University of Lethbridge
Department of Geography
Geography 3235 – Quantitative Techniques for Geographical Analysis
Benefit-Cost Analysis - Assignment 9: The Dam Proposal
This is a complex assignment. We begin by outlining the dimensions of the BCA problem. This
information will allow you to establish, on a year-by-year basis, the specific overall costs and
benefits being contributed to the project. You will then use the list of overall costs and benefits in an
accounting framework to develop the final discounted assessment. The project includes a mix of one
time capital costs, financing costs, and annual operating costs which may increase over time.
No special statistical methodology is involved; this lab is based on straightforward
spreadsheet calculations. What is important in this problem is to practice an orderly approach to
problem solving, dividing the analysis into individual worksheets that can be linked together into one
big Excel “notebook” for the final analysis. This is an important application of spreadsheets and
useful beyond this topic and course.
But before we get to the details of BCA, be prepared to be challenged by an array of annual
costs and benefits. At some point you will exclaim in exasperation, “I don’t know where to start!”
Exactly. This is a key aspect of many practical problem-solving applications. Following the overall
problem description, you will be asked to perform a series of steps that should lead you to an
appropriate problem structure. Use the sample format and worksheet structure in the template
BCA_template_2006.xls on the lab website to structure your approach.
SCENARIO: ONE DAM PROBLEM AFTER ANOTHER
In 2005, the regional municipality of Medicine River proposed a project to augment its water supply,
provide a recreational resource and improve flood control by constructing a dam, reservoir and water
treatment facility. The municipality needs the increased water supply immediately. It will pay for the
land acquisition out of cash reserve funds it has on hand. But all of the construction, engineering,
and tendering costs will be financed by issuing 25-year debentures (bonds). The principal benefits
and costs of the project are specified below. Your mandate is to develop a Benefit-Cost analysis for
this project based on a discount rate of 10% over a 30-year period starting with 2006 as year zero
and 2007 as year one of the analysis.
The main benefits accruing to the community are: increased water supply, improved fire protection
(higher pressure and greater volume), camping and day-use fees from the park surrounding the
reservoir, reduced flood costs, and regional economic spin-off benefits. Annual operating costs
include: debenture financing, maintenance and operation of the dam and road, maintenance and
operation of the water system, and maintenance and operation of the recreational facility.
OVERVIEW OF COSTS AND BENEFITS
Cash vs. Debenture Financing:
The municipality of Medicine River pays for some capital costs in cash (from reserves and revenues)
while other capital costs will use borrowed funds financed through a 25 year municipal bond. Each
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year the bond’s interest cost becomes a part of the annual cost. In the year that the bond is retired,
the capital must be repaid and this capital expense must be included in the annual cost in the year
the principal is paid back to lenders. Therefore, the expenditure of the borrowed capital is not placed
in the cost table for the year of construction (2009) but rather in the year when the capital value of
the bond is paid off. Note that there will be no capital financing cost in the year the debt is incurred
thus the first interest payment will occur one year after the capital is first received. The municipality
has to pay 8.5% interest for the money it borrows in 2008 and expects to pay 9.25% on money it will
borrow in 2009.
Capital & One-time Costs
Land Acquisition (2006)
Dam – Engineering and tendering (2007)
Dam – Construction and commissioning (2008)
Recreation facility – design and tendering
(2008)
Recreation facility – construction (2009)
Water system – Engineering and tendering
(2008)
Water system – Construction & commissioning
of dam (Phase I) (2009)
Water system – Construction & commissioning
of second dam (Phase II) (2020)
$4,250,000
$375,000
$6,500,000
$150,000
$755,000
$125,000
$4,000,000
$2,000,000
Maintenance & Operation of the Dam and Road
Maintenance and operation of the dam and road will cost $105,000 in 2009 which must be adjusted
to increase by 6% each subsequent year.
Improved community water supply.
Medicine River’s municipal water system was condemned some years ago and the municipality is
currently buying sufficient water from the neighboring town of Mariposa to support its 15,000
domestic, 100 commercial and 2 industrial users, billing these users on a cost recovery basis and
simply transferring the funds to Mariposa. Assume that maintenance and operation of the water
system costs $650,000 per year plus 90% of the yearly amount billed for water supplied to
customers (costs to begin when the new water treatment facility comes online).
