Question

White Valley Ski ResortWhite Valley Ski Resort is planning the ski lift operation for its new ski resort. Management is trying to determine whether one or two lifts will be necessary each lift can accommodate 250 people per day. Skiing normally occurs in the 14-week period from December to April, during which the lift will operate 7 days per week which is a total of 98 days. The first lift will operate 90 percent capacity if economic conditions are bad, the probability of which is believed to be about a 0.3. During normal times the first lift will be utilized at 100 percent capacity, and the excess crowd will provide 50 percent utilization of the second lift. The probability of normal times is 0.5.If times are really good, the probability is 0.2., the utilization of the second lift will increase to 90 percent.The equivalent annual cost of installing a new lift, recognizing the time value of money and lift’s economic life is $50,000. The annual cost of installing two lifts is $90,000 if purchased at same time. Each lift costs $200,000 to operate.Lift tickets cost $20 per customer per day. Should one or two lifts be purchased?

Answer 1

Revenue from one lift over 98 days season = 250*98*20 = $ 490,000 (at 100% capacity utilization)

Annual Cost of intalling and operating one lift = 200000+50000 = 250000

Annual Cost of intalling and operating two lifts = 200000*2 + 90000 = 490000

Decision tree is following:

Expected Value of installing one lift = .2*490000 + .5*490000 + .3*490000*.9 - 250000 = $ 225,300

Expected Value of installing two lifts = .2*490000*1.9 + .5*490000*1.5 + .3*490000*.9 - 490000 = $ 196,000

Expected Value of installing one lift is higher. Therefore, one lift should be purchased and installed.