Suppose the City of Waco is considering building a new hiking trail. The trail will be on land that the City currently leases to a farmer for $20,000 annually. To build the trail, the City must discontinue the lease and spend $40,000 in the current year (year 0) for trail construction. The City will bring in a total of $45,000 annually for 5 years (starting in year 1 when the construction is completed) in entrance fees. Annual maintenance and operation costs come to $10,000 (for years 1 through 5). (Assume all costs and benefits are fully included in the preceding description. Round your answers to the nearest cent.)
a. What is the net present value of the hiking trail to the City of Waco if the discount rate is 5%? According to your analysis, should the project be undertaken?
b. What is the net present value of the hiking trail to the City of Waco if the discount rate is 10%? According to your analysis, should the project be undertaken?
c. From the preceding calculations you can see the effect of using a higher discount rate, but why would you use a higher discount rate? That is, what does the discount rate represent and thus when would a higher discount rate be appropriate?
d. Issues surrounding discounting are highly controversial. Present one argument for and one argument against discounting.