The government of a developing country in South-East Asia is considering the construction of a 300MW hydro-electric power generating scheme. This will entail the construction of a dam and the flooding of an area of 2000 hectares of tropical rain forest. The power generated is intended to feed into the grid at times of peak power usage (i.e. the plant will not be generating 24 hours a day and 365 days a year).
You are required to undertake a benefit-cost analysis of the project which considers the impacts detailed below. The analysis is to be done over a period of 60 years using a discount rate of 6%. All values are in 2023 US$.
Question 1 (30 marks)
The dam is mainly constructed of concrete and steel. Over the first 7 years of construction 1.75 million tonnes of concrete will be used (0.25 million tonnes per year). This amount represents a significant proportion of this country’s concrete manufacturing capacity and so will have an effect on the market price. Prior to the project the average sale price of concrete is $120 per tonne at an equilibrium quantity of 1 million tonnes. If the project goes ahead it is expected to shift the demand curve for concrete and increase the market equilibrium price to $130 (at an equilibrium quantity of 1.2 million tonnes). At this higher price some existing consumers of concrete will be displaced.
Calculate the annual costs of concrete using both a diagram and the Harberger equation. Assume that all supply and demand curves are straight lines and any shifts are parallel.
Question 2 (30 marks)
Conduct a benefit-cost analysis of the project using your answer to 1 above as a measure of the costs of the concrete that the project requires and which also includes the following costs and benefits (all in millions of US$). The dam will take 8 years to construct, all benefits will begin from Year 9.
Construction costs
| Year | 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 | |
| Steel | 10 | 10 | 10 | 10 | 10 | 10 | 10 | ||
| Labour | 15 | 15 | 15 | 15 | 15 | 15 | 15 | 7.5 | |
| Generating equipment | 10 | 25 | 25 | 30 | 30 | ||||
| Other costs | 2.5 | 3 | 3.7 | 4 | 2.5 | 2.5 | 2.5 | 2.5 |
Operating costs
These are $13.5 million per year, they start in Year 9 and are assumed to remain constant through the life of the project.
Benefits
The major benefit of the project is the electricity it generates. This will be $40 million in Year 9 and is assumed to remain constant through the life of the project.
Make a recommendation about whether the project is worth pursuing, and explain the reasoning for your recommendation.
Question 3 (20 marks)
A further benefit provided by the construction of the dam is a reduction in flood risk. The low-lying, productive and densely populated farmland downstream of the proposed dam is subject to occasional (a frequency of once every twenty-five years) severe flooding which has been calculated to cause $1.5 billion of damage to property, crops and livestock, and in terms of loss of life.
Incorporate this impact into the analysis assuming that the construction of the dam will reduce the probability of a flood occurring from once every 25 years to once every 100 years (with the same projected damage cost). How does this change the recommendation made in your answer to Question 2, again explaining the reasoning for your revised recommendation.
Question 4 (10 marks)
At what discount rate does the project (including flooding reduction benefits) become unviable?
Question 5 (10 marks)
To which level do benefits from electricity production need to fall before the project (including flooding reduction benefits) becomes unviable?
Notes:
(i) Submit this assignment as an Excel workbook (spreadsheet) via Moodle. Insert any text answers into a text box on one of the sheets of this file, or by embedding a Word file.
(ii) But be sure to include enough explanation to show how you have calculated your net present values and estimated the cash flows (i.e. do not put to many calculations in one cell, try to make your spreadsheet as clear and easy to follow as possible).
Remember that you should submit an Excel file (not a pdf or any other file type) also remember that the Excel file should contain formulas – not just values; otherwise I cannot check your working (and I will be unable to mark your assignment). Do not use the inbuilt Excel NPV formula and avoid using macros and VBA code, i.e. keep your spreadsheets simple.
Marking criteria
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