I'm thinking of building a full service ski resort that would cater to lousy skiers. Your job is to help me determine whether this would be a worthwhile investment. To date, I've already spent $15 Million dollars in research and development costs. In addition, I've spent $4 Million in test marketing that suggests there is huge demand for a beginners-only ski resort. Since I don't plan on cooperating with the U.S. Forest Service, I expect the resort to be shut down after four years of operation (i.e., there are no cash flows in year 5).

In order to build a first class resort, I will need to invest $100 million in buildings and equipment. The initial investment will occur immediately (i.e., in year 0). The assets (i.e., buildings and equity pent) are expected to have a seven-year life, at which time they will be worthless. However, I expect to sell the equipment after four years for $30 million.

Assume all cash flows will occur at year-end, and the first annual cash flow will be recognized 1 year from today. I plan on marketing the ski resort to two distinct customer markets:

1. Season Passes - The season pass market will be comprised of locals who want to enjoy a leisurely day of skiing without having to worry about dodging people all day. I expect to sell my season passes at an average of $730 per pass in the first year. Research indicates that my incremental variable costs will be $600 per pass in the first year.

2. Daily Lift Tickets - This market will be comprised of seasonal visitors. This market allows higher margins because the users aren't as price sensitive. The price per unit of the daily lift ticket will be $60 in the first year, while the variable costs are estimated to be $27 per visitor in the first year.

Industry analysts expect 60,000 season passes to be purchased in the first year; this will grow at an estimated 7.50% per year thereafter. I expect to capture about 8.00% of this market each year. The same analysts expect 12 million daily lift tickets to be sold in the first year, which should increase by 12.00% per year. I should be able to capture 10.00% of this market.

The above prices for the season pass and daily lift ticket assume an allowance for other costs, such as parking, food, and other concessions. I plan on raising my prices each year at 1.00% above the inflation rate, which is forecasted to be 2.00% per year. Variable costs will also increase at 1.00% above the inflation rate.

In addition, the Resort will incur $15 million in marketing and administrative costs in the first year; this number will increase at the inflation rate in all subsequent years.

The immediate initial working capital requirement is $15 million (at the beginning of the project, i.e., year 0) to pay for inventory (t-shirts and hamburger meat). The annual requirements of working capital will be 15% of revenue from in years 1-3, and become $0 at the end of the final year of the project (i.e., year 4).

The Resort will be incorporated, so assume the corporate tax rate (and capital gain tax rate) will be 35%. The discount rate is 12% per year.

I will depreciate the buildings and equipment using the IRS MACRS schedule for seven-year property. The fixed assets will depreciate 14.29% in Year 1, 24.49% in Year 2, 17.49% in Year 3, 12.49% in Year 4, 8.93% in Years 5-7, and the remaining balance in Year 8. As described before, the initial investment for the buildings and equipment is $100 million; and I expect to sell the equipment after four years (i.e., in year 4) for $30 million.

Calculate NPV, IRR, and MIRR of the project. Should I undertake this project?

 

51 Annual Depreciation Expense: 52 53 54 Year 1 Year 2 55 56 Year 3 57 Year 4 58 Year 5 59 Year 6 60 Year 7 61 Year 8 MACRS% 14.29% 24.49% 17.49% 12.49% 62 63 Captal gain/loss 64 Capital gain/loss tax 65 After tax salvage value in year 4 66 67 68 Cash Flow Analysis 69 70 YEAR 71 72 Revenue: 73 74 75 8.93% 8.93% 8.93% 4.45% 98 99 Season Pass Sakes Revenue Daily Lift Ticket Sales Revenue Total Revenue Season Passes Lift Tickets Total Variable Costs 76 Variable Costs: 77 78 79 80 Fixed costs: Marketing & Administrative 81 82 Depreciation: 83 84 CASH FLOY FROM OPERATION (OPCF) 85 86 87 CHANGE IN VC (AWC) 88 89 INITIAL INVESTMENT 90 Working Capital Requirement 91 AFTER TAX SALVAGE VALUE 92 93 PROJECT CASH FLOV 94 95 96 97 DECISION RULES Discount rate Depreciation Remaining BV NPY IRR 100 101 102 103 104 Should I undertake this project? No 105 MIRR 0 0 2 3 4