Suppose that a factory is located in a flood prone area. You have been hired to

Question

Suppose that a factory is located in a flood prone area. You have been hired to identify if the factory owner should increase the factory’s flood protection. Three options are being considered:

a) Do nothing. Damage from a moderate flood is $10,000 and $25,000 in a severe flood.

b) Perform a moderate amount of flood protection improvements for $15,000. There will be no damage from a moderate flood and $10,000 in damage from a severe flood.

c) Perform an extensive amount of flood protection for $20,000. There will be no damage from moderate or severe floods.

The annual flood risk is 0.7 for no flood, 0.2 for a moderate flood, and 0.1 for a severe flood. Assuming an interest rate of 15% and a 15 year analysis period, what would you recommend?

Explanation / Answer

a) Cost of damage from flood = 10000*.2+25000*.1=4500 every year

So Present value of losses in 15 years = 4500/1.15+4500/1.15^2+ .................. + 4500/1.15^15 = $26313.13

b) Cost of damage from flood = 10000*.1=1000 every year

So Present value of losses in 15 years = 1000/1.15+1000/1.15^2+ .................. + 1000/1.15^15 = $5847.37

So PV of total cost = 15000+5847.37 = $20847.37

c)PV o total cost = $20000

SO option c is best as it has minimum cost in present value.

Related Questions

Navigate

• Browse (All)
• Browse S
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.