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111Ch 9 - Benefit Cost Analysis

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Lecture slides to accompany

Engineering Economy 7th edition

Leland Blank

Anthony Tarquin

Chapter 9

Benefit/CostAnalysis

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LEARNN! "#TC"$E%

1. Explain diference in public vs private sectorprojects

2. Calculate B/C ratio or single project

3. Select better o two alternatives using B/Cet!od

". Select best o ultiple alternatives using B/Cet!od

#. $se cost%efectiveness anal&sis to evaluateprojects

'. (escribe !ow et!ical coproises a& enterpublic

  sector projects

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&ifferences' (u)lic *s (ri*ate (ro+ectsCharacteristic  (u)lic  (ri*ate#i$e o% &'vest(e't )arge  #(all, (ei*(, large

)i%e )o'ger +"0 - 0 years #horter +2 / 2 years

A''*al No ro%it 3ro%it

*'i'g 4a5es, %ees, bo's, etc. #tocks, bo's, loa's,

etc.

&'terest rate )ower  Higher

#electio' criteria M*ltile criteria 3ri(arily R6R

7'viro'(e't o% eval*atio' 3olitically i'cli'e  7co'o(ic

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Cash ,lo- Classifications in B/C Analysis

$ust identify cash flo-s as either )enefits. dis)enefits. or costs

BenefitsB011Ad*anta2es to the public

&is)enefts &011&isad*anta2es to the public

Costs C011E3penditures )y the government Note: Savings to government are subtracted from costs

Con*entional B/C ratio 4 B 5 &0/C

 $odified B/C ratio 4 6B 5 &0 5 C/ nitial n*estment(rofita)ility nde3 4 NC,/ nitial n*estment

Note 8' All ter(s (*st be e5resse in same units +i.e. 39, A9, or 9

Note ' Do not *se (i'*s sig' ahea o% costs

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B/C Analysis 5 %in2le (ro+ect

Con*entional B/C ratio 4B 1 &

C

$odified B/C ratio 4 B 5 & 5 $:"C

f B/C ; 8.

accept pro+ect<

other-ise. re+ect

( 4 (= of initial in*est

(= of NC,t

&enominator is

initial in*estment

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B 4 >87?.@@@

E3ample B/C Analysis 5 %in2le (ro+ect

 A flood control pro+ect -ill ha*e a first cost of >8 million -ith an annualmaintenance cost of >@.@@@ and a 8@ year life Reduced flood dama2e is

e3pected to amount to >87?.@@@ per year Lost income to farmers is estimated

to )e >?.@@@ per year At an interest rate of D per year. should the

pro+ect )e undertaken

%olution'  75ress all val*es as A a' the' %i' ;< ratio=

& 4 >?.@@@

C 4 8.@@.@@@A/(.D.8@0 F >@.@@@ 4 >[email protected]

B/C 4 87?.@@@ 5 ?.@@@0/[email protected]

  4 @? I8@

Do not build project 

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Alternati*e %election #sin2 ncremental B/C

Analysis 5 T-o or more Alternati*es

80 &etermine equivalent total cost for each alternati*e

(2) Order alternatives by increasing total cost G0 dentify ! D for eac" alternative. if 2i*en. or 2o to step ?

(#) $alculate %$ for eac" alternative and eliminate all &it" %$'*

(+) Determine incremental costs and benefits for first t&o alternatives(,) $alculate -%$. /f 0*1 "ig"er cost alternative becomes defender 

() 3epeat steps + ! , until only one alternative remains

(rocedure similar to R"R analysis for multiple alternati*es

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Cost Effecti*eness Analysis

Service sector projects ri(arily i'volve intan2i)les, notphysical facilities@ e5a(les i'cl*e health care, sec*rity

rogra(s, creit car services, etc.

