you change your advice to the future entrepreneur for opening a hotel in
this site.
QUESTION 4
Final Exam Apr 2007


1 150 80%
2 140 90%
3 90 70%
4 110 80%
5 66 75%
6 120 75%


QUESTION 5
Final Exam OCT 2008

There are five hotels in Pangkor Island with the following number of rooms and current
occupancy percentage:

1 74 82%
2 45 73%
3 58 85%
4 48 70%
5 52 75%

a) Calculate the current average occupancy of the five hotels
considered profitable. Calculate the future supply of rooms that could be supported for
each of the next four years.
QUESTION 6
Final Exam APR 2009


1 200 80%
2 180 90%
3 70 70%
4 130 80%
5 90 70%
6 140 75%

a) Calculate the current average occupancy of the six hotels.

b) Calculate the composite rate of growth in demand.
QUESTION 7
Final Exam Okt 2009

There are five hotels in Stopping Island with the following number of rooms and current
occupancy percentage :-
1 230 84%
2 180 76%
3 190 90%
4 160 72%
5 240 78%
Demand for rooms in the area is broken down into the following sources and growth rates :-
a) Calculate the current average occupancy of the five hotels,
b) Calculate the composite rate of growth in demand,
each of the next four (4) years,
d) Assume the average room occupancy that considered profitable is 75%. Calculate the
future supply of rooms to support this occupancy.
QUESTION 8
Final Exam April 2008

1 150 80%
2 140 90%
3 90 70%
4 110 80%
5 66 75%
6 120 75%


QUESTION 9
Final Exam April 2010

Six competitive hotels have the following number of rooms and current occupancy percentage.

1 300 30%
2 220 40%
3 90 80%
4 150 60%
5 130 65%
6 180 55%
Demand for rooms in the area is broken down into the following sources and growth rates :

a) Calculate current average occupancy of the six hotels.

QUESTION 10
Final Exam Okt 2010


Hot 400 70%
Cold 300 60%
Ice 200 50%
Fire 150 40%
Warm 180 65%
Water 250 45%

Convention delegates 50% 12%
Vacation travelers 20% 6%
a) Calculate current average occupancy of the six hotels.

c) Apply the composite growth rate to the demand figures to obtain projected demand
for each of the next five years.
d) Assume there will be a 250-room hotel opening in year 2, calculate the future supply of
rooms that could be supported for each of the next five years using the current average
occupancy rate.
4.4 Long-term Financing Method
A business needs to acquire long-term financing to:

i) Funding new project
ii) Expanding the existing business
iii) Buying new machines
iv) Launching new product ( R&D and Marketing)
In hotel, usually the amount needed for long-term financing is quite large. The organization must
decide what kind of financing they want to take up. It is either:
a. Debt Financing – Loan or bond
b. Equity Financing – issuing shares
Sometimes, the company uses the combination of debt financing and equity financing. To ease
understanding, the following calculation can be applied to facilitate the decision:
Debt Financing Equity Financing

Amount required 500,000 500,000
Payback Interest @ 10% Dividend @ 10%
Assume operating margin RM 100,000 RM 100,000

(EBIT) is
RM 100,000
Less: Interest 10% @ 500,000 Nil
EBT 50,000 100,000
Assume Tax @ 30% 15,000 30,000
EAT 35,000 70,000
Less: Dividend Nil 10% @ 70,000
Income Net Income = RM 35,000 Retained Earnings = RM
63,000
Note that if the equity financing is 100% then the retained earnings will be carried forward to the
next fiscal year.
For the above technique, we can calculate the value of return. Here from the perspective of
owner, the value of return can be calculated by using Return on Investment Ratio.
4.4.1 Return on Investment

Return on investment is the value of returns for every amount invested by the owner. The
formula is:
Return on Investment = Net Income or Retained
Earnings
Capital or Initial Investment
4.4.1 Return on Equity

Return on equity is the value of returns/dividends received for every amount invested by the
investors/stockholders. The formula is:
Return on Equity = Dividend

Investment
For example:
Ronaldo Café plans to develop the land in its present location. It plans to develop a 2-storey
building in the proposed new business area. The plan is estimated to cost RM 500,000. The
company has three alternatives which are:
i) Acquire long-term loan with 20% interest.
ii) Acquire RM200,000 long-term loan with 20% interest, and issue RM 300,000 new
preferred shares with 35% dividend payout ratio.
iii) Acquire RM 250,000 long-term loan with 20% interest, and RM 250,000 new shares with
35% dividend payout ratio.
If the operating income is expected at RM 200,000 and tax deductible at 34%, calculate the net
income for the three alternatives and decide which one of the available methods should be
chosen. From investor’s perspective, which alternative should be chosen?
Alternative 1 Alternative 2 Alternative 3

