[The following information applies to the questions displayed below.] Adams Coun
ID: 2477368 • Letter: #
Question
[The following information applies to the questions displayed below.]
Adams County’s Board of Representatives is considering the construction of a longer runway at the county airport. Currently, the airport can handle only private aircraft and small commuter jets. A new, long runway would enable the airport to handle the midsize jets used on many domestic flights. Data pertinent to the board’s decision appear below.
Cost of acquiring additional land for runway $ 70,500
Cost of runway construction 230,000
Cost of extending perimeter fence 15,111
Cost of runway lights 37,000
Annual cost of maintaining new runway 18,500
Annual incremental revenue from landing fees 37,500
In addition to the preceding data, two other facts are relevant to the decision. First, a longer runway will require a new snowplow, which will cost $140,000. The old snowplow could be sold now for $14,000. The new, larger plow will cost $10,500 more in annual operating costs. Second, the County Board of Representatives believes that the proposed long runway, and the major jet service it will bring to the county, will increase economic activity in the community. The board projects that the increased economic activity will result in $98,000 per year in additional tax revenue for the county. In analyzing the runway proposal, the board has decided to use a 10-year time horizon. The county’s hurdle rate for capital projects is 22 percent.
Use Appendix A for your reference. (Use appropriate factor(s) from the tables provided.) http://lectures.mhhe.com/connect/0077632451/Appendix%20A.jpg
***PLEASE ANSWER ALL QUESTIONS***
Required: 1. Compute the initial cost of the investment in the long runway. Initial cost of investment 2. Compute the annual net cost or benefit from the runway. 3-a. Determine the IRR on the proposed long runway. (Round your answer to the nearest whole percent) IRR 3-b. Should it be built? O Yes O NoExplanation / Answer
The initial cost of investment of the project is calculated as under:
Cost of acquiring additional land for runway $70,500
Cost of runway construction $230,000
Cost of extending perimeter fence $15,111
Cost of runway lights $37,000
Cost of new snowplow $140,000
Sale of old snowplow ($14,000)
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Initial cost of Investment $478,611
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2.
Annual net cost or benefit from the runway is $98,000.
3a.
The internal rate of return on the proposed runway is calculated as under:
At IRR the present value of cash inflow is equal to present value of cash outflow
Present value of cash outflow=present value of cash inflow
$478,611=$98,000*cumulative present value factor at IRR rate
Cumulative present value factor=$478,611/$98,000
=4.884
The cumulative present value of 16% for 10 years is 4.833 which is near to the value of 4.884. Therefore the IRR rate of project is 16%.
b.
The IRR is 16% which is lower than hurdle rate for capital project of 22% therefore the project should not be built.
1.
The net present value of proposed long runway is calculated as under:
Annual incremental revenue from landing fees $37,500
Annual incremental revenue from increased economic activity $98,000
Less: Maintenance cost ($18,500)
Operating cost of larger plow ($10,500)
Annual incremental benefit $106,500
Annuity discount factor @ 22% 3.9232
Present value of annual benefits $417,821
Initial costs $478,611
Net Present Value ($60,790)
2.
The initial cost of the project = $478,611
Promotional effort =$23,000 per year for 10 years
Present value of promotional effort for 10 years=$23,000*3.9232
=$90,234
Present value of 10 years of revenues= ($478,611+$90,234)
Revenues*3.9232=$568845
Revenues=$568,845/3.9232
=$144,995
Therefore to reach the internal rate of return equals to hurdle rate of 22% the county annual tax revenues should be $144,995 per year.
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