Question

The city of Ottawa is considering to build a new toll highway that spans from Orleans to Kanata, the project cost is estimated to be $90,000,000 and is to be paid in 3 equal payments (Payment 1 before commencement, Payment 2 at the end of the 1st year and Payment 3 at the end of 2nd year when the construction is done). The feasibility assessment of this project is 25 years after construction. This highway benefits the city a total of $5,000,000 by reducing travel times and safety improvements and would generate toll revenues of $7,000,000 per year. The O&M costs for the proposed highway is expected to be $2,100,000 per year. ** The revenues in terms of toll fares are to be treated as negative costs not benefits, i.e., there is no direct benefit to the society by charging the motorists. If the social discount rate for this project is chosen to be 5.5%. Calculate the benefit/cost ratio of this project and comment on its feasibility.

Answer 1

The project is not feasible.

The net benefit to society = $5000000 - $2100000 = $2900000

The cost of the project = 90000000.  

Return on investment is only 2.9 million / 90 million = 3.22% whereas the social discount rate itself is 5.5%. The project cost will not be recovered.