Consider how Wolf Valley, a popular ski resort, could use capital budgeting to decide whether the $8 million Brook Park Lodge expansion would be a good investment.
Assume that Wolf Valley's managers developed the following estimates concerning a planned expansion to its Brook Park Lodge (all numbers assumed):
Number of additional skiers per day ............................................................. 125
Average number of days per year that weather conditions allow
skiing at Wolf Valley ...................................................................................
160
Useful life of expansion (in years) .................................................................. 8
Average cash spent by each skier per day .................................................... $ 240
Average variable cost of serving each skier per day .................................... $ 142
Cost of expansion......................................................................................... $8,000,000
Discount rate ................................................................................................. 12%
Assume that Wolf Valley uses the straight-line depreciation method and expects the lodge expansion to have a residual value of $1,000,000 at the end of its eight-year life.
Requirements
1. Compute the average annual net cash inflow from the expansion.
2. Compute the average annual operating income from the expansion.
3. Compute the payback period.
4. Compute the ARR.