$ost4effectiveness analysis ($E5) co(bi'es (o'etary cost

esti(ates with 'o'-(o'etary be'e%its esti(ates to get

cost1effecti*eness ratio CER0

CER 4 equi*alent total costs/effecti*eness measure

4 C/E

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CER 1 ndependent (ro+ects

(rocedure is as follo-s'+1 eter(i'e total cost B e%%ective'ess (eas*re a' calc*late 7R

+2 6rer roCects= s(allest to largest 7R

+" eter(i'e c*(*lative cost o% roCects a' co(are to b*get, b

+8 *' all roCects s*ch that b is 'ot e5ceee.

ro( the 7Rs show' below, eter(i'e which independent 

rogra(s sho*l be selecte i% the b*get li(it is D00,000.

(ro2ram  CER. >/2raduate  (ro2ram Cost. >

  A 120" "0,000  ; >2 !?,000

  2010 12:,000

  1?"0 ":,000

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CER 1 ndependent (ro+ects ContJd

6irst1 3an7 programs according to increasing $E3:

(ro2ram  CER. >/2raduate  (ro2ram Cost. >

  ; >2 !?,000

  A 120" "0,000

  1?"0 ":,000  2010 12:,000

Ne8t1 select programs until budget is not e8ceeded:

Select programs and 5 at total cost of 9#*1***

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 CER 5 $utually E3clusi*e (ro+ects

(rocedure is as follo-s'+1 6rer alter'atives s(allest to largest e%%ective'ess (eas*re, E 

+2 alc*late 7R %or %irst alter'ative, the e%e'er

+" alc*late i'cre(e'tal cost +E B i'cre(e'tal e%%ective'ess +E7

a' i'cre(e'tal (eas*re +E< +E7 %or challe'ger

+8 &% +E< +E7 F <7e%e'er ,challe'ger beco(es e%e'er@ otherwise, no dominance is rese't a' both alter'atives are retai'e

+ &% o(i'a'ce was rese't i' ste +8, eli(i'ate e%e'er a' co(are

'e5t alter'ative to 'ew e%e'er er stes +" a' +8. &% o(i'a'ce 'ot

  rese't, c*rre't challe'ger beco(es 'ew e%e'er agai'st 'e5t challe'ger,

  b*t ol e%e'er is still viable.

+: o'ti'*e stes +" thro*gh + *'til o'ly 1 alt or 'o'-o(i'ate alts re(ai'

 +> Aly b*get li(it +or other criteria to eter(i'e which o% re(ai'i'g

'o'-o(i'ate alter'atives ca' be %*'e

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CER 5 $utually E3clusi*e (ro+ects

ro( the cost a' e%%ective'ess val*es show' below, eter(i'e which

mutually exclusive alternative sho*l be selecte.

  Cost C0 Effecti*eness E0 CER

(ro2ram  >/person   -ins/person >/-in

  A 2200 8 0

  ; 1800 2 >00

  :?:0 > !?0

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CER 5 $E (ro+ects ContJd

Order programs according to increasing effectiveness measure1 E:

  Cost C0 Effecti*eness E0 CER

(ro2ram  >/person   -ins/person >/-in

  ; 1800 2 >00  A 2200 8 0

  :?:0 > !?0

%olution'

; vs N= <7;  1800<2 >00

A vs ;= E<7 +2200 / 1800<+8 / 2 800 eli(i'ate ;

vs A= E<7 +:?:0 / 2200<+> / 8 1" 'o o(i'a'ce.

$ust use other criteria to select either A or C

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Ethical Considerations

7'gi'eers are ro*ti'ely i'volve i' two areas

 where ethics (ay be co(ro(ise=

(u)lic policy makin2 / de*elopment of strate2y

(u)lic plannin2 - de*elopment of pro+ects

En2ineers must maintain inte2rity and impartiality and

al&ays adhere to code of ethics

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;< (etho *se i' public sector roCect eval*atio'

%ummary of mportant (oints

a' *se 39, A9, or 9, b*t (*st be consistent with *'its %or ;,, a'

or (*ltile (*t*ally e5cl*sive alter'atives, co(are two at a ti(e

a' eli(i'ate alter'atives *'til only one remains

or i'ee'e't alter'atives, co(are each agai'st &N a' select  

all t"at "ave %$ ; *

CEA analysis co(bi'es cost a' nonmonetary measures

7thical co'sieratio's are especially prevalent i' *blic sector roCects