The communities of the capital regional district have asked you to examine two potential solutions. One is the creation of light rapid transit (LRT). The other is increasing the size of the road to accommodate greater traffic flow, as well as the use of express bus lanes.
The LRT project has larger up-front costs. It is estimates the cost of the rail project to be $1 billion dollars, spread out over three years. Once operational, the LRT is predicted to generate $150 million per year in fares. It is estimated that it will bring 2,500 cars per day off the road, an amount that will increase by 500 per year in the first ten years of operation. It is also estimated that, once operation, the decrease in traffic will save drivers a total of 5,000 hours per workday in traffic (assuming 10,000 cars per day will have their total daily travel time cut by 30 minutes each per day) initially. Every additional 100 cars per day off the road will save drivers 20 seconds of travel time daily. While it will cost $20 million per year to maintain and operate the rail line, it is estimated that it will save the CRD approximately $40 million per year in costs related to road maintenance and health from increased pollution. All these benefits and costs will occur in the first 20 years, after which no further benefit or cost will be realized form this project.
Increasing the size of the roadway will have more immediate benefits, not take as long to build and will cost less to make. The construction itself is estimated to cost $400 million and would be completed in one year. 500 cars per day will be brought off the road. This will be constant for 15 years, at which time the extra cars brought off the roads due to increased public transportation will be 0. Commute times will initially be cut by15 minutes per day initially, dropping by 1 minute per day in every subsequent year until year 15 when the decrease in commute time will be 0. The cost of maintaining roads in CRD will be $80 million per year to accommodate for the increased volume of traffic that is anticipated from the increased size of the road.
You are asking to make a recommendation regarding which project, if any, the CRD should pursue. In doing so, you are told that the social cost per extra minute of commuting time is $1.5 million per year. You are also told that for every 100 cars brought of the road, the CRD saves $100,000 in infrastructure costs. You have also been told that the relevant discount rate is 5%.
Using only the information provided, do the following.
1. What is the NPV of both projects? Using Microsoft Excel (or similar spreadsheet software), create a model for the Net Present Value of all cash flows. Provide an annual breakdown of all the benefits and costs of each project. Show any relevant tables which will help make your case and help the reader understand the basis for your NPV calculation. (You should not you’re your entire model! But you should include your spreadsheet model for both projects in an appendix.) Discuss which project the NPV suggest the CRD should pursue, if any.
2. Calculate and interpret the internal rate of return (IRR) for both projects? Discuss the strengths and weakness of using this measure to determine the best course of action for the CRD.
3. Calculate and interpret the payback rate of these two projects. Discuss which project is more desirable according to this criteria. Discuss the advantages and disadvantages of using this approach.