Reference no: EM131361026

A city is planning a new convention center and has received bids from two contractors. One contractor's proposal would cost $10,000,000 to build plus upkeep of $150,000 per year for its expected 30-year life span. Annual revenues are known with certainty to be $1,000,000. Salvage value at the end of the 30 years is expected to be zero. The second contractor proposes a larger and more durable facility at an initial cost of $20,000,000. This facility will also have an expected life span of 90 years and maintenance costs will be $400,000 per year. Because this facility is considerably larger, there is some uncertainty regarding the rate at which it will be utilized. Consequently, it is estimated that there is a 75% probability that annual earnings over each of the 30 years will be $3,000,000 and a 25% probability that annual earnings will be only $1,500,000. (Expected annual earnings = .75*3,000,000 + .25*1,500,000). Finally, it is anticipated that at the end of the 90 years the entire structure will have to be torn down at a cost of $5,000,000. If the city uses a discount rate of 7%, should it build either facility? If so, which one? Please briefly explain the basis for your conclusions. If both yield a positive net present value, explain/show how you will go about choosing between them using the roll-over method. In answering these questions, assume that all the relevant benefits and costs are listed above. Also assume that the discount rate and the dollar figures appearing above are all measured in real terms and that the annual rate of inflation is 2%.