Question
(Instructor-provided worksheet is recommended.) New City is considering building a recreation center. The estimated construction cost is $12 million with annual staffing and maintenance costs
(Instructor-provided worksheet is recommended.) New City is considering building a recreation center. The estimated construction cost is $12 million with annual staffing and maintenance costs of $750,000 over the twenty year life of the project. At the end of the life of the project, New City expects to be able to sell the land for $4 million, though the amount could be as low as $2 million and as high as $5 million. Analysts estimate the first year benefits (accruing at the end of the year of the first year) to be $1.2 million. They expect the annual benefit to grow in real terms due to increases in population and income. Their prediction is a growth rate of 4 percent, but it could be as low as 1 percent and as high as 6 percent. Analysts estimate the real discount rate for New City to be 6 percent, though they acknowledge that it could be a percentage point higher or lower. a. Calculate the present value of net benefits for the project using the analysts predictions. Costs = $12 million construction + 750,000 annual staffing/maintenance costs for 20 years = $21,118,600 Costs = $1,200,000 for year 1 + 4% growth for remaining 19 years + 4,000,000 salvage value= $23,790,800 NPV = $23,790,800 - $21,118,600 = $2,672,200 b. Investigate the sensitivity of the present value of net benefits to alternative predictions within the ranges given by the analysts. Submit a copy of your Excel spreadsheet for problem 3 showing the present value of net benefits for the project (part a). For part b, you can vary the assumed values for the scrap value of land ($2 M to $5M), growth rate of benefits (0.01 to 0.06) and discount rate (0.05 to 0.07) as an exercise but submit your results for the best-case analysis and the worst-case analysis.
Problem 3 Spreadsheet | |||||||
Assumptions: | |||||||
Annual Discount Rate | 0.06 | ||||||
Annual Growth Rate of Benefits | 0.04 | ||||||
Construction Cost | $12,000,000 | ||||||
Annual Operations Cost | $750,000 | ||||||
First Year Benefit | $1,200,000 | ||||||
Scrap Value | $4,000,000 | ||||||
Construction | Operational | Annual | Scrap | Annual | PV Annual | ||
Cost | Cost | Benefit | Value | NB | NB | ||
Year | 0 | ||||||
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Net Present Value | $0 |
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