49003 ECONOMIC EVALUATION
ECONOIVtrC EVALUATION This assignment is about evaluation of two project options. OptionA Option A envisages generation of electriciry from water ftydro-electric project). The project is proposed to be located in a remte area on a paoefl of fertile agricultural land with an expected yield (benefits) over 30 years of $600Mn. This bnd, ifpunchased at the prevailing ma*€t price, will cost $l00Mn. Other capital on the project is as follows: lnvestisation and Sun'er Civil Works Electrical Works Transmission and Distribution \envork Establishment costs dunns con:::-lJ1 ion ($Mn) 30 1700 s00 250 :'o It is expected that the project u il1 requrre S-l-sMn annually for maintenance purposes; additionally 0.5 percent of capital costs u'i1l be speni amuallr'on salaries and wages. The project is designed for a usefu1 liie of 30 years. at the end of which it can be sold at 10 percent of project capital cost. Option B Option B is a thermal project - electricity is generated from coal. The projet will require a one-off expenditure of $200Mn to expand the coal mining capacrty of the existing mine near the proposed project site. In the absence of the project, the site willbe develo@ into a major manufacturing complex which will have an expected life-time benefits of $50OMn- Theproject site is currently pric€d at $50Mn- Other infrasnrcture related capital costs forthe project are estimated to be $1750 Mn. This project will have 20 years of usefirl life. It is estimated that 2Mn tonnes of coal will be burnt every year to produce electricity. The coal is priced at $50 p€r toflne. This coal, if not used for power generation, can be exported at a price of$80 per tonne- Salaries and wages to the employees will cost $20Mn annually and maintenance an additional I percent of capital cost. In social terms, salaries and wages will amormt to $4OMn- Tasks a) Evaluate the two options from Financial and Economic considerations- For the purpose of these evaluations, select two viabilit-v indicators that are most suited for evaluating these projects. Provide a justification for your selection (i.e., why the indicators selected by you are best suited for evaluating these projects?). Which option will you recommend from a Finacial perspectir,e? Why? Which option will you recommend from an Economic perspective.? Why? b) c) Alterretive Ac(ionmenl - ?Ol R d) Would you recolnmendation change if expected inflation over the usef,rl lives of these projects is 5%o? e) What is the basis for analysis/comfarison of costs/benefrts - 'Real terms' or Nominal terms'? Provide justification in support of your answer. Assumption/Other Information i. Options A and B are comparable in term of their electricity gene,rating capacities. Both options generate 2000Mn units of electriciqv annually. 2. Electricity is priced in the market at 20c per unit. However consumers are willing to pay 30c per unit. 3. All capital costs are incrrrrd at time t :0. (ie, ignore project construction time). 4. Electricity generated, elecrricity tariffs, annual costs and the discount rate remain constant through the usefirl lives of the projecs. 5. Market prices may be used wherever information is not adequate to calculate economic prices. 6. Economic and financial discormt rates (exclusive of inflation and escalation) are the same, ie t0%. 1 Alrerrative Assiqnrrent - ?01 R 15 Assignment 2 – A 2018 1 UNIVERSITY OF TECHNOLOGY SYDNEY Faculty of Engineering and Information Technology 49003 ECONOMIC EVALUATION Autumn 2018 Assignment # 2 Due: 4 June 2018 (no later than 4.00 pm) Notes: 1. This assignment is worth 25% of the total score. 2. The Answer Sheet for this assignment should be uploaded using the appropriate link on UTSOnline. Assignment 2 – A 2018 2 EVALUATION OF PROJECT PROPOSALS Everyone is impressed by the ingenuity shown by you in evaluating Proposals A and B from a macro perspective (Assignment #1). So much so, you have been invited, once again, for a further analysis of the two project proposals. The main objective of this analysis is to ascertain the financial and economic viabilities of the two proposals. The estimated capital cost of each of these proposals, you might recall, is $30 billion (bn). Other details are provided below. PROPOSAL A Financial Proposal A envisages generation of electricity from water - a hydro-electric project. The useful economic life of this project is estimated to be 60 years. This project will generate 50,000 million (mn) units of electricity annually. Electricity will be sold to the public at a tariff of 8 cents per unit. The annual operation and maintenance costs are expected to be 3.3 percent of the capital cost. Economic (Social) The economic (social) costs and benefits for this project must be estimated from Figure 1. PROPOSAL B Financial Proposal B is a thermal project - electricity will be generated from coal. The annual operating costs for this project are estimated to be 8 percent of the capital cost. This project will also have a useful economic life of 60 years. It will generate 45,000mn units of electricity annually. The electricity from this project will be sold at 12 cents per unit. Economic (Social) The economic (social) costs and benefits for this project must be estimated from Figure 2. Task Your task is simply to present the results of your analysis in the answer-sheet provided separately. Assignment 2 – A 2018 3 Notes: • You must provide the background details (i.e., select calculations), for various answers provided by you in the answer-sheet, in an Annexure (no more than two pages). You must type-write your Annexure. You must not attach any computer- printed spread-sheet in the Annexure. The minimum permissible font size for the Annexure is 12 (Times Roman or equivalent). • The completed answer-sheet must however be a stand-alone document (i.e., the reader should be able to understand the entire logic behind your reasoning without needing to refer to the Annexure. • There is no tolerance on specified word/page limits. Any written material beyond these limits will not be marked. • Please tick (√) only one box wherever a multiple choice is provided. Assumptions (common to both proposals) • All capital costs are incurred at time t=0 (i.e., ignore project construction time). • For financial evaluation, electricity generated, electricity tariffs, annual costs and the discount rates remain constant throughout the economic lives of the projects. For economic evaluation, these entities remain constant for the duration of each market structure (i.e., monopoly, oligopoly, and competition). • The economic (social) costs and benefits must be estimated exclusively from Figures 1 and 2. The costs and benefits represented in these figures are all inclusive, i.e., total costs include capital and operating costs and the demand curves reflect all benefits provided by the projects. • For the purpose of estimation of economic (social) costs and benefits assume that the market structure for electricity sector is currently monopoly. It is expected to remain so for the first twenty years of the project life-span. The government however proposes to transform this market initially into an oligopoly (for the years 21 to 40) and eventually competitive (years 41-60). While it is difficult to precisely estimate the price and quantity outcomes that will prevail in an oligopoly market, the economic brains of the time have suggested that these outcomes are as shown by dotted lines in Figures 1 and 2. • The real annual discount rate is 10 percent. Annual inflation is expected to be 5 percent and escalation (due to the scarcity of coal as fuel for electricity generation), 3 percent. Further, the economic and financial discount rates are assumed to be the same. Assignment 2 – A 2018 4 Figure 2 Economic (Social) Costs and Prices: Proposal B Figures 1 and 2 are Not-to-scale. Therefore, please do not use these figures to estimate various areas. You should instead use various values on X and Y axes to estimate various areas. P = MC=ATC Marginal Revenue Demand Cents/unit 15 12 6 36,000 45,000 Output (Million units/year) 9 40,500 P = MC=ATC Marginal R Demand Cents/unit 12 8 4 40,000 50,000 Output (Million units/year) 6 45,000 Figure 1 Economic (Social) Costs and Prices: Proposal A