Recent flooding has damaged the spillway of the state owned Crab Claw Dam near P

Question

Recent flooding has damaged the spillway of the state owned Crab Claw Dam near Puke Bay, Oregon, and it must be repaired or replaced. Two alternatives are available: (a) repair the existing spillway at a cost of $800,000 or (b) take this opportunity to build a new spillway and small hydroelectric power installation at a new site on the south side of the dam. Maintenance costs of the old spillway, if repaired, are estimated to be $20,000 per year. Construction costs for the hydroelectric project and new spillway are expected to be $1,500,000. Operation and maintenance costs for the hydroelectric portion are estimated to be $57,000 annually. Sale of electric power from the proposed installation is expected to provide an annual income of $80,000. A maintenance cost of the new spillway, if built, is estimated to be $10,000 per year. If the hydroelectric project is built, it will be necessary to fill in and close the existing spillway at a cost of $100,000. Assuming a 50-year life for all projects and an interest rate of 5%, compounded annually, which project would you recommend?

Explanation / Answer

Since the net present value of cost for repaired is less therefore it is better to repaired and not replaced

If repaired Years Cash flows Discount factor 5% present value 0 -800000 1 -800000 1-50 -20000 18.256 -365118 (Looking the present value annuity table) Net present value of cost -1165118

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