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 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 cost $55 a day. The new lift has an economic life of 20 years.
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.
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.
What subjective factors would affect the investment decision?
What is the net income?
To calculate the before-tax and after-tax NPV of the new lift, we need to consider the cash flows over the 20-year economic life of the lift.
Before-tax NPV:
1. Calculate the additional revenue generated by the lift:
- Additional lift tickets sold per day: 300
- Number of days lift is open: 40
- Additional daily revenue: 300 * $55 = $16,500
- Additional annual revenue: $16,500 * 200 days = $3,300,000
2. Calculate the costs associated with the lift:
- Lift cost: $2,000,000
- Preparing the slope and installing the lift: $1,300,000
- Daily operating cost: $500 * 200 days = $100,000
- Total costs: $2,000,000 + $1,300,000 + $100,000 = $3,400,000
3. Calculate the before-tax annual cash flow: Additional revenue - Total costs = $3,300,000 - $3,400,000 = -$100,000
4. Calculate the before-tax NPV using the required rate of return of 14%:
- NPV = -$100,000 * (1 - (1 + 0.14)^(-20)) / 0.14 = -$100,000 * 8.792 = -$879,200
Therefore, the before-tax NPV of the new lift is -$879,200. Adding the lift would not be a profitable investment based on the before-tax analysis.
After-tax NPV:
1. Calculate the tax shield from depreciation using MACRS:
- MACRS recovery period: 10 years
- Depreciation expense per year: ($2,000,000 + $1,300,000) / 10 years = $330,000 per year
- Tax shield (using 40% tax rate): $330,000 * 0.40 = $132,000 per year
2. Calculate the after-tax annual cash flow: Additional revenue - Total costs + Tax shield = -$100,000 + $132,000 = $32,000
3. Calculate the after-tax NPV using the required rate of return of 8%:
- NPV = $32,000 * (1 - (1 + 0.08)^(-20)) / 0.08 = $32,000 * 9.818 = $314,176
Therefore, the after-tax NPV of the new lift is $314,176. Adding the lift would be a profitable investment based on the after-tax analysis.
Subjective factors that could affect the investment decision include:
1. Market demand: Is there a strong demand for additional lift capacity? Are there already long lift lines during peak periods?
2. Competition: What is the competitive landscape? Are other ski resorts in the area already offering similar capacity and experiences?
3. Weather conditions: Are there any climate-related factors that could affect skier attendance and revenue, such as unpredictable snowfall or changing weather patterns?
4. Environmental impact: Are there any environmental regulations or concerns that could hinder the implementation of the new lift?
5. Customer experience: Will the addition of the new lift enhance the overall skiing experience for customers and attract more visitors?
6. Long-term profitability: Considering the economic life of the lift, will the additional revenue generated outweigh the costs over the 20-year period?
7. Future expansion plans: Does the addition of the new lift align with Deer Valley Lodge's long-term growth and expansion strategy?