Question

A highway construction company is under contract to build a new roadway through a scenic area and two rural towns in Colorado. The road is expected to cost $18,000,000, with annual upkeep estimated at $150,000 per year. Additional income from tourist (Benefits) of $900,000 per year is estimated. The road is expected to have a useful commercial life of 20 years. Determine if the highway should be constructed at a discount rate of 6% per year, applying the Conventional B/C method . Remember to state your decision (Build or don’t build).

Answer 1

As per the information provided in the question

The cost of construction of Road = $18000000

The annual upkeep cost is = $150000

Income from the tourist per year is = $900000

Useful life of the road =20Years

Discount Rate = 6%

Present worth of the Cost = 18000000 + 150000(P/A,6%,20)

Present worth of the Cost = 18000000 + 150000(11.4699)

Present worth of the Cost = 18000000 + 1720485 =$19,720,458

Present worth of the Benefit =900000(P/A,6%,20)

Present worth of the Benefit =900000(11.4699)= $10,322,910

As per the conventional B/C method

B/C Ratio = Present worth of the Benefit / Present worth of the Cost

B/C Ratio = 10322910 / 19720458 = 0.5234

As the B/C Ratio=0.5234 < 1 (Don’t Build)

So the road should not be build by the construction company as its B/C ratio is less than one