Finance Case Study: Investment Appraisal for IHG
Question
Task: Individual Finance Case Study (1750 words) For this individual case study, you are required to select a company or an organisation of your own choice (this could be the company you have working experience with or a company that you target to work for in the future).
The recent COVID-19 pandemic has affected the businesses and economy dramatically. The Board of Directors is currently considering diversifying its business risk and plan to make some investments that would help the business sustain and grow in the long term.
Assume you were the Chief Financial Officer of the company/organisation, you were tasked to produce a report to the Board of Directors that identifies a potential investment project to help the business grow in the post COVID-19 environment. Write a professional report to the Board of Directors. In your report, you shall propose an investment project, considering the risk and return, evaluating the investment opportunity and analysing its potential impact on the company/organisation with consideration of its financial performance before you make recommendation, including the following discussions:
1. Motivation of the proposed investment
2. Conduct investment appraisal using both quantative and qualitative information
3. Critically discuss the risk and return and its potential impact on its financial performance
4. Conclusion and make recommendation
Data can be accessed via FAME for publicly traded UK Company, stock exchange, Yahoo Finance, as well as the annual report and official website. If you choose a private company, please ensure you can assess the data for your analysis. Analysis, links, examples and applications of the concepts and discussion should be made to current businesses and situations to show understanding of this module and its contents.
Answer
Introduction to Finance Case Study
The recent COVID-19 has impacted the business scenario as a whole and it is imperative that the business needs to plan strategically for growth. Investment is one of the chief scope that can help the business to grow. Intercontinental hotels group (IHG) is planning to expand the business and hence its investment will be routed for the acquisition of the Six Senses Hotels Resorts and Spas.
Intercontinental hotels group is a multinational company founded in the year 2003. The headquarters of the firm is located in Denham, Buckinghamshire, England. The company states to own about 5700 hotels in about 100 different nations. InterContinental hotel group holds a part in many other brands including Regent Hotels, Kempton Hotels & Resorts, Hualuxe, Six Senses Hotels Resorts and Spas , Six Senses Hotels, Crown Plaza, InterContinental Hotels, etc. More than 37000 people have been employed by the firm in the hotel industry, ergo creating a good opportunity for the society (IHG 2019). As per the financial reports of the organization, the business generated total revenue of $4.63 billion with the net income standing at $390 million (IHG 2019). The major objective of the firm is to provide the best experience to the customers and at the same time provide an efficient internal environment to its employees. The hotel is observed to operate in three different ways which are a franchisor, a manager, and on a lease/ownership basis
1. Motivation of the proposed investment
The company Intercontinental hotels group is planning to acquire the organization gain popularity in the financial world. The company will target the investors of the market who are withdrawing money from various sectors and choosing specific industries including E-Commerce and Hotel industries for getting maximum Investments (Klebnikov 2020). This will help the organization to get higher demand for shares in the market and procure the required funding to fulfil the financial requirement of the acquisition deal that is going to take place. However, the financial statements depict that the level of Debt is quite high and COVID -19 issues because of which it will be best recommended for the organization to issue a new or fresh share to obtain a financial source for acquisition. At present, the organization is not having sufficient funding to acquire the hotel but the budgeted intensified potential of the business after the acquisition of the hotel makes it very reasonable for the firm to have an additional debt to acquire the firm. This deal will not only improve the organization's performance but will also at the same time open the new funding source for the firm which will further help to increase the overall profitability of the organization. The initial inference from the aforesaid acquisition is that there will be higher diversity in the customer base of IHG. This will have a positive implication on the entire company and hence will lessen the risk. Another implication that can be seen is the growth in the profitability of the company. The strategy of expansion will help the company in expanding its base and hence will be able to cater to the customers and thereby enhance the profit level (Leepsa & Mishra 2013)
2. Investment Appraisal using quantitative
In the given task we have analyzed the NPV, sensitivity analysis and IRR of the International Hotel Group Plc. We have considered the following assumption while calculation NPV analysis
Discount rate of 12%
For the purpose of the study, the cash flow are £10.9; £12.5; £13.2; £14.3; £15.9 from year 1 to 5 respectively (assumed)
We have considered two scenarios for the analysis of NPV:
Scenario 1 – the total amount for the beginning investment £ 44,000
Scenario 2 - the investment at the beginning is £ 50,000
Thus the company should invest only if the NPV is positive; in case of negative NPV the investment proposal should be rejected.
Refer: Table 1: Net Present Value
Critical discussion of Sensitivity analysis
(Refer table 2)
The investment Sensitivity analysis is done considering the discount rate. if the discount rate is changed from12% to 11% followed by the investment at beginning of £ 44,000 the sensitivity is seen with 8.33% while change in rate of discount the changes in NPV will be seen by 4.54%. hence, it can be commented that the investment proposal that contains the investment figure of £ 50,000 is highly sensitive to the discount rate linked to NPV
IRR
(Refer table 3)
The IRR helps in measuring how well a project, capital expenses or investment performs over a period of time. Moreover, the figure in the IRR helps the companies to compare one investment with that of another to know whether the project is viable. If the IRR is more than average or moves ahead of the cost of capital of the company then investment should be done in the project. While selecting various investments, the investment that has the highest IRR should be chosen (Pucheta-Martiinez & Garcia-Meca 2019).
