The U.S. Army Corps of Engineers is considering the feasibility of constructing

Question

The U.S. Army Corps of Engineers is considering the feasibility of constructing a small flood dam in an existing arroyo. The initial cost of the product will be $2.2 million, with inspection and upkeep costs of $10,000 per year. In addition, minor reconstruction will be required every 15 years at a cost of $65,000. If the fl;ood damage will be reduced from the present cost of $90,000 per year to $10,000 annually, use the benefit cost method to determine if the dam should be constructed. Assume that the dam will be permanent and the interest rate is 12% per year.

Explanation / Answer

There is an item of cost to be met every 15 years. Let us calculate effective interest rate,k , on 15 year period basis for this cost = (1+0.12)^15 -1 = 4.4736 = 447.36% PC of all costs, C = Initial cost + annual cost + 15 year cost for ever. => = 2200000 + 10000/0.12 + 65000/4.4736 = 2297863.0 ($) Annual benefits = 90000 - 10000 = 80000 ($) PV of benefits for ever, B = 80000/0.12 = 666667 ($) approx. B/C = 666667/2297863 = 0.29 < 1 As B/C is less than 1, it is not recommended. (ANSWER)

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