Great White Hall Flatland Views has advertised for proposals to build a new comm
ID: 2771731 • Letter: G
Question
Great White Hall
Flatland Views has advertised for proposals to build a new community center, but the city council cannot agree on how to evaluate the submitted proposals. The request for proposal (RFP) specified that respondents had to meet certain basic needs, although optional items could be included. The RFP also asked that each respondent calculate a benefit/cost (B/C) ratio using a discount rate of 12%. The RFP did specify the approximate size of each optional facility and the use that could be expected (and the value of such use in dollars per hour). The RFP stipulated that the council would select a package of facilities based on estimated construction costs and B/C ratios. Since this package might not match any proposal, the council could issue a new RFP. However, if a new RFP is issued, only respondents to the first RFP may respond. The council’s intent is to provide an incentive for participation in the first RFP. Instead of a second RFP, the council could choose to simply negotiate with one of the original bidders. Three firms responded to the RFP, but they used different assumptions on how to calculate the ratio as well as including different options within their proposals. Their construction materials and associated lives are similar, but their designs differ substantially. The proposals can be summarized as follows.
Tightfisted Proposal
Averell Johnson, the conservative patriarch of the city’s construction community, has proposed a bare-bones facility (see Table 1). Assuming 50 years of use and end-of-period cash flows, his proposal has a B/C ratio of ____. His proposal also assumes that construction expenditures are all made at the start of the construction period.
Table 1. Tightfisted Proposal
Construction Costs and Time:
1 year; $2.5 million
Annual Operation Costs:
Gym: $120,000
City offices: $190,000
Annual Benefit Derived:
Gym: 60 hours/week, 52 weeks/year at $200/hour
Major Projects Proposal
The proposal that has been supported by the “town and gown” crowd includes a small auditorium/theater and a library as well as the gym (see Table 2). Major Projects Inc. has evaluated the proposal over 30 years of use for the benefits and for a 12-month term for the construction phase. Major Projects has assumed end-of-period cash flows, but they have analyzed the construction phase as 12 month - each with an equal share of the construction expenditures. Their calculated B/C ratio is _____.
Table 2. Major Projects Proposal
Construction Costs:
12 months; $4.8 million
Annual Operation Costs:
Gym: $110,000
City offices: $165,000
Library: $450,000 (mostly salaries)
Theater: $65,000
Annual Benefit Derived:
Gym: 60 hours/week, 52 weeks /year at $200/hour
Library: $0.5 million in improved education
Theater: 16 hours/week, 52 weeks/year at $450/hour
Energy Breakthrough Proposal
The third proposal (Table 3) is from a new firm that specializes in the design and construction of energy-efficient structures. They based their B/C ratio, _____, on assumptions of 40 years of use and costs and benefits end-of-period cash flows except the construction cost which is to be paid in full upfront.
Table 3. Energy Breakthrough Proposal
Construction:
1 year; $3.9 million
Annual operation:
Gym: $ 65,000
City offices: $100,000
Theater: $15,000
Annual benefit:
Gym: 60 hours/week at $200/hour
16 hours/week at $450/hour
Council’s Solution
Overwhelmed by the responses, the city council has decided to hire you as a consultant. Your contract requires you to: calculate comparable ratios, to recommend a package of facilities, and to recommend a contractor.
Questions:
A) Which alternative would you select based on B/C ratio analysis?
B) Are there any other consideration you would have in your final decision? If yes, which other factors would influence your final choice?
C) Given that it takes one year to construct any of the facility, 12 % discount rate, useful life of 40 years, construction costs of $1,300,000 for the gym; $1,400,000 for theatre and $900,000 for the library which of the facilities may be justified based on B/C analysis? Note: the benefits derived from each of the facility are as given the case study above.
Construction Costs and Time:
1 year; $2.5 million
Annual Operation Costs:
Gym: $120,000
City offices: $190,000
Annual Benefit Derived:
Gym: 60 hours/week, 52 weeks/year at $200/hour
Explanation / Answer
Evaluation of B/C Ratios A. Tightfisted Proposal Initial cost $2,500,000 Annual Operation cost $310,000 (120000+190000) Annual Benefit 624000 (60hour/week)*(52weeks)*($200/hour) Net annual benefit $314,000 (624000-310000) Number of years of benefit 50 Present value of Benefits $2,607,613 (using excel,Rate=12%,,Nper=50,Pmt=314000) Benefit/Cost Ratio 1.0430 (2607613/2500000) B Major Projects Proposal Initial cost $4,800,000 Annual Operation cost $790,000 (110000+165000+450000+65000) Annual Benefit 1498400 (60hour/week)*(52weeks)*($200/hour)+0.5million+16*52*450 Net annual benefit $708,400 (624000-310000) Number of years of benefit 30 Present value of Benefits $5,706,292 (using excel,Rate=12%,,Nper=50,Pmt=314000) Benefit/Cost Ratio 1.188810901 C Energy Breakthrough Proposal Initial cost $3,900,000 Annual Operation cost $180,000 (65000+100000+15000) Annual Benefit 998400 (60hour/week)*(52weeks)*($200/hour)+16*52*450 Net annual benefit $818,400 (624000-310000) Number of years of benefit 30 Present value of Benefits $6,592,363 (using excel,Rate=12%,,Nper=50,Pmt=314000) Benefit/Cost Ratio 1.690349374 CONCLUSION: Ënergy Breakthrough proposal has the highest Benefit Cost Ratio . Hence,Energy Breakthrough proposal nshould be selected
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