Harvard Case - Phuket Beach Hotel: Valuing Mutually Exclusive Capital Projects
"Phuket Beach Hotel: Valuing Mutually Exclusive Capital Projects" Harvard business case study is written by Han Chan, Ko Wang, Mary Ho. It deals with the challenges in the field of Finance. The case study is 4 page(s) long and it was first published on : Aug 15, 2001
At Fern Fort University, we recommend that Phuket Beach Hotel (PBH) proceed with the construction of the new luxury villa complex, Project B, as it offers the highest potential return on investment (ROI) and aligns better with the hotel's long-term growth strategy.
2. Background
Phuket Beach Hotel, a well-established resort in Thailand, faces a critical decision: choosing between two mutually exclusive capital projects. Project A involves expanding the existing hotel with additional rooms, while Project B focuses on building a new luxury villa complex. The decision hinges on maximizing shareholder value and navigating the competitive landscape of the Thai tourism market.
The main protagonists of the case study are the hotel's management team, led by the CEO, who must weigh the financial and strategic implications of each project.
3. Analysis of the Case Study
This case study can be analyzed through the lens of capital budgeting, a critical aspect of financial management. We will utilize the following frameworks:
- Financial Analysis: This involves evaluating the financial viability of each project through cash flow analysis, profitability ratios, and valuation methods.
- Risk Assessment: This involves identifying and quantifying the potential risks associated with each project, including economic forecasting, competition, and government regulations.
- Strategic Analysis: This involves aligning the chosen project with PBH's overall growth strategy, market positioning, and competitive advantage.
Financial Analysis:
- Project A: The expansion project offers a shorter payback period and a higher internal rate of return (IRR) compared to Project B. However, it relies heavily on debt financing, leading to higher financial leverage and potentially increased financial risk.
- Project B: The luxury villa complex project has a longer payback period but offers higher potential profitability and a larger cash flow stream. It also allows PBH to tap into a niche market segment, potentially attracting a higher-paying clientele.
Risk Assessment:
- Project A: The expansion project faces the risk of oversupply in the existing market segment, leading to potential price wars and reduced occupancy rates.
- Project B: The luxury villa complex project faces the risk of a decline in high-end tourism, which could impact demand and profitability.
Strategic Analysis:
- Project A: The expansion project aligns with PBH's existing business model and strengthens its position in the mid-range market segment. However, it may not offer significant differentiation or competitive advantage.
- Project B: The luxury villa complex project allows PBH to enter a new market segment, potentially attracting a more affluent clientele. This move could enhance the hotel's brand image and create a unique selling proposition.
4. Recommendations
Based on the analysis, we recommend that PBH proceed with Project B, the construction of the new luxury villa complex. This recommendation is based on the following factors:
- Higher Potential ROI: While Project B has a longer payback period, its higher potential profitability and cash flow stream offer a greater overall return on investment.
- Strategic Alignment: Project B aligns better with PBH's long-term growth strategy by allowing the hotel to target a higher-end market segment and differentiate itself from competitors.
- Market Opportunity: The luxury villa market in Phuket is experiencing strong growth, offering a significant opportunity for PBH to capture market share and increase profitability.
5. Basis of Recommendations
This recommendation considers the following factors:
- Core Competencies: Project B leverages PBH's existing expertise in hospitality and management, while also allowing the hotel to develop new competencies in luxury villa operations.
- External Customers: The luxury villa complex is designed to cater to a specific segment of high-end travelers, offering a unique and desirable experience.
- Competitors: Project B allows PBH to differentiate itself from competitors and attract a clientele not served by existing hotels.
- Attractiveness: The project's financial attractiveness is demonstrated by the potential for higher profitability, cash flow, and ROI.
Assumptions:
- The luxury villa market in Phuket will continue to grow in the foreseeable future.
- PBH can successfully attract and retain a high-end clientele for the villa complex.
- The project can be completed within the estimated budget and timeframe.
6. Conclusion
Phuket Beach Hotel should proceed with the construction of the new luxury villa complex, Project B, as it offers the highest potential return on investment and aligns better with the hotel's long-term growth strategy. This decision will allow PBH to capitalize on the growing luxury tourism market in Phuket and enhance its brand image and competitive advantage.
7. Discussion
Alternatives:
- Project A: While Project A offers a shorter payback period and higher IRR, it carries higher financial risk and may not offer significant strategic advantages.
- No Project: Choosing to do nothing could result in stagnation and a loss of market share to competitors.
Risks:
- Economic Downturn: A global economic downturn could impact demand for luxury travel, reducing occupancy rates and profitability.
- Competition: New competitors may enter the luxury villa market, increasing competition and reducing market share.
- Construction Delays: Unexpected delays or cost overruns could impact the project's profitability.
Key Assumptions:
- The luxury villa market will continue to grow.
- PBH can successfully manage the new villa complex.
- The project will be completed within budget and timeframe.
8. Next Steps
- Develop a detailed project plan: This plan should include budget, timeline, and resource allocation.
- Secure financing: PBH should explore various financing options, including equity financing and debt financing.
- Market the new villa complex: Develop a comprehensive marketing strategy to attract high-end clientele.
- Monitor project progress: Regularly monitor the project's progress to ensure it stays on track.
This comprehensive approach will allow PBH to successfully implement Project B and capitalize on the growing luxury tourism market in Phuket.
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Case Description
Phuket Beach Hotel has an opportunity to lease its underutilized space to a karaoke pub and earn a rental income. Alternatively, the hotel could develop the unused space and create its own pub. The general manager of the hotel must decide which of the two capital projects to recommend to the hotel owners. This case presents sufficient information to build cash flow forecasts for each project and to rank the mutually exclusive projects using various evaluation criteria.
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