The government has hired you to advise them on the merits of a project that is b
ID: 1139996 • Letter: T
Question
The government has hired you to advise them on the merits of a project that is being proposed. The project is expected to generate benefits of $14 million today, $5 million in one year from today, and $1 million in two years from today. (These are the only years of concern). The project costs nothing today, but will cost $20 million in two years. Assume the interest rate is 10%. Just focus on the net present value of the stream of benefits and costs. If the benefit-cost ratio is greater than 1, the project should be allowed. What is your policy suggestion?
Explanation / Answer
Net present value ($ Million) = 14 + 5 x P/F(10%, 1) + 1 x P/F(10%, 2) - 20 x P/F(10%, 2)
= 14 + 5 x 0.9091** + 1 x 0.8264** - 20 x 0.8264**
= 14 + 4.55 + 0.82 - 16.53
= 2.84
Since NPV > 0, project should be allowed.
Benefit-cost ratio (NCR) = Present value of benefits / Present value of costs
= $[14 + 5 x P/F(10%, 1) + 1 x P/F(10%, 2)] million / $[20 x P/F(10%, 2)] million
= (14 + 5 x 0.9091** + 1 x 0.8264**) / (20 x 0.8264**)
= (14 + 4.55 + 0.82) / 16.53
= 19.37 / 16.53
= 1.17
Since BCR > 1, project should be allowed.
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