Net Present Value (NPV) and Benefits Cost Ratio (BCR) are the two most appropriate viability indicators for evaluating the two projects (Gitman & Zutter, 2012). This choice is informed by the fact that both indicators take account of the time value of money. The decision criterion for both indicators is to choose the project with the highest value of the indicator provided it is positive.
Given the different useful lives of the two projects, the analysis repeats each project to the least common minimum useful lives such that project A will be repeated once while B will be repeated twice with both projects being analyzed over a period of 60 years.
The Analysis: Financial and economic
This kind of analysis assesses the viability of a project from the perspective of a single organization or organizations which is the utility company in the present case (Gitman & Zutter, 2012). Inputs are valued at their market prices such that the willingness to pay concept does not apply. The capital costs for Project A and B are $3000Mn and $2000Mn respectively. Similarly, the annual operating costs for A and B are $60Mn and $140Mn respectively. The calculations in the appendix show A to have an NPV of $235Mn while B has an NPV of $250Mn. The BCR are 1.06 and 1.11 respectively.
Unlike financial appraisal, economic analysis goes beyond the organizational impact of a project to consider the wider social issues (Gitman & Zutter, 2012) .Inputs for which markets are distorted are measured at shadow prices. The total capital cost for project A will be $3500Mn with the $600Mn foregone benefits from land being the cost of that land as opposed to the market price. Similarly the total capital cost for project B is $ 2450Mn as the society will have to forego $500Mn of benefits if the project is established at the site. The same principle is used in treating coal that can be exported at $80 per tonne such the total annual operating costs for Project B is $224.5Mn. Total annual benefits for both projects using 30 cents as the price of electricity is $600Mn. A calculation of the viability indicators using the same approach as in the financial evaluation but with these new inputs will give NPV for A as $1678Mn and a BCR of 1.39 while the NPV for B will be $874Mn with a BCR of 1.17.
b).Option from a financial perspective
I would recommend B given that it has higher viability indicators than its counterpart. Its NPV is $250Mn against only $235Mn for A. Similarly, its BCR of 1.11 is higher than 1.06 for A.
c).Option an economic perspective
I would recommend A given that it has higher viability indicators than its counterpart. Its NPV is $1678Mn against only $874Mn for B. Similarly, its BCR of 1.39 is higher than 1.17 for B.
d).Whether recommendation would change
The 5% yearly inflation would not affect my recommendation given that the effect will be uniform throughout both projects.
e).Basis of analysis
The above analysis has been conducted on a nominal basis since the inputs have not been adjusted for the effect of inflation.
Gitman, L.J. & Zutter, C.J. (2012).Principles of Managerial Finance.13th edn.Boston, MA: Prentice Hall.
Do you need an Original High Quality Academic Custom Essay?