Question

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	$	75,000
Cost of runway construction		355,000
Cost of extending perimeter fence		23,158
Cost of runway lights		40,000
Annual cost of maintaining new runway		20,000
Annual incremental revenue from landing fees		45,000

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 $155,000. The old snowplow could be sold now for $15,500. The new, larger plow will cost $13,000 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 $66,000 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 6 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

Formula sheet

A	B	C	D	E	F	G	H	I	J	K	L	M	N	O
2
3		1)
4		Initial cost of investment can be calculated as follows:
5
6		Cost of acquiring additional land for runway	75000
7		Cost of runway construction	355000
8		Cost of extending perimeter fence	23158
9		Cost of runway lights	40000
10		Cost of new snowplow	155000
11		Proceeds from sale of old snowplow	15500
12		Total initial investment	=SUM(D6:D10)-D11
13
14		Hence Total initial investment is	=D12
15
16		2)
17		Annual net cost or benefit can be calculated as follows:
18
19		Annual incremental revenue from landing fees	45000
20		Additional tax revenue due to increased economic activity	66000
21		Total annual revenue	=SUM(D19:D20)
22
23		Annual cost of maintaining new runway	20000
24		Annual cost due to larger plow	13000
25		Total annual cost	=SUM(D23:D24)
26
27		Annual net benfit	=D21-D25	=D21-D25
28
29		Hence annual net benefit is	=D27
30
31		3)
32
33		Calculation of IRR:
34
35		IRR can be calculated using the excel IRR function as follows:
36		Cash Flow can be represented as follows:
37		Year	0	=D37+1	=E37+1	=F37+1	=G37+1	=H37+1	=I37+1	=J37+1	=K37+1	=L37+1	=M37+1
38		Free Cash Flow	=-D14	=$D$29	=$D$29	=$D$29	=$D$29	=$D$29	=$D$29	=$D$29	=$D$29	=$D$29	=$D$29
39		IRR	=IRR(D38:N38)	=IRR(D38:N38)
40
41		Hence IRR of the project is	=D39
42
43		4)
44
45		As per IRR rule, a project should be accepted when IRR of the project is higher than the hurdle rate.
46
47		Since IRR of the project is lower than the hurdle rate of 6%.
48
49		Hence the project should not be accepted.
50