Question

Suppose that global warming might raise sea levels such that much of Bangladesh would be flooded soon after the year 2050. The government of Bangladesh is considering two options for addressing this issue. Option 1 is to pay $8 billion today (year 2016) to reduce emissions. Option 2 is to build up levies in 34 years (year 2050) which is estimated to cost $25 billion at that time. Should government act now or later if the discount rate is 3%?

What is the present value of reducing emissions in year 2016? (Express your answer as an integer.)
What is the present value of building up levies in 34 years? (Include two digits after the decimal point.)
Should government act now or later, under these assumptions, and based on economic grounds?

Answer 1

To make this decision, the government of Bangladesh needs to make a cost-benefit analysis between the two options.

The present value shows the cost of reducing emissions in the year 2016: $ 8bi

The value of the future rate should be calculated by financial mathematics, by the compound interest formula for the future value. Let's find out how much the present value in 2016 $ 8bi will be worth in 2050.

Future value = Present Value (1 + i) ^ n

Where: i = interest rate = 3% per annum

n = number of periods = 34

Future Value = 8,000,000,000 (1 +0.03) ^ 34

Future value = 21,855,242,364

Therefore, comparing both costs for the year 2050

2016: $ 21bi

2050: $ 25bi

The government should invest now because it will cost US $ 4 billion.