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The state of Glottamora has $100 million remaining in its budget for the current year. One alternative is to give Glottamorans a one-time tax rebate. Alternatively, two proposals have been made for state expenditures of these funds. The first proposed project is to invest in a new power plant, costing $100 million and having an expected useful life of 20 years. Projected benefits accruing from this project are as follows:

YEARS BENEFITS PER YEAR ($ MILLIONS)
1-5 $ 0
6-20 20

The second alternative is to undertake a job retraining program, also costing $100 million and generating the following benefits:

YEARS BENEFITS PER YEAR ($ MILLIONS)
1-5 $20
6-10 14
11-20 4

The state Power Department argues that a 5 percent discount factor should be used in evaluating the projects, because that is the government's borrowing rate. The Human Resources Department suggests using a 12 percent rate, because that more nearly equals society's true opportunity rate.

b. Evaluate the projects using both the 5 percent and the 12 percent rates.
c. What rate do you believe to be more appropriate?

Microeconomics, Economics

  • Category:- Microeconomics
  • Reference No.:- M944999

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