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Deer Valley Lodge, a ski resort in the Wasatch Mountains of Utah, has plans to eventually add five new chair lifts. 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 in the slopes, but there are only 40 days a year when the extra capacity will be needed. (Assume that Deer park will sell at 300 lift tickets on those 40 days) Running that 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 and the added cosh expenses for each skier-day are $5. The new lift has an economic life of 20 year.
1. What if 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 adding the lift to be profitable investment.
2. What if 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 adding the lift will be profitable investment.
3. What subjective factors would afect the investment decision?
An Excel spreadsheet is very helpful for these kinds of questions. Plug in what you know. The capital cost is $3.3 million. The net increase revenue stream is 40*300*(55-5) = $0.6 million for 20 years. Discount the first year by 1.14, the second year by 1.14^2, and so on. Add discounted revenues to get the NPV of all future revenues. Compare this to $3.3 million to see if the lift is a profitable investment.
2) Taxes complicate the problem, but do not change the basic nature of the problem. Instead of a 14% discount rate, use an 8% rate. Second, convert the revenue stream to and after-tax stream. Using straight line depreciation, the Lodge would get a $0.33 deduction for the first 10 years. So year 1 after tax revenue is (1-.4)*(0.6-.33)=$.162 million. Deflate this by 1.08. Repeat for 9 more years, at which time the depreciation deduction goes away. But keep going for another 10 years.
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