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Ben Thair, CEO of Behemoth Ski Resorts Company, was currently evaluating whether to buy the small USKI ski operation on the land adjacent to one of...
Ben Thair, CEO of Behemoth Ski Resorts Company, was currently evaluating whether to buy the small USKI ski operation on the land adjacent to one of Behemoth's mega resorts. The policy was to only pay the fair value of existing operations and not to include any synergies or operational improvements.
USKI has one ski lift which just cost them $6,000,000 to rebuild. It has two years of depreciation at a rate of $3,000,000 per year until it is fully depreciated. Behemoth notes that lift tickets at USKI cost $70 right now, and will stay there for this year. Beyond the first year of operating, ticket prices were expected to increase at a 3% rate for the next two years. USKI told Behemoth that they have typically had 100,000 skier-days per year of existing customers and they expect these numbers to be steady into the future. Because the newly rebuilt lift has been having some startup problems each day, at the end of the first year there will be an addition to net parts inventory for maintenance. This amount of inventory increase totals $2,000,000 and will simply be held in storage, replaced as needed but not declining or growing in total, for the entire time the lift operates, which in this case is assumed to be forever. Annual operating costs for the lift are expected to be $2,000,000 for lift operators and power, and $500,000 for maintenance and all other operating costs. Beyond the first year of operating, operating costs were expected to increase at a 3% rate for the next two years. For computational purposes, Mr. Thair planned to treat all revenues and expenses as occurring annually at the end of each year.
The lift will be well-maintained and thus will be treated as if its cash flows go on forever, but there will be a slight slowdown projected. After the third year of operations, permanent increases in revenues and costs will be only 2%, not 3%.
USKI currently has existing debt on the balance sheet with a current value of $25 million. The private company has a book value of equity of $30 million.
The current risk free interest rate for ten year Treasury bonds is 3%. Behemoth Ski Resorts thinks that the market risk premium is 6%. Behemoth has a corporate tax rate of 30%. The Beta of Behemoth is 1.2 and Behemoth expects to finance its purchase, should it buy USKI, by keeping its capital structure the same and if needed issuing the proper proportions of new debt and new equity. Behemoth is 50% equity and 50% debt (each based on market values), and its expected debt costs will continue to be an interest rate of 7% per year.
Dunn Thatt is the financial analyst for Behemoth Ski Resorts and Mr. Thair asked him to determine the maximum price that could be paid for entire USKI operation. Once that number is agreed upon, Mr. Thair also wants Mr. Thatt to determine the maximum price that Behemoth could pay for the equity of USKI if Behemoth were to assume the debt of USKI. Note any additional assumptions that you make in your analysis should you need to make any.
