Cost Benefit Analysis Case

Cost Benefit Analysis Case

Cost Benefit Analysis Case

You are an economist for an international NGO that makes subsidized loans for the improvement
of agricultural production. You have been approached by the Government of Nepal, which wants
your organization to fund construction of a US $41 million irrigation system in the Dang Valley,
the heart of agricultural production in the country. The purpose of the new system is to increase
agricultural production, but there are other costs and benefits that may accrue as well.
There has been a traditional system of wells and canals, but it is more than 50 years old and has a
number of problems. First, 100,000 gallons of water per month are lost because of leaks in the
canals. Second, in the last 10 years, 20 people have drowned in the existing canals. Third, the
runoff from the canals flows into the Rapti River. When it rains, runoff from the fields flows
directly into the canals, and pollution from pesticides has substantially increased pollution of the
river, especially over the past 10 years. This has, among other things, substantially affected the
fishing of the river. Pollution has killed many fish, and while those who have not died are not
safe to eat, the local population has nonetheless continued to eat them, and many have gotten
sick or died.
You have the following information on the predicted effects of the new irrigation system.
1. Construction of the new irrigation system is expected to commence in January of next year
(t=0), and it will be completed within two years (t=1,2). The $41 million in construction costs
will be repaid over 25 years, at a 3-percent interest rate. A 25 year horizon for this irrigation
scheme has been predicted by your team of engineers as the time frame over which this
investment will have the predicted effects; after 25 years another infrastructure investment
decision will need to be made.
2. Once the system is operational, the increase in water availability (because there will no longer
be cracks in the system) is expected to increase agricultural production in the Dang Valley by
10 to 12 percent annually. There are a total of 20,000 hectares (ha) of agricultural land in the
1 This case is obviously hypothetical and the numbers shown may differ substantially from actual conditions in
Nepal.
valley. Current estimates are that crops produced on this land are valued at US$950 per ha per
year under current conditions.
3. In order to prevent the kinds of problems, especially drownings and illegal appropriation of
water from the canal, that have plagued the current system, the plans are to pay local people to
provide security. A total of 10 such security personnel will be needed, and they will be paid the
equivalent of US$1,000 per month (that is, $100/month for each person hired).
4. There will also be costs to maintain the system, which will increase as the system ages. There
will be no material costs for maintenance over the first five years, but materials will cost
$200,000 per year in years 6 to 15, and $500,000 per year after that. It is assumed that labor will
be donated by local farmers. This will represent a total of 1,000 hours of labor in years 6 to 15,
and 2,500 hours after that.

 

 

What is cost-benefit analysis and how is it calculated?

 

Cost Benefit Analysis Case

5. Because of this improved security, the number of drownings is expected to be cut in half
when the new canal becomes operational.
6. The reduced pollution will also have benefits for the fishing industry, increasing the income
to fishermen. Current estimates are that a ton of fish results in revenue to fishermen of $500,000
annually, and that this will increase by 8 to 12 percent as a result of the new system.
7. In addition, it is estimated that one life will be saved every four years as a result of the
reduction in pollution of the Rapti River. In addition, the reduction in water-borne illnesses will
reduce doctor and hospital visits by 1,000 per year. It is estimated that one of these visits
currently costs between $50 and $100.
8. Each doctor or hospital visit results in one-half day, on average, of lost productivity for
workers. It is estimated that the average worker makes $30 to $50 per day.
9. The increased agricultural production will increase the value of the agricultural land, currently
worth approximately $2,000 per ha, by an estimated 10 percent.
10. During the period of construction, increased air pollution will have negative health effects,
resulting in 500 doctor/hospital visits and 250 lost labor days per year of construction.
Based on your benefit cost analysis, should this project be implemented or not? Explain your
calculations and conclusions.