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# Capital Budgeting Analysis

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For Question 1, how did you calculate the initial investment?
How did you calculate the net cashflows - cashflows in and cashflows out?
How you do that get the PV of the net cash inflows?
After that do I take that calculation and subtract the initial investment?

For Question 2
How do I calculate the after tax cash flows, and how do I get the PV of that--3:24pm?
How do I then calculate the PV of the tax savings?
Finally how do I calculate the NPV after tax...this calculation should show the investment in the lift is more profitable on an after-tax basis than on a pretax basis?

Other
Responsibility Centers and Financial Control
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Solution
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.

The calculations are in the attached file. The before tax NPV of the new lift is \$11,565. Since the NPV is positive, adding the lift is a profitable investment.

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.

The after tax NPV comes to \$577,263. In the second year, there is a loss and it is assumed that this loss would result in lower income tax by the company as a whole. This savings in income tax has been considered as an income for the project. Since the NPV is positive, adding the lift is a profitable investment.

3.What subjective factors would affect the investment decision? The subjective factors which could affect the decision could be -
a. Quality of snow - whether it will allow the additional skiers to ski.
b. The impact on the area when there are additional 300 skiers on the slope for 40 days
c. Facilities available to accommodate the extra skiers for 40 days
Deer Valley Lodge.xls View File

#### Solution Preview

For Question 1 how did you calculate the initial investment

The initial investment is given in the question. It says that each lift will cost \$2 million and in addtion installing the lift will cost \$1.3 million. The initial investment is the cost of the equipment plus any other cost incurred in installing the equipment

How did you calculate the net cashflows - cashflows in and cashflows out

Cash flow in in the income generated by the project. It is given in the question that by installing the lift, you will get 300 additional skiers for 40 days in a year and each skier will purchase a ticket for \$55. The revenue per day would be 300 skiers each buying a \$55 ticket = 300 X 55. Over 40 days this would come to 300 X 55 X 40=660,000 ( this is row 5,6,7 in excel file).
Cash flow out is the cost of running the lift and any other expenses. It is given in the question that running the lift costs \$500 and ...

#### Solution Summary

The solution has the capital budgeting analysis for the insallation of a new lift at Deer Valley

\$2.19

## Cost of Capital, Capital Structure, and Capital Budgeting Analysis

Purpose of the project:
In this project, you are supposed to be a financial manager who determines the cost of debt, cost of preferred stock, cost of common equity, capital structure, and the weighted average cost of capital (WACC) for a Phizer (PFE). You will use the estimated WACC as the discount rate to conduct capital budgeting analysis for a hypothetical project (the information given below) that is under consideration by Phizer (PFE), and decide whether the project should be accepted.

(1) Compute Weighted Average Cost of Capital (WACC)
- Estimate the firm's before-tax and after-tax component cost of debt; (Note: If the information about the current corporate tax rate is not available, you need to estimate the tax rate based on the historical tax payments).
- Estimate the firm's component cost of preferred stock;
- Use three approaches (CAPM, DCF, bond-yield-plus-risk-premium) to estimate the component cost of common equity of the firm.
- Calculate the firm's weighted average cost of capital (WACC) using market-based capital weights.

(2) Cash Flow Estimation
- Assume that Phizer (PFE) is considering a new project. The project has 8 years life. This project requires initial investment of \$300 million to construct building and purchase equipment, and \$20 million for shipping & installation fee. The fixed assets fall in the 7-year MACRS class. The salvage value of the fixed assets is \$15 million. The number of units of the new product expected to be sold in the first year is 2,000,000 and the expected annual growth rate is 10%. The sales price is \$300 per unit and the variable cost is \$220 per unit in the first year, but they should be adjusted accordingly based on the estimated annualized inflation rate of 2.8%. The required net operating working capital (NOWC) is 12% of sales. Please use the corporate tax rate that you obtained in Step (1) for the project. The project is assumed to have the same risk as the corporation, so you should use the WACC you obtained from prior steps as the discount rate.

- Compute the depreciation basis and annual depreciation of the new project.
- Estimate annual cash flows for the 8 years.
- Draw a time line of the cash flows.

(3) Capital Budgeting Analysis
- Using the WACC you obtained from in Step (1) as the discount rate for this project, apply capital budgeting analysis techniques (NPV, IRR, MIRR, PI, Payback, Discounted Payback) to analyze the new project.
- Perform a sensitivity analysis for the effects of key variables (e.g., sales growth rate, cost of capital, unit costs, sales price) on the estimated NPV or IRR in order to demonstrate the sensitivity of the model. The Scenario analysis of several variables simultaneously is encouraged, but not required.
- Discuss whether the project should be taken and summarize your report.

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