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Touter Solution For Assignment 2

Proposal B has a higher net present value (NPV) of $22.5 billion compared to Proposal A's NPV of $17.78 billion based on an economic evaluation considering consumer surplus, producer surplus, total surplus, costs, and benefits over 60 years with a 10% discount rate. Proposal B also has a higher benefit-cost (B/C) ratio of 2.1 compared to Proposal A's B/C ratio of 2.4. The internal rate of return (IIR) for Proposal B is infinite since the NPV equals zero, while Proposal A has an IIR of 7.4%.

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89 views2 pages

Touter Solution For Assignment 2

Proposal B has a higher net present value (NPV) of $22.5 billion compared to Proposal A's NPV of $17.78 billion based on an economic evaluation considering consumer surplus, producer surplus, total surplus, costs, and benefits over 60 years with a 10% discount rate. Proposal B also has a higher benefit-cost (B/C) ratio of 2.1 compared to Proposal A's B/C ratio of 2.4. The internal rate of return (IIR) for Proposal B is infinite since the NPV equals zero, while Proposal A has an IIR of 7.4%.

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Student Name: Miran MUKERJI ID: 11470174

Financial Evaluation
Item Proposal A Proposal B
Interest Rate (1+Ia)= (1+Ir) (1+If )(1+Ie )=>> 1.15=(1+ Ir)+1.045+0
We use Ir for long term project=> Ir= 10%
PVIFA 9.9672 ≈ 10
(10%,60)
Investment 40bn 40bn
Annual Cost C=40bn x 2.5%= 1bn C=40bn x 5%= 2bn
Annual B= 40,000mn x 0.1=4 bn B= 50,000mn x 0.12=6 bn
Benefit
NPV -I0+(B-C) PVIFA (10%,60)+Ln/(1+i)n
=-40 + (4-1) x 10 + 0 = -10 =-40 + (6-2) x 10+0= 0
IIR 0= -I0+(B-C) PVIFA (i,60) (set NPV to zero)
40= 3 x PVIFA (i,60) 40= 4 x PVIFA (i,60)
PVIFA (i,60) = 13.33 PVIFA (i,60) = 10
(looking in the table for a factor close to this
value)
I= 7%-8% (trying 7.4%, 7.5% and 7.6%) IIR= 10%
IIR= 7.4%
PB Look for n in the table for value that satisfy
PVIFA (10%,n)= 13.33 PVIFA (10%,n)= 10
n=PB>> 60 years n=PB= 60 years
B/C BCR= [B x PVIFA (10%,60)] /[PV of costs]
= (4 x 10)/(40+ 1x 10) = (6 x 10)/(40+ 2x 10)
B/C = 0.8 B/C = 1
EAC =PV Costs x (1/ PVIFA (10%,60))
= (40+ 1 x 10)/10 = (40+ 2 x 10)/10
EAC= 5 bn EAC= 6 bn

