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Prepare a capital budgeting analysis with the given information below:

Lily owns and operates the Lily Amusement Park. The park was opened 12 years ago with the proceeds of her inheritance from her great-father, James. Currently, the park encompassed 145 acres, with 55 acres left for development. A recent land valuation had the 200-acre property valued at $2,300,000. During the past five years, management had added two thrill rides, a wildlife adventure ride, and several gift shops and snack bars as attendance at the park had doubled. Park revenues and net income had grown at, respectively, 17.6 and 14.4 percent compounded annually during the past 10 years. Park revenue was generated from three divisions: (1) park usage, (2) gifts, and (3) food. Expenses in the gift and food divisions were a combination of fixed and variable. Fixed expenses included salaries, costumes, training, utilities, and taxes. Variable expenses in the gift division represented the costs of the purchased products, which averaged 65 percent of revenue. In the food division, food expenses were variable at 75 percent of revenue. Exhibit 1 gives selected income data for each of the divisions for the last year. Corresponding balance sheet information is provided in Exhibit 2.

Lily was considering using 20 acres of the 55 vacant for the addition of a scary wild ride for adults and children over 12 years of age. She had hired Park Consultants; the design team had narrowed the choice to two mutually exclusive designs. One, called "The Island Escape", would be a roller coaster where passengers try to escape the evil powers of a strange creature. The alternative design, The Pirate Princess", would be a thrill ride through decorations reflecting a wild surf beach. This ride was a very innovative and exciting addition to the park, while the Island Escape was like the average rollercoaster. Jenny definitely intended to develop one of the rides, but her decision was complicated by the cost differential between the twothe Pirate Princess would cost more than three times as much as Island Escape and there was some uncertainty about the pulling power of this ride for the cost. So far Lily had spent $135,000 with Park Consultants. She had asked Park Consultants to estimate the investment outlays required for each of the rides. The Island Escape was relatively easy to evaluate: its total cost was estimated to be $1,925,000, including design, building, and installation. The investment for the Pirate Princess was more difficult to measure; however, the best estimate was $6,576,000. But Lily anticipated that this amount might vary by as much as 10 percent either way. The amusement park always depreciated assets using a straight-line method over a five-year horizon. Because of the daily use of this equipment, the salvage value of both rides was assumed to be a dismantle-and-demolition expense of $200,000, with no resale value of the equipment assumed.

Estimation of the benefits associated with each ride was more difficult. Each ride would seat 50 patrons per trip. On average, a ride would last six minutes, with 2 minutes to load and 2 minutes to unload between rides. Thus, each ride would make 60 trips per day in an average 10-hour day. Lily hoped that the purchase of the Island Escape would bring in 1,000 additional customers every day of the year. The consultants thought her estimate overly optimistic, and to demonstrate why they drew on the calculations in Exhibit 3, which shows that a typical patron spends $25.95 on each visit to the park. One thousand new customers every operating day translates into annual revenue of $9,471,750 (see Exhibit 4). The consultants also told Jenny that the incremental cash flows from that large an attendance increase would result in an internal rate of return well beyond a reasonable level for one ride. After several hours of research and discussion, they arrived at projections reflecting the probable average number of new patrons per day who would be attracted to the park by the Island Escape ride. The estimates of the number of new patrons who would be attracted to the park each day by the Pirate Princess ride differed significantly. As other parks developed new rides, patrons would not blaze about Lily Parks new ride and the number of new patrons would decline. Exhibits 5 and 6 detail the probabilities of new patrons for each project. Lily forecast the expenses associated with each of the new rides and indicated that two crews would be hired to manage the rides and that the total cost would be $700,000 per year to manage the rides would be fixed and should remain constant over the forecast period. However, the new crews would need initial training in the operation of either ride. Training would amount to $40,000. Also estimated is that all other costs would be variable (products for gift shops, food for restaurants, and snack bars). The consultants used the information in Exhibit 3 to estimate the variable cost of goods sold at 56.18 percent of revenue. She also felt that both rides would require investments in net working capital. In the first year of operation, the Island Escape would require an estimated $200,000 in net working capital, while the Pirate Prince would require an estimated $300,000. Taxes were forecasted to remain constant at 30% over the entire period. With the forecast parameters completed. Jenny thinks that the rides were risky and that they should use a required rate of return suitable for this risk of 15%. She was also worried about her costs and the back-office administration costs. Although they will not increase Lily thinks the new ride should be allocated a cost of $25,000pa. She thought the staff training and fees paid to Park consultants should be spread over the 5-year life of the project. Park consultants had in working out the salvage value in 5 years contacted the tax office to ask for their advice on the effective lives of the new rides. The tax office advised that the new rides would have an effective tax life of 10 years. The consultants also estimated that land values would increase at 3% per year over the 5-year life. There is no tax on the profits or loss on the sale of land. The tax office also advised that the staff training could be claimed as a tax deduction when paid.

EXHIBIT 1 Lily Amusement Park Selected Income Data for current year Company Park Gift Food Sales 50315 9792 21231 19292 Cost of Goods Sold 28270 0 13800 14469 Gross Profit 22045 9792 7431 4823 Other expenses 7968 4896 1589 1483 Earnings Before Tax 14077 4896 5842 3340 Tax 5350 Net income 8727

EXHIBIT 2 Lily Amusement Park Selected Balance Sheet for current year Assets Company Park Gifts Food Cash 23513 20562 1524 1427 Account Rec. 2123 0 2123 0 Inventory 4149 0 3185 965 Net Fixed Assets 28502 22521 2123 3858 Total Assets 58287 43083 8955 6250 Liabilities Current Liabilities 18119 2448 7695 7976 Long term debt 20000 Shareholders funds Paid up capital 15000 Retained Earnings 5169 Total Liabilities Equity 58288

EXHIBIT 3 Lily Amusement Park Revenue analysis by Customer 1. Revolutions per daytimes ride utilization per revolution = average number of patrons per day 60*88.53=8,312 2. Annual revenue divided by annual operating days = average revenue per day $50,315,250/265= $137,850 3. Average revenue per day divided by the number of patrons per day = average revenue per patron $137,850/5,312= $25.95 4. Average cost of park admittance in the current year = $5.05 based on $5.95 for adults and $3.95 for children 5. Current year average amount spent on gift per person= $10.95 6. Current year average amount spent on food per person= $9.95

EXHIBIT 4 Lily Amusement Park Projected Revenue increase from 1,000 additional patrons per day

1. New patrons per day times annual operating days = equivalent new annual patrons 1000*365= 365,000 patrons 2. Equivalent annual patron times average revenue per patron = projected revenue increase 365,000*$25.95= $9,471,750

EXHIBIT 5 Lily Amusement Park The Island Escape Projected new patrons per day Year New patron/ day Probability of Occurrence 1 - 5 200 .10 340 .20 390 .40 560 .20 670 .10

EXHIBIT 6 Lily Amusement Park The Pirate Princess Projected new patrons per day Year New patron/day Probability of Occurrence 1 - 2 750 .20 1,000 .60 1,500 .20 Year 3 - 5 750 .30 1,600 .40 3,000 .30

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