Question

RECEV V VI Pulid L UWTULUI. 3. A town's recreation department is trying to decide how to use a piece of land. One option is to put up basketball courts with an expected life of 8 years. Another is to install a swimming pool with an expected life of 24 years. Tee basketball courts would cost $180,000 to con- struct and yield net benefits of $40,000 at the end of each of the 8 years. The swimming pool would cost $2.25 million to construct and yield net benefits of $170,000 at the end of each of the 24 years. Each project is assumed to have zero salvage value at the end of its life. Using a real discount rate of 5 percent, which project offers larger net benefits?

Answer 1

In order to find out which project offer larger net benefits; it is important to calculate present value (PV) of the net benefits of each alternative. Option 1: Basketball court PV(NB) = PV(benefit) - PV(cost) PV(NB) = 40,000(P/A,5%,8) – 180,000 PV(NB) = 40,000(6.463) – 180,000 PV(NB) = $78,520 Option 2: Swimming pool PV(NB) = PV(benefit) - PV(cost) PV(NB) = 170,000(P/A,5%,24) – 2,250,000 PV(NB) = 170,000 (13.799) – 2,250,000 PV(NB) = $95,830 Since PV of net benefits of constructing a swimming pool are greater than that of constructing a basketball court, it is optimal to construct a SWIMMING POOL