Problem
Conventional capital budgeting techniques are a useful starting point for investment decisions. The Metropolitan Housing Authority is charged with providing housing to low-income residents. The authority is currently assessing two options, each of which would provide homes for 100 families. Under the first option the authority would renovate an existing apartment building that it owns at a cost of $8 million. Tenants would rent their apartments from the authority at subsidized rates. The authority estimates that its net annual cash operating costs (after taking into account the rent paid by the tenants) would be $300,000 per year. The expected remaining useful life of the building would be 20 years. Under the second option, the authority would make direct cash assistance payments to the tenants, and they would arrange for their own housing. The expected annual payment to each family would be $12,000 per year-a total of $1,200,000 per year for 100 families. The authority evaluates all capital projects using a discount rate of 8 percent.
1. Based on the limited information provided, which option would be the more cost-effective?
2. What other financial or nonfinancial factors should the authority consider in selecting between the two options?
Granof, Michael H.; Khumawala, Saleha B.; Calabrese, Thad D.; Smith, Daniel L.. Government and Not-for-Profit Accounting: Concepts and Practices, 7th Edition (Page 692). Wiley. Kindle Edition.