Economic Evaluation Assignment 2: Project Proposal Analysis, 49003

This assignment solution provides a comprehensive analysis of two project proposals (A and B) from both financial and economic perspectives. It includes calculations and evaluations of key financial metrics such as Net Present Value (NPV), Internal Rate of Return (IRR), Payback Period (PB), and Benefit-Cost ratio (B/C). Furthermore, the solution explores economic aspects like Life Cycle Cost, Equivalent Annual Cost, Consumer Surplus, Producer Surplus, and Total Surplus, considering factors like opportunity cost, market structures (monopoly, oligopoly, and competitive markets), and the impact of hyperinflation. The assignment also delves into the concept of demand elasticity and the need for government subsidies to encourage competitive pricing. The student's answers and recommendations are provided with justifications based on the economic principles and financial indicators.

Name:
Student #:
49003 ECONOMIC EVALUATION
Assignment # 2 (Autumn 2019)
Due: 3 June 2019
ANSWER-SHEET
Please summarize your results in the table below: (9 Marks)
Financial Economic
Proposal A Proposal B Proposal A Proposal B
NPV = 0 (at real
discount rate)
= 0 (at real
discount rate)
N.A. N.A.
IRR 10% (same as
real discount
rate)
10% (same as
real discount
rate)
N.A. N.A.
PB 10 years 10 years N.A. N.A.
B/C
PV of return /
initial
investment
=0.9973
=1
PV of return /
initial
investment
=0.9978
=1
N.A. N.A.
Life Cycle Cost $ 100 bn. $ 160 bn. $ 84 bn. $ 144 bn.
Equivalent Annual Cost $ 5 bn. $ 6 bn. $ 1 bn. $ 2 bn.
Consumer Surplus N.A. N.A. $ 8 bn. $ 8 bn.
Producer Surplus N.A. N.A. $ 10 bn. $ 15 bn.
Total Surplus N.A. N.A. $ 18 bn. $ 23 bn.
Deadweight Loss N.A. N.A. N.A. N.A.
Note: NPV; Equivalent Annual Cost; Life Cycle Cost; and Surpluses (Consumer, Producer, and
Total)and Deadweight Loss - must be rounded off to the nearest billion dollars (i.e., no decimals),
and IRR and PB - to the nearest ‘whole’ percents and years (i.e., no decimals), and B/C - to one
decimal point only.
1. Which proposal will you recommend from investor’s perspective? (2 Marks)
A B Either Neither
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Neither Because both the projects generate a negative NPV.
2. From a financial perspective, will you select any of these projects on the basis of the indicator of
Consumer Surplus? (2 Marks)
Yes No
Yes Because a higher consumer surplus indicates consumers are willing to pay higher. There is
scope of price increase.
3. Will your recommendation, based on economic perspective, change if the opportunity cost of
money is zero? (2 Marks)
Yes No
Yes Because economic profits take into account the opportunity cost of money. If economic
benefits change, recommendation shall change accordingly.
4. In Figure 2, will the response of demand to changes in prices in the range of 9 to 12 cents per
unit be: (2 Marks)
Elastic Inelastic
Inelastic Because there are no alternatives to electricity.
5. Will your recommendation, based on economic perspective, change if – due to unanticipated
global financial turmoil – there is hyperinflation after the first ten years of the projects’ life
spans? (2 Marks)
Yes No
Yes Because with hyperinflation the cost of production increases.
6. Will your recommendations, based on economic perspective, change if the government succeeds
in converting the monopoly market, into an oligopoly market, but is unable to transform
oligopoly market into a competitive market (i.e., the market stays as an oligopoly for the last 40
years of project life-spans)? (3 Marks)
Yes No
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Yes Because prices in oligopoly market is higher than in a competitive market.
7. How much subsidy (expressed in present value terms) will the government need to provide for
Proposal B in order to encourage the producer to sell electricity at the competitive market prices
throughout the 60 year project duration? (3 Marks)
$ bn
= (0.12-0.06) * 30 + (0.09-0.06) * 10 (in bn.)
= 2.1 bn. per year * PVIF of 40 years
= $ 20.5 bn.
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20.5