Question: CVC supplies power to the city of Cali in Columbia, South America. They are planning to build a dam to meet the city's burgeoning power needs. The dam will cost $8 million up front to build and will begin producing electricity the following year. The production of electricity is valued at $1,000,000/year and the dam will produce a constant value for 14 years at which time it must be closed due to siltation.
A. If the real interest rate is 8%, what is the present value of the project? At 5%?
B. CVC is contemplating subsidizing large scale pine plantations by private landowners who own the surrounding denuded hillsides. Columbian hydrologists have estimated that an initial $2.5 million dollar subsidy at the time of building the dam will increase the longevity of the project 12 years. What is the net present value of this supplemental investment at 5% and 8%? Should the planting subsidy be undertaken?