A government project with the objective of advancing the technological capabilit
ID: 2744683 • Letter: A
Question
A government project with the objective of advancing the technological capabilities of the nuclear industry will cost $100 Million. It is believed that 80% of those funds would have come from investment and 20% from consumption. The before tax rate is 8% and the after tax rate is 5%. a) What is the discount rate for this project? b) Some economists would argue that using private rates as reference is wrong in this particular case. Why might they be right? Should the correct rate be higher or lower than in (a)? Why?
Explanation / Answer
a. The consumption (20%) or 20 million will not be liable for income tax and hence rate is 8% here.
On the other hand, investment income (80%) or 80 million is taxable and hence the rate is 5% here
So the discount rate = 0.8*5 +0.2*8 = 5.6%
b. Private rates are the rate for the general public and private companies. The interest rates for government tend to be lower than private rates because they are lending to the government and this money loaned is less risky when compared to private loans since the government will pay back and is a sort of risk free loan. Hence the economists are right. So, the correct rate should be lower than that calculated in (a).