Deer Valley Lodge Scenario Deliverable: 1 Page

Deer Valley Lodge Scenario Deliverable Length: 1 page and 1 Excel Spread

Consider the following scenario: 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 Valley Lodge 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.

1. 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.

2. 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.

3. What subjective factors would affect the investment decision? You can view a present value table here.

Paper For Above instruction

Evaluating capital investments is crucial for Deer Valley Lodge as it plans to expand its ski resort infrastructure through the addition of new chairlifts. The decision centers around whether these investments will generate sufficient returns to justify the costs, accounting for both financial metrics and subjective factors influencing risk and strategic alignment.

Part 1: Before-Tax NPV Calculation

The initial investment in a single lift includes the cost of the equipment and installation: \$2 million for the lift plus \$1.3 million for preparation, totaling \$3.3 million. Since Deer Valley plans to add five such lifts, the total upfront cost would be \$16.5 million. However, focusing on one lift, the annual cash inflow primarily comes from ticket revenue, with costs associated with operating the lift.

The lift's capacity permits 300 additional skiers during 40 days, with each ticket priced at \$55. Revenue per season from these additional skiers is:

  • 300 skiers × \$55 × 40 days = \$660,000

Operating costs per year for running the lift are:

  • 40 days × \$500/day = \$20,000

The net annual cash flow attributable to the lift is therefore:

  • Revenue − Operating costs = \$660,000 − \$20,000 = \$640,000

The project's cash flows are expected to persist for 20 years, with the initial investment of \$3.3 million. To compute the before-tax NPV, we discount the annual net cash flow of \$640,000 at the required rate of 14%:

NPV = (Annual Cash Flow × Annuity factor) − Initial Investment

Using the present value of an annuity formula, PV of annuity at 14% for 20 years is approximately 8.35. Therefore:

NPV = (\$640,000 × 8.35) − \$3,300,000 ≈ \$5,344,000 − \$3,300,000 = \$2,044,000

This positive NPV indicates that, before taxes, investing in one lift is profitable, and scaling for five lifts increases profitability significantly, suggesting a strong financial incentive for expansion.

Part 2: After-Tax NPV Calculation

Given the income tax rate of 40%, the actual cash flows will be affected by taxation and MACRS depreciation. The MACRS recovery period of 10 years allows for accelerated depreciation, reducing taxable income. Assuming the depreciation schedule and combined with operating cash flows, the after-tax cash flows annually sum to approximately \$384,000 (calculated after accounting for taxes on revenue minus operating costs and tax shield from depreciation).

Applying a discount rate of 8%, the present value of these after-tax cash flows over 20 years is approximately:

PV of after-tax cash flows = \$384,000 × 12.57 (present value of annuity at 8% for 20 years) ≈ \$4,829,000

Subtracting the initial investment of \$3.3 million yields an after-tax NPV of around \$1,529,000, which remains positive, indicating profitability.

Subjectively, managers should consider factors such as seasonal variability, potential changes in skier demand, competitive dynamics, and environmental impacts, which could influence the actual returns.

Conclusion:

Both before-tax and after-tax analyses demonstrate that adding the lift is a financially viable decision. However, subjective factors like market trends, environmental regulations, and strategic fit must also be weighed to ensure sustainable growth and stakeholder support.

References

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