Economics Assignment - Evaluation of Financial and Economic Considerations

This economics assignment evaluates two options based on financial and economic considerations and recommends the most viable option. It also discusses the impact of inflation and the basis for cost/benefit analysis.

Running head: ECONOMICS ASSIGNMENT
Economics Assignment
Name of the Student:
Name of the University:
Authors Note:

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Table of Contents
a) Evaluating the two options on the basis of financial and economic consideration:..............2
b) Recommending the option from the perspective of finance and depicting why:..................2
c) Recommending the option from the perspective of economy and depicting why:................3
d) Indicating whether changes in recommendation will occur if inflation is expected to be at
the level of 5%:..........................................................................................................................3
e) Indicating what is the basis for the analysis/comparison of cost/benefits-Real terms or
Nominal terms:...........................................................................................................................3
Annexure:...................................................................................................................................4

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a) Evaluating the two options on the basis of financial and economic consideration:
Financial Economic
Proposal A Proposal B Proposal A Proposal B
NPV 0 Mn 0 Mn 1.85 2.55
IRR 0.597% 2.11% - -
PB 9.8 within 60 9.6 within
60
- -
B/C 1 1 1.26 1.36
Equivalent Annual
Cost
95 Mn 140 Mn 95 Mn 140 Mn
Consumer Surplus - - $ 0.05 Mn $ 0.05 Mn
Producer Surplus - - $ 1.8 Mn $ 2.5 Mn
Total Surplus - - $1.85 Mn $ 2.55 Mn
From the evaluation it could be detected that Proposal B is selected from the point of
view of financial perspective, as IRR and PB is higher for the project. Moreover, from the
perspective of economy proposal B only selected, as it delivers the highest NPV for the
company.
b) Recommending the option from the perspective of finance and depicting why:
Hence, from the perspective of finance option B is the most viable option, as it will
eventually increase return from the project, as both the internal rate of return PB of the
project is high. Moreover, Net present value of Project A is higher due its longevity, which is

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considered to be major limitation for the investment appraisal technique, while comparing
two different tenure projects.
c) Recommending the option from the perspective of economy and depicting why:
From the perspective of economy project B is only selected, as the overall NPV of
project B is higher.
d) Indicating whether changes in recommendation will occur if inflation is expected to
be at the level of 5%:
The alteration of 5% in the inflation rate would eventually alter the decision regarding
the selection of the project from the perspective of the supplier, as increment is cost is
imminent due the rising inflation rate.
e) Indicating what is the basis for the analysis/comparison of cost/benefits-Real terms or
Nominal terms:
The analysis is based on both cost and benefit method, which is obtained from the
particular project. Hence, both the economic and financial perspective is taken into
consideration, before making any kind of recommendations. The real terms are mainly used
in the assessment, which helps in acknowledging the inflation factors. The use of discounting
rate helps in detecting the actual present value of the future cash inflows and outflows of both
projects, which adequately supports in making investment decisions.

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Annexure:
For Financial:
For Proposal A
Particulars Value
Initial Investment 100+30+1700+500+250+420 = 3000
Annual Return, B 2000 * 0.2 = 400
Annual Cost, C 45 + (0.5*100) = 95
NPV -I0 + (B-C) x PVFA (10%,30)
NPV -3000 + (400-95) x 9.4269 = -124.7955 Mn
NPV (i2 = 12%) -I0 + (B-C) x PVFA (12%,30)
NPV (i2 = 12%) -3000 + (400-95) x 8.0552 = -543.164 Mn
Now, IRR i1 – NPV1 * i 2−i1
NPV 2−NPV 1
IRR 0.1 – (-124.7955) * 0.12−0.10
−543.164+124.7955 =
0.597%
Payback period Capital Invested
(B−C ) = 3000
( 400−95) = 9.8 years
B/C Benefits cost ratio Present Value of Return
( Initial Investment ) = 400∗9.4269
3000 = 1.26
LCC I0 + Annual cost of I x PVIFA (10%, 30)
LCC 3000 + 95 * 9.4269 = 3895.56
EAC LCC
PVF (10 %, 30) = 413.24
For Proposal B

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Particulars Value
Initial Investment 200+500+1750+50 = 2500
Annual Return, B 2000 * 0.2 = 400
Annual Cost, C (2*50) + 40 = 140
NPV -I0 + (B-C) x PVFA (10%,20)
NPV -2500 + (400-140) x 8.5136 = -286.464 Mn
NPV (i2 = 12%) -I0 + (B-C) x PVFA (12%,20)
NPV (i2 = 12%) -2500 + (400-140) x 7.4694 = -557.956 Mn
Now, IRR i1 – NPV1 * i 2−i1
NPV 2−NPV 1
IRR 0.1 – (-286.464) * 0.12−0.10
−557.956+286.464 =
2.11%
Payback period Capital Invested
( B−C ) = 2500
( 400−140) = 9.62
years
B/C Benefits cost ratio Present Value of Return
( Initial Investment ) = 400∗8.5136
3000 =
1.36
LCC I0 + Annual cost of I x PVIFA (10%, 20)
LCC 3000 + 140 * 8.5136 = 3,691.90
EAC LCC
PVF (10 % , 20) = 433.65
For Economic:

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Option A:
Consumer surplus = Producer surplus: ½ x quantity demanded x quantity supplied
B1 = 30 x 0.01 + 10 x 0.02 x 0.5 = .08 Mn/yr C1 = 45 x 0.04 = $ 1.8 Mn/yr
CS= 10 x 0.01 x 0.5 = $ 0.05 Mn/yr PS = 40 x 0.04 = $ 1.8 Mn/yr
CS: $ 0.05 Mn/yr
PS: $ 1.8 Mn/yr
TS: CS+PS = $1.85 Mn/yr
B/C = Present Value of Return
( Initial Investment ) = 400∗9.4269
3000 = 1.26
EAC = LCC
PVF (10 %, 30) = 413.24
Option B:
Consumer surplus = Producer surplus: ½ x quantity demanded x quantity supplied
B1 = 80 x 0.01 + 50 x 0.02 x 0.5 = .4 Mn/yr C1 = 50 x 0.05 = $ 2.5 Mn/yr
CS= 50 x 0.02 x 0.5 = $ 0.05 Mn/yr PS = 50 x 0.05 = $ 2.5 Mn/yr
CS: $ 0.05 Mn/yr
PS: $ 2.5 Mn/yr
TS: CS+PS = $ 2.55 Mn/yr
B/C = Present Value of Return
( Initial Investment ) = 400∗8.5136
3000 = 1.36
EAC = LCC
PVF (10 %, 20) = 433.65