he state of Glottamora has $300 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 $300 million and having an expected useful life of 20 years. Projected benefits of the new power plant are as follows: Years Benefits per Year ($ Millions) 1 - 5 0 6 - 20 60 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 60 6 - 10 42 11 - 20 12 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. The present value interest factor at the end of years from 0 - 20 for the two discount rates are given in the following table. Discount Rates 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 5% 1.000 0.952 0.907 0.864 0.823 0.784 0.746 0.711 0.677 0.645 0.614 0.585 0.557 0.530 0.505 0.481 0.458 0.436 0.416 0.396 0.377 12% 1.000 0.893 0.797 0.712 0.636 0.567 0.507 0.452 0.404 0.361 0.322 0.287 0.257 0.229 0.205 0.183 0.163 0.146 0.130 0.116 0.104 Evaluate the projects using both the 5 percent and the 12 percent rates. Project Net Benefits at Discount Rate = 5% Net Benefits at Discount Rate = 12% ($ Millions) ($ Millions) Power Plant Job Retraining Program If you agree with the Power Department that the government’s borrowing rate is the appropriate discount rate, which project will you choose?

Managerial Economics: Applications, Strategies and Tactics (MindTap Course List)

14th Edition

ISBN:9781305506381

Author:James R. McGuigan, R. Charles Moyer, Frederick H.deB. Harris

Publisher:James R. McGuigan, R. Charles Moyer, Frederick H.deB. Harris

Chapter17: Long-term Investment Analysis

Section: Chapter Questions

Problem 9E

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The state of Glottamora has $300 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 $300 million and having an expected useful life of 20 years. Projected benefits of the new power plant are as follows:

Years	Benefits per Year
($ Millions)
1 - 5	0
6 - 20	60

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	60
6 - 10	42
11 - 20	12

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. The present value interest factor at the end of years from 0 - 20 for the two discount rates are given in the following table.

Discount Rates	0	1	2	3	4	5	6	7	8	9	10	11	12	13	14	15	16	17	18	19	20
5%	1.000	0.952	0.907	0.864	0.823	0.784	0.746	0.711	0.677	0.645	0.614	0.585	0.557	0.530	0.505	0.481	0.458	0.436	0.416	0.396	0.377
12%	1.000	0.893	0.797	0.712	0.636	0.567	0.507	0.452	0.404	0.361	0.322	0.287	0.257	0.229	0.205	0.183	0.163	0.146	0.130	0.116	0.104

Evaluate the projects using both the 5 percent and the 12 percent rates.

Project	Net Benefits at Discount Rate = 5%	Net Benefits at Discount Rate = 12%
($ Millions)	($ Millions)
Power Plant
Job Retraining Program

If you agree with the Power Department that the government’s borrowing rate is the appropriate discount rate, which project will you choose?

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