You have been hired to compare two alternatives for obtaining additional water needed by the city of Chicago. The first alternative, building a new reservoir on a river that is quite popular for whitewater rafting, has an initial cost of $1.2 million, annual O&M of $100,000/year, and annual benefits of $300,000/year. The second alternative would involve building a new pipeline to an existing reservoir and would have an initial cost of $300,000, annual O&M of $50,000/year, and annual benefits of $100,000/year (assuming the benefit will start at the end of the first year). Both alternatives will produce sufficient water to meet the needs of the city for a long time (note that some engineering projects in the world have lasted over 2,000 years!). The first alternative can even produce some surplus water, but some environmental groups are against the construction of the new reservoir.
Assume that both alternatives have an indefinite lifetime and that the city uses an interest rate of 3%. Note that in both alternatives, the annual benefits to the city are revenues from water sales.
a) Form a cash flow table for the two alternatives. A cash TABLE is another way to show the receipts and disturbances by time.
b) Compare the two alternatives using the following methods:
i) Present worth analysis
ii) Annual cash flow analysis
iii) Incremental benefit/cost ratio (note this is different from the B/C ratio method)
iv) Internal rate of return (not incremental)
v) Payback period
c) Make a recommendation to the city as to which project should be selected, justifying your recommendation. Discuss at least two other issues that the city should consider beyond your economic analysis