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9. Exercise 17.9

The state of Glottamora has $200 million remaining in its budget for the current year. One alternative is to give Glottamorans a one-time tax rebate. Alternatively, two proposals have been made for state expenditures of these funds. The first proposed project is to invest in a new power plant, costing $200 million and having an expected useful life of 20 years. Projected benefits of the new power plant are as follows:

Years	benefits per year ($millions)
1-5	0
6-20	40

The second alternative is to undertake a job retraining program, also costing $100 million and generating the following benefits:

Years	Benefits per year ($Million)
1-5	40
6-10	28
11-20	8

The state Power Department argues that a 5 percent discount factor should be used in evaluating the projects because that is the governments borrowing rate. The Human Resources Department suggests using a 12 percent rate because that more nearly equals societys true opportunity rate. The present value interest factor at the end of years from 0 - 20 for the two discount rates are given in the following table.

Discount rate	0	1	2	3	4	5	6	7	8	9	10	11	12	13	14	15	16	17	18	19	20
5%	1.000	0.952	0.907	0.864	0.823	0.784	0.746	0.711	0.677	0.645	0.614	0.585	0.557	0.530	0.505	0.481	0.458	0.436	0.416	0.396	0.377
12%	1.000	0.893	0.797	0.712	0.6306	0.567	0.507	0.452	0.404	0.361	0.322	0.287	0.257	0.229	0.205	0.183	0.163	0.146	0.130	0.116	0.104

Evaluate the projects using both the 5 percent and the 12 percent rates.

Project Net Benefits at Discount Rate = 5% ($ Millions) and Net Benefits at Discount Rate = 12% ($ Millions)

Power Plant

Job Retraining Program

Project	Net Benefits at discount Rate = 5% ($Million)	Net Benefits at Discount Rate =12% ($Million)
Power Plant	( $ ? )	$?
Job Retraining Program	$?	$?

If you agree with the Power Department that the governments borrowing rate is the appropriate discount rate, which projects will you choose?

a) Job retraining program

b) Power plant

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