The objective of the paper is to estimate environmental externalities related to a run of river project in Sri Lanka and to investigate inequity in distribution of impacts among different social groups. Diversion of the river resulted in loss of water sports (for high-income groups both local and remote), loss of historical monuments (for remote high-income groups) and recreation losses (for local poor). Removal of forest cover leads to loss of non-timber products (for local poor) and carbon storage (for remote high- and low-income groups). Loss of home garden productivity was borne by local poor groups. Benefit of the project, generation of 145 GWh annually, was a gain for the grid connected groups. The impacts were valued using various valuation methods. The base case of the cost benefit analysis resulted in NPV of US$ 11,335,730. When distributional weights are applied for different income groups, both the sign and magnitude of net benefits change. In order to be viable, the project needs diversion of at least 9% of generated electricity to the poorest households in the country. Implications for energy policy towards reducing externality and inequality impacts are also discussed. (C) 2009 Elsevier Ltd. All rights reserved.