Capital District Transportation Authority

Prep Memo—Week 1

Homework Assignment—Week 1 (due 9:00pm Sunday, February 4)

The exercises below use as their basis the Capital District Gondola project (described in the pre-start memo) which is posted on Blackboard). This project is currently in the feasibility and planning stages. Note: Some of the facts in the narrative below have been altered for the sake of the homework assignment.

Discounted Cash Flows—Projects have their own distinct cashflow profiles composed of revenues and expenses. (In the problem below, we are equating revenues with the expected benefits that will result from this transportation infrastructure, e.g. travel time savings, less traffic congestion, cleaner air, etc.)  The Capital District Transportation Authority (CDTA), which is a public agency, wants to compare the costs of building and operating the gondola with its expected benefits.  Since both the costs and benefits are multi-year—i.e., the project has an expected life of 30 years—it is necessary to discount (present value) the respective cost and benefit streams using a defensible discount rate (see pp. 170-176 of Stokey and Zeckhauser). These projected cost and benefit streams are shown below.

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Using a discount rate of 7% (which is the rate mandated by the U.S Office of Management and Budget for public investment and regulatory analyses https://www.wbdg.org/FFC/FED/OMB/OMB-Circular-A94.pdf), calculate the respective present values (NPV) of the costs and benefits. Based on your numbers, does this project make sense from the perspective of the public? How do the relative NPV’s change if the horizon is only 20 years? What if the discount rate is 5% (using 20 and 40 year time horizons)?