An outlay of $1,000 today yields an annual benefit of $80 beginning next year and continuing forever. There is no inflation and the market interest rate is 10 percent before taxes and 5 percent after taxes.
a. What is the internal rate of return?
b. Taxes levied to fund the project come entirely from consumer spending. Is the project admissible? Why? Suppose instead that taxes are collected by reducing private firms’ investments. Is the project admissible in this case? Finally, suppose consumers spend 60 cents of their last dollar and save 40 cents. Is the project admissible now? Explain your calculations.
c. Suppose the social discount rate is 4 percent. What is the present value of the project?
d. Now suppose 10 percent annual inflation is anticipated over the next ten years. How are your answers to (a), (b), and (c) affected?