Suppose one chairlift costs $2 million now you have to install the lift for $1.3 million, this lift allows 300 skiers on the slopes,for 40 days out of a year, running it costs $500 a day for the 200 days that it is open, now suppose the lift tickets cost $55 a day and cash expenses for each skier-a-day $5, with that said the chairlift has an economic life expectancy of 20 years.
1. Assume before-tac required of return for the resort is 14%, then compute the before-tax NPV of the new lift and advise the manager to accept or reject the investment.
2. Assume after-tax required return is 8%, the income tax rate is 40% and the MACRS recovery period of 10 years, now compute the after-tax NPV of the new lift again tell the manager whether to accept or reject the offer.
3. What subjective factors would affect the investment decision?
First work out how much the installed chairlift would actually cost, including taxes, licenses, permits, daily cost to run, etc.
Then work out how much you would make assuming that you can fill the seats every day during the season. Work out how much that amount would mean per day for the whole year (you have to pay the loan even in the summer.
Then decide if this is a good idea or not. Also assume average weather conditions. A heavy snow year may yield more money, a light one less.
Figure in a fudge factor to take care of the inevitable catastrophes -- breakdowns, bad weather (no snow), employee problems, war, avalanche, etc.
After that, it's a simple math problem using the right formula.
To calculate the before-tax NPV of the new lift, we need to consider the initial cost, the annual operating costs, the revenue generated, and the required return. Let's break it down step by step:
1. Calculate the total cost of installing the chairlift: $2 million + $1.3 million = $3.3 million
2. Calculate the total annual operating cost: $500/day * 200 days = $100,000
3. Calculate the total revenue generated per year:
- Number of skiers per day = 300
- Number of days the lift operates = 40
- Daily revenue from lift tickets = $55 * 300 = $16,500
- Total annual revenue = $16,500 * 40 = $660,000
4. Calculate the net cash flow per year: Revenue - Operating cost = $660,000 - $100,000 = $560,000
5. Now, let's calculate the before-tax NPV using the required return rate of 14% and the economic life expectancy of 20 years. We can use the formula:
NPV = -Initial Investment + (CF1 / (1 + r)^1) + (CF2 / (1 + r)^2) + ... + (CFn / (1 + r)^n)
CF1 = Net cash flow in Year 1 = $560,000
CF2 = Net cash flow in Year 2 = $560,000
...
CFn = Net cash flow in Year n = $560,000
NPV = -$3.3 million + ($560,000 / (1 + 0.14)^1) + ($560,000 / (1 + 0.14)^2) + ... + ($560,000 / (1 + 0.14)^20)
You can now calculate the NPV using the above formula.
If the before-tax NPV is positive, it means the investment is expected to generate more returns than the required rate of return. In that case, you advise the manager to accept the investment. Otherwise, if the NPV is negative, it indicates that the investment is not expected to generate enough returns and should be rejected.
To calculate the after-tax NPV, we need to consider the income tax rate and the MACRS recovery period. Let's proceed with step 1 to 4 (up to calculating the net cash flow per year) from above, and then follow these additional steps:
1. Determine the annual depreciation expense using the MACRS recovery period. Since the recovery period is 10 years, divide the total cost of installation by 10: $3.3 million / 10 = $330,000
2. Calculate the tax shield on depreciation:
Tax shield on depreciation = Depreciation expense * Tax rate
Tax shield on depreciation = $330,000 * 0.4 (assuming an income tax rate of 40%) = $132,000
3. Adjust the net cash flow by adding the tax shield on depreciation to it: Net cash flow + Tax shield on depreciation = $560,000 + $132,000 = $692,000
4. Now, use the same formula as before to calculate the after-tax NPV:
NPV = -$3.3 million + ($692,000 / (1 + 0.08)^1) + ($692,000 / (1 + 0.08)^2) + ... + ($692,000 / (1 + 0.08)^20)
Calculate the NPV using the above formula.
Similarly, if the after-tax NPV is positive, you advise the manager to accept the investment. If it is negative, the investment should be rejected.
Subjective factors that could affect the investment decision might include:
- Fluctuations in customer demand, including potential changes in the number of skiers or ticket prices.
- Competitor activity and market conditions.
- Potential changes in government regulations impacting the resort or ski industry.
- Environmental considerations, such as the impact on local ecosystems and wildlife.
- Feedback from customers or market research indicating potential shifts in preferences or trends.
- Current financial situation and other potential investments or projects competing for resources within the resort.