Hilton Hotels is very interested in developing a new hotel in Zambia. The company estimates that the hotel would need an initial investment of $20 million. Hilton Hotel expects the hotel will generate positive cash flows of $3 million a year at the end of each of the next 20 years. The project's cost of capital is 13%. a. What is the project's net present value?
b. Hilton expects the cash flows to be $3 million a year, but it recognizes that that cash flows could actually be much higher or lower, depending on whether the government imposes a large hotel tax. One year from now, Hilton will know whether the tax is imposed. There is a 50% chance that the tax will be imposed, in which case the yearly cash flows will only be $2.2 million. At the same time, there is a 50% chance that the tax will not be imposed, in which case the yearly cash flows will be $3.8 million. Hilton is deciding whether to proceed with the hotel today or to wait for one year to find out if the tax will be imposed. If Hilton waits for one year, the initial investment will remain at $20 million. Assume that all the cash flows are discounted at 13%. Use decision-tree analysis to determine whether Hilton Hotel should proceed with the project today or wait a year before deciding.