Organization: Arizona State University
Date: Thursday, 16 Apr 1992 15:02:35 MST
From: C. K. Ng <ASCKN@ASUACAD.BITNET>
Newsgroups: soc.culture.asean
Subject: Re: MRT in K.L

In article <1992Apr17.030008.4736@csc.canterbury.ac.nz>,
chuah@elec.canterbury.ac.nz (DanC) says:
>
>Important note:  If you are not one who gets into economics, press the
>kill button now.
>
>
>In article <92106.195917ASCKN@ASUACAD.BITNET> ASCKN@ASUACAD.BITNET (C. K. Ng)
>writes:
>
>>  A project like MRT is a long-term capital investment.  The initial
>                           ^^^^^^^^^^^^^^^^^^^^^^^^^^^^
>>outlay may be astronomical in magniture, but the (expected) return
>>can be long into the future.  By expected return, I am referring only
>                               ^^^^^^^^^^^^^^^^^^
>>to the monetary return.  In project evaluation like this, the
>>universally acceptance criterion is simply applying the net present
>>value (NPV) rule taught in all Principle of Finance classes at
>>the undergraduate level.  In a netshell, it says that as long as the
>>present value of the expected net future cash inflow exceeds the initial
>>outlay, then a positive NPV would result, and the project should
>>be accepted under non-binding capital rationing.  Of course, if
>>it's an exclusive project in which ONLY ONE has to be chosen from
>>a few alternatives, then the one with the highest NPV should be
>>chosen.
>
>I am not an economic export, neither am I an economic professor,
>however, I must question the above comments.  How can one evaluate
>what a long term public project will return in future.  There are
>so many hidden factors.  Take for example, a dam.  It provides people
>with water to drink.  However, the water meter charges can never
>recover the cost of building the dam in the first place.
>However, people can justify building the dam by the fact that drinking
>water is a necessasity of life.  How can the contrinution of the
>dam be calculated in terms of net present value.  Furthermore, the
>calculation of net present value depends a lot on interest rate and
                                                   ^^^^^^^^^^^^^
>inflation projections.  How accurate are these projections anyway?
 ^^^^^^^^^
According to the Fisherian theory, nominal interest rate has already
included expectationary inflation, and it's nominal interest rate
that is used in the NPV formula.
   Interest rate does fluatuate over time.  But, we don't have to
asssume a flat term-structure of interest rate in our NPV valuation.
Specifically, NPV can be expressed as:


NPV = -C_0 + C_1/(1+r_1) + C_2/(1+r_2)^2 + ... + C_T/(1+r_T)^T

where C_0 = initial investment in $,
      r_t = (nominal) interest rate in period t in decimal form,
      C_t = expected net cash inflow in period t in $,
      T = life span of the project in # of periods.

Most textbook authors tend to assume flat term-structure of
interest rate, i.e., r_1 = r_2 = .... = r_T for simplicity sake.
But, in actuality, we can accommodate varying term structure of
interest rate.  Moreover, even if our predicted r_t may not turn out to
be actual ex post r_t when the time comes, it's only natural that
at times we are overestimating it while at other times we are under-
estimating it, and such opposite deviations would tend to annul each
other, and hence our problem of inaccuracy in predicted r_t can be
mitigated to a certain extent.  The same canceling effect can be
applied to the forecasted (my English is very Americanized now)
cash flow of C_t as well, and hence work to the advantage of our
prediction on the NPV.

>Bringing the arguement back into the current discussion, how can we
>quantify the expected return of say the savings in reducing polution
>caused by the installment of the MRT system?  How can we quantify
>the time saved by an efficient transport system?  Or let me put
>my case this way.  How can we quantify the expected return of
>the alternatives seeing that there are so many hidden factors
>involved?

See my subsequent argument which hinges on the distiction of public
good/project versus private good/project.

>>So, the improvement over the environment should be
>>considered as an addition to the expected return equation.
>
>The question is by how much?
>
>>   Next comes the survivability question.  There's a rather
>>simple solution to this.  Tax!
>
>Tax also has to be taken into account as part of the cost, no?

   As I qualified in my first response, I am using the word tax
here rather loosely.  We can think of the pollution generated by
the automobiles as a form of externality.  Collecting toll from
drivers along routes served by the MRT can be thought of as a form
of tax in the microeconomics sense, and such toll should not be
deemed as a form of financial outlay to the MRT project though it
is a form of expense to the drivers who insist in driving during
those peak business commuting hours along those routes served by
the MRT, e.g., Jalan Tun Abdul Razak.

>>   Evaluating the project based NPV rule is more meant for commer-
>>cially oriented projects where the investors are assumed to be
>>profit maximizers.  However, for a public project like this, the
>>NPV rule can only be applied to a certain extent.
>
>Agreed.  Sometimes mere profit and loss alone cannot be used to
>justify a public project.
>
   Absolutely right, and the key word here is PUBLIC.  The NPV rule
of project evaluation is more for commercial projects, while a public
project like the MRT should be considered somehow differently.  Didn't
I say this in my very first response to the original poster?? Perhaps
I didn't emphasize it enough to make it conspicuous.

  If we had already built the arches for aesthetic purposes, there
is at least an equal reason to build an MRT for the purpose of providing
inexpensive means of transportation for the "little guys".

   Chee-Keong Ng, Ph.D.
   With fear and partiality.
Newsgroups: soc.culture.asean