Question

1. The initial cost of constructing a permanent dam (i.e., a dam that is expected to last forever) is $425 million. The annual net benefits will depend on the amount of rainfall: $18 million in a "dry" year, $29 million in a “wet" year, and $52 million in a "flood" year. Meteorological records indicate that over the last 100 years there have been 86 "dry" years, 12 "wet” years, and 2 "flood" years. Assume the annual benefits, measured in real dollars, begin to accrue at the end of the first year. Using the meteorological records as a basis for prediction, what are the net benefits of the dam if the real discount rate is 5 percent?

Answer 1

From the given data we can calculate

Expected annual benefits = 18 x (86/100) + 29 x (12/100) + 52 x (2/100) = 15.48 + 3.48 + 1.04 = $20 Million

Now, PW of annual benefit when included with the discount rate = $20 million / 0.05 = $400 Million

Net benefits or PW = - 425 + 400

= - $25 Million

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