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(Solved) chap04:gruber SM 2E.qxd A government is considering paving a highway with a newly developed "wear-proof" material.


chap04:gruber SM 2E.qxd

A government is considering paving a highway with a newly developed "wear-proof" material. Paving the highway would cost $4 billion today, but it would save $400 million in maintenance costs for each of the next 10 years. Use the concept of present value to determine whether the project is worth undertaking if the government can borrow at an interest rate of 4%. Is it worth it if the interest rate is 0%? 8%? A politician says to you, "I don't care what the interest rate is. The project is clearly a good investment: it more than pays for itself in only 8 years, and all the rest is money in the bank." What's wrong with this argument, and why does the interest rate matter?

 


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