A highway in a rural town has a dangerous curve. Improving the highway will cost $10...

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A highway in a rural town has a dangerous curve. Improving thehighway will cost $10 million today, at time t = 0. The discountrate is r = .05 and a planning horizon of 10 years has beenadopted. It is known that the new bridge will create benefits (dueto a decline in deaths) of $1.5 million per year for each of the 10years from t = 1 to t = 10.
a. Compute the present value (today, at t = 0) of the benefitover 10 years from t = 1 to t = 10. Should the highway beimproved?
b. Finally, let’s say the new highway, being safer than the oldone, will also save one statistical life per decade. What shouldthe value of the statistical life be in order to change thedecision in part a.?
c. Now suppose a member of the city council argues successfullythat the planning for this project should use a discount rate of r0 = .03 rather than the original value of r = .05. Discuss how thischange will affect the decision. How would you advise the council,as a staff economist, to select the “best” discount rate for theproject?

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3.7 Ratings (572 Votes)

PART 1 To decide whether a project should be undertaken or not one of the means is through Net Present Value or NPV If the NPV is positive project should be undertaken and vice versa As per the calculations below the NPV is 1582602 The benefits are more than the cost Hence the highway should be improved discount rate 5 present value formula cash flows1discount ratet time t 0 1 2 3 4 5 6 7 8 9 10 See Answer

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A highway in a rural town has a dangerous curve. Improving thehighway will cost $10 million today, at time t = 0. The discountrate is r = .05 and a planning horizon of 10 years has beenadopted. It is known that the new bridge will create benefits (dueto a decline in deaths) of $1.5 million per year for each of the 10years from t = 1 to t = 10.a. Compute the present value (today, at t = 0) of the benefitover 10 years from t = 1 to t = 10. Should the highway beimproved?b. Finally, let’s say the new highway, being safer than the oldone, will also save one statistical life per decade. What shouldthe value of the statistical life be in order to change thedecision in part a.?c. Now suppose a member of the city council argues successfullythat the planning for this project should use a discount rate of r0 = .03 rather than the original value of r = .05. Discuss how thischange will affect the decision. How would you advise the council,as a staff economist, to select the “best” discount rate for theproject?