Break Even Analysis
WENDY STEDMAN, UNIT 5
MANAGERIAL ACCOUNTING
CVP/BREAK EVEN ANALYSIS
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?
1. Investment = $2,000,000 + $1,300,000 = $3,300,000
Annual cash inflow = 300 skiers x 40 days x $55/skier-day = $660,000
Annual cash outflow = (200 days x $500/day) = $100,000
PV of cash flows @ 14% = ($660,000 - $100,000) x 6.6231
= $3,708,936
NPV = $3,708,936 - $3,300,000 = $408,936
The additional new lift will create value of $408,936, annual return over the Economic Life of 20 years of the initial investment, so it is a profitable investment. Since, the lift is brand new, in the first few years the effective age of the lift will remain at zero, but as the lift ages and deteriorates, an age/life ratio would have to
MANAGERIAL ACCOUNTING
CVP/BREAK EVEN ANALYSIS
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?
1. Investment = $2,000,000 + $1,300,000 = $3,300,000
Annual cash inflow = 300 skiers x 40 days x $55/skier-day = $660,000
Annual cash outflow = (200 days x $500/day) = $100,000
PV of cash flows @ 14% = ($660,000 - $100,000) x 6.6231
= $3,708,936
NPV = $3,708,936 - $3,300,000 = $408,936
The additional new lift will create value of $408,936, annual return over the Economic Life of 20 years of the initial investment, so it is a profitable investment. Since, the lift is brand new, in the first few years the effective age of the lift will remain at zero, but as the lift ages and deteriorates, an age/life ratio would have to