Question

The State of DeNile built a new toll road 3 years ago for $900 million. The state can charge tolls on the road for the next 20 years and expects to spend $3 million per year on maintenance and toll collection. Toll revenue is expected to be $80 million per year. The state has recently received an offer from the Otto Corporation to lease the road for 20 years. The company will pay DeNile $1 billion and will receive exclusive rights to collect and keep the tolls. Otto Corp will also be responsible for all maintenance and other expenses. The state can invest its money at 6% annual return. Should the state take this offer? Why or why not?

Answer 1

If Do not lease:

Annual cash flows = annual revenue - maintenance cost

=80-3

=77 million

year for which cash flows received (n) =20

annual return (i) =6%

PV of annual cash flows = annual cash inflows*(1-(1/(1+i)^n))/i

77*(1-(1/(1+6%)^20))/6%

=883.1839338 million

Calculation of NPV:

Amount received from lease today = 1 billion or 1000 million

This is Cash inflows

If state Leased out road, then PV of cash flows of Road collection will lost. So this would be cash outflows

So PV of cash outflows = 883.1839338 million

NPV = PV of cash inflows - PV of cash outflows

=1000-883.1839338 million

=116.8160662 million

NPV of offer to lease out the road for 20 years has positive NPV that is $116.82 million. So it should accept offer from Otto corporation for leasing.