Hemisphere Corp. is considering a Build-Operator-Transfer (BOT) contract to cons

Question

Hemisphere Corp. is considering a Build-Operator-Transfer (BOT) contract to construct and operate a large dam with a hydroelectric power generation facility in a developing nation in the southern hemisphere. The initial cost of the dam is expected to be $30 million, and it is expected to cost $100,000 per year to operate and maintain. Benefits from flood control, agricultural development, tourism, etc., are expected to be $2.8 million per year. At an interest rate of 8% per year, should the dam be constructed on the basis of its conventional B/C ratio? The dam is assumed to be a permanent asset for the country.

Explanation / Answer

Present value of Benefit = Annual benefit /rate

             = 2,800,000/ .08

              = $ 35,000,000

Present value of operating and maintenance cost =100000/.08 = 1,250,000

Benefit to cost ratio = Present value of benefit /(Initial cost + present value of operating and maintenance cost)

         = 35,000,000 /(30,000,000+1,250,000)

        = 35,000,000 /31,250,000

        = 1.12

since the B/C ratio is more than 1 ,construction of dam is justified.

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