Question

Two public infrastructure projects have the economic profiles that follow:

Option B.

Year	Capital Cost	Operating and Maintenance Cost	Benefits
1	2,500,000	0	0
2	500,000	50,000	750,000
3		100,000	750,000
4		100,000	750,000
5		100,000	750,000
6		100,000	750,000
7		100,000	750,000
8		100,000	750,000
9		100,000	750,000
10		100,000	300,000

Option A

Year	Capital Cost	Operating and Maintenance Cost	Benefits
1	2,000,000	0	0
2	1,000,000	10,000	0
3	500,000	70,000	120
4		90,000	600,000
5		90,000	800,000
6		90,000	800,000
7		90,000	800,000
8		90,000	800,000
9		100,000	800,000
10		100,000	500,000

Use this data to compute for each (a) the Net Present Value at discount rates of 10 and 5 percent (c) the internal rate of return for each. Describe the facts about the projects that would dictate which criterion is appropriate, and which project is preferable under each circumstance.

Answer 1

Option B

NPV 10%	643430.64
NPV 5%	1401438.65
IRR	15.87%

Option A

NPV 10%	-818879.82
NPV 5%	-131795.41
IRR	4.22%

The NPV is negative in both cases for Option A. This implies that the option is not suitable and is loss making.

As per IRR method, the option with the higher IRR is selected. Hence Option B is again preferred over Option A.

WORKINGS