Reference no: EM131263408

Suppose the government of a municipality is trying to determine how to deal with pesticide contamination of its water supply. It wants to undertake a benefit-cost analysis of two alternative policy options for controlling pesticides:

• Upgrading its municipal water treatment plant to remove the pesticides, or
• Banning the use of the offending pesticides in the metropolitan area.

Assume that either technique reduces the pesticides to a level that does not adversely affect human health. The costs of these control options are as follows:

• Municipal treatment upgrades: Capital costs = $20-million. The new plant is constructed over the course of the initial year. It starts operating at the end of this year. Once the plant begins operation, it has operating costs of $1-million per year. Once constructed, the plant lasts for five years, then must be replaced with a new plant.
• Pesticide ban: Annual operating costs due to substitution of non-toxic methods of controlling "pests" = $3.5-million each year.

Let the discount rate be 5 percent. The municipality's planning horizon is 10 years. Suppose the present value of the benefits of the project are $40-million. Which project should the municipality adopt?

Assume now that the benefits differ by the type of treatment option chosen. In particular, they remain at a present value of $40-million for the pesticide ban, but there would be additional benefits in the form of less damage to ecosystems from the treatment plant. How high would these benefits have to be each year to make the government indifferent between choosing the treatment plant or the pesticide ban?