<PAGE>
 
                                                                    EXHIBIT 10.7

                       SUPPLEMENTAL DEVELOPMENT AGREEMENT
                       ----------------------------------


     THIS AGREEMENT, made as of the 18th day of April, 1997, by and among THE
STATE OF MINNESOTA ACTING THROUGH ITS OFFICE OF THE COMMISSIONER OF IRON RANGE
RESOURCES AND REHABILITATION (hereinafter referred to as the "IRRRB"), the GRAND
RAPIDS ECONOMIC DEVELOPMENT AUTHORITY, a public body politic and corporate and a
political subdivision under the laws of the State of Minnesota (hereinafter
referred to as the "Authority"), and ASV, INC., a Minnesota corporation
(hereinafter referred to as "ASV").

                                    RECITALS
                                    --------

     A.   The IRRRB, the Authority and ASV entered into a Development Agreement
as of July 14, 1994 in order to provide for construction of a manufacturing
facility (the "ASV Manufacturing Facility") to be located upon certain land
(identified in the Development Agreement as the "Land").

     B.   The Authority is in the process of acquiring fee title to certain
additional land (the "Additional Land"), as described in Exhibit "A" attached,
located in the City of Grand Rapids, County of Itasca, State of Minnesota, which
will be leased by the Authority to ASV pursuant to a supplemental lease (the
"Supplemental Lease"), a copy of which is attached as Exhibit "B", which will
supplement and modify the terms of that certain Lease and Option Agreement (the
"Lease"), entered into as of July 14, 1994 by and between the Authority and ASV
with regard to the Land and pursuant to the Development Agreement.

     C.   The Additional Land is subject to a Ground Lease and Assignment (the
"Ground Lease") dated November 27, 1996, a copy of which is attached hereto as
Exhibit "C".  It is the intent of the parties that this Ground Lease shall
terminate prior to execution of the Supplemental Lease and that any improvements
and partial improvements shall, pursuant to the terms of the Ground Lease,
become the property of the Authority.

     D.   The IRRRB, the Authority and ASV desire to supplement and modify the
Development Agreement, and other documents and agreements made and entered into
pursuant to or otherwise relating to the Development Agreement in order to
construct additions and improvements to the ASV Manufacturing Facility (as
defined in the Development

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<PAGE>
 
Agreement). These improvements and additions (the "Phase II Development") shall
be constructed upon the Additional Land and a portion of the Land.

     E.   The Authority and ASV have agreed to cooperate in obtaining from
Norwest Bank Minnesota North, National Association, (the "Bank") a loan to
enable construction of the Phase II Development (the "Norwest Loan") to be
secured by the Land, ASV Manufacturing Facility, the Additional Land and the
Phase II Development.

     F.   The IRRRB intends to become a participant with Norwest in the Norwest
Loan, upon terms and conditions to be separately negotiated between the Bank and
the IRRRB.

     NOW, THEREFORE, in consideration of the foregoing and the mutual
obligations of the parties hereto, each of them does hereby covenant and agree
with the others as follows:

                                   ARTICLE I 

             RATIFICATION AND CONTINUANCE OF DEVELOPMENT AGREEMENT
             -----------------------------------------------------

     1.1  Except as is specifically deleted, replaced or otherwise modified by
          express terms of this Supplemental Development Agreement, all terms
          and conditions of the Development Agreement shall continue in full
          force and effect, unaffected by this Supplemental Development
          Agreement.

     1.2  All representations, warranties, covenants and obligations contained
          in the Development Agreement, not so deleted, replaced or modified,
          are hereby ratified and reaffirmed by the IRRRB, the Authority and
          ASV, to extend to the Additional Land and the Phase II Development.

