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Water Resources Planning and DM: Modul 2 H.P. Nachtnebel

Economic Assessment Techniques

Module 2H.P. Nachtnebel


Extended Framework

Economic Social objectives Ecological

have to be simultaneously addressed

MULTI-OBJECTIVE DECISION MAKING


Economic Evaluation Techniques

Investment (reservoir, levee, hydropower station) Costs (building and operation costs…) Criterion of efficiency

Maximizegiven budget, maximize outputgiven output, minimize costs


Application to a General Example

Economic assessment of a hydropower project Privat investors view


Components in Economic Evaluation


Basics of Economic Assessment

Time horizon T (Life Time) Interest rate i Criterion

benefit-cost ratiopresent net valueannuity valueinternal interest rate

Interest rate

A nominal interest rate is the interest rate that does not take inflation into account. It is the interest rate that is quoted on bonds and loans.

real interest rate is the interest rate that does take inflation into account. As opposed to the nominal interest rate, the real interest rate adjusts for the inflation and gives the real rate of a bond or a loan.



Benefits and Costs

Benefits

Costs

Time horizon T

time

Investment Operation Costs

Return flows

t=0


Discounting

Receiving the same amount now is higher appreciated thanreceiving it later

time

nintXtX)1(

)()0(

high interest rate

low interest rate


Discounting

Each revenue, each investment is discounted to a reference point

The evaluation is independent from the reference point The evaluation is independent from the selected criterion


Discounting

Several flow elements (costs, benefits) are discounted

time

t=0


Discounting

Several flow elements (costs, benefits) are discounted and accumulated

time

t=0

Present value of benefits, costs


Discounting

Several flow elements (costs, benefits) are discounted and accumulated

T

tt

t

iN

1 )1(

time

t=0

Present value of benefits, costs

Present value of benefits

T

tt

t

iK

1 )1(Present value of costs


Evaluation Criteria

Benefit cost ratio BCR

Net present value NPV

Internal interest rate

0)1()1(0

T

tt

tt

t NPVi

Ki

N

1

)1(

)1(

0

0

BCR

iK

iN

T

tt

t

T

tt

t

T

tttt irfor

rKN

0

____0)1(


Internal Interest Rate

The Internal Rate of Return (IRR) is the discount rate that generates a zero net present value for a series of future cash flows.

The Internal Rate of Return provides a simple ‘hurdle rate’, whereby any project should be avoided if the cost of capital exceeds this rate.

A simple decision-making criteria can be stated to accept a project if its Internal Rate of Return exceeds the cost of capital and rejected if this IRR is less than the cost of capital.

Examples of Small Hydropower Schemes



Economic Efficiency of a Small Hydro Power Projecta private company is planning this project

capacity [kW] 500

specific costs [€/kW] 2 800

investmen costs[Mio €] 1.4

planning horizon (years) 25

interest rate (private) 7

annual benefits [€/a] 183 000

maintenance and operation costs [% of investment] 2.5

Annual maintenance costs [€/a] 35 000

recovery factor (7%,25 years) 0.0858

present value of benefits [Mio €] 2.132

present value of costs [Mio €] 1.806

net present value [€] 326 000

annual costs [€/a] 155 000

net annuities [€/a] 28 000


Economic Efficiency of a Small Hydro Power Projecta private company is planning this project

capacity [kW] 500

specific costs [€/kW] 2 800

investmen costs[Mio €] 1.4

planning horizon (years) 25

interest rate (private) 7

annual benefits [€/a] 183 000

maintenance and operation costs [% of investment] 2.5

annual maintenance costs [€/a] 35 000

recovery factor (7%,25 years) 0.0858

present value of benefits [Mio €] 2.132

present value of costs [Mio €] 1.806

net present value [€] 326 000

annual costs [€/a] 155 000

net annuities [€/a] 28 000

Benefit cost ratio 1.18


Uncertainty of Economic Efficiency of a SHPP

Sensitivity analysis

The variability in the input is related to the variability of the output

The input variables can be ranked with respect to the reaction of the output


Economic Efficiency of SHPInvestition Einnahmen Lebens-

dauerZinsfuß Kap. Wert Änderung

[Mio €] [€] [Jahre] [%] [Mio €] [%]1,4 183.000 35.000 25 7 0,326

Investition 10% 1,54 183.000 35.000 25 7 0,186 -42%-10% 1,26 183.000 35.000 25 7 0,466 42%

