ECON7740 Cost Benefit Analysis Tutorial 3
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ECON7740 Cost Benefit Analysis
Tutorial 3
Question 1
Deriving and Comparing Incremental Cash Flows for Options
The cash flows shown below relate to the net benefits for 3 policy options, A, B and C where A is the Base Case (Status Quo) scenario.
You are required derive the incremental cash flows and calculate the NPVs for options B and C assuming a 6% (real) discount rate.
Option/Year 
51
52
52.5
B-A
C-A
Disc. Rate=
|
NPV(B) = NPV(C) = |
Question 2
Comparing Options with Unequal Lives (EANB)
Two regulatory options to mitigate the effects of pollution on residents adjacent to an industrial area are under consideration. The outcome (benefits) of each is identical, but their cost profiles differ.
Option A has a life of 3 years, an initial (year 0) cost of $400K and annual costs of $6K. Option B has a life of 5 years, an initial cost of $500K and annual costs of $10K.
Assume a 15-year life for the project and at the end of each option's life it will need to be replaced at the same cost.
Show how you would compare the three options, assuming a discount rate of 5% per annum.
Discount rate= 5%
Option/year
A
B
PV of Costs =
|
A B |
EANB=
|
A B |
Question 3
Comparing Options with Unequal Lives (Roll Over)
A local government is trying to decide how to use a piece of land for the community. There are two options:
Option A is to use the land as a basketball court with an expected like of 8 years. The court would cost $180,000 to construct and would yield a net benefit of $40,000 at the end of each year.
Option B is a swimming pool with an expected life of 24 years. The swimming pool would cost $2.25 million to construct and would yield $170,000 at the end of each year.
Show how you would compare the three options, assuming a discount rate of 5% per annum.
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B |
A |
NPV Roll Over |
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B |
A |
Option/year |
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B |
A |
NPV= |
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B |
A |
Option/year |
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B |
A |
Option/year |
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8 |
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$K |
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170,000 |
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13 |
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-2,250,000 |
- 180,000 |
0 |
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16 |
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170,000 |
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14 |
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170,000 |
40,000 |
1 |
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24 |
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170,000 |
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15 |
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170,000 |
40,000 |
2 |
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170,000 |
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16 |
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170,000 |
40,000 |
3 |
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170,000 |
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17 |
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170,000 |
40,000 |
4 |
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170,000 |
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18 |
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170,000 |
40,000 |
5 |
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170,000 |
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19 |
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170,000 |
40,000 |
6 |
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170,000 |
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20 |
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170,000 |
40,000 |
7 |
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170,000 |
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21 |
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170,000 |
40,000 |
8 |
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2022-09-02