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.)

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. The County Board of Representatives believes that if the county conducts a promotional effort costing $35,500 per year, the proposed long runway will result in substantially greater economic development than was projected originally. However, the board is uncertain about the actual increase in county tax revenue that will result.

Required:

Suppose the board builds the long runway and conducts the promotional campaign. What would the increase in the county’s annual tax revenue need to be in order for the proposed runway’s internal rate of return to equal the county’s hurdle rate of 6 percent? (Round intermediate and final answer to the nearest dollar amount.)

uired increase in tax revenue?

Answer 1

Let us start with the cashflows assuming that the runway is constructed and the promotional effort is done.

First let us assume that the increase in tax revenue is $66,000 per year as projected. Assuming that the construction costs are upfront and all revenues & annual costs are realized at the end of the year, the cash flows will look like:

Year	0	1	2	3	4	5	6	7	8	9	10
Incremental revenue from landing		45,000	45,000	45,000	45,000	45,000	45,000	45,000	45,000	45,000	45,000
Increased tax revenue		66,000	66,000	66,000	66,000	66,000	66,000	66,000	66,000	66,000	66,000
Cost of land	(75,000)
Cost of construction	(355,000)
Cost of perimeter	(23,158)
Cost of runway lights	(40,000)
Maintenance		(20,000)	(20,000)	(20,000)	(20,000)	(20,000)	(20,000)	(20,000)	(20,000)	(20,000)	(20,000)
Cost of new snoplow	(155,000)
Salvage of old plow	15,500
Operating cost of new plow		(13,000)	(13,000)	(13,000)	(13,000)	(13,000)	(13,000)	(13,000)	(13,000)	(13,000)	(13,000)
Promotional effort		(35,500)	(35,500)	(35,500)	(35,500)	(35,500)	(35,500)	(35,500)	(35,500)	(35,500)	(35,500)
Total Cash Flows	(632,658)	42,500	42,500	42,500	42,500	42,500	42,500	42,500	42,500	42,500	42,500

The IRR of these calcuations can't be computed (mathematically, IRR is coming to be negative)

Now, using excel (or trial and error), we can compute the value of increased tax per year to make IRR equal to 6%.

Increased tax value = $109,450

Year	0	1	2	3	4	5	6	7	8	9	10
Incremental revenue from landing		45,000	45,000	45,000	45,000	45,000	45,000	45,000	45,000	45,000	45,000
Increased tax revenue		109,450	109,450	109,450	109,450	109,450	109,450	109,450	109,450	109,450	109,450
Cost of land	(75,000)
Cost of construction	(355,000)
Cost of perimeter	(23,158)
Cost of runway lights	(40,000)
Maintenance		(20,000)	(20,000)	(20,000)	(20,000)	(20,000)	(20,000)	(20,000)	(20,000)	(20,000)	(20,000)
Cost of new snoplow	(155,000)
Salvage of old plow	15,500
Operating cost of new plow		(13,000)	(13,000)	(13,000)	(13,000)	(13,000)	(13,000)	(13,000)	(13,000)	(13,000)	(13,000)
Promotional effort		(35,500)	(35,500)	(35,500)	(35,500)	(35,500)	(35,500)	(35,500)	(35,500)	(35,500)	(35,500)
Total Cash Flows	(632,658)	85,950	85,950	85,950	85,950	85,950	85,950	85,950	85,950	85,950	85,950

IRR = 6%