The state of Glottamora has $100 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 $100 million and having an expected useful life of 20 years. Projected benefits accruing from this project are as follows:

BENEFITS PER YEAR

YEARS ($ MILLIONS)

1–5............. $0

6–20............ 20

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

BENEFITS PER YEAR

YEARS ($ MILLIONS)

1–5 .............$20

6–10 ............. 14

11–20 ............. 4

The state Power Department argues that a 5 percent discount factor should be used in evaluating the projects, because that is the government’s borrowing rate.

The Human Resources Department suggests using a 12 percent rate, because that more nearly equals society’s true opportunity rate.

a. What is implied by the various departments’ desires to use different discount rates?

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

c. What rate do you believe to be more appropriate?

d. Make a choice between the projects and the tax-refund alternative. Why did you choose the alternative you did?