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Business Economics : Capital Business Cost

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Question:

Discuss about the Business Economics for Capital Business Cost.

 

Answer:

Proposal A

On forming a project that generates electricity from water, using a hydro-electric project, the initial capital invested on the project is $40 billion.

The capital cost of the electricity generation plant is $40 billion.

Operation and maintenance cost of the plant

= 2.5 % of capital cost

= 2.5 % of $40 billion

= $1 billion

Hence, according to Kuklinski et al. (2015), total expenditure incurred on the thermal project = capital costs + operation and maintenance costs.

= $41 billion.

Apparent rate of interest is the stated interest rate of a given amount, whereas, real interest rates is slightly different from the nominal interest rate, where the rate calculates the actual value of interest depending upon inflation (Sen 2013).

As stated by King and Low  (2014), the inflation rate is denoted as  = nominal interest rate – real interest rate

Along with the real and apparent annual discount rates,  as 10 percent and 15 percent, thereby focussing on a 5% inflation rate. Hence, the final expenditure on the project for a span of 60 years

= 41 billion * (1 + r)n , where r = inflation rate and n = number of years

= 41 billion * (1 + 5%)60

= 766 billion

The revenue of the project is divided over a period of 60 years with a variation in the market structure. The first 10 years are considered to be, monopoly framework, the next 20 years, the government introduces the market to be oligopoly in nature and the last 30 years as competitive in nature.

Following figure 1, it can be denoted that, under monopoly, the price charged by the producer is 8 cents, where the producer sells 30 billion units of electricity, under oligopoly framework the price changed is 6 cents selling 35 billion units and in the competitive framework, the producer charges 4 cents selling 40 billion units of electricity.

Proposal A

Figure 1 : Proposal A

By calculating the revenue generated by the project over a period of 60 years, we can say that

= ( 30*8*10) + ( 35*6*20 ) + ( 40*4*30)

= 2400 + 4200 +4800

= 11400 billion

Hence, the  benefit that the project experiences = 10634 billion in a span of 60 years.

 

Proposal B

On forming a project that generates electricity from coal, using a thermal-electric project, the initial capital invested on the project is $40 billion.

The capital cost of the electricity generation plant is $40 billion.

Operation and maintenance cost of the plant

= 5 % of capital cost

= 5 % of $40 billion

= $2 billion

Hence, as per Greenstone, Kopits and Wolverton  (2013), total expenditure incurred on the thermal project = capital costs + operation and maintenance costs.

= $42 billion.

Apparent rate of interest is the stated interest rate of a given amount, whereas, real interest rates is slightly different from the nominal interest rate, where the rate calculates the actual value of interest depending upon inflation (Laubach and Williams 2016).

As stated by Holston, Laubach and Williams  (2016), the inflation rate is denoted as  = nominal interest rate – real interest rate

Along with the real and apparent annual discount rates,  as 10 percent and 15 percent, thereby focussing on a 5% inflation rate. Hence, the final expenditure on the project for a span of 60 years

= 41 billion * (1 + r)n , where r = inflation rate and n = number of years

= 42 billion * (1 + 5%)60

= 785 billion

The revenue of the project is divided over a period of 60 years with a variation in the market structure. The first 10 years are considered to be, monopoly framework, the next 20 years, the government introduces the market to be oligopoly in nature and the last 30 years as competitive in nature.

Following figure 2, it can be denoted that, under monopoly, the price charged by the producer is 12 cents, where the producer sells 30 billion units of electricity, under oligopoly framework the price changed is 9 cents selling 40 billion units and in the competitive framework, the producer charges 6 cents selling 50 billion units of electricity.

Proposal B

Figure 2: Proposal B

By calculating the revenue generated by the project over a period of 60 years, we can say that

= ( 30*12*10) + ( 40*9*20 ) + ( 50*6*30)

= 3600 + 7200 +9000

= 19800 billion

Hence, the  benefit that the project experiences = 19015 billion in a span of 60 years.

 

References:

Greenstone, M., Kopits, E. and Wolverton, A., 2013. Developing a social cost of carbon for US regulatory analysis: A methodology and interpretation.Review of Environmental Economics and Policy, 7(1), pp.23-46.

Holston, K., Laubach, T. and Williams, J., 2016, July. Measuring the natural rate of interest: International trends and determinants. In NBER International Seminar on Macroeconomics 2016. Journal of International Economics (Elsevier).

King, M. and Low, D., 2014. Measuring the''world''real interest rate (No. w19887). National Bureau of Economic Research.

Kuklinski, M.R., Fagan, A.A., Hawkins, J.D., Briney, J.S. and Catalano, R.F., 2015. Benefit–cost analysis of a randomized evaluation of Communities That Care: monetizing intervention effects on the initiation of delinquency and substance use through grade 12. Journal of experimental criminology, 11(2), pp.165-192.

Laubach, T. and Williams, J.C., 2016. Measuring the natural rate of interest redux.

Sen, A.K., 2013. Approaches to the choice of discount rates for social bene?t-cost analysis. Discounting for Time and Risk in Energi'Policy, pp.325-53.

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