The City of Houston is considering the expansion of a highway (hypothetical exercise). The construction phase of the project lasts five years and no benefits are generated during construction. Benefits start after construction is completed and there is also a maintenance cost every year after construction ends. The cost and benefits of this construction project are summarized in the following table. All values are given in real terms (that is, have been corrected for inflation).
|
Item
|
Quantity
|
Price/Value
|
Period
|
|
Costs:
|
Asphalt
|
1 million bags
|
$75 per bag
|
First 5 years
|
|
Labor
|
1 million hours
|
Half at $20 per hour and half at $10 per hour
|
First 5 years
|
|
Maintenance
|
|
$5 million per year
|
Years 6 to 30
|
|
|
|
|
|
|
Benefits:
|
Driving Time Saved
|
500,000 hrs/per year
|
$19 per hour
|
Years 6 to 30
|
|
Lives Saved
|
5 lives per year
|
$7 million per life
|
Years 6 to 30
|
Use a spreadsheet to calculate and answer the following questions. Attach your spread sheet to show your work. All benefits and costs are realized at the end of each period. Therefore, the costs and benefits at period t=0 are zero. The first payments of the project occur at t=1. Consider 30 years when evaluating the project.
a) Assume a 5% real discount rate. What is the present discount value of the project? Should the project be done?
b) Now assume a 7% real discount rate. What would the present discounted value of the project be? Should the project still be approved under this discount rate?