Question

Required information

[The following information applies to the questions displayed below.]

Washington 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	$	63,000
Cost of runway construction		305,000
Cost of extending perimeter fence		19,880
Cost of runway lights		32,000
Annual cost of maintaining new runway		16,000
Annual incremental revenue from landing fees		25,000

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 $115,000. The old snowplow could be sold now for $11,500. The new, larger plow will cost $7,000 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 $76,000 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 10 percent.

Use Appendix A for your reference. (Use appropriate factor(s) from the tables provided.)

Required:

1. Compute the initial cost of the investment in the long runway.

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.)

3-b. Should it be built considering IRR?

Compute the initial cost of the investment in the long runway.

Initial cost of investment

Compute the annual net cost or benefit from the runway.

Annual net benefit

Determine the IRR on the proposed long runway. (Round your answer to the nearest whole percent.)

IRR

%

Answer 1

Initial cost of investment :

Land acquisition + Runway construction + Extension of perimeter fence + Runway lights + New snow plow - Salvage value of old snow plow

= ($63000) +($305000) +($19880) + ($32000) +($115000) -($11500)

=$523380

Annual incremental benefit:

Runway maintenance + Incremental revenue from landing fees + Incremental operating costs for new snow plow + Additional tax revenue

($16000) +25000 +($7000) +$76000 =$78000

Internal rate of return:

Annuity discount factor associated with the internal rate of return = Initial cost of investment ÷Annual incremental benefit

= $523380 ÷ $78000 = 6.71

Find 6.145 in the 10-year row of Table IV . It falls in the 10% column, so the internal rate of return on the runway project is 8%