Einnahmen 10% 1,4 201.000 35.000 25 7 0.540 65%-10% 1,4 164.000 35.000 25 7 0,112 -65%

Betriebsk. 10% 1,4 183.000 38.500 25 7 0,285 -12%-10% 1,4 183.000 31.500 25 7 0,366 12%

Lebensd. 10% 1,4 183.000 35.000 27,5 7 0,385 18%-10% 1,4 183.000 35.000 22,5 7 0,213 -34%

Zinssatz 10% 1,4 183.000 35.000 25 7,7 0,221 -32%-10% 1,4 183.000 35.000 25 6,3 0,439 34%

Betriebs-kosten

[€/a]Ausgangssituation

Changes in income (return flows) strongest change in the NPVt

Changes in op.costs small sensitivity in NPV

Investment Benefits Operationcosts

Benefits

Initial caseInvestment

Planning hor.

Op. costs

sensitivityPlanning horizon

Interest rate NPV

Interest rate


Stepwise Development of Hydropower

Alternative 1 Construction of a 500kW plant now (previous example)

Alternative 2 Stepwise development

- First implementation of a 350 kW plant- In 10 years a second plant is added with 200 kW


Economic Efficiency of SHP: Two Alternatives

Alternative Icapacity [kW] 500 350 200specific costs [€/kW] 2 800 3 100 3 600Investment costs [Mio €] 1.4 1.08 0.72interest rate [%] 7 7 7annual income [€] 183 000 145 000 95 000operation and maintenance costs [€/a] 35 000 25 000 10 000start of loperation in years 0 0 10life time[years] 25 25 25present value of benefits [Mio €] 2.13 1.69 0.44present value of costs [Mio €] 1.81 1.38 0.41net present value [€] 320 000 310 000 30 000annual benefits [€/a] 183 000 145 000 38 000annual costs [€/a] 155 000 118 000 35 000benefit cost ratio 1.18Internal interest rate [%] 9.5 9.7

Alternative II

1.19


Optimal Capacity of a SHP

Optimal capacity when BCR is at maximum or incremental BCR =1In this case between 760 und 890 kW

P spec.costs

Invest. op.costs benefits present value present value

benefits costs[kW] [€/kW] [Mio €] [€/a] [€] [Mio €] [Mio €]380 3 526 1.34 35 000 200 2.33 1.748 1.33510 3 160 1.61 36 000 240 2.8 0.47 2.03 0.281 1.38640 2 780 1.78 38 000 265 3.09 0.29 2.222 0.193 1.39760 2 552 1.94 40 000 285 3.32 0.23 2.405 0.183 1.38890 2 325 2.07 44 000 298 3.47 0.15 2.58 0.176 1.34

increments increments BCR


Some Examples: Comparison of two Alternatives

Alternative A: high investment costlow operation costs

Alternative B: low investment costshigh operation costs

Interest rate i

Present value of costs


Some ExamplesComparison of two Alternatives

Alternative A: high investment costlow operation costs

Alternative B: low investment costshigh operation costs

Interest rate i

Present value of costs


Considering Uncertainty

Internal interest rate Sensitivity analysis Simulation


Simulation

For each variable a pdf is assumed Hundreds of simulations A pdf for the efficiency criterion is obtained

1 BCR

Probability


Summary and Conclusions

economic evaluation steps were described problem definition data collection identification of objectives, criteria, preferences selection of methodology

B-C ratiopresent valueinternal interest rate

sensitivityThis holds for each step in water resources management

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