Deer Valley: After-tax NPV, etc.
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Consider the following scenario:
Deer Valley Lodge, a ski resort in the Wasatch Mountains of Utah, has plans to eventually add five new chairlifts. Suppose that one lift costs $2 million, and preparing the slope and installing the lift costs another $1.3 million. The lift will allow 300 additional skiers on the slopes, but there are only 40 days a year when the extra capacity will be needed. (Assume that Deer Valley Lodge will sell all 300 lift tickets on those 40 days.) Running the new lift will cost $500 a day for the entire 200 days the lodge is open. Assume that the lift tickets at Deer Valley cost $55 a day. The new lift has an economic life of 20 years.
1. Assume that the before-tax required rate of return for Deer Valley is 14%. Compute the before-tax NPV of the new lift and advise the managers of Deer Valley about whether adding the lift will be a profitable investment. Show calculations to support your answer.
2. Assume that the after-tax required rate of return for Deer Valley is 8%, the income tax rate is 40%, and the MACRS recovery period is 10 years. Compute the after-tax NPV of the new lift and advise the managers of Deer Valley about whether adding the lift will be a profitable investment. Show calculations to support your answer.
3. What subjective factors would affect the investment decision?
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Solution Summary
The solution determines the after-tax NPV for Deer Valley.
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Deer Valley Lodge
Initial investment
Cost of lift $2,000,000
Installation costs $1,300,000
Total initial investment $3,300,000
Revenue
Capacity - number of skiers 300
Number of days of operation 40
Lift ticket price per person $55
Revenue $660,000
Expenses
Running costs per day $500
Number of days the lodge is open 200
Expenses $100,000
Net income / Cash flow $560,000
(Revenue - Expenses)
Before tax NPV
Before tax required rate of return 14%
Economic life in years 20
Before tax annual cash flow $560,000
Before tax NPV = Present value of future cash flows - Initial investment
$408,936
Present value of future cash flows = Annual cash flows * Present value annuity factor, 14%, 20 years
$3,708,936
Advise
As the before ...
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