A municipality is considering the construction of a reservoir for city water sup

Question

A municipality is considering the construction of a reservoir for city water supplies. Two different sites have been selected as technically, politically, socially and financially feasible. The options are mutually exclusive and have an infinite service life. The city uses a 6% interest rate in all analysis of this type. The Rattlesnake Canyon site will cost $ 15,000,000 and provide annual benefits of $2,000,000 per year. The Blue Basin site will cost $27,000,000 and provide $3,000,000 benefits per year. The city council has asked you to do a benefit/cost analysis of the alternatives and recommend the best site.

Explanation / Answer

B/C Ratio = PV of Benefits/PV of Costs 1. R Canyon : B/C Ratio = PV of Perpetuity of 2M pa @6%/15M = (2,000,000/6%)/15,000,000 = 2.22 2. B Basin : B/C Ratio = PV of Perpetuity of 3M pa @6%/27M = (3,000,000/6%)/27,000,000 = 1.85 SO B/C Ratio of Rattlesnake Canyon is higher at 2.20 & hence this is recommended

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