Question: A new regulatory policy will have an immediate cost of $75 million, and will create costs of $15 million at the end of each of the next two years. The policy will generate benefits of $40 million and $80 million at the end of the next two years, respectively. Assume that society's marginal rate of time preference is 2% and the marginal rate of return on private investment is 7%.
a. Assuming that all costs displace only consumption and all benefits are consumed (and selecting the discount rate accordingly), what is the net present value (NPV) of the project?
b. Assuming that all costs displace investment and all benefits are re-invested (and selecting the discount rate accordingly), what is the net present value (NPV) of the project?
c. Now suppose that all benefits will be consumed but 75% of the policy's costs at each point in time will be incurred by the firms subject to the new regulation and will displace private investment (rather than consumption).
i. Using the SPC method, what is the NPV of the project if the shadow price of capital (SPC) is 1.3?
ii. Conceptually, what does it mean for the SPC to be equal to 1.3 (i.e., what does this particular number mean)