                                   ARTICLE II

                    CONSTRUCTION OF THE PHASE II DEVELOPMENT
                    ----------------------------------------

     2.1  The Authority hereby agrees to immediately proceed to acquire fee
          title to the Additional Land free and clear of any liens, encumbrances
          or restrictions except as set forth on the attached Exhibit "A" and to
          furnish all material and labor and to do all things necessary for the
          construction of the Phase II Development in a good and workmanlike
          manner in accordance with the Preliminary Plans and Specifications
          described or set forth on Exhibit "D" attached hereto and made a part
          hereof (the "Preliminary Plans and Specifications") and to complete

                                      -2-
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          the construction thereof in accordance with applicable building and
          zoning regulations, as the same are presently enforced by the
          governmental bodies having jurisdiction thereof. ASV agrees to
          forthwith cause final plans and specifications for the Phase II
          Development (the "Final Plans and Specifications") to be prepared in
          accordance with the Preliminary Plans and Specifications. When said
          Final Plans and Specifications have been approved by the Authority and
          ASV, a list and description of said Final Plans and Specifications
          shall be attached to each party's copy of this Agreement and the
          Authority shall construct and complete the Phase II Development in a
          good and workmanlike manner in accordance with said Final Plans and
          Specifications and the aforesaid applicable building and zoning
          regulations.

     2.2  The Authority and ASV shall cause the Phase II Development to be
          substantially completed in accordance with the approved Final Plans
          and Specifications on or before January 1, 1998, provided, however,
          that in the event substantial completion is delayed by act or neglect
          of ASV or those acting for or under ASV, by the Authority's inability
          to obtain materials, by act of God, act of war, act of governmental
          authority other than the Authority, labor disputes, fire weather,
          casualties, changes requested by ASV to the approved plans and
          specifications or any other cause beyond the control of the Authority,
          then the time for completion shall be extended for the period of any
          such delay.

     2.3  Particularly, ASV has been made aware that the Additional Land is
          currently owned in fee by the City of Grand Rapids, a Minnesota
          municipal corporation, for the benefit of the Itasca County Grand
          Rapids Airport Commission, is subject to certain zoning ordinances and
          other conditions relating to the Additional Land and that approval of
          acquisition of the Additional Land by the Authority, and construction
          of the Phase II Development is subject to approval by the Federal
          Aviation Administration, which is beyond the control of the Authority,
          and the time for completion shall specifically be extended for a
          period of any delay occasioned by the Federal Aviation Administration.

                                      -3-
<PAGE>
 
     2.4  ASV hereby agrees to pay the amount, if any, by which the total cost
          of the Phase II Development, including attorney fees, Construction
          Manager fees and other direct costs or out-of-pocket payments for the
          Phase II Development shall exceed the total of the proceeds of the
          Norwest Loan and the sum of $7,500.00, and shall provide the IRRRB and
          the Authority reasonable evidence and assurances that ASV can pay such
          amount, if any, as it becomes due and payable. That amount shall not
          be interpreted to include the value of improvements to the Additional
          Land prior to the effective date of the Supplemental Lease, or any
          items of personalty acquired by ASV to become improvements or fixtures
          upon the Additional Land and which were acquired for such purposes
          pursuant to the Ground Lease. A schedule of these items is attached
          hereto as Exhibit "E".

     2.5  The parties agree that the portion of the Phase II Development
          constructed upon the Land, and in accordance with the Preliminary
          Plans and Specifications and the Final Plans and Specifications, shall
          be permitted as alterations, additions or improvements to the Lease
          Property pursuant to Article IX of that certain Lease and Option
          Agreement between the authority and ASV dated as of July 14, 1994.
          Those alterations, additions or improvements shall remain subject to
          all terms of that Lease and Option Agreement, which shall be otherwise
          deemed unaffected by the Supplemental Development Agreement or any
          other documents or agreement entered into pursuant hereto.

                                  ARTICLE III

                          SUPPLEMENTAL LEASE AGREEMENT
                          ----------------------------

     3.1  As soon as feasible following acquisition of the Additional Land by
          the Authority, the Authority and ASV shall each execute and deliver
          the Supplemental Lease.

     3.2  ASV shall remain obligated to make all payments of monthly rental
          pursuant to the Lease, together with all additional payments of
          monthly rent as set forth in the Supplemental Lease.
 

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<PAGE>
 
     3.3  At such time the Authority has acquired fee title in the Additional
          Land, it shall grant to the IRRRB a mortgage thereon as additional
          collateral supplementing the Mortgage dated as of August 17, 1994
          between the Authority and the IRRRB with regard to the Land,
          subordinate to the Norwest Loan.

