Nowhereton is a coastal town with a small population, mostly known for being home to the now almost extinct seven fingered Deliciosa Treefrog. Other than by sea, the only way of accessing the town is via a rough dirt road off a main expressway. Recently the local council has been considering making the town more accessible by improving the condition of the road. In the past two years, there have been several instances where critically ill or injured residents have had to be airlifted out of the town because driving out was not viable. Other likely benefits from having a better road include higher land values, greater potential for revenue from tourism related activities, and convenience for residents who may have to leave town for things such as supplies or routine medical treatment. However, one major drawback would be the increased likelihood of damage to the environment and native wildlife due to a larger tourist population and more movement throughout the area.

The following financial information has been provided to the council in order to help with the decision. While the road itself would last many years, the council has decided to analyses the costs over a 5-year time horizon and apply its usual hurdle rate of 12% for capital expenditure projects. The tax rate is 30% (were going to assume the council pays tax!).

Required: 1. Should the council reject the road project based on the negative NPV? Discuss two (2) potential issues with the council using NPV to make a decision about this road into Nowhereton.

Cost of clearing land Cost of levelling the ground Cost of tarring the new road Cost of sealing the road Cost of lighting and signage Annual maintenance cost of road Annual revenue from road tolls $ 100,000 30,000 10,000 10,000 60,000 12,000 35,000 *Note: costs of developing the road are one-off in nature and will not be depreciated. The council calculated the net present value of the proposed road project as follows: $ Revenue from road tolls 35,000 Less maintenance cost of road 12,000 Pre-tax annual incremental benefits 33,000 Tax @ 30% 9,900 After-tax annual incremental benefits 23,100 Present value of after-tax annual incremental benefits (@ 3.6048) 83,270.88 Less Initial investment 210,000 NPV of the project -126,729.12