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COST-BENEFIT ANALYSIS
ECONOMICS 416
SPRING 2019
PROJECT
Answer all parts of each of the following six questions. The project will be graded as a
single piece (rather than question-by-question), and it accounts for 30% of your final
grade on this course. You are encouraged to work in groups of up to four people, and
submit a single project from the group. It is strongly recommended that you do your
analysis in Excel. Submission of the project should be via a single PDF document sent as
an email attachment to [email protected] Due date: 4:30pm Monday 12 April.
1
DAMMING THE PIPER
INTRODUCTION
The Province of British Columbia is considering building an irrigation project. The
proposed project involves flooding a valley by constructing a dam on the Piper River.
The new reservoir would supply irrigation water to fruit growers downstream from the
dam. The discharge of water would also be used to generate electricity. The project will
destroy the recreational fishing on the downstream river and will flood existing grazing
land upstream from the dam. The local town draws its water from an existing lake on the
river and the project will degrade that water; a filtration system will be built to restore the
water quality.
Details of the project are as follows:
Construction will take place in year 1. Non-labour construction costs are expected to
be $22m, of which $12m will be spent to import rock fill from the United States.
The project will require 100 workers for 2000 hours each during construction. These
workers will be drawn from the local area, where they are currently unemployed.
Their current activities are estimated to have no social value. The workers will be
paid $10 per hour. During the year in which they are employed by the project they
will loose $10,000 in unemployment benefits (currently paid by the Provincial
government) and will have to pay 10% of their earnings in Federal income taxes.
The project will begin providing irrigation benefits in year 2; these will continue
forever. The irrigation services will boost the productivity of the fruit growers,
shifting their aggregate supply curve from S 0 to S1 in Figure 1. Price will fall from
$200 per tonne to $180 per tonne. Annual production will rise from 100,000 tonnes
per year to 120,000 tonnes per year.
The project will generate 3000 MWh (megawatt-hours) of electricity every year,
beginning in year 2. This electricity will be sold to BC Hydro (the provincial
2
electricity utility) at the prevailing (competitive) market price of $100 per MWh. BC
Hydro will then export twenty percent of this electricity to the United States (at $100
per MWh).
Based on studies conducted elsewhere, the value of the existing recreational fishing is
estimated to be $500,000 per year. Twenty percent of this value accrues to tourists
from the United States. The fishing will be permanently lost, beginning in year 2.
The grazing land to be flooded is owned by the Province and is currently leased to a
private firm for $200,000 per year. This land will be permanently flooded in year 2
and the lease will be cancelled.
The water filtration plant will be built in year 1 by a local private firm. The estimated
cost of construction is $1m. There are no ongoing operating costs. The plant will be
leased back to the government for $100,000 per year in perpetuity, beginning year 2.
The Federal government will contribute an infrastructure grant of $5m in year 1.
The marginal cost funds is 1.2.
The Province of British Columbia is the referent group.
In your answers, delay any consideration of the cost of funds until Question 5.
3
1. CONSTRUCTION COSTS
(a) What is the economic cost of labour (inclusive of any tax outflows). Explain your
answer.
(b) What is the financial outlay for labour incurred by the referent governmen?
(c) What is the economic cost of non-labour construction? How would your answer be
different if the rock fill was purchased in British Columbia (at the same price)?
Explain your answer.
2. CONSUMER AND PRODUCER SURPLUS
(a) What is the change in producer surplus for fruit farmers?
(b) What is the change in consumer surplus for fruit buyers?
3. ELECTRICITY AND FISHING
(a) What is the economic benefit of the electricity generation? How would your answer
be different if all the electricity was exported to the United States?
(b) What is the economic cost of the lost recreational fishing? Does it matter that some
of the fishers are tourists from the United States?
4. GRAZING LAND AND WATER QUALITY
(a) Explain why you do not have enough information to determine the true economic cost
of the lost grazing land. What is the lower bound on this cost? (For the remainder of
the analysis assume this lower bound is the true cost).
(b) What is the economic cost of the filtration plant? Explain your answer.
4
5. THE COST OF FUNDS
(a) Explain what it means for the marginal cost of funds to be greater than one, and
explain why it is greater than one.
(b) Construct a table that summarizes the financial outlays and receipts for the referent
government on a yearly basis.
(c) Calculate the cost of funds on a yearly basis.
6. NET PRESENT VALUE
(a) Construct a table that summarize all costs and benefits on a yearly basis. Include a
bottom-line entry for net benefits.
(b) Calculate the NPV. Assume the PSDR is 10%.
⎡
1
1
1 ⎤ 1+ r
Hint: ⎢1 +
+
+ …….. +
⎥=
2
r
(1 + r ) ∞ ⎦
⎣ (1 + r ) (1 + r )
(c) Based on NPV, should the project proceed?
(d) How would the NPV be different if we took a national perspective?
(e) How would the NPV be different if we took a global perspective?
5
$
300
S0
S1
200
180
100,000
120,000
tonnes
FIGURE 1
6
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