Imagine that you have been hired by the Maine Department of Natural Resources to assess a proposal for constructing a new dam that is expected to last for 50 years. The initial cost of the dam is $425 million, while the annual net benefits (annual benefits less annual maintenance costs) will depend on the amount of rainfall: $18 million is a “dry” year, $29 million in a “wet” year, and $52 million in a “flood” year. Meteorological records indicate that over the past 100 years there have been 86 “dry” years, 12 “wet” years, and 2 “flood” years. Assume that construction occurs this year (t=0) and the annual net benefits begin to accrue at the start of next year (t=1) and continue for 50 years (i.e., until t=50).
a. Assuming that the historical data are good predictors of future weather conditions, what are the expected net benefits of the dam project if the social discount rate is 5%? (Hint: Homework 2 Data [in Moodle] provides a template that you can use.)
b. Would you recommend that the state go forth with the dam project? Why or why not?