PART A: EVALUATION OF INVESTMENT PROPOSALS
This part of the assignment is about evaluating two project proposals. The main objective of this evaluation is to determine the financial and socio-economic viabilities of the two investment proposals. Details of these proposals are provided below.
Proposal A
Proposal A envisages generation of electricity from water - a hydro-electric project. The capital cost of this project is estimated to be $6 billion (bn). The project will have a useful economic life of 50 years, and will generate 10,000 million (mn) units of electricity annually. Electricity produced by this project will be sold to the public at a tariff of 10 cents per unit for the first twenty years, and 8 cents thereafter. The annual operation and maintenance costs will be 6 percent of the capital cost for the first twenty years and 6.7 percent thereafter.
The socio-economic costs and benefits for this project can be estimated from Figure 1.
Figure 1: Social Cost and Price Structure: Proposal A
Figure 2: Social Cost and Price Structure: Proposal B
Proposal B
Proposal B is a thermal project - electricity will be generated from coal. It will cost $5bn to build. Its annual operation and maintenance will be 13 percent of its capital cost. This project will have a useful economic life of 25 years. It will generate 8,000mn units of electricity annually. Electricity from this project will be sold at 15 cents per unit. At the end of its useful life, this project can be sold for 1 percent of its capital cost.
The socio-economic costs and benefits for this project can be estimated from Figure 2.
Task
Your task is simply to summarize the results of your analysis in the answer-sheet provided separately.
Notes:
- You must provide the background details (i.e., select calculations), for various answers provided by you in the answer-sheet, in an Annexure (no more than two pages). The minimum permissible font size for the Annexure is 12 (Times Roman or equivalent). You must type-write your annexure.
- The completed answer-sheet must however be a stand-alone document (i.e., the reader should be able to understand the entire logic behind your reasoning without necessarily needing to refer to the Annexure. The logic behind your reasoning, for each question, must of course be provided in the Annexure.
- Please tick (√) only one box wherever multiple choice is provided.
Assumptions (common to both proposals)
- All capital costs are incurred at time t=0 (i.e., ignore project construction time).
- Economic (Social) costs and benefits (Figures 1 and 2):
- costs and benefits are all inclusive, i.e., costs include capital as well as operation and maintenance costs, and benefits include revenue and salvage value;
- costs and benefits remain unchanged throughout the useful economic lives of the two projects; and
- electricity market is a ‘monopoly' market.
- The ‘Real' discount rate for hydro project is 10 percent. The ‘Apparent' discount rate for thermal project is 18.97 percent. Inflation - applicable for both projects - is expected to be 3 percent. Coal price is likely to escalate by 5 percent.
PART B: RATE OF RETURN
Private electricity utilities often argue that public electricity utilities earn the same rate of return as their private sector counterparts and that the returns for public utilities be computed on the basis of the private sector's cost of capital.
a) Please provide possible reasoning behind this argument (no more than three lines).
b) Do you agree with this reasoning? (Yes or No)
c) Why? (no more than four lines)
PART C: OPPORTUNITY COST
Provide a philosophical critique of the concept of ‘opportunity cost' to value inputs and outputs associated with large electricity infrastructure projects (No more than two dot points, with each dot point no more than three lines).
PART D: APPROPRIATENESS OF ‘NPV'
Please review the following articles:
Arya, Anil; Fellingham, John C.; and Glover, Johanathan C (1998) Capital Budgeting: Some Exceptions to the Net Present Value Rule, Issues in Accounting education, Vol 13, No. 3, August 1998.
Berkovitch, Elazar and Israel, Ronen (2004) Why NPV Criterion does not Maximize NPV, The Review of Financial Studies, Spring 2007, Vol.17, No.1, pp. 239-255.
Ross, Stephen A. (1995) Uses, Abuses, and Alternatives to the Net-Present-Value Rule, Financial management, Vol. 24, No. 3, Autumn 1995, pp. 96-102.
Based on your review, please answer the following questions:
a) What ‘common theme' is discussed in each of these articles? (No more than two lines.)
b) How do the perspectives offered by each of these articles on the common theme (as above) differ from each other? (No more than two lines for each article.)
c) What is the most insightful comment you can make based on your review of the three papers? (No more than two lines
d) Provide reasoning in support of your answer to part c) above. (No more than three lines)
PART E: ‘INTEREST'
In some cultures charging of ‘interest' (and its precursor ‘usury') was historically considered undesirable. In some cultures, it still is? The use of interest rate is however commonplace in modern public discourse?
Why was/is charging of ‘interest' viewed negatively by some cultures? (no more than four lines).
What developments may have contributed to the transformation of the viewpoints on ‘interest' - from being undesirable, to being desirable, to being indeed imperative? (no more than two ‘dot' points, with each dot point no more than three lines).
Attachment:- Answer Template.pdf