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    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 Preview

    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 ...

    Solution Summary

    The solution determines the after-tax NPV for Deer Valley.

    $2.19

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