A construction firm is developing a large upscale residential community in the foothills outside of town. As part of the development streetlights need to be installed in each phase of the development. The firm must either pay a subcontractor to install the streetlights or else install the lights themselves. If the developer installs the lights themselves, they will need to purchase a large storage container for the lights and installation materials. The storage container will cost $30,000 and be depreciated to a book value of $0 over 3 years on a straight-line basis. Also, the developer will need to purchase $1,000 of new inventory, $500 of which will be on accounts payable. It will take three years to install all the streetlights in this development and the cost to install the lights will be $2,000 per year. When the project is over, the developer plans to sell the storage container for $5,000 and return the inventory and accounts payable to pre-project levels. The developer’s tax rate is 21%. Hiring a subcontractor will cost the developer $11,000 per year. If the developer’s weighted average cost of capital is 15%, what is the NPV of the developer installing the streetlights themselves? What is the IRR? Should the developer install the lights themselves or hire a subcontractor to do it?

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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A construction firm is developing a large upscale residential community in the foothills outside of town. As part of the development streetlights need to be installed in each phase of the development. The firm must either pay a subcontractor to install the streetlights or else install the lights themselves. If the developer installs the lights themselves, they will need to purchase a large storage container for the lights and installation materials. The storage container will cost $30,000 and be depreciated to a book value of $0 over 3 years on a straight-line basis. Also, the developer will need to purchase $1,000 of new inventory, $500 of which will be on accounts payable. It will take three years to install all the streetlights in this development and the cost to install the lights will be $2,000 per year. When the project is over, the developer plans to sell the storage container for $5,000 and return the inventory and accounts payable to pre-project levels. The developer’s tax rate is 21%. Hiring a subcontractor will cost the developer $11,000 per year. If the developer’s weighted average cost of capital is 15%, what is the NPV of the developer installing the streetlights themselves? What is the IRR? Should the developer install the lights themselves or hire a subcontractor to do it?

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