COST-BENEFIT ANALYSIS NPV 2

Question 1

additional loss

caused by postponement equal (K1 - K0), as shown by

Answer 1

FGHI

Question 2

CASE areas

Answer 2

The rule shows a comparison of the area t1DEt2 with t1ACt2 plus FGHI

Question 3

if investment costs are expected to rise in the future, it will be optimal for the project to be undertaken

Answer 3

earlier than if investment costs remain constant over time.

Question 4

Case C: Potential Benefits Rise and Decline According to Calendar Time, example

Answer 4

the growth in demand for a given type of electricity

generation plant in a country is expected to continue until it can be replaced by a cheaper technology.

Question 5

NPV formula for Case C: Potential Benefits Rise and Decline According to Calendar Time, example

Answer 5

the area under the B(t) curve minus K1

NPV= -K /(1+r) + sigma[Bt /(1+r)^t ]

Question 6

In case of c it only pays to keep the project in operation so long as

Answer 6

Bt n+1 > rSVtn - ∆SVtn+1

Question 7

Case D: Both Costs and benefits do not change systematically with calendar time

In this case, the optimal date to start the project
is determined by

Answer 7

estimating the net present value of the project in each instance and choosing the time to start the project which yields the greatest net present value

Question 8

The reason for wanting to ensure that mutually exclusive projects are compared over the same span of time is to give them the same

Answer 8

opportunity to accumulate value over time

economic rent for fixed factor of production.

Question 9

in order to equalize or adjust two project lives two condition have to met

Answer 9

both projects must be supra-marginal (i.e., have positive NPVs) and should be repeatable at least a finite number of times.

Question 10

repeat, repeatable projects until

Answer 10

The construction of the repeated projects is initiated so as to maintain a level of service

Question 11

Projects with Interdependent and Separable Components

Answer 11

The analyst should attempt to break the project down into its various components and examine the incremental costs and benefits associated with each of the components to determine whether it increases or decreases the NPV of the project

Question 12

to maximize the NPV of the whole package, it may mean that

Answer 12

the efficiency of some of the components will be reduced. In this case, the overall project might be improved if one or even two of the components were dropped from the investment package.

Question 13

To appraise such an integrated investment package

Answer 13

we should begin by evaluating each of the components as an independent project.

Question 14

The technology and operating plans will have to be designed

Answer 14

to maximize the net benefits from the combined facilities

Question 15

Frequently, the project which ends up with the greatest NPV is one containing

Answer 15

fewer components that were initially proposed by its sponsor.

Question 16

A common investment problem of the type which involves separable component projects arises

Answer 16

when a decision is being made as to whether or not existing equipment should be replaced.

Question 17

existing equipment decision

Answer 17

(a) Keep the old asset and do not buy the new asset now;
(b) Sell the old asset and purchase the new one; or
(c) Keep the old asset and in addition buy the new one.

Question 18

B0

Answer 18

present value of all future benefits that could be generated by the old asset (evaluated net of operating cost)

Question 19

SV0

Answer 19

liquidation or scrap value of the old asset if sold

Question 20

Bn

Answer 20

present value of future benefits (net of operating costs)

from the new asset

Question 21

Cn.

Answer 21

the present value of the investment costs for the new asset

Question 22

In order that alternative (a) be feasible

Answer 22

present value of the future benefits from the old asset exceed its liquidation value, i.e., Bo-SVo>0

Question 23

In order for alternative (b) to be feasible

Answer 23

it is necessary that the present value of the future benefits from the new asset are bigger than the present value of its investment costs, Bn-Cn>0.

Question 24

For alternative (c) to be feasible

Answer 24

The total benefits produced by both assets combined
must be greater than the costs of the new investment plus the liquidation value of the old asset.
Bn+o-(Cn+SVo)>0