Suppose that a project to shore up a levee separating the Gulf of Mexico from a

Question

Suppose that a project to shore up a levee separating the Gulf of Mexico from a nearby town will save the town $500,000 in damages from a storm and subsequent flooding 100 years from now. i) Calculate the present value of this project using a social discount rate of 3% and assuming that inflation is 2% (thus a nominal social discount rate of 5%). ii) Next, calculate the present value using the same inflation rate, but a social discount rate of 1%. Show your calculations in a table. If the cost of renovating the bulkhead is $10,000 in the present, would the project be feasible? Use the present value of net benefits to support your decisions and explain how this differs from the benefit-cost ratio. Discuss the importance of choosing the social discount rate and how society may be inappropriately evaluating the benefits of environmental projects.

Explanation / Answer

Present Value = 500000/ ( 1 + ( 5/100) ) ^100 = $ 3802.245

Social discount rate = 1 %

Nominal Interest rate = 1 + 2 = 3 %

Present value = 500000/ ( 1 + ( 3/100) ) ^100 = $ 26016.42

For Case I renovating would not be favourable as net present value = -10000 + 3802.245 < 0 so we incur a loss

For case II renovating would be favourable as net present value = -10000 +26016.42 > 0 so we incur a gain

Social discount rate should be lesser for a much better outcome. Because lesser the Sicual Discount rate more is the Net Present Value

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