Marie Curatolo September 20, 2011

MGNT01HT 2011 Assignment: Global Economy

The proposed plan accomplishes the first stage of a Cost Benefit Analysis (CBA) by defining the project. In this case, the welfare of the company and the welfare of the local residents affected by noise pollution and visual impact are considered. The project is given over an eighteen-year time period. The plan also achieves the second and third stages of CBA by giving values that correspond to physical impacts of the project. Initial construction costs ( 5,000,000), annual maintenance costs ( 200,000), dismantlement costs ( 400,000), all reflect labor and resource allocation. The physical impact of the output of the farm is given at 10 million kWh per year with a market value of 1,000,000. The social cost of the negative externalities of noise pollution and visual impact was calculated doing a contingent valuation study which indicated a mean annual compensation cost of 80 per household. The contingent valuation method (CVM), in this case, attempts to make up for the absence of a market for social goods by asking them how much those affected would be willing to accept as compensation for increases in noise pollution and visual impacts. CVM is advantageous in that it can be used in a variety of situations, it is able to empirically measure both use and non-use (existence) values, and it allows access to insight on reasoning behind valuation of a good by people. However, CVM has several disadvantages including that it measures stated preferences and not actual behavior, its results are not sensitive to the quantity of good produced or protected, and it may yield answers based on limited information provided in the questionnaire. There is also an argument that public valuations are not as credible as professional ones. Still it is one of the most widely-used methods of valuing externalities. The fourth stage of discounting cost and benefit flows is achieved by converting them to present value terms to reflect the decreasing value of money over time. The cost or benefit (X) received at time (t) is equal to X[1/(1+0.5)^t)] where 0.5 reflects the given 5% discount rate. See Figure 1 (in Appendix) for a list of these values. The fifth stage (the net present value test) is achieved by taking the sum of the discounted benefits and subtracting the sum of the discounted costs. For this project, the sum of the discounted benefits is 11,274,066.25 and the sum of the discounted costs is 11,028,722.71. The difference between values is 245,343.54. This is the net present value and it is greater than zero. Therefore, it would be cost beneficial to accept this project at the given parameters. Sensitivity analysis was performed by increasing and decreasing parameters by +/- 25% of its original value (See Table 2). This range captures a realistic change in any parameter. When these transformed values were then used to perform CBA, they yielded net present values. These values are presented in Figure 1 below. According to these results, the most sensitive parameter affecting net present value is the revenue (either amount of kWh generated or price per kWh). Therefore, small increases in these factors can have greater results and it would be most parsimonious to target them as a benefit increasing strategy. Conversely, attention should be paid not to let these factors decrease, since small decreases can lower net present value significantly. Initial construction cost is also highly cost-sensitive, so measures to decrease this cost are recommended. The least cost-sensitive parameter is the dismantlement cost, so it is suggested that this cost be of little concern. Based on cost-sensitivity, it is also recommended to try to increase the project lifespan and/or decrease compensation costs either by reducing the number of households affected or the amount of compensation paid per household.

S e n s itiv ity A n a ly s is
P ro je ct L ife sp a n C o m p e n sa tio n C o st* * A n n u a l B e n e fits (R e v e n u e )* D ism a n tle m e n t C o st P a ra m e te r M a in te n a n ce C o st In itia l C o n stru ctio n C o st D isco u n t R a te (6 9 3 ,1 1 2 .1 5 )

1 ,1 8 8 ,0 1 2 .7 2 1 ,1 4 7 ,2 6 8 .8 4

(6 5 6 ,5 8 1 .7 6 )

(2 ,5 7 3 ,1 7 3 .0 2 ) 2 8 6 ,8 9 5 .6 0 2 0 3 ,7 9 1 .4 7 (3 1 8 ,3 5 9 .7 8 ) (1 ,0 0 4 ,6 5 6 .4 6 ) (1 9 4 ,4 3 7 .4 8 ) 0 8 0 9 ,0 4 6 .8 5 1 ,4 9 5 ,3 4 3 .5 4 7 4 8 ,1 9 6 .5 3