Economic Evaluation
PVIFA PVIFA (10%,20) ≈ 8.5 , PVIFA (10%,40) ≈ 9.7 , PVIFA (10%,60) ≈ 10
Consumer Monopoly: Monopoly:
Surplus CSM=0.5 x(30,000 mn)x(0.12-0.08)=0.6bn/y CSM=0.5 x(30,000 mn)x(0.15-0.12)=0.45 bn/y
Total CSM= 0.6bn x PVIFA (10%,20) Total CSM= 0.45bn x PVIFA (10%,20)
Total CSM= 0.6 x 9.7 = 5.1 bn Total CSM= 0.45 x 8.5 = 3.8 bn
Oligopoly: Oligopoly:
CSO= 0.5 x(35,000 mn)x(0.12-0.06)=1 bn/y CSO= 0.5 x(40,000 mn)x(0.15-0.09)=1.2 bn/y
Total CSO= 1bn x PVIFA (10%,40-20) = Total CSO= 1.2bn x PVIFA (10%,40-20) =
= 1 x (9.7)- 1x (8.5) = 1.2 bn = 1.2 x (9.7)- 1.2x (8.5) = 1.4 bn
Competitive Competitive
CSC= 0.5 x(40,000 mn)x(0.12-0.04)=1.6 bn/y CSC= 0.5 x(50,000 mn)x(0.15-0.06)=2.25 bn/y
Total CSC= 1.6bn x PVIFA (10%,60-40) = Total CSC= 2.25bn x PVIFA (10%,60-40) =
= 1.6 x 10 – 1.6 x 9.7 = 0.48 bn = 2.25 x 10 – 2.25 x 9.7 = 0.67 bn
Total Consumer Surplus Total Consumer Surplus
CS=5.1+1.2+0.48=6.78 bn CS=3.8+1.4+0.67=5.87 bn
Producer Monopoly: Monopoly:
Surplus PSM=30,000 mn x(0.08-0.04)=1.2 bn/y PSM=30,000 mn x(0.12-0.06)=1.8 bn/y
Total PSM= 1.2 bn x PVIFA (10%,20) Total PSM= 1.8 bn x PVIFA (10%,20)
Total PSM= 1.2 x 8.5 = 10.2 bn Total PSM= 1.8 x 8.5 = 15.3 bn
Oligopoly: Oligopoly:
PSO= 35,000 mn x (0.06-0.04)=0.7 bn/y PSO= 40,000 mn x (0.09-0.06)=1.2 bn/y
Total PSO= 0.7 bn x PVIFA (10%,40-20) = Total PSO= 1.2 bn x PVIFA (10%,20-40) =
= 0.7 x (9.7)- 0.7x (8.5) = 0.84 bn = 1.2 x (9.7)- 1.2x (8.5) = 1.44 bn
Competitive Competitive
P=MC => PS=0 P=MC => PS=0
Total Producer Surplus Total Producer Surplus
CS=10.2+0.84+0=11bn CS=15.3+1.44+0=16.7 bn
TS TS= CS+PS = 6.78+11= 17.78 5.87+16.7=22.5
NPV = Total Surplus (as calculated above) =TS as calculated above
(economic) =17.78 =22.5
Cost/y CM=30,000 mn x(0.04)=1.2 bn/y CM=30,000 mn x(0.06)=1.8 bn/y
CO=35,000 mn x(0.04)=1.4 bn/y CO=40,000 mn x(0.06)=2.4 bn/y
CC=40,000 mn x(0.04)=1.6 bn/y CC=50,000 mn x(0.06)=3 bn/y
Benefit/y Producer Benefit + CS (0.6+1+1.6) CS=0.45+1.2+2.25
BM=30,000 mn x(0.08)+0.6=3 bn/y BM=30,000 mn x(0.12)+0.45=4 bn/y
BO =35,000 mn x(0.06)+1=3.1 bn/y BO =40,000 mn x(0.09)+1.2=4.8 bn/y
BC =40,000 mn x(0.04)+1.6=3.2 bn/y BC =50,000 mn x(0.06)+2.25=5.2 bn/y
IIR NPV=(B-C)x 1/(1+i) =0, Then the equation is true only when IIR= ∞
60

PB Can’t calculate economic value of initial capital investment


B/C [3x8.5+(3.1x9.7-2.1x8.5)+(3.2x10-3.2x9.7)]/ [4x8.5+(4.8x9.7-4.8x8.5)+(5.2x10-5.2x9.7)]/
[1.2x8.5+(1.4x9.7-1.4x8.5)+(1.6x10-1.6x9.7)]= [1.8x8.5+(2.4x9. 7-2.4x8.5)+(3x10-3x9.7)]= 2.1
2.4
EAC = [1.2x8.5+(1.4x9.7-1.4x8.5)+(1.6x10- = [1.8x8.5+(2.4x9. 7-2.4x8.5)+(3x10-3x9.7)]/10
1.6x9.7)]/10 = 1.2 bn = 1.9 bn

Q.9 If Ia >15 then the Ir will further increase and make both projects even further unfeasible
Q.12 Hyperinflation will decrease Ir ,this will make both projects feasible when Ir < 7.4% and Ir < 10%
respectively
Q.13 NPV= (3-1.2) x PVIFA (10%,20) + [(3.1-1.4) x NPV= (4-1.8) x PVIFA (10%,20) + [(4.8-2.4) x
PVIFA (10%,60)- (3.1-1.4) x PVIFA (10%,20)] PVIFA (10%,40)- (4.8-2.4) x PVIFA (10%,20)] + 0
= 1.8x8.5+(1.7x10-1.7x8.5)=17.9 bn =1.8x8.5+(1.2x10-1.2x8.5)=23 bn
Q.14 Monopoly will be willing to sell for competitive
price if subsidy provided is equal to the total
producer’s surplus they will miss
Total lost PS @ Competitive Price =
Current PSM+ Dead Weight Loss
PSM= 1.2 bn
Dead Weight Loss = 0.5x(40,000-
30,000)x(0.08-0.04)= 0.2 bn
Total for 60 years= 1.4 x PVIFA(10%,60)
Total subsidy= 1.4x10=14bn

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