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: Do nothing. Damage from a moderate flood is $10,000 and $25,000 in a severe flood. Perform a moderate amount of flood protection improvements for $15,000. There will be no damage from a moderate flood and SI0,000 in damage from a severe flood. Perform an extensive amount of flood protection for S20,000. 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

Scenario Analysis No Flood Moderate Flood Severe Flood Probability 0.7 0.2 0.1 Damages Do Nothing $                   -   $                   2,000 $            2,500 Moderate flood protection $                   -   $                          -   $            1,000 Extensive flood protection $                   -   $                          -   $                   -   Cost of flood Future value of $ (amount) for 15 years @15% MINUS Cost of damages Do Nothing $          67,500 --->Damages for each year multiply by 15 Moderate flood protection $        107,056 ---> Future value of $15000 investes today minus cost of damages each year multiply by 15 Extensive flood protection $        162,741 ---> Future value of $20000 investes today minus cost of damages each year multiply by 16 Clearly from three options. Option -1 is best in terms of flood cotrol as it has least cost associated with it

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