6404 Economics of the Public Sector
Semester 2, 2015
Student: u3102883
Week 10 Tutorial 6
Consider two projects, A and B, with capital costs of $100 million and $20 million respectively. Given an opportunity cost of capital of 7 per cent, A provides an NPV of $30 million. B provides an NPV of $10 million. Explain why A is better than B, although it costs five times as much and produces only three times the net benefit.
Net present value method calculates the amount invested today compared to the future cash amounts after they are discounted by a specified rate of return. The net present value (NPV) is one of the three cost-benefit measures of net social benefit (NSB). When considering mutually exclusive projects applying NPV alone, …show more content…
When calculating the opportunity cost of Project A against $80 million, the NPV equals $5.6 million. Add the $5.6 million with the NPV of Project B, $10 million equates to $15.6 million. Comparing this to the NPV of Project A, there is a difference of $14.4 million.
Despite Project B costing five times less and proportionally produces a higher NPV than Project A, Project A is better than Project B because it has a higher NPV than Project B and when calculating the opportunity cost of capital tat 7 per cent there is a shortfall of $14.4 …show more content…
IRR calculates a rate of return offered by the project regardless of the required rate of return. Unlike other formulas, with IRR, the i (discount rate) is not known. Once the discount rate is known, a comparison of the discount rates is conducted to determine the best rate of return. If the calculated discount rate is higher than the minimum acceptable rate of return, then the project is preferred. The IRR is the discount rate that would make the present value of the project zero. The formula to calculate IRR is:
Where IRR, T = year, B = benefits, C = cost, i = unknown.
IRR may be a preferred method then NPV as it is easier to understand for some people and it provides a check against large projects giving a warning that a project may not be efficient.
Benefit-cost ratio is the figure used to state the worth of a project verses the money to be spent executing the project in the overall assessment of a cost benefit analysis. This ratio represents a value of the benefits and costs represented in actual dollars spent and attained. The benefit cost ratio should be conveyed using discounted present values. The formula to calculate the benefit/cost ratio
Semester 2, 2015
Student: u3102883
Week 10 Tutorial 6
Consider two projects, A and B, with capital costs of $100 million and $20 million respectively. Given an opportunity cost of capital of 7 per cent, A provides an NPV of $30 million. B provides an NPV of $10 million. Explain why A is better than B, although it costs five times as much and produces only three times the net benefit.
Net present value method calculates the amount invested today compared to the future cash amounts after they are discounted by a specified rate of return. The net present value (NPV) is one of the three cost-benefit measures of net social benefit (NSB). When considering mutually exclusive projects applying NPV alone, …show more content…
When calculating the opportunity cost of Project A against $80 million, the NPV equals $5.6 million. Add the $5.6 million with the NPV of Project B, $10 million equates to $15.6 million. Comparing this to the NPV of Project A, there is a difference of $14.4 million.
Despite Project B costing five times less and proportionally produces a higher NPV than Project A, Project A is better than Project B because it has a higher NPV than Project B and when calculating the opportunity cost of capital tat 7 per cent there is a shortfall of $14.4 …show more content…
IRR calculates a rate of return offered by the project regardless of the required rate of return. Unlike other formulas, with IRR, the i (discount rate) is not known. Once the discount rate is known, a comparison of the discount rates is conducted to determine the best rate of return. If the calculated discount rate is higher than the minimum acceptable rate of return, then the project is preferred. The IRR is the discount rate that would make the present value of the project zero. The formula to calculate IRR is:
Where IRR, T = year, B = benefits, C = cost, i = unknown.
IRR may be a preferred method then NPV as it is easier to understand for some people and it provides a check against large projects giving a warning that a project may not be efficient.
Benefit-cost ratio is the figure used to state the worth of a project verses the money to be spent executing the project in the overall assessment of a cost benefit analysis. This ratio represents a value of the benefits and costs represented in actual dollars spent and attained. The benefit cost ratio should be conveyed using discounted present values. The formula to calculate the benefit/cost ratio