A 10-mile stretch of state highway is to be reconstructed at a cost of $30,000,0
ID: 1176851 • Letter: A
Question
A 10-mile stretch of state highway is to be reconstructed at a cost of $30,000,000. Road users' costs on the existing facility are $2,000,000/year and maintenance costs are $6,000/year. The new facility will reduce these to $1,000,000/year and $2,000/year, respectively.
The highway can be rebuilt now, in one year, if a serial bond issue bearing 6%/year, paid semi-annually, is issued for 20 years. If financed out of current taxes, construction will proceed at 2 miles/year, taking 5 years to complete. In each year 1/5 of the construction cost will be paid, and 1/5 of the maintenance and users' costs reductions is experienced.
In either instance, the service life of the new road is considered to be 30 years from the project inception. The minimum desirable rate of return is 8%/year.
As the project manager, which funding plan would you recommend to the state? Why?
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The present worths for both options have to be computed. I have the final answers, so please compare your answer with mine:
Present worth for the serial bond option = $36,764,176
Present worth for the pay-as-you-go option = $36,977,774
We will need to select the best option based on the present worths above, please provide detailed steps on how we computed the present worth values.
Explanation / Answer
I would go with the bond serial option.
In Bond serial option, interest paid will be $1.8 million over than span of 20 years. Considering that the road will be done 4 years before the 2nd option, there is huge savings in maintenance of the road. Over to that the road will remain usable for the next 29 years while if we select the pay as you go option, road will remain usable for the next 25 years. Considering, the benefits, bond serial option is the best way to get this project done.
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