Direct and indirect construction costs total $580,000 and exclude incentive. A separate supported entrepreneurial incentive is 8% of that base. Land and other additions are excluded. What full improvement cost results?
Correct Answer
C) $626,400
580000×1.08 = 626400. Common errors: leaving out the entrepreneurial incentive gives $580,000; reporting only the incentive gives $46,400; grossing up by dividing by 0.92 instead of adding 8% of the base gives $630,435.
Why This Is the Correct Answer
Option C is correct because full economic cost includes direct costs, indirect costs and a market-supported entrepreneurial incentive. The incentive is 8% of $580,000, or $46,400, so the full cost is $580,000 × 1.08 = $626,400.
Why the Other Options Are Wrong
Option A: $46,400
Option A, $46,400, reports only the incentive: $580,000 × 0.08 = $46,400. The question asks for the full improvement cost, which is $580,000 + $46,400 = $626,400.
Option B: $580,000
Option B, $580,000, leaves out the entrepreneurial incentive. Full improvement cost adds the 8% incentive, giving $580,000 × 1.08 = $626,400.
Option D: $630,435
Option D, $630,435, grosses up by dividing by 0.92: $580,000 ÷ 0.92 = $630,435. That treats 8% as a share of the total, but the stem defines it as 8% of the base, so the result is $580,000 × 1.08 = $626,400.
Percent of Base Means Multiply
If the incentive is a percent of the cost base, multiply the base by (1 + rate). Divide by (1 − rate) only when it is a percent of the total.
How to use: Use this to choose between add-on and gross-up methods for incentive.
Exam Tip
Identify the base the percentage is stated on before deciding whether to multiply or divide.
Common Mistakes to Avoid
- -Omitting entrepreneurial incentive from cost new
- -Grossing up when the rate is stated on the base
- -Reporting the incentive alone as the cost
Concept Deep Dive
Analysis
This question tests adding entrepreneurial incentive to direct and indirect costs to reach full improvement cost. The incentive is stated as 8% of the cost base, so it is added on top of that base rather than grossed up.
Background Knowledge
Full economic cost includes all direct costs, all indirect costs and a market-supportable entrepreneurial profit or incentive. Entrepreneurial incentive is the reward a developer expects for the risk and effort of a project. How the percentage is applied depends on how the market or the problem defines its base.
Real-World Application
An appraiser estimates $580,000 in direct and indirect costs for a new building and finds that local developers expect an 8% incentive on cost. She adds $46,400 to reach a full cost new of $626,400.
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