Course taster

Example 1

Dam case study

A small dam, such as the one below, is to be constructed by your water company to allow for small-scale hydroelectric generation and to control flooding into a residential district. There will also be some recreational activity opportunities once the dam has been built.

Figure 1.6: Dam case study

hydro electric dam

Image source: AdobeStock (Accessed on 14.03.2022)

Costs would be:

  • materials = £500,000
  • labour = £600,000
  • Total cost = £1,100,000

If there were no changes in monetary value with time and the company received the following benefits:

Dam construction - total cost = £1,100,000

Total benefits when built:

  • Recreation = £400,000
  • Recreation = £400,000
  • Electricity = £500,000
  • Total benefit = £1,200,000
  • Net benefit = £100,000

benefit exceeds cost, so the dam appears to be a good investment.

But, in the real world, where time is a variable, the dam project is revisited:

  • Total costs accrue at start of construction (t = 0)
  • Total benefits accrue when the dam is finished (t = 1)
  • Discount rate = 10%

Should the dam be built? Consider the data, then select the button below to reveal our suggestion:

PV=Vt1+rt

Total costs accrue at start of construction (t = 0)

P0 = £1,100,000 and PV of cost is: PV=£1,100,0001 + 0.100=£1,100,000

Total benefits accrue when dam is finished (t = 1)

P1 = £1,200,000 and PV of benefit is: PV=£1,200,0001 + 0.101=£1,090,909

PV(Benefits) < PV(Costs)

The dam should not be built if just costs are taken into consideration.

Pause and reflect

To decide whether society should build the dam, what other information may be needed, e.g. environmental and social impacts, i.e. non-economic impacts? Can you think of or find an example of something other than direct cost or benefit?