Cost-Benefit Analysis - Assignment Example

Name: Lecturer: Course name: Course code: Date: Q1). incremental initial outlay $0.000 purchase cost $5 million incidental cost planning cost $250,000 clearance cost $750,000 ground works $2.5 million total initial capital $8.5 million Incremental initial outlay is the amount used in the initial stage of the project development and it is going to be deducted from the total the total present value amount at the end of the 28th year in arriving at the net present value of the project. W2 benefit 1). Road congestion reduction. private cars 227500 business cars 234000 light commercial cars 441000 buses 92500 tracks 756,000 total benefit per year 1,751,000 1,751,000 2.accident reductions fatal accidents serious injuries slight injury only accident total benefit per year 4,360,500 4,360,500 net benefits per year therefore $6,111,500 Due to reduction in cost of road accident and congestion, this amount would be regarded has benefit of the project and hence should be added to the project in arriving at the net social benefit and present value of the estimated road construction networks. W4 wages workers (90*$40*40hrs*47 weeks)= $6,768,000 managers (60*$45*40hrs*47 weeks)= $5,076,000 total wages payable $11,844,000 Wages is considered has benefit in arriving at the net social benefit cost of the project to the general public because construction of roads would lead to reduction in rate of unemployment hence improving the living standard due to enhance transports networks. national [ark loss Zone A ($35*0.5km*100,000times)=1,750,000 Zone B($35*1km*60,000times)=2,100,000 Zone C($35*2km*25,000times)=1.750.000 total lost revenue $5,600,000 Revenue Loss of the national park is taken care of by the project in that the amount is treated as an expense to the project hence it will be deducted from the net social benefit in arriving at the present value of the project and consideration is made as to whether the project should continue or not. From the Net present value generated in excel workbook, it can be depicted that there is a positive net present value of the project of $ 523,230,000.this is an important indication that the construction of the road will lead to an improved road networks, reduction in road accident as well as congestion due to the positive net present value the project would generate after discounting at 3 %. The impact of this would lead to improve economy of the country, living standard of the citizen leading to investor’s attraction to the country to do business. The country will in turn have a strong currency exchange combined with balance of payment boosting the gross domestic product (.GDP) Q2) how does noise pollution affect the outcome in terms of NPV and BCR? the effect of noise pollution would lead to reduction in value of the house by ($300,000-250,000*150house} =$7,500,000.This reduction is treated as an expense to the road project in which it will be incurred and treated as an expense and thus it is deducted from the total benefit in arriving at the net social benefit and discounted at 3% to arrive at the net present value as well. From the excel workbook, it can be depicted that the total net present value will be $385,505,000. An impact of noise pollution on the proposed road network would lead to reduction in net social benefit because many people will move away from the road (i.e. depicted by reduction in value of the house) and hence leading to a decline in value of the net present value by ($ 523,230,000-$385,505,000} =$137,725,000.in conclusion, the project appraisal is still worthwhile and thus they should continue with the project. This is because there is still a positive net present value generated from the project implying an affirmative trend to the countries economy due to enhanced road networks. Q3). Establish which variables have the biggest impact on the outcome of the analysis using some simple sensitivity analysis. Performing sensitivity analysis on the effect of noise pollution and the revenue lose of national park. A).National park revenue loss. national [ark loss Zone A ($35*0.5km*100,000times)=1,750,000 Zone B($35*1km*60,000times)=2,100,000 Zone C($35*2km*25,000times)=1.750.000 total lost revenue $5,600,000 Discounting this revenue for the next 28 years using the present value interest factor annuity (P.V.I.F.A 3%) would give P.V.I.F.A @3%= 1-{1 / (1 + r)-t} P.V.I.F.A=1-0.4371)/0.03}$5,600,000=$105,079,006 Noise pollution effect Noise pollution would lead to a reduction in value of the house by $25,000. Per house, For 150 house total value reduction would give (150house*$50,000) =$7,500,000.discounting this value for the next 28 years would give P.V.I.F.A @3%= 1-{1 / (1 + r)-t} P.V.I.F.A=1-0.4371)/0.03}$7,500,000=$140,725,000 From the above sensitivity analysis, it can be depicted that the effect of noise pollution would have a significant effect as compared to revenue loss of national park. Hence stringent measures should be taken to reduce the impact of noise pollution. At the end of 28 years, effect of noise pollution would cost the project $140,725,000. Q4). Given the results of the BCA, and with differing values for certain variables, do you think the project should go ahead? The project should go a head since it yields a positive net present values despite the deference variables factors affecting the cost and achievability of the project. Positive net present values implies despite the negative uncertainties that may occur on the project appraisal, its benefit outweigh the cost and other factors. Sensitivity analysis entails learning the mode of indecision in the output of a representation and the extent it can be assign to a diverse basis of ambiguity The Limitation of sensitivity analysis in giving a verdict as to whether an expense is recognized as highest against other cost is that. Sensitivity analysis is based on sampling of data and thus it posses’ threat because a single model consumes a lot of time as well as standard error on data and hence result generated would not be relied upon heavily in decision making. The limitation from the project is that, a problem of forecasting is envisaged, the project is estimated to take 4 years to completion and the social benefit as well as the net present value is forecasted for the next 28 years. In this case long-term forecasting posse’s problems of predicting future uncertainties such as natural calamities that could affect project success or whether the future generation will have their social benefit well taken care off. In order to curb the effect, the project manger should make short term forecasting to give accurate results or incorporate some statistical models that could integrate factors such as effect of inflation on the project, risk adjusted discounting rate on the current rate of 3% in order to attain an accurate estimation on the project. The above sensitivity analysis signifies that independent variables between input and the model are independent. This might be misleading because at times the data input and the model derived are correlated. This discrepancy posse risks to information provided as well as the sensitivity analysis as a tool for decision making. In summary, sensitivity analysis is an important tool for managerial decision making and thus they aids in making critical decision of whether to invest or not on a project based on sensitivity of revenue changes to cost. But this estimation should be based on specific allowed degree of standard error or tolerable error and the confidence level set on the results generated by the project Reference 1. Messner, S. D. (1967). In A Benefit-cost Analysis of Urban Redevelopment: A Case Study of .. 2. Hansen, J. R. (1978). In Guide to Practical Project Appraisal: Social Benefit-cost Analysis ... 3. analysis, T. s.-b. (1981). In The social appraisal of projects: a text in cost-benefit analysis. 4. Colin H. Kirkpatrick, J. W. (1996). In Cost-benefit Analysis and Project Appraisal in Developing Countries. 5. Dayananda, D. (2002). In Capital Budgeting: Financial Appraisal of Investment Projects (p. ppg 7). 6. Dompere, K. K. (2004). In Cost-Benefit Analysis and the Theory of Fuzzy Decisions: .. 7. George T. Friedlob, F. J. (1996). In Understanding Return on Investment. 8. Harold Bierman, J. S. (2012). In The Capital Budgeting Decision, Ninth Edition: Economic Analysis (p. ppg 197). 9. Lumby, S. (1988). 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