Question

Hurricane Harvey caused a net loss of $127 Billion. Let us assume that in any given year the net loss would be the same for the next 10 years (Jan 1, 2020 to Dec 31, 2029) if a Harvey like hurricane were to recur in Houston and adjoining areas. However, if certain investments are made in 2019 to mitigate risks and enhance resilience in the region, the expected loss can be reduced significantly. Let us assume that scientists, engineers and policy experts have worked together to estimate that if the investments are indeed made in 2019 the net loss would reduce to 10% (i.e., $12.7 Billion expected net loss per year over the period from 2020 to 2029 if a hurricane like Harvey were to recur) but additional investments of $ 6.35 Billion would be needed each year to maintain the investments. At the end of 2029 the salvage value of the investments would be 20% of the cost of the original investment. Other than this salvage value there would be no other costs or gains expected after the 10-year period. According to a Presidential tweet at the time, Harvey was a 500-year event. Assuming this probability assessment to be accurate, what present (2019) investment would be justified from a net present worth perspective? Please feel free to make any appropriate assumptions but try to state them clearly.

Answer 1

According to the probability assessment, it will be beneficial to invest $ 6.35 billion to reduce the net loss to 10% for the upcoming 10 years of span. Natural calamities are unsure and can hit any time. Assuming that a hurricane like Harvey hits Houston and the adjoining ares 6 times from 2020-2029, there will be a huge loss in funds. This loss will not only cost a fortune but also a lot of progressive development. If the scientists, engineers and policy experts have joined hands to develop a way that can reduce the loss to 10% due to such a hurricane, then it should be adapted, even if there is an investment of 6.35 Billion dollars. The present net loss is $ 127 Billion. If another 6 hurricanes hit during 2020-2029, there will be a net loss of $762 Billion, but if the investment of $ 6.35 Billion is done in 2019, the net loss would rise to $ 133.35 Billion and when the 6 hurricanes hit, the net loss would be reduced to just $ 76.2 Billion, which is just 10% of $ 762 Billion, which is quite less. So, the investments should be made to mitigate risks and enhance resilience in the region.