Refer to the Frost Valley Expansion Data Set. Assume that the expansion has zero residual value.
Forest Valley Expansion Data Set
Assume that Frost Valley's managers developed the following estimates concerning a planned expansion to its Waterfall Park Lodge (all numbers assumed):
Number of additional skiers per day ..................................................................... 100
Average number of days per year that weather conditions allow
skiing at Flint Valley ............................................................................................. 150
Useful life of expansion (in years) ............................................................................ 8
Average cash spent by each skier per day ......................................................... $ 250
Average variable cost of serving each skier per day ......................................... $ 150
Cost of expansion ..................................................................................... $6,000,000
Discount rate ........................................................................................................ 12%
Assume that Frost Valley uses the straight-line depreciation method and expects the lodge expansion to have a residual value of $600,000 at the end of its eight-year life.
Requirements
1. Will the payback period change? Explain and recalculate if necessary.
2. Will the project's ARR change? Explain and recalculate if necessary.
3. Assume that Frost Valley screens its potential capital investments using the following decision criteria: Maximum payback period = 5 years and minimum accounting rate of return = 10%.
Will Frost Valley consider this project further or reject it?