Question

The federal government is considering closing down a substantial portion of the John Day Fossil Beds in Oregon and selling the land to private interests. In considering this policy, economists advise the government to choose the option that has the highest net present value. They consider costs and benefits into the infinite future.Closing the fossil beds provides an immediate $3 million from the sale of the land andan annual savings of $100,000 in reduced maintenance costs. However, recreational users and conservationists no longer derive any benefit from the land, losing $500,000in benefits annually.

a) If the discount rate is r = 2.5%, are the benefits of closing the monument larger than the costs?

b) If the discount rate is r = 5%, are the benefits of closing the monument larger than the costs?

Answer 1

a) Net benefit if you sold immediately = $3,000,000 and saving of $100,000 annually.

Present Value of Benefit = $3,000,000 + ($100,000)/i

= $3,000,000 + $100,000/0.025

= $7,000,000

Present Value of Cost = Lost Benefits annually / i

= $500,000/0.025 = $20,000,000

Here the cost is greater than benefits if it is closed annually.

Therefore it is not advisable to close the monument

b) Net Benefit if you sold immediately = $3,000,000 and saving of $100,000 annually.

Present Value of Benefit = $3,000,000+ $100,000/0.05

= $5,000,000

Present Value of Cost = Lost Benefits/ i

= $500,000/0.05 = $10,000,000

Here also cost is greater than benefits in the infinite life period.

Therefore it is not advisable to close the monument

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