                                   ARTICLE IV

                             ADDITIONAL PROVISIONS
                             ---------------------

     4.1  Authority Representatives Not Individually Liable.  No member,
          official or employee of the Authority shall be personally liable to
          ASV, or any successor in interest, in the event of any default or
          breach by the Authority or for any amount which may become due to the
          ASV or successor or any obligations under the terms of this Agreement.

     4.2  Titles of Articles and Sections.  Any titles of the several parts,
          articles and sections of this Agreement are inserted for convenience
          of reference only and shall be disregarded in construing or
          interpreting any of its provisions.

     4.3  Notice and Demands.  Except as otherwise expressly provided in this
          Agreement, a notice, demand or other communication under this
          Agreement by any party to any other party hereto shall be sufficiently
          given or delivered if it is dispatched by registered or certified
          mail, postage prepaid, return receipt requested, or delivered
          personally; and

          A. In the case of ASV, is addressed to or delivered
             personally to ASV at 840 Lily Lane, Grand Rapids, Minnesota 55744.

          B. In the case of the Authority, is addressed to or delivered
             personally to the Authority at City Hall, 420 North Pokegama
             Avenue, Grand Rapids, Minnesota 55744.

          C. In the case of IRRRB, is addressed to or delivered personally to
             the IRRRB at Box 441, Highway 53 South, Eveleth, Minnesota 55734.

          Each party hereto may from time to time by notice to the other parties
          hereto as provided above change the address with respect to such
          party.

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     4.4  Counterparts.  This Agreement may be executed in any number of
          counterparts, each of which shall constitute one and the same
          instrument.

     IN WITNESS WHEREOF, the Authority, the IRRRB and ASV have each caused this
Agreement to be duly executed in its name and behalf on or as of the date first
above written.
                                    GRAND RAPIDS ECONOMIC
                                    DEVELOPMENT AUTHORITY
       

                                    BY:   /s/ Skip Drake
                                        --------------------------
                                              Its President

                                    AND:  /s/ Thomas Saxhaug
                                        --------------------------
                                               Its Vice President

                                    ASV, INC.


                                    BY:   /s/ Gary Lemke
                                        --------------------------
                                              Its President


                                    THE STATE OF MINNESOTA ACTING
                                    THROUGH ITS OFFICE OF THE
                                    COMMISSIONER OF IRON RANGE
                                    RESOURCES AND REHABILITATION


                                    BY: /s/ Shawn K. Harper
                                        -------------------
                                            Its Deputy Commissioner

STATE OF MINNESOTA  )
                    ) ss.
COUNTY OF ITASCA    )

     The foregoing instrument was acknowledged before me this 18th day of April,
1997, by Skip Drake and Thomas Saxhaug, the President and Vice President,
respectively, of the Grand Rapids Economic Development Authority, a public body
politic and corporate and a political subdivision under the laws of the State of
Minnesota, on behalf of the body.


                                        /s/ Sara L. Holum
                                        ----------------------------
                                            Notary Public

                                      -6-
<PAGE>
 
STATE OF MINNESOTA  )
                    ) ss.
COUNTY OF ITASCA    )

     The foregoing instrument was acknowledged before me this 17th day of April,
1997, by Gary Lemke, the President of ASV, Inc. a corporation under the laws of
the State of Minnesota, on behalf of the corporation.


                                                    /s/ Jacquelyn M. Berard
                                                    ---------------------------
                                                        Notary Public


STATE OF MINNESOTA  )
                    ) ss.
COUNTY OF ST. LOUIS )

     The foregoing instrument was acknowledged before me this 27th day of May,
1997, by Shawn K. Harper and ___________________, the Deputy Commissioner and
____________________, respectively, of the State of Minnesota acting through its
office of the Commissioner of Iron Range Resources and Rehabilitation, on behalf
of the State


                                                  /s/ Sheryl Ann Aho Kochevar
                                                  -----------------------------
                                                      Notary Public

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                                LIST OF EXHIBITS
<TABLE>
<CAPTION>
 
<S>               <C>  
Exhibit "A"       - Legal Description of Additional Land
 
Exhibit "B"       - Supplemental Lease
 
Exhibit "C"       - Ground Lease
 
Exhibit "D"       - Preliminary Plans and Specifications
 
Exhibit "E"       - Personalty to Become Improvements or Fixtures
</TABLE>

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