Earnings Before Interest 200,000 200,000 200,000
and Tax
Less: Interest (20%) (20% x 500,000) (20% x 200,000) (20% x 250,000)
(100,000) (40,000) (50,000)
Earnings Before Tax 100,000 160,000 150,000
Less: Tax (34%) (34,000) (54,400) (51,000)
Earnings After Tax 66,000 105,600 99,000
Dividend (35%) Nil (35% x 105,600) (35% x 99,000)
(36,960) (34,650)
Net Income/Retained 66,000 68,640 64,350
Earnings
Return on Income (ROI) (66,000/500,000) (68,640/200,000) (64,350/250,000)
= 13.2% = 34.3% = 25.7%
HIGHEST ROI
Return on Equity (ROE) NO ROE because (39,690/300,000) (34,650/250,000)
NO EQUITY = 13.2% = 13.9%
HIGHEST ROE
Therefore the company must decide which alternative is suitable before it proceeds with the
business operation. From the above example, from the owner’s perspective, Alternative 2 is
more attractive, however from the investor’s perspective, Alternative 3 looks more attractive.
EXERCISES
Question 1
Zoela Resort plans to acquire new land for business expansion. The additional fund needed for
the acquisition of new land is RM 2,500,000. The company has two alternatives which are either
by taking a long-term loan with 20% interest or fund raised by issuing preferred stock. The
dividend will be paid at 40% of profit after tax.
The earnings before interest and tax is expected at RM 1,400,000. The business tax is set at
30%. Calculate the net income for both of the long-term financing alternatives and decide which
method of long-term financing the company should choose.
Question 2
Darul Khusus Cruise has an immediate plan to raise fund for purchasing a new ship that will
cost the company RM 20,000,000. To realize the funding, the company has two alternatives
which are:
Alternative 1: Acquiring long-term loan at 5% interest
Alternative 2: Acquiring 20% long-term loan with 9% interest, and issuing
80% common stock with 60% dividend paid based on earning
after tax
The earnings before interest and tax are expected at RM 2,500,000. The business tax is set at
32%.
Question 3
Nubhan would like to open a star rating hotel in his hometown at Senaling. He needs to raise
capital to fund for the project. He has two options which are:
Loan from Bank Islam Equity Financing

Project 3-star Hotel 4-star Hotel
Initial investment RM 2.5 million RM 4.7 million
Sales volume 45,000 units 27,800 units
Selling price per unit RM 185 RM 340
Variable cost 20% of sales 19% of sales
Fixed Cost RM 150,000 RM 180,000
Commitment 12% interest per annum 25% dividend payout
Business Tax is set at 20% per annum. Calculate the net income for both of the financing
method and decide which method should the company choose?
Question 4
Menara Laksamana Tuah plans to develop the land in its present location. It plans to develop a
2-storey building in the proposed new business area. The plan is estimated to cost RM 300,000.
The company has three alternatives which are:
i) Acquire long-term loan with 15% interest.
ii) Acquire RM100,000 long-term loan with 15% interest, and issue RM 200,000 new
preferred shares with 35% dividend payout ratio.
iii) Acquire RM 150,000 long-term loan with 15% interest, and RM 150,000 new shares with
35% dividend payout ratio.
chosen from the company’s perspective
Question 5
Stacy would like to venture in lodging business. She needs to raise capital to fund for the
project. She has the following options which are:
Loan from Bank Equity Financing 50% Loan from Bank
Mualamat Mualamat
50% Equity Financing
Project 2-star Hotel 3-star Hotel Chalet
Initial investment RM 3.3 million RM 5.2 million RM 6.6 million
Sales volume 55,000 units 31,500 units 27,400
Selling price per RM 130 RM 340 RM 420
unit 15% of sales 20% of sales 25% of sales
Variable cost RM 300,000 RM 500,000 700,000
Fixed Cost 15% interest per annum 45% dividend payout 15% interest per annum
Commitment 45% dividend payout
Business Tax is set at 30% per annum. Calculate the net income for all the financing method
and decide which method should the company choose? If you are the potential investors, which
alternative should you choose?
Question 6
Upin Berhad would like to open a new hotel in Sungai Buloh. The company has two alternatives
which are:
40% Loan from Bank and 60% Loan from Bank and
60% Equity financing 40% Equity financing
Project Boutique Hotel Chalet

