Question

The Ocean City Water Park is considering the purchase of a new log flume ride. The cost to purchase the equipment is $1,800,000 and it will cost an additional $180,000 to have it installed. The equipment has an expected life of 6 years, and it will be depreciated using a MACRS 5-year class life. Management expects to run about 250 rides per day, with each ride averaging 8 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 5% per year. The variable cost per rider will be $1.40 and inflation is expected to be 3% per year, and total fixed costs will be $240,000 per year. After six years, the ride will be dismantled at a cost of $75,000 and the parts will be sold for $650,000. The cost of capital is 12%, the re-investment rate is 10% and its marginal tax rate is 35%.

a. Calculate the initial outlay, annual after-tax cash flows, and the terminal cash flow.

Answer 1

Calculation of initial outlay Cost of purchasing equipment Installation costs Total initial outlay 18,00,000 1,80,000 19,80,000 Calculation of terminal cash flows Sale value of equipment Installation costs Net terminal cash inflow tax on profit from sale @35% Post-tax terminal inflows 6,50,000 75,000 5,75,000 2,01,250 3,73,750

Calculation of annual after-tax cash flows Formula No. of riders No. of rides per day No. of tickets sold per day No. of days per year No. of tickets sold per year Year 1 8.0 250.0 2,000.0 120.0 2,40,000.0 Year 2 8.0 250.0 2,000.0 120.0 2,40,000.0 Year 3 8.0 250.0 2,000.0 120.0 2,40,000.0 Year 4 8.0 250.0 2,000.0 120.0 2,40,000.0 Year 5 8.0 250.0 2,000.0 120.0 2,40,000.0 Year 6 8.0 250.0 2,000.0 120.0 2,40,000.0 250*8 Price per ticket 4.00 4.20 4.41 4.63 4.86 5.11 Tickets sold per day*120 $4 in year 1 and 5% p.a. increase thereafter $1.4 in year 1 and 3% p.a. increase thereafter Price per ticket - variable cost per ticket Variable cost per ticket 1.40 1.44 1.49 1.53 1.58 1.62 Contribution per ticket 2.60 2.76 2.92 3.10 3.29 3.48 Contribution for the year Tickets sold per year (i.e. 2,40,000) * contribution per ticket 6,24,000.0 6,61,920.0 7,01,937.6 7,44,163.7 7,88,715.0 8,35,714.2 Fixed costs 2,40,000.0 2,40,000.0 3,96,000.0 Depreciation [(Purchase cost+installation cost)/5), i.e. (1,800,000+180,000)/5 Contribution-fixed costs-depreciation 2,40,000.0 3,96,000.0 25,920.0 12,000.0 2,40,000.0 3,96,000.0 65,937.6 2,40,000.0 2,40,000.0 3,96,000.0 3,96,000.0 1,08,163.7 1,52,715.0 -12,000.0 5,95,714.2 Profit before tax tax losses brought forward Taxable profit for the year Profit before tax - tax losses brought forward from previous years -12,000.0 13,920.0 65,937.6 1,08,163.7 1,52,715.0 5,95,714.2 Tax @35% Profit after tax Cash flows after tax Taxable profit*35% (Zero if loss) Profit before tax-tax Profit after tax + Depreciation -12,000.0 3,84,000.0 4,872.0 21,048.0 4,17,048.0 23,078.2 42,859.4 4,38,859.4 37,857.3 70,306.4 4,66,306.4 53,450.3 99,264.8 4,95,264.8 2,08,500.0 3,87,214.2 3,87,214.2