Chapter 11-Cost-Benefit Analysis Public economics
1 Chapter 11 – Cost-Benefit Analysis Public Economics
Introduction Cost-benefit analysis is a set of practical procedures for guiding public expenditure decisions
2 Introduction • Cost-benefit analysis is a set of practical procedures for guiding public expenditure decisions
Present value Project evaluation usually requires comparing costs and benefits from different time periods Dollars across time periods are not immediately comparable, because of inflation and returns in the market
3 Present Value • Project evaluation usually requires comparing costs and benefits from different time periods • Dollars across time periods are not immediately comparable, because of inflation and returns in the market
Present value Present dollars into the future Suppose you invest $100 today in the bank At the end of year 1, it is worth(1+ 05)X$100 or$105 At the end of year 2, it is worth(1+05)x$105, or$11025 The interest compounds over time. that is the interest is also earning interest
4 Present Value: Present Dollars into the Future • Suppose you invest $100 today in the bank – At the end of year 1, it is worth (1+.05)x$100, or $105 – At the end of year 2, it is worth (1+.05)x$105, or $110.25 – The interest compounds over time, that is the interest is also earning interest
Present value Present dollars into the future Define R=initial investment amount r=rate of return on investment T=years of investment The future value(F of the investment is T FV=R(1+r
5 Present Value: Present Dollars into the Future • Define – R=initial investment amount – r=rate of return on investment – T=years of investment • The future value (FV) of the investment is: FV R( r) T = 1+