Sources of risk; best building height

Sources of risk in engineering projects in Nepal

Risk exists when outcomes are uncertain but their probabilities can be estimated. The main sources in Nepal are:

• Political and policy risk: frequent changes of government and policy, bandhs and strikes, delays in decisions, changes in tax and royalty rules.
• Cost and time overrun: poor design, delayed land acquisition, right-of-way and compensation disputes, weak contract management, delayed payments to contractors.
• Natural hazards: earthquakes, floods, landslides, and hydrological variation (for hydropower), plus difficult terrain and monsoon disruption.
• Market and revenue risk: demand uncertainty and a small market, dependence on a single buyer (such as NEA) and changes in tariff.
• Financial risk: interest-rate changes, shortage of liquidity or foreign currency, inflation and exchange-rate variation (imported materials and equipment).
• Technical and supply risk: unproven technology, dependence on imports through India, transport delays, scarcity of skilled labour.
• Social and environmental risk: local opposition, EIA conditions and community demands.

Most economical building height

Net resale value is the salvage at year 5. PW(i) = −First cost + Annual revenue (P/A, i, 5) + Resale (P/F, i, 5) (Rs million).

Worked example at i = 10%: (P/A,10%,5) = 3.7908, (P/F,10%,5) = 0.6209.

4 floors: −125 + 19.91(3.7908) + 200(0.6209) = 74.66 million
5 floors: −200 + 37.815(3.7908) + 300(0.6209) = 129.62 million

Break-even interest rate between the two heights

The fifth floor needs an extra investment of Rs 75 million and gives extra annual revenue of 17.905 million and extra resale value of 100 million. Setting PW(5) = PW(4):

−75 + 17.905(P/A,i,5) + 100(P/F,i,5) = 0   →   i* = 27.7%

(IRR of 4 floors = 23.5%; IRR of 5 floors = 25.0%.)

Sensitivity diagram

   198.8 |    5
         |
   170.5 |
         |
   142.3 |
         |            5
   114.1 |    4
         |
    85.8 |
         |            4       5
    57.6 |
         |                    4
    29.4 |                            5
         |                            4
     1.1 |------------------------------------*-----------
         |
   -27.1 |                                            *
         +------------------------------------------------
             5       10      15      20      25      30   
          interest rate i (%)   (y: PW in Rs million; 4 = 4 floors, 5 = 5 floors)

Ranges of i

• 5% ≤ i < 23.5%: both PWs are positive and the 5-floor building has the larger PW.
• 23.5% < i < 25%: the 4-floor PW is negative (above its IRR of 23.5%), while the 5-floor PW is still positive, so 5 floors is better.
• 25% < i < 27.7%: both PWs are negative (the 5-floor PW is zero at 25% and negative above it); 5 floors is the smaller loss.
• 27.7% < i ≤ 30%: the 4-floor building has the larger (less negative) PW, but both PWs are negative.

Answer: Comparing the two heights, the 5-floor building is the more economical for 5% ≤ i < 27.7% and the 4-floor building for 27.7% < i ≤ 30% (the curves cross at i* = 27.7%). If not building is also an option, the 5-floor building is worth building only for i ≤ 25%; above 25% neither height earns the required return, and the 4-floor building's advantage above 27.7% is only a smaller loss.