Question

1. The initial cost of constructing a permanent dam (i.e., a dam that is expected to last forever) is $830 million. The annual net benefits will depend on the amount of rainfall: $36 million in a “dry” year, $58 million in a “wet” year, and $104 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?

2. Use several alternative discount rate values to investigate the sensitivity of the present value of net benefits of the dam in exercise 1 to the assumed value of the real discount rate.

Answer 1

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