Qualitative information
As said by Zhu & Zhu (2016) various benefits will be observed by the organization after acquiring the firm. InterContinental Hotels Group will acquire Six Senses Hotels Resorts and Spas which will help to increase the revenue of the organization's business by improving the logistics department. Acquiring Six Senses Hotels Resorts and Spas will also help the organization to gain access to the intangible assets of Six Senses Hotels Resorts and Spas which will enhance the Goodwill of the firm in the market. Combining the staff of the organization and expanding the operations with Six Senses Hotels Resorts and Spas will help the organization to improve the quality of human resources at the same time. Further, an increase in the base of customers will also be noticed as Six Senses Hotels Resorts and Spas is a renowned organization in the industry that offers best-in-class services to the customers. Hence, it is a very good opportunity for the InterContinental hotel group to acquire the business of Six Senses Hotels Resorts and Spas. The acquisition will bring additional business and thereby help the business to flourish in the long run.
3. Critical discussion of risk and return
The project’s realized return might not link to the return expected. Risk can be defined as the variability in the project’s expected return. In another sense, it is the deviation degree from the return that is expected. Risk is linked to the possibility that returns that are realized will be less as compared to the returns that were expected. Hence, realization links to the expectation there will be no risk (Sherman 2015).
The main factor that supports NPV is the appraisal process when it comes to investment and the time value of the capital considered. The appraisal of investment is done to understand and compute the true investment value at the current scenario. On the other hand, the factor that is side by side is the computation of the risk rate which needs to be computed in the process of investment appraisal and hence provides the investment value that is accurate (Atril 2014).
However, computation of the risk rate is complex and difficult because there is no presence of the specific method of computation. Hence, due to this reason the study remains difficult. Hence, reliance on the risk rate is challenging and the same is risky while using in the assessment of the administration.
Similarly, for the purpose of computation of NPV, two scenarios are undertaken. In the scenario 1 the investment value is £ 44,000 while in the second it is£ 50,000. Hence, as per the risk and return concept it is advisable to invest in the project where the NPV is positive while negative NPV will lead to the rejection of the proposal.
The IRR of the investment proposal in case of scenario 1 with investment of £ 44,000 is 21% other factor remaining constant. This reflects that if the rate of discount comes below 21% then positive NPV will be seen and the proposal must be accepted considering the cost of capital ranks below 21%. It will help in bringing more wealth to the shareholder but if the cost of capital goes higher 18% the proposal will be rejected. The IRR of the investment proposal in case of scenario 2 with investment of £ 55,000 is 18% other factor remaining constant. This denotes that when the discount rate goes below 18% then NPV will be in positive zone and the proposal can be accepted if the cost of capital ranks lowers than 18%. This can help in generation of shareholder wealth but if the discount rate/cost of capital goes higher 18% it will lead to rejection of the project. However risk and return factors are even subjected to various other factors like the dividend, earnings, growth of the stock, buy backs and inflation. Alternatively the risk spectrum helps in undertaking decision. Hence, it must be understood that higher return potential will attract higher risk.
Conclusion & Recommendation
The report aims to provide insight and analysis into the investment appraisal using quantitative and qualitative information of IHG. The initial part of the report sheds light on the organization’s performance. The results reveal that the organization is failing to surpass the industry average and hence not able to post a stellar result. Moreover, an assessment of the investment project has been done that indicates the organization should accept the project when the business has the potential to undertake risks. The last part denotes the acquisition of InterContinental Hotels Groups and for the same Six Senses Hotels Resorts and Spas has been selected. The planned acquisition is sought because it has the maximum chances of increasing the revenue and providing major benefits. In the present scenario the business is failing to provide the desirable impact due to COVID-19. Hence, it is advisable that the company should acquire the business of Six Senses which will create a formidable presence and hence the sales can be boosted. As per the overall study, it can be concluded that IHG is not operating at the full potential as indicated by the situation and the investment in terms of acquisition will help the business to fetch great results. Hence, it is recommended from the quantitative and qualitative information followed by the risk analysis that the business should be selected.
References
Atril, P 2014, Financial Ratios, In: Financial Management for Decision Makers, (7th Edition). Pearson Education Limited
IHG 2019, IHG 2019 annual report & accounts, viewed 25 April 2021, https://www.ihgplc.com/-/media/ihg/annualreports/2019/pdf/ar-report-2019/ihg_2019ar.pdf?la=en&hash=9F491366E66A68491D6C545E1692F43F
Klebnikov, S 2020, These Two Companies Are Reportedly Considering A Merger To Become The Biggest Hotel Operator In The World. viewed 25 April 2021 https://www.forbes.com/sites/sergeiklebnikov/2020/08/20/these-two-companies-are-reportedly-considering-a-merger-to-become-the-biggest-hotel-operator-in-the-world/?sh=79d8012d4748
Leepsa, N. M., & Mishra, C. S 2013, ‘Do mergers & acquisitions pay off immediately? evidence from mergers & acquisitions in India’, South Asian Journal of Management, vol. 20, vol. 3, pp. 39-57.
Pucheta-Martiinez, M. & Garcia-Meca, E 2019, ‘Monitoring, corporate performance and institutional directors’, Australian Accounting Review, vol. 29, no. 1, pp. 208-219.
Sherman, E 2015, A manager's guide to financial analysis : Powerful tools for analyzing the numbers and making the best decisions for your business (6th ed) Ama Self-Study
Zhu, H., & Zhu, Q 2016, ‘Mergers and acquisitions by Chinese firms: A review and comparison with other mergers and acquisitions research in the leading journals: APJM’, Asia Pacific Journal of Management, vol.33, no. 4,pp. 1107-1149.