When finally completed, the new water system will add capacity to support an estimated
50,000 domestic, 500 commercial, and 30 industrial water users. As soon as the new water supply is
operational and tested, the region will cease buying water from Mariposa and start supplying the
users from the new facility. The region bills its individual users for annual water consumption at the
following average rates which are not expected to change over the life of the project.
Use Category
Domestic
Commercial
Industrial
Average Water
Consumption Fees
$700
$1,600
$10,000
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The region anticipates that the new water treatment facility will come on stream through the
existing distribution system in 2010. The transfer of users from the Mariposa water supply will
provide an immediate cash flow at the existing rate as a benefit of the project. After 2010, regional
growth is forecast to proceed by a constant increment of 1400 domestic users, 15 commercial users
and an average of one industrial user per year into the foreseeable future which the region expects
will approach but not exceed the new facility’s water treatment capacity.
Engineering estimates the total capital cost of the water treatment facility will be $6,000,000.
The region plans to phase-in the installation of equipment as follows: 2/3 of the total capital expense
in 2009 (in preparation to provide service in 2010) and the final 1/3 of the total capital expense in
2020. It will pay for the first phase with a 25 year debenture which will be issued in 2008; the final
1/3 will be funded from cash reserves expected to be available at that time.
Recreational Facility
The project will provide a campground with 125 campsites and day-use facilities such as trails,
softball diamonds, and a picnic area with a capacity of 300. The region is short of recreational
facilities thus it will be fully utilized as soon as it opens in 2009. Full utilization means that the
campground will operate annually at 90% capacity for five months per year, at 40% capacity for
three months per year, and will be closed for the other four months. The daily camping fee averages
$30.00 while the day-use fee averages $12.00. It is estimated that the day-use facilities will operate
at 50% of capacity throughout the year. (The key to this problem is to calculate the average daily
utilization rate over the whole year; that is, the total daily capacity weighted by the proportion of the
year for which that capacity is expected. Multiplying this daily value by 365 days and by the revenue
per user will reveal the expected revenue per year.)
Assume maintenance and operation of the recreation facility will have fixed costs of
$250,000 per year plus variable costs which will amount to 85% of the annual revenue obtained from
fees collected.
Fire Protection
Based on annual fire insurance claims, emergency services staff estimate that the project will
provide an average annual benefit of $50,000 (beginning when the new treatment facility comes on
stream) due to the increase in water pressure and increased reservoir capacity.
Flood Protection
Based on an analysis of regional costs for repair of flood damage and flood insurance claims over
the past 25 years, public works staff estimate the flood protection benefit to average $35,000 per
year beginning the year after the dam is commissioned.
Regional Economic Growth Impact
Regional staff estimates that every $1.00 paid for water by domestic users generates an additional
$0.07 in regional economic activity, commercial users generate an additional $0.60 in regional
economic activity for every $1.00 of water expenditures, and that every $1.00 paid for water by
industry generates an additional $1.00 in regional economic activity. Also it is estimated that for
every $1.00 paid in camping fees, an additional $0.80 is spent in Medicine River while every $1.00 in
day-use fees generates an additional $0.25.
ASSIGNMENT REQUIREMENTS
Using the template provided, develop a series of annual cost and benefit worksheets for each
theme, itemizing the costs and benefits for each year. Calculate the total cost and total benefit that
should be assigned to the project for each year. This will require a number of worksheets, however,
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the task is simplified by the template provided and by using Excel creatively to copy the same
general format and contents from one table to another.
Finally, develop an overall summary table of showing historical figures for annual cost, benefit and
net benefit and net present values for annual cost, benefit and net benefit and at last, the benefitcost ratio.
Structuring your spreadsheet
Create a single spreadsheet file and within the spreadsheet, create several tabbed worksheets to
calculate costs and benefits for each theme of the project. Some of the worksheets, will make
reference (by mouse clicking cells in other sheets while setting up a calculation formula) to cost and
benefit information calculated for another theme. Note that the spreadsheet template shortens some
lists and leaves out some data to reduce file size. You will have to be sure that your spreadsheet is
complete in all respects and enter any additional information yourself.