3 ,0 6 3 ,8 6 0 .1 0 2 5 % In cre a se 2 5 % D e cre a se

- 3 ,0 0 0 ,0 0 0 2 ,0 0 0 ,0 0 0 1 ,0 0 0 ,0 0 0 - -

1 ,0 0 0 ,0 0 0 2 ,0 0 0 ,0 0 0 3 ,0 0 0 ,0 0 0 4 ,0 0 0 ,0 0 0

N e t P r e s e n t V a lu e

Figure 1. Graphical representation of net present value at +/-25% of original value. *Changes in annual benefits could reflect proportional changes (increase or decrease by 25%) in either the number of kilowatt hours generated or the price per kilowatt hour. **Changes in compensation costs could reflect proportional changes in either the number of households or payment per household per year.

Year (t)

Discount Factor (1.05^t)

Annual Benefits/Revenue

Present Value of Benefits (Annual Benefits*1.05^t)

Maintenance Costs 5,000,000.00 200,000.00 200,000.00 200,000.00 200,000.00 200,000.00 200,000.00 200,000.00 200,000.00 200,000.00 200,000.00 200,000.00 200,000.00 200,000.00 200,000.00 200,000.00 200,000.00 200,000.00 400,000.00

Annual Compensation Costs (80 Euros*4000 households) 320,000.00 320,000.00 320,000.00 320,000.00 320,000.00 320,000.00 320,000.00 320,000.00 320,000.00 320,000.00 320,000.00 320,000.00 320,000.00 320,000.00 320,000.00 320,000.00 320,000.00 -

0 1 1 0.952380952 1,000,000.00 952,380.95 2 0.907029478 1,000,000.00 907,029.48 3 0.863837599 1,000,000.00 863,837.60 4 0.822702475 1,000,000.00 822,702.47 5 0.783526166 1,000,000.00 783,526.17 6 0.746215397 1,000,000.00 746,215.40 7 0.71068133 1,000,000.00 710,681.33 8 0.676839362 1,000,000.00 676,839.36 9 0.644608916 1,000,000.00 644,608.92 10 0.613913254 1,000,000.00 613,913.25 11 0.584679289 1,000,000.00 584,679.29 12 0.556837418 1,000,000.00 556,837.42 13 0.530321351 1,000,000.00 530,321.35 14 0.505067953 1,000,000.00 505,067.95 15 0.481017098 1,000,000.00 481,017.10 16 0.458111522 1,000,000.00 458,111.52 17 0.436296688 1,000,000.00 436,296.69 18 0.415520655 Total 11,274,066.25 Total Net Present Value 245,343.54 Table 1. Net present value for given (original) values of parameters. Appendix

Present Value of Total Costs ([Maintenance + Compensation costs]*1.05^t 5,000,000.00 495,238.10 471,655.33 449,195.55 427,805.29 407,433.61 388,032.01 369,554.29 351,956.47 335,196.64 319,234.89 304,033.23 289,555.46 275,767.10 262,635.34 250,128.89 238,217.99 226,874.28 166,208.26 11,028,722.71

Hypothetical Change to Value Effect on Net Present Value (I +/- .25*I) Parameter Original Value (I) 25% Increase 25% Decrease 25 % Increase 25% Decrease Discount Rate 5% 6.25% 3.75% (194,437.48) 748,196.53 Initial Construction Cost 5,000,000.00 6,250,000.00 3,750,000.00 (1,004,656.46) 1,495,343.54 Maintenance Cost 200,000.00 250,000.00 150,000.00 (318,359.78) 809,046.85 Dismantlement Cost 400,000.00 500,000.00 300,000.00 203,791.47 286,895.60 Annual Benefits (Revenue)* 1,000,000.00 1,250,000.00 750,000.00 3,063,860.10 (2,573,173.02) Compensation Cost** 320,000.00 400,000.00 240,000.00 (656,581.76) 1,147,268.84 Project Lifespan 18 Years 23 Years 14 Years 1,188,012.72 (693,112.15) Table 2. Effects of changing parameters on net present value. *Changes in annual benefits could reflect proportional changes (increase or decrease by 25%) in either the number of kilowatt hours generated or the price per kilowatt hour. **Changes in compensation costs could reflect proportional changes in either the number of households or payment per household per year. Colors correspond to representation in Figure 1.