Question

Considering a policy with costs in year 0 and benefits in year 1, if the undiscounted benefits next year are $121 and the social discount rate is 10%, the costs this year μst be less than $_____ for the policy to have a positive net present value.

a) $121
b) $100
c) $110
d) $130

Answer 1

To calculate the maximum cost for the policy to have a positive net present value, we can use the formula for calculating present value. In this case, the costs must be less than $110 for the policy to have a positive net present value.

Step-by-step explanation:

To calculate the maximum cost for the policy to have a positive net present value, we need to find the present value of the benefits and compare it to the costs. The formula for calculating present value is:

Present Value = Future Value / (1 + Discount Rate)

In this case, the future value of the benefits is $121 in year 1, and the social discount rate is 10%. Plugging these values into the formula, we get:

Present Value = $121 / (1 + 0.10) = $110

Therefore, the costs this year must be less than $110 for the policy to have a positive net present value. The correct answer is option c) $110.