Review of a hotel DCF with incomplete construction and lapsed approvals
A valuer is asked by a bank to review another firm's valuation of a 120-room resort hotel in Kalutara. The hotel is 70% complete. The report values the completed hotel at LKR 4.8 billion using a 10-year DCF, 75% occupancy from year 1, an average daily rate of LKR 18,000, an 8% discount rate, and a terminal value of 12 times year-10 EBITDA. Construction is 12 months behind schedule, the contractor has lodged claims, the environmental approval for the beachfront works has lapsed, and the operator agreement is still unsigned. The bank is considering a LKR 2.5 billion loan. The original valuer is a friend of the developer. The reviewer's firm has been offered the future annual valuation of the hotel if the loan proceeds.
1. Identify the review issues raised by the file and explain why each matters to the bank.
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Review issues. The review must test whether the report is fit for the bank's purpose. Key issues: the hotel is 70% complete and 12 months late, so the 'completed hotel' value is an 'as if complete' value, not 'as is'. The contractor's claims are a cost to complete. The lapsed environmental approval for beachfront works is a legal and permitting risk that could stop or delay opening. The unsigned operator agreement means the brand, management fee, and ramp-up assumptions are unconfirmed. The original valuer's friendship with the developer is an independence issue for the original report, not necessarily for the reviewer, but it should be noted. The reviewer's firm's offer of future work is a self-interest threat: disclose it and ensure the review is objective.
2. Test the key DCF assumptions and state the corrections or sensitivities you would require.
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Assumptions test. 75% occupancy from year 1 is aggressive for a new resort; use a ramp-up over two to three years. The average daily rate of LKR 18,000 needs evidence from comparable Kalutara resorts; if unsupported, sensitivity-test it. The 8% discount rate looks low for construction, permitting, and operator risk; test 10-12%. The terminal value at 12 times EBITDA implies a capitalisation rate of about 8.3%, close to the discount rate, but EBITDA is not NOI; use a stabilised NOI, deduct capex, and include selling costs. The 10-year DCF should include the cost to complete, delay costs, pre-opening expenses, and working capital. If the report uses a terminal value beyond the lease or without renewing the operator agreement, correct it.
3. State what the reviewer should do, including independence and reporting actions.
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Action. Produce a review report that states the scope, the documents reviewed, the basis of the original valuation, and the reviewer's conclusions. Distinguish 'as is' from 'as if complete' and quantify the cost to complete and delay. Recommend a revised value range or that a new valuation be obtained if the original is materially unreliable. Disclose the offer of future work and the original valuer's relationship; if the reviewer cannot be objective, decline. Do not simply replace the original valuer's assumptions with the bank's desired loan amount. The review should be useful to the credit committee: it should show the key sensitivities and the conditions that must be met before the loan proceeds.