NPV Method: Capital Budgeting and Investment Decisions
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Deer Valley Lodge, a ski resort in the Wasatch Mountains of Utah, has plans to eventually add 5 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 park 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 costs $55 a day and the added cash expenses for each skier-day are $5. 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 net present value 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 modified accelerated cost recovery system (MACRS) recovery period is 10 years. Compute the after tax net present value 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.
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Solution Summary
This posting demonstrates how to set up a capital investment decision problem. After taking into account all the relevant incremental costs and revenues, the incremental cash flows from the investment decision are calculated and finally the NPV (both pre tax and Post tax) is worked out. The final decision based on the NPV is suggested. An Excel attachment is also provided as part of the solution.
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Cost of new Equipment 2 million
Installation 1.3 million
Noumber of units purchased 5
Numbers of customers served 300
Numbers of days served 40
Cost to run extra equipment 500 per day
no of days operations is run 200
Customer ticket 55 per day per customer
variable operation expenses 5 per day per customer
Economic life ...
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