Topic: Memo

Order Description All the requirements for the memo have been stated in the attached file, please read it carefully. Thank you EC303- Economic Evaluation in the Public Sector, Fall 2015 Amjad Rabi Assignment 2: due on Tuesday November 10th, 2015 at 5:30 pm in class. Please read the word of caution about ‘collaboration’ provided in assignment 1 Important note: Any question about this assignment should be posted in the discussion board created for this purpose on MLS. Students are encouraged to discuss and answer questions in this board. The instructor may or may not contribute. The point here is to mimic situations faced by policy analysts in which the wording of documents can be unclear yet they have to arrive to the best interpretation with minimal questions asked to the supervisor. Electrification of the Demoland Railroad The purpose of this assignment is to illustrate some of the problems that arise in the evaluation of a government investment. The objective of this problem is to review the conclusion of a feasibility study done by an international consulting group. Develop your results from the point of view of the Demoland Railway Services and the economy of that country. Determine the best alternative between financing by USAID (United States Agency for International Development), the government of England, or the government of Demoland for diesel locomotives or by the government of Demoland with its funds for electric locomotives. The loans offered by USAID and England are only for the cost of locomotives. The International consulting group made a detailed calculation of the costs of operation for diesel locomotives. This study arrived at the conclusion that electrification would be more economical than conversion to diesel. Even though the initial costs of electrification were higher than conversion to diesel, the savings in operating costs was significant. In addition, the savings in foreign exchange signified a substantial benefit for the economy of Demoland. The total investment of capital in electrification was estimated to be LCU1 103 million as contrasted with LCU42 million for conversion to diesel. The annual operating costs were estimated at LCU 8 million and LCU 12 million respectively. The cost in foreign exchange for capital investment in electrification would be LCU63 million as contrasted with LCU33 million for conversion to diesel. On the other hand, the annual operating costs in foreign exchange would be only LCU0.4 million for electrification, while in contrast, it would be LCU 3.9 million for conversion to diesel. The total cost in foreign 1 Local Currency Unit exchange during the life of the project was estimated at LCU 75 million in the case of electrification and LCU 165 million in the case of conversion to diesel. On the basis of this information, they arrived at the conclusion that electrification would have a clear advantage over the conversion to diesel, and, therefore, they recommended the electrification. The details on costs are presented at the end. The government of Demoland had received an offer of a loan from USAID to buy the diesel locomotives to be repaid over a period of 30 years after (excluding) a ten year grace period on a principal repayment, with an annual rate of interest of 1 percent during the first 10 years, and 3 percent during the next 30 years of the loan. The British government had offered a loan to buy the diesel locomotives to be repaid in 30 years, after a grace period of five years, without interest. After the grace period of both loans, the service (amortization plus interest) of both loans should be repaid in equal annual installments. The objective of this assignment is to check the conclusions of the feasibility study carried out by the international consulting group. Therefore, examine from the point of view of the Demoland Railway and the economy of this country what best alternative among financing by: 1- USAID in respect to the diesel locomotives, 2- England in respect to the diesel locomotives, 3- Demoland with its own funds in respect to the: a. diesel locomotives, b. Electric locomotives. Use the following assumptions: 1. The government of Demoland will assume the total financial responsibility for the electrification project. The source of this capital is taxes. 2. The social rate of discount in Demoland is 8 percent. 3. The cost of diesel oil for the Demoland Railway includes a tax, which represents a little less than three-forth of its final costs. Because taxes are domestic payment, the figures in table I include the tax, and those in table 2 exclude it. 4. The accounting price (shadow price) of foreign exchange in Demoland is 50 percent higher than the official rate of exchange, which is US 21 cents – 1 LCU. 5. One year is needed for the installation of diesel project and two years for electrification project. After the period of installation, the useful life of the equipment in the case of electrification is 35 years and in the conversion to diesel 20 years. 6. All locomotives are purchased at the last year of the period of installation. In the case of the electrification project, assume that three-fourths of all other capital costs are expended during the first year of installation, and the reminder during the second. 7. For greater ease, assume that all payments are made and all incomes are received at the end of the year. 8. After the new equipment enters operation, the social income stimulated by both projects will be LCU 18 million for each year of the useful life of both the diesel and electric locomotives. 9. Loan payment plans: a. On the loan from the USAID, the first 10 years of the loan has a grace period on the payment of principal (no principal payment due), but it does require an annual payment of one percent of the original loan amount. For the next 30 years (year 11 to 41) at a three percent rate of interest, annual payment for the USAID loan is LCU1.67 million. (This 1.67 includes both interest payment and principal payment. It is usually not provided, but for simplicity I gave it to you). b. There is no interest on the loan from England. There is a grace period of 5 years. For the next 30 years (year 6 to 36) the original amount is to be paid in 30 equal installments. Table I: Total Cost of Alternatives (millions of LCU)2 Conversion to Diesel Electrification Cost of capital3 41.88 103.25 Annual Operating Costs Fuel or Energy 8.65 6.08 Maintenance 3.541.71 1.71 Total (annual operating costs) 12.19 7.79 Table II: Costs Needing Foreign Exchange for Imports (millions of LCU) 2 USAID England Electrification Cost of capital3 Locomotives 32.82 32.82 32.40 Other --- --- 30.85 Total (cost of capital) 32.82 32.82 63.25 Annual Costs Fuel4 2.16 2.16 --- Maintenance 1.77 1.77 0.39 Interest & Principal See assumption 9 See assumption 9 --- Total (annual costs) 0.39 2 The forign exchange costs in table II are subtotal of the total costs (national and foregn exchange) given in table I. 3 For timing of electrification capital expenditures see assumption 5 and 6. 4 See assumption 3 Expected work and deliverables: 1- Use excel to create the cash flow of each benefit and cost and then calculate the present value of the a. Cost of the loan b. Other capital costs c. Costs of operation d. Flow of benefits 2- You need to find the above figures independently for each of the following:  Diesel: i. Locomotive financed by USAID ii. Locomotive financed by England iii. Financing by Demoland  Electrification: iv. Financing by Demoland 3- You need to write a one-page memo including the following items:  One paragraph introduction  A table includes of 5 columns First column: Alternative name. Second column: Sum of PV of social benefits Third column: Sum of PV of social costs Forth column: Net benefit Fifth column: Benefit/cost ratio This table should include rows to illustrate all alternatives stated in “2.”  One paragraph to indicate your conclusion and to argue why your conclusion is different (or the same) from the recommendation by the international consultant group. 4- You need to attach an appendix that includes your methodological approach (how you arrived at your conclusion). This is NOT the same as printing your excel file, it is the model you used including the mathematical formulas. (Should be 1-3 pages) 5- All excel work should be saved. You do not need to submit it, but I may ask for it. Failure to provide the excel workbook if I ask for it will result in an F grade and no excuse will be accepted.