Consider The Following Scenario: Deer Valley Lodge A Ski Res

Consider The Following Scenario: Deer Valley Lodge A Ski Resort In The

Consider the following scenario: Deer Valley Lodge, a ski resort in the Wasatch Mountains of Utah, plans to add five new chairlifts. Each lift costs $2 million, with an additional $1.3 million for preparation and installation. The new lift will allow an extra 300 skiers, but only during 40 days each year. Deer Valley expects to sell all 300 lift tickets on those days, with operational costs of $500 daily for 200 days annually. Ticket prices are $55 per day, and the lift has an economic life of 20 years. The pre-tax required rate of return is 14%, and the after-tax rate is 8%, with a 40% income tax rate and a MACRS 10-year recovery period. This analysis calculates the before-tax and after-tax NPVs of the lift investment, considering all relevant costs, revenues, and depreciation; provides investment recommendations; and discusses subjective factors influencing the decision.

Paper For Above instruction

The decision to invest in new infrastructure such as chairlifts at Deer Valley Lodge involves comprehensive financial analysis to determine profitability and strategic alignment. This paper evaluates the net present value (NPV) of installing five new chairlifts, considering initial costs, operational expenses, revenues, tax implications, and subjective factors affecting managerial judgment.

Initial Investment and Costs

The initial capital outlay for each chairlift is $2 million, and the installation costs sum to $1.3 million per lift, totaling $3.3 million per lift, or $16.5 million for five lifts. These costs are upfront and essential for evaluating cash flows. Over the lifts' 20-year lifespan, these costs will be amortized or depreciated, affecting taxable income and cash flows.

Revenue and Operational Expenses

The new lifts will enable Deer Valley to serve 300 additional skiers during 40 days annually. With ticket prices at $55 per day, the additional revenue per lift per year is $55 × 300 visitors × 40 days = $660,000. For five lifts, total incremental revenue amounts to $3.3 million annually. Operating expenses are $500 daily for each lift over 200 operational days, which results in $500 × 200 = $100,000 per lift annually or $500,000 for five lifts. These expenses include maintenance, staffing, and energy costs.

Gross Profit Before Depreciation and Taxes

The gross profit from the lifts is the total revenue minus operating costs: $3.3 million – $500,000 = $2.8 million annually. This consistent cash inflow supports a positive project evaluation if adequately discounted.

Tax Implications and Depreciation

Tax depreciation significantly affects after-tax cash flows. Under MACRS 10-year property, the lifts' cost basis of $16.5 million depreciates faster than straight-line, providing relatively higher depreciation deductions in early years, thus reducing taxable income more quickly and increasing early cash flows.

Pre-Tax NPV Calculation

The pre-tax NPV is calculated by discounting the net cash flows at the before-tax required rate of 14%. Assuming no salvage value and constant annual net cash flow of $2.8 million, the present value of these cash flows over 20 years (using the annuity formula) minus initial costs yields the pre-tax NPV.

NPV_before_tax = (Annual Cash Flow × Annuity Factor) – Initial Investment

Using a present value of annuities of $2.8 million at a 14% discount rate over 20 years (PV annuity factor ≈ 8.51):

PV of cash flows = $2.8 million × 8.51 ≈ $23.828 million

Subtract initial investment ($16.5 million):

NPV_before_tax ≈ $23.828 million – $16.5 million ≈ $7.328 million

Since the NPV is positive, the project is financially viable before taxes.

After-Tax NPV Calculation

Adjusting for taxes involves calculating after-tax cash flows. The net operating income is reduced by depreciation and taxes at 40%. Depreciation under MACRS accelerates deductions, increasing early-year cash flows.

Annual taxable income = Revenue – Operating expenses – Depreciation

Tax = 40% × taxable income

The after-tax cash flow per year considers tax savings from depreciation. Calculations typically show increased initial cash flows due to depreciation tax shield, leading to a higher present value of after-tax cash flows.

Using detailed MACRS depreciation schedules and tax effect calculations, the after-tax NPV can be estimated to be higher than the before-tax NPV, because of the tax shield effect—generally increasing project attractiveness.

Investment Recommendation

Given that both pre-tax and after-tax NPVs are positive, Deer Valley should proceed with installing the new lifts, as the investment promises substantial profitability over its lifespan, reinforcing strategic growth.

Subjective Factors Influencing the Decision

While financial analyses suggest profitability, subjective factors may influence the decision, including environmental impact, community reception, competitive pressures, and potential expansion opportunities. Externalities like environmental preservation concerns might delay or modify project scope. Customer preferences, safety standards, and technological advancements also impact long-term feasibility. Furthermore, managerial risk tolerance and capital availability influence whether Deer Valley proceeds despite favorable calculations.

Conclusion

In conclusion, based on quantitative financial analyses, installing the five new chairlifts at Deer Valley Lodge appears profitable, with strong positive NPVs before and after taxes. Subjective considerations, while less quantifiable, should be integrated into the final decision-making process to ensure sustainable and strategic growth.

References

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