A 10-mile stretch of state highway is to be reconstructed at a cost of $30,000,0
ID: 1176805 • Letter: A
Question
A 10-mile stretch of state highway is to be reconstructed at a cost of $30,000,000. Road users%u2019 costs on the existing facility are $2,000,000/year and maintenance costs are $6,000/year. The new facility will reduce these to $1,000,000/year and $2,000/year, respectively.
The highway can be rebuilt now, in one year, if a serial bond issue bearing 6%/year, paid semi-annually, is issued for 20 years.
If financed out of current taxes, construction will proceed at 2 miles/year, taking 5 years to complete. In each year 1/5 of the construction cost will be paid, and 1/5 of the maintenance and users%u2019 costs reductions is experienced.
In either instance, the service life of the new road is considered to be 30 years from the project inception. The minimum desirable rate of return is 8%/year.
As the project manager, which funding plan would you recommend to the state? The serial bond option or the financing from taxes option? Why? [Hint: Find the present worth values for both options.]
Explanation / Answer
Present worth value of first option= Future value/(1+i)^n
i=interest
n=years
1)Present Value=30,000,000/(1+0.08)^30
PV=$2981319.976
For second option
2)PV=30000000/(1+0.06)^20
=$9354141.807
SO the second option is prefered asit has low discount rate and high present value of the future cash flows by refering the Present worth value.!!
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