A government is offering a 10 year contract for off-shore drilling rights. The h

Question

A government is offering a 10 year contract for off-shore drilling rights. The highest bonus bid is $5 million dollars. However, another firm offers to $800,000 per year for 10 years in production royalties. a. (3 points) What is the PV of the bonus bid if the discount rate is 5%? b. 3 points) What is the PV of the production royalties if the discount rate is 5%? 3. (15 points) A local landfill currently charges $100 per half ton load of waste to dump. The marginal costs to the landfill of operating the dump are about $60 per half ton load of waste. A nearby incinerator charges $120 per half ton of waste, and it costs about $5 per half ton more to haul it to the incinerator.

Explanation / Answer

a) PV for bonus bid :-
= 5000000/(1-0.05) + (5000000/(1-0.05)^2 + 5000000/(1-0.05)^3 + 5000000/(1-0.05)^4 + 5000000/(1-0.05)^5 + 5000000/(1-0.05)^6 + 5000000/(1-0.05)^7 + 5000000/(1-0.05)^8 + 5000000/(1-0.05)^9 + 5000000/(1-0.05)^10
= 67018257 $
b) PV = 800000/(1-0.05) + (800000/(1-0.05)^2 + 800000/(1-0.05)^3 + 800000/(1-0.05)^4 + 800000/(1-0.05)^5 + 800000/(1-0.05)^6 + 800000/(1-0.05)^7 + 800000/(1-0.05)^8 + 800000/(1-0.05)^9 + 800000/(1-0.05)^10
= 10722921 $
A local landfill charges 100 $ for 1/2 ton of waste
MC = 60 $ for 1/2 ton of waste
Incinerator charges 120$ for 1/2 ton waste
So, total charged by incinerator = 120+5 =125$
Landfill charges are more compared to incinerator as MC is also there in case of landfill charges.
It is better to go for ininerator dumping of wastes.

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