Question

5. (10 points) Suppose the government is considering selling NB power to Hydro Quebec. From historical data, NB power can be expected to achieve net profits of S7 million a year forever at the start of each year and the discount rate is 4%. a. What is the maximum price Hydro Quebec will be willing to offer for the purchase of NB power? b. Economists in Quebec believe both the net profits and the discount rate above are too optimistic, they argue that in the pessimistic case, these two values should be adjusted by 25% in the favor of the purchasers. Compute the new maximum price Hydro Quebec would be offering in this pessimistic case. PV simple perpetuity due = - +R

Answer 1

a) Price willing to be offered = Profit / Discount Rate = $7 million /0.04 = $175 million

b) Price willing if profit Increases by 25% and discount rate decreases by 25%

= 7*1.25/0.75*0.04

= $291.67million is the answer