A dam is proposed in an area that will lead to flooding of land which will lead to some environmental damage as well as loss of agricultural and forestry products due to flooding. The dam will generate electricity. The dam will have a useful life of 30 years after which its reservoir will be full of sediment and the dam will need to be removed. The characteristics of the project are as following: Initial cost: $150 million/year for 3 years
Operating costs: $15 million/year
Electricity generated: 1 billion Kilowatt hours/year
Price of electricity: 0.075/kilowatt/hour
Value of agricultural and forest products lost from flooded land: $30 million/year
The additional, less quantifiable losses include 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 water-borne
diseases.
a. Conduct a cost-benefit analysis using the quantifiable factors
previously listed. Assume that the lifespan of the dam is 30 years. Assume that the
construction begins now (in Year 0). All other impacts start once the dam is
completed (in Year 3) and continue for 30 years (until Year 32). Do the analysis
for two possible discount rates of 7% and 3%. What recommendation would you
make at each discount rate? Explain.
b. Now consider an alternative project where a number of smaller dams
can be built that do not require any flooding. This would result in no negative
impacts on agricultural land and forests, as well as no ecological damage or
resettlement costs. At 7% discount rate, how does the project compare to the larger
project at the same discount rate?