ECOR3800-C: Assignment 2

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ECOR 3800C - Assignment #2

Due Date: March 1, 2011 4:00 PM
Learning objective tested: Understand equivalent uniform annual worth and be able to independently develop analytical solutions to this problem.

2-1

For the following cash flow diagram, calculate the value of R that results in an equivalent uniform annual worth of zero. Assume interest rate of 10%.
R R R R R R R

$1,000

$1,000

$1,000

Learning objective tested: Develop analytical solutions to projects with infinite analysis period.

2-2

For the cash flow diagram presented in problem 2-1, develop an analytical expression of the equivalent uniform annual worth if this 6-year investment cycle is repeatable for infinite number of times.

Learning objective tested: More sophisticated understanding of cash flow diagrams, using equivalent uniform annual worth and incremental analysis for project evaluation.

2-3 The City of Sunnyside is contemplating a new highway development. This highway will connect the burgeoning urban centre of Caterpillar to the more established municipality Butterfly. The paths connecting Caterpillar and Butterfly are outlined as follows:

A
Vegetation

Caterpillar

Butterfly

ECOR3800-C: Assignment 2

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Path A is almost the shortest path. It involves vegetation clearance and a 2 km bridge. Total length of Path A is 15 km. Path B circumvents the vegetation area and crosses the nearby river through a 750m bridge. The total length of Path B is 25 km. The highway development was open for bids under a build-own-operate-transfer project financial structure. The awarded contractor will finance the design and the construction of the highway development. Subsequently, the contractor is allowed a 20 year period of limited ownership and operation, after which the highway's ownership will be transferred to the public. Two main contenders emerged: Latso and Woodsie Inc. The cost/benefit estimates of the two companies were as follows:

Latso Inc. (Path A) Item

Earthwork and pavement: Phase 1: Two-lane twoway Part 2 (after 10 years): Two lanes each direction Bridge Toll

Cost
$8 million/km $12 million/km

Woodsie Inc. (Path B) Item Cost

Total construction cost: Phase 1: Transit corridor Part 2 (after 10 years): 1] Parallel two-way two-lane highway 2] Sound barriers Bridge Transit fare $5 million/km $9 million/km

$60 million $5/trip (0--10) $10/trip (10--20)

$5 million $35 million $4/traveler (0--10) $7/traveler (10--20) $10/trip (10--20) 2200 travelers per day to increase by 1300 every 5 years.

Demand forecast:

2000 trips/day to increase by 1000 trips/day for each following 5 years

Highway toll Demand forecast: Transit:

Maintenance: Year 10 Year 20

$2 million/km $4 million/km

Highway (after 10 years): 900 trips/day to increase by 1000 trips/day every 5 years. Operation/maintenance: Transit: Procurement $10 million Operation/maintenance $1 million/yr Highway: Year 20 Cost financing: Cost to the City

Cost financing: Cost to the City

Credit line, 3% interest $450 million

$3 million/km Credit line, 2.5% interest ?

ECOR3800-C: Assignment 2

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You are leading a team to assess the financial feasibility of these two projects from a third-party's perspective. In doing so, the following assumptions are made: 1- Construction costs are concentrated as point costs at time zero and the end of year 10. 2- Revenues during the 20 years after construction are collected by the contractor as uniform annual series. The contractor collects 100% of all revenues during these 20 years. 3- Highway maintenance is conducted every 10 years with costs concentrated at one point. 4- Balance on the project costs is repaid by the contractor to the crediting institution in the form of 20 equal annual instalments distributed over the lifetime of the project. 5- Based on the bidding patterns of Latso and Woodsie, their target interest rate is somewhere in between 5% and 7%. Precisely, the interest rate is Uniformly distributed between the values 0.05 and 0.07. 6- The City will repay the contractor at the end of the operation period the current-dollar project costs. That is, the book value of costs discarding the contractor's discount rate. For example, if the contractor would pay $400 million after 10 years to finance the project at the end, the City would pay the same amount after 20 years. 7- For simplicity, Ignore all other external costs or revenues such as inflation, depreciation, social impact, and corporate taxes. Questions: [2-3-1] Construct the cash flow diagram for both companies. [2-3-2] Calculate the EUAW for both companies, Latso bidding on Path A and Woodsie bidding on Path B, using a discount rate of 6.0% (mean value). [2-3-3] Calculate the Internal Rate of Return (IRR) perceived by both companies. [2-3-4] What is the probabilities that Path A will be feasible for Latso and Path B will be feasible for Woodsie. [2-3-5] From the perspective of a contractor in this profession, other than Latso and Woodsie, find the IRR on the investment increment moving from the project proposed by Woodsie to that proposed by Latso. [2-3-6] Additional information: A committee member raised an objection to Latso's project. The member argued that Latso has externalized all environmental damage due to vegetation clearance. The member argued that Latso's proposal is unconscientious since it ignores the project's impact on the local environment. Advocacy groups estimated that the cost of restoring all existing environmental systems due to vegetation clearance is $1 million/yr for the first 10 years. Question: Including environmental cost, and assuming that the City will not offset this cost, find Lotso's IRR. Comment on the results. --- End of Problems---