Managerial Accounting-Deer Valley Lodge
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Managerial Accounting
November, 1, 2012
Investment Opportunities
Deer Valley Lodge is thinking about adding a new ski lift to their ski attraction. Before making the investment decision, they would like management to analyze the opportunity to see if it is one that will be of benefit to the firm. Before management can give them advice on whether to go ahead with the project, there are a few calculations that need to be made.
Keep in mind that total amount of the investment is the cost of one lift plus the cost of installation and preparation of the slope. So, the total investment is $2,000,000+$1,300.000, or $3,300,000. Management then needs to determine the net annual revenues and annual expenses that will be attributed to the new ski lift. In this case, the annual revenues is the price of the tickets x number of tickets x number of days, or 300x40x55=$660,000. The annual expenses are the cost of operating the ski each day x number of days of operation, or 500×200=$100,000. The new ski lift would account for $560,000 in net annual cash flows, or 660,000-100,000=560,000. The present value (PV) of the net annual cash flow at 14% at 20 years is calculated using the formula PV=net cash flow x 6.623, or $560,000x 6.623=$3,708,800. Therefore the net present value of the investment equals PV- initial investment, or $3,708,880-$3,300,00=$408,880.If the net present value is 0 or a positive number, the investor should go forward with the project; however if it results in a negative figure for the rate selected, they should not invest in the project because it does not meet the firms needs or objective (Net present value, 2012). The investment in the new ski lift will result in a positive figure; therefore, Deer Valley Lodge should be undertaken.
Next management will have to calculate the after-tax NPV of adding a new lift and advise the company on whether the investment would still add value to the company. Assuming that the income tax rate is 40%, the company will pocket 60% of their year income. Remember the net annual income attributed to the lift is $560,000. If $560,000 is multiplied by the 60% the company will keep, Deer Valley Lodge will end up with 560,000×0.60, or $336,000. The rate of return in this case will fall to 8% PV of after-tax cash flow at 8% is calculated as $336,000×9.818, or PV@8%=$3,298,848. Which mean the after-tax net income is $3,298,848. The next task is to find the NPV that of the tax savings that comes from depreciation. The money saved on taxes is the amount deducted x the tax rate. In order to find the tax savings on the ski lift investment, the initial investment amount ($3,300,000) is multiplied by the tax rate of 40%, or 3,300,000×0.40=1,320,000, which is the amount of the tax savings on the new lift. The tax savings is then multiplied by the PV factor for a discount rate of 8% over 10 years, which is 0.7059. Therefore, NPV of the tax savings from depreciation