Initial investment RM 5.5 million RM 8.7 million
Sales volume 45,000 units 37,500 units
Selling price per unit RM130 RM220
Variable cost 40% of average selling price 35% of average selling price
Fixed Cost RM 1.2 million RM 1,800,000
Commitment 12% interest per annum 12% interest per annum
30% dividend payout 40% dividend payout
Business Tax is set at 20% per annum. Calculate the net income for each of the two alternative
and decide which alternative should the company choose?
Question 7
Gula Perak Bhd plans to develop the land in one of its present property location. It plans to
develop a 10-floor building for hotel operation. The plan is estimated to cost RM 10 million.
The company has three alternatives which are :
a. Acquire long-term loan with 12% interest.
b. Acquire RM2 million long-term loan with 12% interest, and issue RM8 million new
shares with 35% dividend payout ratio.
c. Acquire RM5 million long-term loan with 15% interest, and RM5 million new
If the operating income is expected at RM3 million and tax deductible at 34%, calculate the net
chosen from the company's perspective.
Question 8
Pilah Jaya Resort has an immediate plan to raise fund for its development of new resort in Ulu
Bendul. The additional fund needed is RM 1,000,000. The company has two options which are
either by taking a long-term loan with 15% interest or fund raised by issuing preferred stock. The
dividend will be paid at 50% of profit after tax. The earning before interest and tax is expected at
RM 250,000. The business tax is set at 34%. Calculate the net income for both of the long-term
financing alternatives and decide which method of long-term financing the company should
choose.
Question 9
Menara Laksamana Tuah plans to develop the land in its present location. It plans to develop a
2-storey building in the proposed new business area. The plan is estimated to cost RM 300,000.
The company has three (3) alternatives which are :-
a. Acquire long-term loan with 15% interest,
b. Acquire RM100,000 long-term loan with 15% interest, and issue RM 200,000
new preferred shares with 35% dividend payout ratio,
c. Acquire RM 150,000 long-term loan with 15% interest, and RM 150,000 new
income for the three alternatives and decide which alternative should be chosen from the
company's perspective.

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CHAPTER 4: FEASIBILITY STUDY

4.1 Feasibility Study Format

4.1.2 General Market Characteristics

4.1.3 Site Evaluation

4.1.4 Supply and Demand Information

4.2 Basic information of the supply and demand information:

4.3 Supply and Demand Analysis

You are required to calculate the following:

Total rooms available in 5 hotels: 277

b. Composite growth rate:

Rooms Occupancy Supply Current New Rooms

Rooms Occupancy Supply Current New Rooms

Quiz 2 APR 2009

Hotel Rooms Occupancy

Source Percentage Growth rate

a) Calculate the current average occupancy of the six hotels

Test 2 OCT 2008

Hotel Rooms Occupancy

Source Percentage Growth rate

a) Calculate the current average occupancy of the six hotels

Test 2 APR 2009

Hotel Rooms Occupancy

Source Percentage Growth rate

a) Calculate the current average occupancy of the six hotels

Final Exam Apr 2007

Hotel Rooms Occupancy

Source Percentage Growth rate

a) Calculate the current average occupancy of the six hotels

Final Exam OCT 2008

Hotel Rooms Occupancy

Source Percentage Growth rate

Final Exam APR 2009

Hotel Rooms Occupancy

Source Percentage Growth rate

a) Calculate the current average occupancy of the six hotels.

Final Exam Okt 2009

Hotel Rooms Occupancy

Source Percentage Growth rate

a) Calculate the current average occupancy of the six hotels

Final Exam April 2010

Hotel Rooms Occupancy

Source Percentage Growth rate

a) Calculate current average occupancy of the six hotels.

Final Exam Okt 2010

Hotel Rooms Occupancy

Source Percentage Growth rate

a) Calculate current average occupancy of the six hotels.

A business needs to acquire long-term financing to:

Debt Financing Equity Financing

Assume operating margin RM 100,000 RM 100,000

4.4.1 Return on Investment

4.4.1 Return on Equity

Return on Equity = Dividend

Alternative 1 Alternative 2 Alternative 3

Loan from Bank Islam Equity Financing

Project Boutique Hotel Chalet

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