I am thinking about going into the hotel business throughacquiring 12 hotels spread throughout the Rocky Mountain region. Ihave projected out the costs of hiring managers to run the hotels,as well as the other many costs of operating them. Based on this, Ihave a good handle on the cash flows the project will generate, andI now need to estimate the cost of equity I will use to discountthese cash flows.
Unfortunately, I am out of time, and so I need you, my brilliantfinancial protege, to give me an estimate of a reasonable cost ofequity for this project. Obviously, I don't have the 10 millionneeded to acquire the hotels myself and will need to attractadditional equity financing from outside investors. So when I meetwith these investors, I need a logical estimate and explanation forwhat the cost of equity is that they should be earning. So don'tjust give me a number, you have to tell me why you pick what youdo.
Obviously, they could invest in many other hotel chains andmanagement companies, many of which are publicly traded. So yourbest approach is to look at the cost of equity for these pure-plays(the ticker for Hilton is HLT, but I would rely on estimates frommore than one company so look up their competitors) and makeadjustments based on our situation. For instance, consider thefollowing differences:
Are your pure-play firms more or less risky based on geographicdispersion relative to us?
Are your pure-play firms more or less risky based on easieraccess to additional capital?
Am I or these pure-plays more likely to achieve operatingefficiency (higher profit margins) over the next four or fiveyears?
There are certainly other considerations you might come up withthat I am missing right now, so feel free to include them as well.But make adjustments to your estimates to fit my situation. Thenwrite up your conclusions in a professional sounding report that isno longer than one page. Put any additional tables in anappendix.
(The 12 hotels are not relevant. They only give you the industrythat you are researching. If you want to value a company, you haveto figure out what companies in that same industry are selling for,or what kind of discount rate investors expect for firms in thatindustry. So you have to look at other firms in the same industry.So you will look up hotel firms, and calculate their cost ofequity. And then you will make adjustments to their costs based onthe subject firm with 12 hotels. So think about this logically.Would you rather invest in Hilton, with thousands of hotels, orthis company with 12? Which is less risky? Which has more growthpotential? These are the kinds of issues you would think about whenestimating the cost of equity using the pure play approach. But no,this is not based on an actual firm, so there won't be stuff on theinternet about it. )
