The main objective of this analysis is to ascertain the financial and economic viabilities of the two proposals. The estimated capital cost of each of these proposals, you might recall, is $20 billion (bn). Other details are provided below.
PROPOSAL A
Financial
Proposal A envisages generation of electricity from water - a hydro-electric project. The useful economic life of this project is estimated to be 60 years. This project will generate 40,000 million (mn) units of electricity annually. Electricity will be sold to the public at a tariff of 7 cents per unit. The annual operation and maintenance costs are expected to be 4 percent of the capital cost.
Economic (Social)
The economic (social) costs and benefits for this project must be estimated from Figure 1.
Figure 1 Economic (Social) Costs and Prices: Proposal A
PROPOSAL B
Financial
Proposal B is a thermal project - electricity will be generated from coal. The annual operating costs for this project are estimated to be 9.4 percent of the capital cost. This project will have a useful economic life of 30 years. It will generate 40,000mn units of electricity annually. The electricity from this project will be sold at 10 cents per unit.
Economic (Social)
The economic (social) costs and benefits for this project can be estimated from Figure 2.
Figure 2 Economic (Social) Costs and Prices: Proposal B
Task
Your task is simply to summarize (in your own hand) the results of your analysis in the answer-sheet provided separately.
Assumptions (common to both proposals)
- All capital costs are incurred at time t=0 (i.e., ignore project construction time).
- Electricity generated, electricity tariffs, annual costs and the discount rate remain constant throughout the economic lives of the projects.
- The economic (social) costs and benefits must be estimated exclusively from Figures 1 and 2. The costs and benefits represented in these figures are all inclusive, i.e., costs shown in the figures include capital and operating costs; and the demand curves reflect all benefits(welfare) provided by the projects.
- For the purpose of estimation of economic (social) costs and benefits assume that the market structure for the electricity sector is currently monopoly. It is expected to remain so for the first ten years of the project life-span. The government however proposes to transform this market initially into an oligopoly (for the years 11 to 20) and eventually competitive (years 21-60). While it is difficult to precisely estimate the price and quantity outcomes that will prevail in an oligopoly market, the economic brains of the time have suggested that these outcomes are as shown by dotted lines in Figures 1 and 2.
- The apparent annual discount rates are 15.5 and 18.96 percent for hydro and thermal projects, respectively. Over the next 60 years, the annual inflation is expected to be 5 percent, and escalation (due to the scarcity of coal as fuel for electricity generation), 3 percent. Further, the real economic and financial discount rates are assumed to be the same.