Question

The Ocean City Water Park is considering the purchase of a new log flume ride. The cost to purchase the equipment is $3,500,000 and it will cost an additional $250,000 to have it installed. The equipment has an expected life of 6 years and will be depreciated using a MACRS 7-year class life. Management expects to run about 150 rides per day, with each ride averaging 25 riders. The season will last for 120 days per year. In the first year, the ticket price per rider is expected to be $4.00, and it will be increased by 4% per year. The variable cost per rider will be $1.40, and total fixed costs will be $320,000 per year. After six years, the ride will be dismantled at a cost of $115,000 and the parts will be sold for $450,000. The cost of capital is 12%, and its marginal tax rate is 35%. Calculate the initial outlay, annual after-tax cash flow for each year, and the terminal cash flow. Calculate the NPV, IRR, and MIRR of the new equipment. Is the project acceptable?

Answer 1

The initial outlay is $3,865,000. The annual after-tax cash flow for each year is $234,600. The terminal cash flow is $335,000. The NPV, IRR, and MIRR will determine if the project is acceptable.

Step-by-step explanation:

To calculate the initial outlay, you need to sum up the cost to purchase the equipment, the cost to install it, and the dismantling cost at the end. So, initial outlay = Equipment cost + Installation cost + Dismantling cost = $3,500,000 + $250,000 + $115,000 = $3,865,000.

To calculate the annual after-tax cash flow for each year, you need to subtract the variable cost per rider and the fixed costs from the revenue per year and then apply the tax rate. For example, in year 1, revenue = ticket price × number of riders × number of days = $4.00 × 150 riders × 120 days = $720,000. Operating costs = variable cost per rider × number of riders × number of days + fixed costs = $1.40 × 150 riders × 120 days + $320,000 = $378,000. After-tax cash flow = (revenue - operating costs) × (1 - tax rate) = ($720,000 - $378,000) × (1 - 0.35) = $234,600.

The terminal cash flow can be calculated as the salvage value minus the dismantling cost at the end of year 6. Terminal cash flow = Salvage value - Dismantling cost = $450,000 - $115,000 = $335,000.

The NPV, IRR, and MIRR can be calculated using a financial calculator or software. The project is acceptable if the NPV is positive, the IRR is greater than the cost of capital, and the MIRR is greater than the cost of capital.