Homework 6 Benefit-Cost Analysis and Valuation 2010

Homework 6 Benefit-Cost Analysis and Valuation 2010 - AEM...

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AEM 2500, Environmental and Resource Economics Benefit-Cost Analysis and Valuation Homework #6 (Distributed Oct. 22, Due Oct. 29 at 9:00 AM in the Red Box outside Warren 102. Late homeworks will not be accepted unless previous arrangements have been made with Prof. Poe. ) 10 Points. All graphs should be clearly labeled and all other work legible. If we are unable to interpret your work, you will receive a lower score. 1. Harris , Ch. 6 #1, p. 132. The World Bank is considering an application from the country of Equatoria for a large dam project. Selected project costs and benefits (in dollar values) are as follows: Construction costs: $500 million/year for three years. Operating costs: $50 million/year. Hydropower to be generated: 3 billion kilowatt hours/year. Price of electricity: $0.05/kilowatt hour. Irrigation water available from dam: 5 billion gallons/year. Price of water: $0.015/gallon. Agricultural product lost from flooded lands: $45 million/year. Forest products lost from flooded lands: $20 million/year. Additional losses are less easily quantifiable: human costs to villagers who will be forced to move, watershed damage, and ecological costs of habitat destruction. It is also possible that the new lake area may contribute to the spread of waterborne diseases. a. Do a formal benefit-cost analysis using the quantifiable factors listed above, assuming that the costs and benefits of operating the dam begin in year 4 and continue on to the indefinite future. Remember to distinguish between one time costs and annual costs. In this particular exercise, it is easiest to calculate all the benefits and costs in terms of year three, when the dam is completed. To do this you will have to compound all the construction costs in years 1,2 and 3 up to year three. This can be done using the formula C t (1+r) (3-t) for t=1,2 and 3. In essence what you are doing is setting year 3 to be the decision period that compares construction costs incurred to that date with operating costs and benefits into the indefinite future. For costs or benefits extending into the indefinite future, use the formula for an infinite series, PV [ B ] = or PV [C] = t as discussed on page 124 in Harris. The reason that we can do this is because we have established year three as the “reference” or “zero” period for comparing the benefits and costs extending from year 4 to the foreseeable future. Be sure that you understand why this is the case for this exercise. Do a complete benefit-cost analysis for two possible interest rates (r): 10 percent and 5 percent. In each case do your figures indicate a definite “yes”, a definite “no” or an uncertain result. b.
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Homework 6 Benefit-Cost Analysis and Valuation 2010 - AEM...

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