The cost of capital reflects the cost of financing new projects/investments for a company. Currently,...
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The cost of capital reflects the cost of financing new projects/investments for a company. Currently, the cost of capital for an average company in the hotel industry is about 6.1%. In other words, for an average company in the hotel industry about $6.10 of every $100 raised through all sources of financing goes to pay returns to bondholders, stockholders, and preferred stockholders (if there are any).
Assume that Ray Inc. has a cost of capital equal to the industry average cost of capital (6.1%) and has the following prospective projects:
Project A - Invest in distressed hotel assets from other hotel companies with an estimated rate of return of 9.8%;
Project B - Investment in a New Guest Services Rollout amid a pandemic with an estimated rate of return of 8.0%; and
Project C - Renovation of five currently owned properties in the Sun Belt with an estimated rate of return of 5.5%.
Discuss the accept/reject decision process of the Ray Inc. capital budgeting analyst in terms of both risk and return of these projects (A, B & C). Keep in mind that the estimated rate of return for each project is already reflecting (theoretically) all cash flow impact from that type of project.
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