Question

Benefit Cost Analysis:

You are trying to decide if you should place a solar panel on your apartment. You can buy the solar for 1000 dollars today, and it will reduce your electricity bill by

$300/year from today until you graduate four years from now (NOTE: this means it is a 4-year project). If you face an interest rate of 10%, should you buy the solar panel for your apartment?

Time Benefits Costs 0 300 1000 1 300 0 2 300 0 3 300 0

Would a subsidy of of $100 in the first year affect your purchasing decision? How would a $200 fee to remove the solar panel when you graduate (T=3) affect your decision (assume there is still a subsidy)?

Answer 1

At 10% rate, with the given costs and benefits, the net present value of the cashflows would be =

= 300+300/1.1 + 300/1.1² + 300/1.1³ - 1000

= $46.056

As the net present value of the cashflows is positive, we will install the solar panels.

A subsidy of $100 would reduce our initial cost and hence would increase our net present value by $100 but will not change our decision as even before the subsidy we had already decided to install the solar panels.

So, with the subsidy, our total net present value of the cashflows would be $146.056

If there is a removal cost of $200 at the end of time 3, the present value of this cost would be $200/1.1³ = $150.263

Assuming that the subsidy is still there, the total net present value after incurring the removal cost would be =

= $146.056 - $150.263

= -$4.21

Now as the net present value of all the cashflows is less than 0, we will decide not to install the solar panels.

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