Suggested Sequence of Steps to Solve the Problem
You need to be familiar with the annual costs and benefits associated with each of the themes
before you can set up the annual table and the summary table for discounting. We will start with the
easiest and progress to the more challenging tables explained in the steps below.
1. Dam and road operation and maintenance is simply a cost and does not deliver any specific
quantified benefits. Set up a worksheet to detail these annual costs. Your worksheet should start
with the initial annual cost of $105,000 for 2009 which increases by 6% per year until 2036.
2. Next we deal with the debt financing worksheet. The problem is to calculate financing costs over
each annual financing period, beginning on the first anniversary date. List all the years with
financing costs. Because there are two distinct debentures being issued in different years with
different interest rates, you should set up a column for each one with a third column that totals
the annual cost of the two debentures in each year. At the top of each loan column you should
list the principal amount being borrowed, the interest rate, and the term of the debenture. From
this information you can calculate the annual interest to be paid. Be sure to include the final
capital payment at the end of the term of each loan.
3. Now we set up a separate worksheet to deal with the Recreation theme which includes both
costs and benefits. Annual operation costs are directly derived from the activity level (i.e.,
revenue generated) thus revenues must be calculated first. Set up a column for the two sources
of revenue, camping and day use. At the top of the column, list the parameters that drive the
revenue generation and then down the column perform the annual calculations. Add a third
column to sum the revenue generated each year. Add another column to calculate total annual
operating costs which is a function of revenues.
4. Using an approach similar to that used in step 3, set up a separate worksheet to calculate the
costs and benefits for the water service theme.
5. The economic development worksheet draws on information in other worksheets. Organize your
calculations by year in columns just like other worksheets you have developed so far. Establish
columns for each of the impacts and at the top, indicate the parameters driving the spin-off. The
calculation down each column simply involves making a cell in this spreadsheet equal to the
parameter times the appropriate activity level cell in the associated worksheet. To do this across
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the worksheet, simply start the calculation formula in the active worksheet. When you need to
reference a data cell in another worksheet, just click its tab (thus opening it), click on the cell in
the new worksheet then hit the Enter key which brings you back to the active worksheet. This
sets up the cell addressing across worksheets. Once you have finished organizing this
worksheet you can proceed with the next major worksheet that pulls all of the costs and benefits
together.
6. Create an Annual Costs worksheet based on all of the cost and benefit themes and generate
one column of benefits and one column of costs per year. This worksheet is built by copying the
relevant columns from the previous worksheets. In addition, it is here that you can include the
occasional capital expenditures that the region made from cash reserves.
7. Finally, set up the final worksheet where you will perform the cost, benefit, net benefit and net
present value calculations by discounting historical values. Start your table with the year 2006 as
year zero and list all subsequent project years.
8. Plot the annual net benefit and NPV data on a graph.
9. Explore the sensitivity of the BCA by comparing discount rates of 5% and 15%. This is simply
done by simply changing the discount rate in the main cost benefit table and noting how the
chart of discounted net benefits changes.
10. Examine and discuss the differences between the 5, 10 and 20 percent discounted studies.
Comment on the key differences with respect to the perspectives of the public and private sector
and the importance of the discount rate.
11. Provide a 2-3 page summary of this analysis in which you highlight the results from the base
case such as BCR, most important costs/benefits over the duration of the project and discuss the
limitations of the analysis – such as missing cost/benefits and the influence of key assumptions.
12. Hand in your answers to questions 10 and 11 and e-mail your spreadsheet to your laboratory
instructor.
Acknowledgement
This laboratory assignment was originally developed by Dr. Ross Newkirk in the School of Planning
at the University of Waterloo and modified by Dr. Clarence Woudsma in the Department of
Geography at the University of Waterloo. Their contribution is gratefully acknowledged. The
assignment was further modified by Ian MacLachlan and Lewis Baarda, Department of Geography,
University of Lethbridge, November 12, 2006.
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