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 $ 82,500 Cost of runway construction 280,000 Cost of extending perimeter fence 19,908 Cost of runway lights 45,000 Annual cost of maintaining new runway 22,500 Annual incremental revenue from landing fees 57,500 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 $180,000. The old snowplow could be sold now for $18,000. The new, larger plow will cost $16,000 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 $94,000 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 18 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?

Answer 1

Part 1

Initial cost of investment in a longer runway:

Land acquisition	(82500)
Runway construction	(280000)
Extension of perimeter fence	(19908)
Runway lights	(45000)
New snow plow	(180000)
Salvage value of old snow plow	18000
Initial cost of investment	(589408)

Part 2

Annual net incremental benefit from runway:

Runway maintenance	(22500)
Incremental revenue from landing fees	57500
Incremental operating costs for new snow plow	(16000)
Additional tax revenue	94000
Annual incremental benefit	113000

Part 3-a

IRR = 14%

Internal rate of return

Annuity discount factor associated with the internal rate of return = Initial cost of investment / Annual incremental benefit = 589408/113000 = 5.216

It falls in the 14 percent column, so the internal rate of return on the runway project is 14 percent

Part 3-b

No. because IRR is less than the hurdle rate