ECONOMICS

Economics

Economics

Question 1

The present value of an asset is a measure of the asset's worth at time zero, or the time at which the asset is valued. However, taking into account the cost of the asset, the Net Present Value is the difference between what an asset is worth and what it costs. This relationship can be expressed as:

Net Present Value = Present Value of All Future Cash Flows - Cost of the Asset

An asset with a positive Net Present Value is expected to bring wealth to its owner because it is worth more than it costs. Of course, since the present value is based on expected cash flows, there is no guarantee that it will bring wealth. An asset with a negative Net Present Value would not be purchased because the asset costs more than it is worth. This would be like buying a car for $20,000 when it has a sticker price of $18,000.

The problem many novice investors have occurs when the Net Present Value of an asset is zero. A Net Present Value of zero simply means that the asset is worth what it costs. In other words, given the risk of realizing the expected future cash flows of the asset, the price is perfectly in line with the risk. An asset with a Net Present Value of zero is expected to create wealth equal to the risk associated with purchasing the asset; it is a fair investment.

When making financial decisions, it is important to choose only assets with a Net Present Value of zero or higher otherwise the investor is bearing too much risk given the expected future cash flows.

The concept of buying assets either for a fair price or for a price less than what the asset is worth is a simple concept. However, Net Present Value often gives novice investors trouble because a value of zero simply means that the price of an asset is fair. A Net Present Value of zero means the investor is expected to receive a return appropriate for the amount of risk taken on. It does not mean that the investor is expected to realize a zero return.

Cost of Capital =

20%

Project

Year

$ 000

0

Project Cost

10

1-~

Inflows

15

 

NetFlows

25

Net Present Value

$18.75

Therefore, from above analysis, the company should undertake the project as its NPV is substantially positive.

Question 2

A fuel tax (also known as a petrol, gasoline or gas tax, or as a fuel duty) is an excise tax imposed on the sale of fuel. In most countries the fuel tax is imposed on fuels which are intended for transportation. Fuels used to power agricultural vehicles, and/or home heating oil which is similar to diesel are taxed at a different, usually lower, rate.

In the United States, the fuel tax receipts are often dedicated or hypothecated to transportation projects so that the fuel tax is considered by many a user fee. In other countries, the fuel tax is a source of general revenue.

Because of the relatively inelastic nature of demand for petrol, in the short run ...