The state of Glottomora has $100 million remaining in its budget for the current year. One alternative is to give Glottomorans 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:
Years 1-5 = $0 benefits per year
Years 6-20 = $20million benefits per year
The second alternative is to undertake a job retraining program, also costing $100 million and generating the following benefits:
Years 1-5 = $20 million
Years 6-10 = $14 million
Years 11-20 = $4 million
The state Power Department argues that a 5% discount factor should be used in evaluating the projects, because that is the government’s borrowing rate. The HR department suggests using a 12% rate, because that more nearly equals society’s true opportunity rate.
Question: Make a choice between the projects and the tax-refund alternative. Why did you choose the alternative you did?