The paper 'Cost-benefit Analysis and the Environment' is a great example of a Finance and Accounting Assignment. PV has been calculated by discounting the difference between the benefits and the costs with the given rate of 3% for the cash flows provided above starting from year 4. While the initial cost is assumed to have been accrued over the first 3 years of constructing the roads. Hence, the initial cost is calculated by discounting the costs incurred from year 0 to year 3 using a 3% social discount rate. NPV for option 1 Social discount rate = 3% NPV = Σ [CF ÷ (1+ r)t ] NPV = PV- Initial cost PV = $67,112,119.34 Initial cost = 45,346,733 NPV = $ 67,112,119 – 45,346,733 = 21,765,386. NPV for option 2 NPV = PV – Initial cost PV = 68,717,118 Initial cost = 52,833,731 NPV = 68717118 - 52833731 = 15,883,387 BCR for option 1 Benefit cost ratio = present value (PV) ÷ initial cost of a project PV = $67,112,119.34 Initial cost = 45,346,733 BCR = $ 67,112,119 ÷ 45,346,733 = 1.48 NBCR = (1.48 – 1) x 100 = 48% BCR for option 2 BCR = PV – Initial cost PV = 68,717,118 Initial cost = 52,833,731 BCR = 68717118 ÷ 52833731 = 1.30 NBCR = (1.30 – 1) x 100 = 30% Question 2 Looking at the results obtained from the NPV calculation; option 1 = 21,765,386 and option 2 = 15,883,387, option 1 would be preferred to option 2, this is because it has a higher NPV indicating that it would generate more benefits to the community. Moreover using the BCR results still option 1 would be preferred to option 2 because it has a higher present value to initial cost ratio, implying that option 1 would generate more benefits than the costs it incurs. Question 3 Total loss in asset value due to option 1 $300,000 - $250,000 = $50,000 (this loss will be experienced by 150 houses in all the years) Therefore, total loss = 150 x $50000 = $7500,000 Discounting this loss at a social cost rate of 3% over the 28 years; = (7500,000 ÷ 1.0328) = 3,278,076 Total loss in asset value of the 500 houses in option 2 $50,000 x 500 = 2500,000 (2500,000 ÷ 1.0328) NPV after 28 years = 1,092,692 The pollution resulting from the second option is lower than that which results from the first option however adding the two effects to their respective initial NPVs above option 1 still remains to be the preferred option over the second one. Question 4 Conducting a sensitivity analysis on different variables in the construction of the two roads the outcomes show that any variable that increases the social costs that result from the negative effects of the road construction in the area greatly affects outcomes.
Therefore variable such as cost accruing from the pollution caused by the vehicles using the new roads heavily affects the outcomes negatively. (Sassone, P.
G., & Schaffer, W. A. (1978). Question 5 The analysis fails to address the effects that the project may have on the value of such assets as the land and the accessibility of the resources in the area. It doesn’ t also show the benefit of improved living standards of the dwellers of the area where the road is to be constructed. In addition, the benefits accruing the government for example taxes levied on the road users are also not addressed. Moreover, the analysis conducted to evaluate the best option to go for may also have some limitations such as; the cost of the social benefits may not be very clear in that the criteria used to give social benefits monetary value would not necessarily be precise.
These may lead to poor or wrong judgment as far as the choice of projects is concerned. In addition, the choice made for the discounting rate may also not be the best thus leading to exaggerated results. This is because the value decreases as the cashflows increase, hence with as many cashflows as the ones included in this analysis it is possible to get a forced answer.
(Hanley, & Spash, 1993).
Hanley, N., & Spash, C. L. (1993). Cost-benefit analysis and the environment (pp. 1-8). Cheltenham: Edward Elgar.
Sassone, P. G., & Schaffer, W. A. (1978). Cost-benefit analysis: A handbook (Vol. 182). New York: Academic Press.