A township is considering making upgrades to a gravel road, including repairing

Question

A township is considering making upgrades to a gravel road, including repairing some washed out sections, widening the road, adding culverts, and filling ditches. The cost of the upgrade will be $40,000. Annual costs to maintain the road will be $4000. Annual benefits to the users of the road are estimated to be $9500 per year, primarily based on reduction in incidents/accidents, and also vehicle general wear-and-tear costs.

a.What is the breakeven point in terms of initial cost of paving the road, when your decision as to whether go with the gravel option or paved option changes?

b.Calculate the payback period for the two options (gravel vs. paved) using the information from parts “a” and “b”. What is your decision, based on payback period? Do the results concur with part C? In economic analysis is it possible for the payback period analysis to have different results from B/C analysis? Which analysis method would you recommend? Why?

c.In this problem only the economic consequences were evaluated. Do you think this type of decision is only economic, or are there other factors that could/would/should be considered? Briefly discuss…

Explanation / Answer

a. The break-even point (BEP) is the point at which total cost and total revenue are equal. There is no net loss or gain, and one has broken even.

In this case, the initial investment is of $40000. And every year, there shall be a gain of $5500 (i.e. the total estimated benefit of $9500 to users less annual cost to maintain the road of $4000).

Break even point shall be 7.27 years i.e. $40000 divided by $5500. In simple terms we are saying, an annual benefit of $5500 for 7.27 years shall make the initial investment/cost be paid off.

b.There is insufficient information for this subpart. Usually Payback period shall have same calculation as Breakeven point. Ofcourse if the interest rate would have been given, we could have discounted the annual benefits.

c.Mostly the decisions are based on economic and finance perspective, investors usually see what is the total benefit on making an investment, or how much time an investment shall take to frutify.

However, when there are public infrastructure projects, consideraton is also given to non-economic factors like citizens suitability, type of contractors available, other non economic costs etc.

I hope I have been able to answer your query. Please feel free to revert for any further clarification. Thanks.

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