A city is planning a social project for its citizens. It has received bods from 2 contractors. Contractor A proposed that the project would cost $40,000 to build plus upkeep costs of $5,000 per year for its expected 5 year life span. Annual revenues are anticipated to be $15,000. Salvage value at the end of the 5 years is expected to be $5,000.

Contractor B proposed a larger facility at an annual cost of $80,000. This facility will also have an expected life span of 5 years $8,000 per year. Annual earnings for this facility are anticipated to be $30,000. Finally, it is anticipated that at the end of the 5 years the entire structure will be torn down at a cost of $5,000.

If the real social discount rate is assumed to be 5% should the city build either facility? If so, which one? Briefly explain the basis for your conclusions, provide sufficient information on how you arrived at your decision. In answering these questions, assume that all the relevant benefits and costs are listed above, all the benefits and costs (with the exception of the initial construction cost) are realized at the end of each year

Question 4

(i) Mr. Michael is planning an around the world trip. The utility from the trip is a function of how much he spends on the trip (Y), is given by:

U(Y) = In Y

Mr. Michael has $20,000 to spend on the trip.

a. If there is a 25% probability that he would lose $2,000 of his cash on the trip, what is the trip's expected utility?

b. Suppose that Mr. Michael can buy insurance against losing $2,000 at an actuality fair insurance premium. Compute what would be a fair insurance to cover the expected loss.

c. Show that his utility will be higher if he purchases this fair insurance than if he faces tha chance of losing $2,000 without insurance.

d. What is the maximum amount that Mr. Michael will pay to insure his $2,000 expected loss?