Reference no: EM133056285

Cost Benefit Analysis and Environmental Valuation

1. Consider a plan to plant trees on an area of land being farmed. The costs and benefits are summarized in the table below. Assume that the land, cultivation, fencing and planting costs occur during the start of the project (beginning of the first year) while weeding costs occur during the end of the first three years of the project. The cost of harvesting (felling) occurs at the end of the project at year 10. There are two benefits to society, the value of timber sold in the market and the value of carbon sequestered during the life time of the trees. Assume that both benefits occur at the end of the 10-year project.

1. If you were hired by a private landowner to conduct a benefit cost analysis study to determine the viability of planting trees, what would you recommend to private landowner? In your analysis, include only costs and benefits that you think a profit maximizing landowner would care about. In your recommendation, provide both NPV and BCR estimates assuming a 3% discount rate. Show your answer in sheet1.
2. Assume that you were hired by the department of environment and natural resources to see if such projects are welfare improving for society. What would you include in this BCA that you did not include for the private landowner? Recalculate NPV and BCR using the same discount rate. What is your recommendation now? Show your answer in sheet2.
3. A private firm is deciding to making a dam with a project life of 30 years. There are two main benefits from the dam that the firm would like to produce: electricity sold to a nearby city and irrigated water sold to farmers. Creating the dam will take 4 years. Electrical production and selling irrigated water starts at the 5^th year of the project. Total revenue from electrical production is $3 million annually. Revenues from electricity rise at rate of 6% given the projected inflation of the price of energy starting after the 5^th year. Total revenues from selling irrigated water $1 million annually. Revenues from irrigated water are fixed given the negotiated contract between the firm and farmers. All benefits are incurred at the end of the year.
   
   The capital investment costs $20 million spread evenly over the first 4 years of the project. After the dam is constructed, there are annual operating, maintenance and labor costs. The annual operating cost is $250,000 with an inflation rate of 2%. The annual maintenance cost is $200,000 with an inflation rate of 4% and the annual labor cost if $100,000 with an inflation rate of 3%. All costs are incurred in the beginning of the year and inflation occurs at the beginning of the fifth year. The discount rate of the owner of the firm is 10%.
   
   The dam also leads to a reduction in fishing activity because it disrupts the life cycle of fishes. This leads to an annual loss of $700,000 in fishing activity starting in the very beginning of the project.
4. Set up the parameters table and financial flow in sheet3 of the private firm. Include only relevant benefits and costs that the private firm would care about. Solve for the net present value and benefit cost ratio. Give your recommendation to the private firm in sheet 3 regarding the feasibility of the dam project.
5. Set up the parameters table and financial flow in sheet4 of a social planner who cares about all costs and benefits that society would incur because of the dam. Calculate net present value and the benefit cost ratio. Give your recommendation to the social planner in sheet 4 regarding the feasibility of the dam project.
6. A private firm wishes to examine the profitability of constructing a phosphate fertilizer plant. The project will produce 10,000 tons of fertilizer per year starting in the first year, which will be sold in the domestic market for $350 per ton. It is expected to have a 20 year life.
   Investment in plant and equipment will cost $7.5 million, spread evenly over 3 years and land will cost $1 million to be paid fully by the end of the first year. At the end of the project, the land will be sold for its purchase price. The plant will depreciate in value by 4% per year and can be sold for its depreciated value after 20 years.
   The plant will need 100 workers and 20 office and managerial staff. The average wage for production workers is $800 per month, while that for management staff is $2000 per month. Raw materials will be $20 per ton of output produced while utilities will cost $5 per ton of output.
   Labor, raw materials and utility costs will rise by 7% annually after the first year. The price of fertilizer is expected to rise by 3% after the first year of production. The firm has a private discount rate of 12%.
7.  
   1. Set up the parameters table and financial flow in sheet5 of an excel sheet and calculate net present value and benefit cost ratio.
   2. Your economic advisor predicts that with the unexpected effects of the recession domestic market price for fertilizer may actually be $275 per ton. Given all your results, should the private firm continue with the project? Show your sensitivity test and explain answer in sheet 6.