# Purdue AGEC 40600 - Lecture notes (17 pages)

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## Lecture notes

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Lecture Notes

- Pages:
- 17
- School:
- Purdue University
- Course:
- Agec 40600 - Natural Resource and Environmental Economics

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AGEC FNR 406 10 LECTURE Rice drying on the Philippine National Highway Benefit Cost Measures Lecture Goals 1 Present three tools of benefit cost analysis 2 Discuss advantages and disadvantages of BCA Don t neglect to review the BCA packet Three BCA tools 1 Net Present Value NPV 2 Benefit Cost Ratio BCR 3 Net Present Value NPV Net Present Value NPV NPV is the current value of all net benefits associated with a project Net benefit is simply the sum of benefits minus the sum of costs The net present value of benefits is the present value of those net benefits The net benefits are converted to present value by discounting NPV Formula t T NPV t 1 Benefit t Cost 1 r t t Key Point If the project has a NPV 0 then it is worth considering on its economic merits If the project has a NPV 0 then it fails to return benefits greater than the value of the resources used NPV Example Time Benefit Cost Net Benefit 0 100 150 50 1 100 100 0 2 100 50 50 all 300 300 0 50 1 1 0 0 1 1 1 50 1 1 2 8 68 Benefit Cost Ratio BCR BCR is computed as the PV of Benefits divided by the present value of Costs Discounted benefits and discounted costs are calculated and summed separately then divided BCR Formula Benefitt t 1 r t 1 BCR t T Costt t t 1 1 r t T Key Point If the project has a BCR 1 then it is worth considering on its economic merits If the project has a BCR 1 then it fails to return benefits larger than its costs BCR Example Num 100 1 1 0 100 1 1 1 100 1 1 2 273 54 Den 150 1 1 0 100 1 1 1 50 1 1 2 282 22 BCR 273 54 282 22 0 97 1 Internal Rate of Return IRR The IRR is the maximum interest rate that could be paid for the project resources that would leave enough money to cover investment costs and still allow society to break even The IRR is the discount rate at which the PVof benefits equals the present value of costs IRR Formula Solve for the IRR by finding i that solves PV Benefits PV Costs Use algebra or a spreadsheet Key Point The IRR must exceed the chosen discount rate for the project

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