Question

Would a policy that had current high costs and significant future benefits be more feasible given a discount rate of 3% or 6%? Please briefly explain.

Answer 1

Ans. Let the high cost be H and future benefit each year will be B. The feasibility of the project will depend on the value of the net present worth at discount rate d% for n years. So,

NPW = -H + B/(1+d) + B/(1+d)^2 + B/(1+d)^3 + B/(1+d)^4 +........+ B/(1+d)^n

So, from the above equation, it is clear that the net present worth of the policy depends inversely on the discount rate. Thus, the policy will be more feasible if discount rate is lower i.e. 3% as NPW will be higher in this case as compared to when the discount rate is 6%.