Project evaluation

[jimbo3000]

Hey, maybe someone can help me with my task:

Assume two periods, today and the future, and an interest rate i = 10% for discounting the future period. Imagine a private firm operating within the power sector and consider an investment project over the two periods with the following monetary outcomes in million €:
Construction costs today 70
Social (environmental) damages via air pollution in the future 33
Firm’s revenue in the future 110
Free knowledge creation for society today 50
Wage payments today 20
Wage payments in the future 22

A. Assume that there are no policies in place. Would the private profit‐maximizing management of this firm implement this project today and for what reason? Which concept(s) do you use to answer this question? Please write out the calculation and the values that you include and the result in million €. Briefly explain your solution procedure and interpret the outcome.

B. Would you as a public policy maker with a social (and environmental) objective like to get the project being implemented today and for what reason? Write out the calculation with the values that you include and the result in million €. Briefly explain your solution procedure and interpret the outcome.

My answers:
A:
Concept: Cost-benefit Analysis with Net present value (NPV). I would compare my NPV for if the firm implements the project now, with if the firm implements it in the future.

Profit-maximization
For implementation Now I would include the "Construction costs today" and the "Wage payment today" as costs for today, the benefits would be the "Firm’s revenue in the future".

For implementation Future I would include the "Construction costs today" and the "Wage payments in the future", the benefits would still be "Firm’s revenue in the future".

Now:
Costs = Construction costs today + Wage payment today = 70 + 20
Benefits = Firm’s revenue in the future = 110
Difference = 20

NPV = 20/1,1 = 18,18

Future:
Costs = Construction costs today + Wage payment in the future = 70 + 22
Benefits = Firm’s revenue in the future = 110
Difference = 18

NPV = 18/1,1 = 16,36

Because NPV Now is bigger as NPV Future, i would recomend the implementation of the project Now.

B: For B i would include "Social (environmental) damages via air pollution in the future" as additional "costs" for both Now and Future. And "Free knowledge creation for society today" as additional "benefits" only in Now.

Sorry, my mothertongue isn't english. I hope someone can help me, because I'm really not sure about my calculations.

Have a nice day
Jonathan

 

[JeffM]

I am having trouble understanding the problem.

It does not seem to me that it is asking you to compare construction now versus construction later. (I may be wrong of course on what the question means.) But what it seems to me to be asking is to compare the public versus the private benefits now. It makes no sense to me that the future costs of construction will be the same as current costs.

 

[jimbo3000]

Hi Jeff, thanks for your answer. Yes you are probably right. Probably I was thinking to complicated.

So my answer for A would be :
For profit-maximization I would invest now, because the NPV > 0.

Costs = Construction costs today + Wage payment today = 70 + 20
Benefits = Firm’s revenue in the future = 110
Difference = 20

NPV = 20/1,1 = 18,18

Would you agree on that?

 

[JeffM]

Hi Jeff, thanks for your answer. Yes you are probably right. Probably I was thinking to complicated.

So my answer for A would be :
For profit-maximization I would invest now, because the NPV > 0.

Costs = Construction costs today + Wage payment today = 70 + 20
Benefits = Firm’s revenue in the future = 110
Difference = 20

NPV = 20/1,1 = 18,18

Would you agree on that?

Again, I'm not sure. Please look at the question very carefully.

On the assumption that we are dealing with a go/no go decision today, what do those 22 million in wages in the future represent. Do they represent an offset from the revenues to be gained? If that is the proper interpretation, then the analysis is incorrect because you have not taken that offset into account.

You have said that English is not your native language, but it is mine. The more you quote from the text of the problem word for word, the better I'll be able to help you.

 

[jimbo3000]

Sadly the text of the problem is copied 1:1 from the excercise

At least I now know, that the task isn't that easy to understand for others either...

Thanks for trying to help