Exercise Ch.6.

  1. Draw up a financial and an economic analysis of an effluent-treatment plant project that processes 1000 tonnes of raw sewage and waste per day.  The market construction cost of the building is $L.2.5 million over 2 years.  The labour cost of constructing the building is $0.8 million over 2 years, but these workers must be paid at a minimum wage, which is double the free-market wage for this type of labour.  Of the remaining $L1.7 million, $$L0.5 million represents taxes and tariffs paid on domestic and imported construction materials and a further $L0.2 million is income tax on skilled technicians' and engineers' salaries.

The imported equipment needed by the plant, landed in the country, cost $L1 million in year 2, but a tariff of 20 per cent, which must be paid by the project, is added to this cost.

The operating costs of the project are $L0.8 million per annum from year 3 to year 20 and include $0.1 million in income taxes and $0.5 million in taxes on fuel and raw materials.

The clean water produced by the project can be re-used and is sold to the water supply author authority for industrial use at $L2.5 per tonne.  But the environmental benefits of the cleaner water are calculated to be worth  another $L3.5 per tonne, in terms of the savings enjoyed by the local fishing and tourist industry, and in the saving in water cleaning costs made by the local water supply authority.

The real financial cost to the project of borrowing will be 10 per cent but the social opportunity cost of funds to the country, the real social discount rate, is 11 per cent.

Determine the financial and economic NPV of this project and its financial and economic internal rates of return.  Should the project be undertaken:

a.      If the operator is private and only concerned with its profitability?

b.      If the project operator is the government, and is concerned with the welfare of the whole country?

c.      If the project is privately operated, should the government consider subsidising it?