Business partners, Nelson Cook and Jay Hartford, are considering building a mountain bike park in Springfield, Oregon, called "Mountain Bike Adventures". The local government has agreed to rent ten acres of land to Nelson and Jay for a limited number of years.
In Year 0, Nelson and Jay would acquire the necessary assets and set up operations. In Years 1, 2, and 3, the business would be in full operation. In Year 4, Nelson and Jay plan to shut down the business and dispose of its assets.
Nelson and Jay plan to charge $15 for park admission and the expected number of ticket sold in Year 1 is 4,000. The number of ticket sold is expected to increase by 10% in Year 2, and then by another 10% in Year 3. The park will also have a mountain bike rental service that charges $10 per hour. It is expected that 50% of the ticketholders do not have a mountain bike and they are going to rent a bike for three hours on average.
In Year 0, Nelson and Jay plan to acquire 100 mountain bikes for $300 each. In Year 4, the bikes are expected to be sold at $30 each. Bikes will be depreciated according to a 5-year MACRS property class schedule, which depreciates 0% in Year 0, 40.0% of the purchase price in Year 1, 32.0% in Year 2, and 19.2% in Year 3.
Variable costs (including gasoline, bike maintenance and repairs, liability insurance, hourly wages, etc.) are expected to be 70% of same-year total revenue (including both ticket sales and bike rentals) in Years 1 through 3. Working capital requirements (including accounts receivable and inventory) are expected to be $3,000 in Year 0, 20% of same-year total revenue in Years 1 to 3, and $0 in Year 4. An annual land rental fee of $12,000 will be due in each of Years 1 through 3, and this is expected to be the only fixed cost for the business.
The marginal tax rate is 30% and the cost of capital for this project is 8%.
1. Using the original assumptions in the problem, what is the EBIT break-even point for the number of tickets sold in Year 3? In other words, what is the number of tickets sold in Year 3 for which the project's EBIT is zero (rounded to the nearest dollar)?
2. Nelson is worried that the assumption about the mountain bike prices in Year 0 is too optimistic. He wants to consider the possibility that the price of mountain bikes in Year 0 will be $350 each. Assuming the bikes are still expected to be sold at $30 each in year 4, what is the new salvage value in year 4 (rounded to the nearest dollar)?
3. Nelson is worried that the assumption about the mountain bike prices in Year 0 is too optimistic. He wants to consider the possibility that the price of mountain bikes in Year 0 will be $350 each. Assuming the bikes are still expected to be sold at $30 each in year 4, what is the new NPV (rounded to the nearest dollar)?
4. Originally, the variable costs are expected to be 70% of the same-year total revenue. Jay thinks this assumption is too low, he expects that the costs will be 70% of the total revenue in year 1, 75% of the total revenue in year 2, and 80% of the total revenue in year 3. What is the new NPV (rounded to the nearest dollar)?
5. If the cost of capital for the project is 11% instead of 8%, what is the new NPV (rounded to the nearest dollar)?