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	$	79,500
Cost of runway construction		270,000
Cost of extending perimeter fence		19,840
Cost of runway lights		43,000
Annual cost of maintaining new runway		21,500
Annual incremental revenue from landing fees		52,500

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 $170,000. The old snowplow could be sold now for $17,000. The new, larger plow will cost $15,000 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 $76,000 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 12 percent.

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 12 percent. The County Board of Representatives believes that if the county conducts a promotional effort costing $27,000 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 12 percent? (Round your intermediate calculations and final answer to the nearest whole dollar.)

Answer 1

SOLUTION:

We are given the following,

Initial Investment

Cost of acquiring additional land for runway	$	79,500
Cost of runway construction		270,000
Cost of extending perimeter fence		19,840
Cost of runway lights		43,000
Cost of New snowplow		170,000
Salvage of old snowplow		(17,000)

Incremental Initial Cost = 79500 + 270000 + 19840 + 43000 + 170000 - 17000

= 565,340

The Operating Cash Flows are:

Annual incremental revenue from landing fees	52,500
Annual cost of maintaining new runway	(21,500)
Incremental Operating Cost of New Plow	(15,000)
Additional Tax Revenue	76,000
Incremental Annual Net Revenue	92000

PV of Annual Net Revenue = 92000 * PVIFA (12%, 10)

= 92000 * 5.6502

= 519,818

NPV = 519,818 - 565,340

= - 45,522

With Additional yearly promotional effort,

for getting an IRR of 12% the annual net revenue should be = 565,340 / 5.6502

= $ 100,057

Additional Tax Revenue required = 100,057 - 92000 + 27000

= $ 35,057

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