A state government has the option of damming a major river to generate energy an

Question

A state government has the option of damming a major river to generate energy and divert water to local agriculture. The cost of constructing the dam and associated infrastructure is 100 million. The value of the energy generated and the water is 10 million per year forever. There are, however, losses to ecosystem services associated with damming. These environmental costs amount to 6 million a year forever. The interest rate: i = 0.05.

(a) What is the present value of the returns to building the dam? (b) What is the present value of the costs (construction and environmental) to building the dam? (c) Should the state government build the dam?

Explanation / Answer

(1) Present value of Net Benefits

Pv=(P/(1+r)i = 10-6/(1.05) = 3.8295Million (the returns are taken as net of environmental costs each year)

(2) Present value of Costs

Pv=(P/(1+r)i = 100/(1.05)^0=100 MillionApprox

(3) The returns are expected to be forever which means that the returns will surely outweight the costs, say after 50 years the returns would roughly be 200 Million. The costs may be huge but the investment has huge social advantage. Though this may not be the best option to invest.

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