Solutions Guide:   Please do not present as your own.  This is only meant as a solutions guide for you to answer the problem on your own.

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?

Solution

1. Investment = $2,000,000 + $1,300,000 = $3,300,000Annual cash inflow = 300 skiers x 40 days x $55/skier-day = $660,000Annual cash outflow

= (200 days x $500/day) = $100,000

PV of cash flows @ 14% = ($660,000 - $100,000) x 6.6231 = $3,708,953

NPV = $3,708,953 - $3,300,000 = $408,953

The new lift will create value of $408,953, so it is a profitable investment.

2. After-tax cash flows = $560,000 x .6 = $336,000

PV of after-tax cash flows @ 8% = $336,000 x 9.8181 = $3,298,897

PV of tax savings = $3,300,000 x .4 x .7059 (from Exhibit 11-7) = $936,540

NPV after-tax = $3,298,897 + $936,540 - $3,300,000 = $935,438

The investment in the lift is more profitable on an after-tax basis than on a pretax basis.

3. Subjective factors that might affect this decision include: (please reword) Profits on sales of food, rental of equipment, and other items purchased by

the additional skiers. More satisfied customers because of less crowding on the days that the

additional lift does not result in additional skiers being attracted to Deer Valley.

Additional skiers may not be as many as estimated if the weather is poor.