ASSIGNMENT- II

Question 1
The average annual damage from floods in a river basin is estimated to be
$400,000. Estimates have been made for several alternate proposals for flood
mitigation works: channel improvements (25 yr life), two mutually exclusive dams (A
and B, 100 yr lives), and various combinations of these. The table below shows the
first cost, estimated annual damages, and the annual OM&R disbursements for each
alternative, and the sum of the annual damages and annual costs.

a. Compare the projects using an interest rate of 6 percent.

b. Compare the conclusions of the economic analysis with the interest rate of 3
percent used in with the 6 percent rates used in your solution to Part (a). What
generalizations can you make regarding the influence of the interest rate on such
studies?
 Part a
Solution
Projects
 Channel Improvements
 Dam A
 Dam B
Alternatives
 I (Channel Improvements)
 II (Dam A)
 III (Dam B)
 IV (Dam A with Channel Improvement)
 V (Dam B with Channel Improvement)
Lives
 Channel Improvement = 25 years
 Dam A & B = 100 years
Discount Rate
 𝑖 = 6% per year
The annual investment costs can be computed for each alternative by multiplying the
investment cost by the appropriate capital recovery factor
CR F T =i¿ ¿
𝑖 = 6% = 0.06
T = 25 yrs (Channel Improvement), 100 yrs (Dam A & B)
Project Total CRF Annual Annual Total
Investmen Investment Operation & Annual
t$ Cost Maint Cost
$ $ $
(a) (b) (a) x (b) = (c) (d) (c) + (d)
I (Channel
500000 0.07822 39110 100000 139110
Improvement)
II (Dam A) 3000000 0.06017 180510 60000 240510
III (Dam B) 4000000 0.06017 240680 80000 320680
IV (Dam A with
180510+39110
Channel 3500000 160000 379620
= 219620
Improvement)
V (Dam B with
240680+39110
Channel 4500000 180000 459790
= 279790
Improvement)

In order to calculate benefits, the annual damage of each alternative is subtracted

from the damage caused by the “Do nothing” alternative
 Project Do nothing Annual Total Annual Benefits
Annual Damage Damages $
$ $

(a) (b) (a) - (b) = (c)

I (Channel Improvement) 400000 250000 150000
II (Dam A) 400000 190000 210000
III (Dam B) 400000 125000 275000
IV (Dam A with Channel
400000 100000 300000
Improvement)
V (Dam B with Channel
400000 60000 340000
Improvement)

In order to compare the additional benefit to the cost of any alternative compared to
other alternatives, applying the incremental cost benefit ratio method

Benefit
Compariso Projec Cost ΔB ΔC ΔB/ Conclusio
s B/C
n t $ $ $ ΔC n
$
13911 1.07 15000 13911
Ø→I I 150000 1.078 Ø< I
0 8 0 0
24051 0.87 10140 B/C < 1
I → II II 210000 60000 0.591
0 3 0 (Discard II)
32068 0.85 12500 18157 B/C < 1
I → III III 275000 0.688
0 7 0 0 (Discard III)
B/C < 1
37962 0.79 15000 24051
I → IV IV 300000 0.623 (Discard
0 0 0 0
IV)
45979 0.73 19000 32068 B/C < 1
I→V V 340000 0.592
0 9 0 0 (Discard V)

Preferred Alternative = I (Channel Improvement)

Part b
 Solution
Discount Rate
 𝑖 = 3 % per year

Project Total CRF Annual Annual Total

Investmen Investment Operation & Annual
t$ Cost Maint Cost
$ $ $
(a) (b) (a) x (b) = (c) (d) (c) + (d)
I (Channel
500000 0.0574 28700 100000 128700
Improvement)
II (Dam A) 3000000 0.0316 94800 60000 154800
III (Dam B) 4000000 0.0316 126400 80000 206400
IV (Dam A with
94800+28700
Channel 3500000 160000 283500
= 123500
Improvement)
V (Dam B with
126400+28700
Channel 4500000 180000 335100
=155100
Improvement)

Benefits have been already calculated I Part (a) and same applied in incremental
cost benefit ratio method
Comparison Project Benefit Cost B/C ΔB ΔC ΔB/ΔC Conclusion
s $ $ $
$
Ø→I I 150000 128700 1.165 150000 128700 1.165 Ø< I
I → II II 210000 154800 1.356 60000 26100 2.298 II > I
II → III III 275000 206400 1.332 65000 51600 1.259 III > II
III → IV IV 300000 283500 1.058 25000 77100 0.324 IV < III
III → V V 340000 335100 1.014 65000 128700 0.505 V < III

Preferred Alternative = III (Dam B)

Influence of interest rate

 The lower the interest rate, the higher the return value of the project’s future
costs and benefits. Conversely, the higher the interest rates the lower the
future return value will be.
 The selection of the appropriate discount/interest rate is important to ensure
that future project returns are not being over or under estimated in today’s
value