ECN706Sem: Cost Benefit Analysis
College of Business, Hospitality and Tourism Studies School of Economics and Finance Department of Economics and Customs ECN706Sem: Cost Benefit Analysis Semester 1, 2020 Final Exam Assessment 2 FIJI NATIONAL UNIVERSITY
Question 1
A highway department is considering building a temporary bridge to cut travel time during the three years it will take to build a permanent bridge. The temporary bridge can be put up in a few weeks at a cost of $750,000. At the end of three years, it would be removed and the steel would be sold for scrap. The real net cost of this would be $81,000. Based on estimated time savings and wage rates, fuel savings, and reductions in risks of accidents, department analysts predict that the benefits in real dollars would be $275,000 during the first year, $295,000 during the second year, and $315,000 during the third year. Departmental regulations require use of a real discount rate of 4 percent.
- Calculate the present value cost assuming the construction cost of the temporary bridge occurs at the beginning of year 1 and the net cost of decommissioning the bridge at the end of year 3: (3 Marks)
- Calculate the net present value benefits assuming that the benefits are realized at the end of each of the three years. (3Marks)
- Calculate the net present value benefits assuming that the benefits are realized at the beginning of each of the three years. (3Marks)
- Calculate the net present value benefits assuming that the benefits are realized in the middle of each of the three years. (3Marks)
- Calculate the net present value benefits assuming that half of each year’s benefits are realized at the beginning of the year and the other half at the end of the year. (3Marks)
- Does the temporary bridge pass the net benefits test? (2 Marks)
(Hint: Net present value benefits can be calculated by present value benefits minus present value costs. NPV = PV(benefit) – PV(cost)
Question 2
A town’s recreation department is trying to decide how to use a piece of land. One option is to put up basketball courts with an expected life of eight years. Another is to install a swimming pool with an expected life of 24 years. The basketball courts would cost $180,000 to construct and yield net benefits of $40,000 at the end of each of the eight years. The swimming pool would cost $2.25 million to construct and yield net benefits of $170,000 at the end of each of the 24 years. Each project is assumed to have zero salvage value at the end of its life. The real discount rate for both the project is 5 percent.
(Hint: You may use excel spreadsheet to calculate the net present value as the year length is large).
- Calculate the net present value for the basketball court. (3 Marks)
- Calculate the net present value for swimming pool. (3 Marks)
- Which project should be accepted based on the net present value criteria? (2 Marks)
Question 3
A foreign firm is considering a project which has, at market prices, a present value of benefits of $200 and a present value of input costs of $130. If the project goes ahead, tax with a present value of $50 will be paid to the host country, domestic labour which would otherwise be unemployed will be paid wages with a present value of $50 for working on the project (the wage bill is included in the input costs referred to above), and pollution caused by the project will reduce the value of output elsewhere in the host country’s economy by $10. Assuming that the owners of the foreign firm are not part of the referent group, and that the opportunity cost of unemployed labour is 50% of the market wage, what are the net present values generated by:
- the project benefit-cost analysis (2 Marks)
- the private benefit-cost analysis (2 Marks)
- the efficiency benefit-cost analysis (2 Marks)
- the referent group benefit-cost analysis (2 Marks)
Question 4
Due to a growing concern of Jewellery store robberies, a city increases police surveillance of Jewellery stores. The increased surveillance costs the city an extra $500,000 per year that is from taxpayer’s money, but as a result the amount of Jewellery that is stolen falls. Specifically, without the increase in surveillance, Jewellery with a retail value of $1 million would have been stolen. This stolen Jewellery would have been fenced by the Jewellery thieves for $600,000.
- What would be the benefit or costs to the following people: (3 Marks)
- Jewellery stores
- Taxpayers
- Jewellery robbers
- What is the net social benefit resulting from the police surveillance program if;
- Robbers are part of the society. (2 Marks)
- Robbers are not part of the society. (2 Marks)
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