To raise some revenue to fund other operations, Monroe County is considering turning the stretch of IN-37 that passes through the county into a toll road. You are an analyst for New Capital, an investment firm that is considering whether to contract with Monroe County to lease and operate the toll road. You are advising Susan Jansen, the director of New Capital, given the following information provided by the county.

All project data are in NOMINAL terms. The annual inflation rate is expected to be 3.3% over the lifecycle of this project. The project would start immediately (2018 would be year 0).

The county would lease the road for an initial fixed payment of $2.5 million in year 0, and yearly lease payments of $565,000 in years 1 through 25. In year 26, the toll road reverts back to the county.

The lessee will have two options for the collection of tolls.

First, they could install manual toll booths in which employees would collect tolls at each end of the stretch of road, and charge a flat rate of $2.00 for cars ($4.00 for trucks) to use the entire length of road. These tolls would be adjusted periodically. The expectation is that tolls under this option would bring in $635,000 in year 1, with an expected increase of 5% annually in years 2-25.    

Second, they could replace some of the manual tolls in the first option with I-Zoom electronic toll booths, in which case $1.50 per car ($3.00 per truck) would automatically be debited each time a car (or truck) with a transponder went under the I-Zoom toll. Vehicles that didn’t have the device would be charged $4.00 per car ($8.00 per truck). This type of toll system is expected to yield revenue of $615,000 in year 1, and is expected to increase at 5% annually in years 2-25.

Under either of these options, the increase in tolls could be as high as 6% annually or as low as 4% annually.

The county has stipulated that the lessee of the road will be responsible for constructing toll booths (which will cost $163,000 in year 0 for all manual toll booths, or $335,000 in year 0 if a mix of manual and I-Zoom booths are also used). The lessee will also be responsible for upgrading the road ($200,000 each year for years 0, 1, 2, and 3).

At the end of the project the lessee will be able to sell the toll equipment back to the county. It is expected that the 25-year old equipment will have a value of $32,000 for all manual toll booths, or $70,000 if a mix of manual and I-Zoom booths are also used.

The lessee will also have to maintain the road, which will cost $18,000 in year 4, and is expected to increase at 4.5% per year for years 5-25 (though the increase could be as high as 5% or as low as 4%).

In addition, they will have to pay for employees to collect and maintain the tolls. For manual tolls only, labor will cost $278,000 starting in year 1; for manual and I-Zoom, labor will cost $135,000 starting in year 1. Labor costs are expected to grow 5.2% annually, but the growth could be as low as 4.7% or as high as 5.7%.

To help defray the costs of construction and maintenance, the lessee will be allowed to sell advertising along this stretch of road. This is expected to yield revenues of about $150,000 in year 1, increasing at 4% annually.

Finally, a tax of 4.9% of gross toll and advertising revenue would be paid to the state of Indiana annually.

The director of the firm wants to know if she should invest in this project, and if so, which type of toll system should be built. Her REAL hurdle rate is 6%. You are to do an analysis of the two options under the set of base assumptions, as well as a best case/worst case sensitivity analysis.