This work is about investment analysis. Investment analysis helps an organization’s management in making informed decisions on the activities that add value to the company. Such analysis also show the amount of capital required for any investment, risks, and the cumulative cash flow. This work presents Net Present Value as a method of assessing capital investment options in a business. It involves the before-tax calculations of the Net Present Value and the after-tax calculations of the same. Finally, the management of the given organization -- in this case, the Deer Valley Lodge – is advised on the profitability of the investment.
Preparations and installation cost of 1 lift = $ 1.3M
Total capital investment in one lift = (2 + 1.3) =$ 3.3M
Number of customers served by 1 lift = 300
Number of Days served per year = 40
The cost of running one lift per day =$ 500
Number of days the operations is run per year = 200
Fixed Operational expenses per lift per year = (500 X 200) = $ 0.1M
Income per customer per day = $ 55
Income per year from every lift = (300 X 40 X 55) = $ 0.66M
Operational Profits per lift per year = (0.66 – 0.1) = $ 0.56M
Economic life of each lift = 20 yrs
Pre-Tax Discount Rate = 14%
Post tax Discount Rate = 8%
Tax Rate = 40%
Number of lifts purchased = 5
MACRS recovery period = 10 yrs
The required calculations are in the spreadsheet.
NPV (Net Present Value) measures whether a given investment is profitable or not. It involves the discounting of the net cash flows in a given investment and then subtracting investment outlay. If NPV is positive, then implementing or adopting the given project would be beneficial to the company. The organization’s management should only consider the projects whose Net Present Values is positive. If the given project has a Net Present Value of less than zero, then the organization’s value falls. Such projects should never be considered. However, if the project’s Net Present Value is greater than zero, then the organization’s value increases.
In the above project, the capital investment per lift is given as $3.3 million and the pre-tax Net Present Value is found to be $6.033 million. This investment is worth. The Deer Valley Lodge managers should go ahead and add the five new chairlifts. The post-tax NPV is found to be $4.144 which is also positive. Again, the investment is worth and should be considered.
Subjective factors that affect the investment decision
Investment decisions involve a lot of issues. The capital investment is, in its initial stage, guided by the organization’s competitive strategies. Capital is limited in any organization. Capital must therefore be used in its best way to give it the best advantage. Such decision is arrived at after a thorough assessment of the investment projects, which is normally done at two levels: the feasibility, and the economic profitability. Feasibility is the ability of the given project to produce/generate cash that is enough to cover all its outflows. On the other hand, economic profitability is the economic value that the project adds to the organization.
Capital investment projects must satisfy all the risks in order to be viable. Also, considerations should be made on the project’s tax consequences and the contribution to the overall assets portfolio.
Reference
George T. Friedlob, and Franklin J. Plewa (1996). Understanding Return on Investment (Finance Fundamentals for Nonfinancial Managers Series). 1st edition. Wiley
Harvard Business School. (2009). Net Present Value and Internal Rate of Return: Accounting for Time. Harvard Business School Press
The given case study
