A city is planning a new convention center and has received bids from two contractors. The center one contractor proposed would cost $10,000,000 to build plus upkeep of $150,000 per year for its expected 30-year life span. Annual revenues are anticipated to be $1,000,000. Salvage value at the end of the 30 years is expected to be zero.
The second contractor proposes a larger facility at an initial cost of $20,000,000. This facility will also have an expected life span of 30 years and maintenance costs will be $400,000 per year. Annual earnings for this facility are anticipated to be $2,625,000. Finally, it is anticipated that at the end of the 30 years the entire structure will have to be torn down at a cost of $5,000,000.
Assume that all the relevant benefits and costs are listed above, all the benefits and costs (with the exception of the initial construction cost) are realized at the end of each year, and all the benefits and costs are measured in real terms.
If the nominal social discount rate is 7% and the rate of inflation is currently stable at 2 percent, should the city build either facility? If so, which one?