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 it 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.

Answer 1

The initial outlay for the log flume ride is $3,750,000. Annual after-tax cash flow is calculated by deducting variable costs, fixed costs, depreciation, and taxes from annual revenues, which will also be adjusted for the incremental ticket price increase. The terminal cash flow involves subtracting the dismantling costs from the sale of the parts and adjusting for taxes.

Step-by-step explanation:

The initial outlay for the Ocean City Water Park's new log flume ride includes the purchase price and installation costs, summing up to $3,750,000 ($3,500,000 for the equipment plus $250,000 for installation). The annual revenue can be calculated by multiplying 150 rides per day by 25 riders per ride, by $4.00 per ticket, and by 120 days in the season. This results in annual revenue from ticket sales. However, the ticket price increases by 4% each year, so this will have to be factored in for each subsequent year. Expenses include variable costs per rider, fixed costs, depreciation (using MACRS 7-year schedule), and taxes (35% tax rate).

The calculation of the terminal cash flow involves the dismantling costs and parts sale. You take the revenue from selling the parts and subtract the dismantling costs, then adjust for taxes to find the net terminal cash flow.

To calculate the annual after-tax cash flow, subtract the sum of variable costs, fixed costs, depreciation, and taxes from the annual revenue. With these calculations, we factor in the cost of capital (12%) to analyze the investment's profitability, by calculating the Net Present Value or using other financial metrics.