Text 2 - The Discount Rate (Tip: You can use Excel for this exercise) Country Gringoland is conducting a study to decide what to do with its coral reef area. The country is considering either protecting the coral reef area or mining it. A set of costs and benefits is given for a 10-year period for both projects. The country of Gringoland is, however, a bit confused about the discount rate. a. What is the discount rate? b. Which project should Gringoland choose if the discount rate is 5%? c. Which project should Gringoland choose if the discount rate is 10%? d. Suppose you are hired to critically review the cost-benefit analysis. What would be your main concern? Project 1: Gringoland Marine Park Years 0 1 2 3 5 6 7 8 9 10 Costs (thousands of $) Construction 1250 Recurring costs 130 130 130 130 130 130 130 130 130 130 Foregone recreation 20 20 20 20 20 20 20 20 20 20 20 Benefits Increased tourist revenue 300 300 300 300 300 300 300 300 300 300 300 Net NPV @ 5% NPV @ 10% Project 2: Gringoland Coral Mining Costs (thousands of $) Extraction costs 3000 Costs of coastal erosion 200 200 200 200 200 200 200 200 200 200 Benefits Revenues from limestone 4500 Net NPV @ 5% NPV @ 10%
Added by Dolores M.
Close
Step 1
It reflects the time value of money and the risk associated with the future cash flows. Show moreā¦
Show all steps
Your feedback will help us improve your experience
Umar Sohail Qureshi and 92 other Microeconomics educators are ready to help you.
Ask a new question
Labs
Want to see this concept in action?
Explore this concept interactively to see how it behaves as you change inputs.
Key Concepts
Recommended Videos
You are also proposing a second project with variable costs and returns. Assume that the project is expected to return monetary benefits of $50,000 the first year, and increasing benefits of $10,000 until the end of the project life (year 1 = $50,000, year 2 = $60,000, year 3 = $70,000, year 4 = $80,000, year 5 = $90,000). The project also has one-time costs of $35,000, and variable recurring costs of (year 1 = $25,000, year 2 = $30,000, year 3 = $35,000, year 4 = $40,000, year 5 = $45,000) until the end of the project life. The project has a discount rate of 10% and a five-year time horizon. a) Create a costs-benefits analysis spreadsheet similar to the one on page 121 in Chapter 5. b) Calculate net present value (NPV) of benefits for each year. c) Calculate net present value (NPV) of costs for each year. d) Calculate overall net present value (NPV) at the end of the project life. e) Calculate overall return on investment (ROI) at the end of the project life. f) Perform break-even analysis (BEA) for the project. g) Calculate break-even point for this project.
Supreeta N.
Nick J.
You inherit a phosphate mining company and are now in charge of production decisions. You only have two years to extract all of the phosphate because in three years from now, an environmental regulation will go into effect banning mining in that area. There are 300 tons of phosphate to mine. The marginal benefit (marginal revenue) from selling phosphate (which is used in fertilizers) is: MB = 200 - Q and is the same for both periods. The Marginal Extraction Cost is zero and you face a discount rate of 10%. a. Consider year one. When your marginal benefit = 0, how much are your sales of phosphate (Q)? if you do not sell any phosphate, how much is your marginal benefit? if you sell all 300 tons of phosphate, how much is your marginal benefit? [NOTE: there is no "economics" here ā this is just plugging in numbers to help you make a graph in the next question] b. The answers to part (a), combined with the fact that MEC = 0, should enable you to graph out the Net Marginal Benefit curve for year one (NMB1). c. Knowing that the NMB is the same for year two (NMB2), graph NMB2 on the same graph as NMB1. d. Discount your curve for NMB2, to get PV(NMB2), and plot that line on the graph as well. e. What is the optimal amount of phosphate to sell in the first year and the second year? Recall that the total amount of phosphate available is 300 tons. Show all of your work and label these amounts on your graph. f. If the discount rate rises, what do you think will happen to your answers in part (c)? (you do not need to use actual numbers, but talk about what happens when discount rates rise)
Akash M.
Recommended Textbooks
Principles of Economics
Principles of Microeconomics for APĀ® Courses
Economics
18,000,000+
Students on Numerade
Trusted by students at 8,000+ universities
Watch the video solution with this free unlock.
EMAIL
PASSWORD