Question

(6) THINKING ABOUT COST-BENEFIT ANALYSIS. When evaluating how much to invest on a project the typical Present Value (PV) formula is used where R is the discount rate, Bt is the benefit, and Ct is cost the associated with the project in year t, and n is the number of years associated with the project a. What is the PV of $1 today? In one year (say March 30, 2017), what is the PV of $1 at b. Suppose that Cal is indifferent between receiving $1 today and receiving $1 in one year. c. Suppose Jay sets a discount rate of zero and Rae sets a discount rate of 10%. Which that time (March 30, 2017)? What does this suggest about Cal's rate of time preference? Briefly explain. individual would be willing to spend more in the current period for environmental benefits such as reducing carbon emissions for the next 20 years? Explain your reasoning d. How does the typical PV calculation treat the value of saving an individual's life today? Is this a shortcoming of PV calculation when it comes to evaluating health benefit:s associated with an investment? Explain. Suppose that the government is evaluating a project. It uses a discount rate for costs of 3% and the discount rate on benefits of 7%. What is the problem with the PV calculation that would arise from these using the different discount rates? Explain e.

Answer 1

A. The pesent value of $1 today will be the same. As we can see in the formula given in the question to calculate PV value of n = 0. THus it will be $ 1 only.

B. In this one Cal is using only annual discount rate and time period below one year doesn't make any difference to the PV with in one year. His time of reference is one year. It tells for a year period value of $1 will remain the same for Cal.

C.Jay and Rae sets discount rate of 0% and 10% respectively. Rae would like to dalay its expenses as the PV of thise enviromental expenses will be trun out be low in case of Rae if he spends that money later on years. But in case Jay it will be the same throught 20 years period. In case Rae if he spends larger amount to the later period it will cost him less on Present Value Basis. Thus, Jay will spend more in current period as Rae will refrain from doing so.

E. As in the given formula in question we have taken the same discount rate for the costs and benefits. As in this case, we have two discount rates we will have to evaluate both the costs and benefits seprately with different discount rates.

Year C) 1 2 4 Cash Flows for costs PV for Costs Discount rate-390 XO X1 X2 X3 X4 X5 Cash Flows for Benefits YO PV for Benefits Discount Rate-7% Y1 Y3 Y4 Y5