Question

3. Disney wants to create a new attraction at Disneyland to capitalize on the hype surrounding the Marvel movies. They will spend $60 million today to build this new ride. This new ride would only last for 4 years, after which they would create a newer ride for the next fad. Here are the numbers for the new ride: Year 1 $94 million $50 million $10 million $5 million Year 2 $85 million $40 million $5 million $4 million Revenues from ride COGS Advertising Lost revenues from existing rides Increased sales of merchandise Year 3 $50 million $30 million $1 million $1 million Year 4 $25 million $15 million $0 $0 $3 million $5 million $8 million $10 million They will depreciate the new ride to zero over 4 years using straight-line depreciation. They anticipate that, four years from now, they could sell the ride for $5 million. They will need to increase net working capital by $12 million today, but this amount will decrease by $3 million each year until the end of the investment. They will also use land that they already own for this investment; the land has a market value of $40 million and a book value of $10 million. Disney has a tax rate of 30% and expects a return of 11% on investments like this. Should they make this investment?

Answer 1

Free cash flow (FCF) each year = increase in earnings after tax + depreciation + recovery of working capital.

profit on sale of equipment at end of year 4 = entire salvage value (since the ride is depreciated to zero, its book value is zero and the entire sale price is a profit and hence subject to tax).

after-tax salvage value = salvage value - tax on profit on sale.

NPV is calculated using NPV function in Excel

NPV is $19,577,652.

They should make this investment as the NPV is positive.

B28 foc =NPV(11%,C26:F26) +B26 с ol $60,000,000 $12,000,000 $0 $0 2 Initial Investment 3 Cost of construction 4 Invesment in working capital 5 6 OCF 7 Revenues 8 - COGS 9 - Depreciation 10 - Advertising 11 - Lost revenues 12 + Increased sales of merchandise 13 Increase in earnings - before tax 14 - Taxes 15 Increase in earnings - after tax 16 - Depreciation 17 - Recovery of working capital 18 FCF 19 20 Terminal Cash Flow 21 Salvage Value 22 Tax 23 Salvage Value after tax 24 25 NPV Analysis 26 Project Cash Flows 27 28 NPV $94,000,000 $85,000,000 $50,000,000 $25,000,000 $50,000,000 $40,000,000 $30,000,000 $15,000,000 $15,000,000 $15,000,000 $15,000,000 $15,000,000 $10,000,000 $5,000,000 $1,000,000 $5,000,000 $4,000,000 $1,000,000 $3,000,000 $5,000,000 $8,000,000 $10,000,000 $17,000,000 $26,000,000 $11,000,000 $5,000,000 $5,100,000 $7,800,000 $3,300,000 $1,500,000 $11,900,000 $18,200,000 $7,700,000 $3,500,000 $15,000,000 $15,000,000 $15,000,000 $15,000,000 $3,000,000 $3,000,000 $3,000,000 $3,000,000 $29,900,000 $36,200,000 $25,700,000 $21,500,000 $5,000,000 $1,500,000 $3,500,000 ($72,000,000) $29,900,000 $36,200,000 $25,700,000 $25,000,000 $19,577,562!

А lo 2 Initial Investment Cost of construction 4. Invesment in working capital 60000000 12000000 5 8 25000000 15000000 =$B$3/4 6 OCF 7 Revenues - COGS 9 - Depreciation 10 - Advertising 11 - Lost revenues 12 + Increased sales of merchandise 13 Increase in earnings - before tax 14 - Taxes 15 Increase in earnings - after tax 16 + Depreciation 17 - Recovery of working capital 18 FCF 94000000 50000000 =$B$3/4 10000000 5000000 3000000 =C7-C8-C9-C10-C11+C12 =C13 30% =C13-C14 =C9 =3000000 =C15+C16+C17 85000000 40000000 =$B$3/4 5000000 4000000 5000000 =D7-08-09-D10-D11+D12 =D13*30% =D13-D14 =D9 =3000000 =D15+D16+D17 50000000 30000000 =$B$3/4 1000000 1000000 8000000 =E7-E8-E9-E10-E11+E12 =E13*30% =E13-E14 =E9 =3000000 =E15+E16+E17 10000000 =F7-F8-F9-F10-F11 F12 =F13*30% =F13-F14 =F9 =3000000 =F15+F16+F17 19 20 Terminal Cash Flow 21 Salvage Value 22 Tax 23 Salvage Value after tax 5000000 =F21.30% =F21-F22 24 --B3-B4 =C18 =D18 =E18 =F18+F23 25 NPV Analysis 26 Project Cash Flows 27 28 NPV =NPV(11%,C26:F26) +B26