MN 4020-Engineering

Economics
Assignment 1
Question 1

Net present value is given by following equation.

NPV=FV x discount factor

Where;

FV= future value

Discount factor is given by following equation.

Discount factor = 1(1+i)n

Where;

I= interest rate

n= year

G. W. J. DE. SILVA 070084V

S. L. JAYADASA 070184D
Net present value of cost incurred by = -10000 – 6000. 1(1+0.1)1 – 40000. 1(1+0.1)2
W. A. N. PERERA 070365J
construction for 2 years =$ -18760.2
S. A. K. C. RUPARATHANA 070414K
Net present value of benefits occurred = 500 N=3201(1+0.1)N

by coliseum for year 3-20 = $3,389.00

Likewise we can calculate the net present values for all the costs and benefits. All the values
can be tabulated as follow.

Type of Cost Benefit Year Annual Benefit(+) Discount Total CF

or Cost (-) Factor
(‘000)

Construction outlay 0 -10000 1 -10000.00

Construction outlay 1 -6000 0.9091 -5454.60

Construction outlay 2 -4000 0.8264 -3305.60

Increased Employment 0 4560 1 4560.00

Increased Employment 1 2736 0.9091 2487.30

Increased Employment 2 1824 0.8264 1507.35

Coliseum 3-20 500 6.778 3389.00

State Fair attendance 3-20 1000 6.778 6778.00

Convention & Hotel facility 3-20 1500 6.778 10167.00

Dog Racing track 3-20 1000 6.778 6778.00

Benefit-cost ratio can be defined as follow.

Benefit cost ratio= present worth of benifits present worth of costs

Benefits- cost ratio =

4560.00+2487.30+1507.35+3389.00+6778.00+10167.00+6778.0010000.00+5454.60+3305.60

Benefits- cost ratio = 1.90

Question 2

Benefits-cost ratio = 1.90 > 1

Total NPV > 0

Hence the redevelopment program is viable and should be undertaken.

Question 3

Fairgrounds redevelopment, project has many secondary benefits for the community and the
surrounding of Detroit standard metropolitan statistical area.

Once the development programme has been carried out, the living standard of the community
is expected to increase by giving numerous benefits to the community. Once the
infrastructure is improved massive scale organic growth can also be expected in the area.
With that, there will be new investments in the area and rapid industrial development can be
expected.
This will attract new communities to the area and that will automatically accelerate the
development in the neighbourhood. In the long run this will result to increase the demand for
the real estate of the area.

There are several costs which can be identified. There will be a big expenditure incurred in
maintaining the infrastructure and for the operation of those facilities. This would require a
continuous allocation of resources. The state will have to incur increased utility costs such as
electricity, water, communication etc.

And also there would be a cost for the managerial and supervisory tasks since a project of this
magnitude would require a considerable amount of operational cost as for wages of the
employees.

In terms of intangibles associated with the project the following can be noted,

• Higher recreational value/ living standards

• Greater social intimacy
• Attractive holiday destination
• Increased reputation

Question 4

To associate the benefits mentioned above the main assumption should be that the workers
for the project will be generated from the Detroit Standard Metropolitan Statistical Area. The
following general assumptions of the region could be made if the above is to be true,

• Availability of unemployed workers

• Lack of more attractive employment options
• Availability of skilful workers for the project
• Willingness to undertake short term employment (40hrs per week)

Question 5

Assuming that employment benefits are not included in the analysis

Type of Cost Benefit Year Annual Benefit(+) Discount Total CF

or Cost (-) Factor
(,000)

Construction outlay 0 -10000 1 -10000.00

Construction outlay 1 -6000 0.9091 -5454.60

Construction outlay 2 -4000 0.8264 -3305.60

Coliseum 3-20 500 6.778 3389.00

State Fair attendance 3-20 1000 6.778 6778.00

Convention & Hotel facility 3-20 1500 6.778 10167.00

Dog Racing track 3-20 1000 6.778 6778.00

Benefit-cost ratio = 3389+6778+10167+667810000+5454.6+3305.6

Benefit cost ratio = 1.45

The desirability of the project is not affected since it is still > 1.

This follows the important assumption that the loss of employment benefits does not call for
extra expenditure. For example, if workers are sourced from outside of Detroit, costs need to
be incurred to provide accommodation, transportation etc. Also it is assumed that the loss of
benefits have no effect on the other benefits such as attendance, construction costs etc.

It is still attractive at 1.45 benefit/cost ratio, yet the above factors should also be considered
when making the decision.

Question 6

The assumption here would be that the facility attracts visitors additionally to what the
existing hotel & convention facilities offer. It assumes that no switching of customers from
the existing to the new facility doesn’t happen.

Since this is a new facility visitors will prefer them over the existing ones. Hence although
the new facility will generate more revenue it will be at the cost of existing ones. Thus it is
not realistic to assume that this additional income would happen as such at the very
beginning.

If the existing facilities also upgrade to match what is on offer and also the project generates
enough buzz to attract more patrons then only can this assumption considered realistic.
Question 7

Assuming that only $500,000 of the facility’s annual revenue can be attributed to new
convention and hotel business

Type of Cost Benefit Year Annual Benefit(+) Discount Total CF

or Cost (-) Factor (,000)
(,000)

Construction outlay 0 -10000 1 -10000.00

Construction outlay 1 -6000 0.9091 -5454.60

Construction outlay 2 -4000 0.8264 -3305.60

Coliseum 3-20 500 6.778 3389.00

State Fair attendance 3-20 1000 6.778 6778.00

Convention & Hotel facility 3-20 500 6.778 3389.00

Dog Racing track 3-20 1000 6.778 6778.00

Benefit-cost ratio = 3389+6788+3389+678810000+5454.6+3305.6

Benefit-cost ratio = 1.08

It is still desirable as the NPV is positive and the Benefits/Costs ratio is >1. Yet this value is
only marginally greater than 1. Hence caution should be advised in executing the project
since unexpected expenses may plummet the ratio below a favourable level.

Question 8

Assuming that the fairground is unable to obtain a license to operate a dog-racing track

Type of Cost Benefit Year Annual Cash Flow PV Factor Total CF

(,000) (,000)

Construction outlay 0 -8500 1 -8500.00

Construction outlay 1 -5100 0.9091 -4636.41

Construction outlay 2 -3400 0.8264 -2809.76

Coliseum 3-20 500 6.778 3389.00

State Fair attendance 3-20 1000 6.778 6778.00

Benefit-cost ratio = 3389+67788500+4636.41+2809.76

Benefit-cost ratio = 0.64

The project is no more desirable since both,

• total NPV is negative

• Benefits/Cost ratio is less than 1.

Question 9

Question 10

When there are two or more projects to be evaluated, Cost-effectiveness analysis (CEA) can
be used as an economic analysis to compare the relative costs and outcomes (effects) and to
decide on the best option. Furthermore it should be noted that, Cost-effectiveness analysis
combines, effective factors as well as monetary factors of the project.

In the given case of, Michigan State Fairgrounds there is only one major project to be
evaluated and there are no other options to compare it with. Since Cost-effectiveness
analysis requires several projects to compare and evaluate with each other it cannot be
applied to the given scenario.

In contrast to this, cost benefit area proves one final result whether the project is feasible or
not, where as in Cost-effectiveness analysis (CEA) such result cannot be arrived at.

In conclusion Cost-effectiveness analysis (CEA) is not applicable to evaluate the given

project.