Chapter 7 – Benefit-Cost Ratio

Engineering Economics

CHAPTER 7

BENEFIT-COST RATIO

The method of selecting that is most commonly used by government agencies for analyzing the desirability of public
projects is the benefit/cost ratio (B/C ratio). The B/C method of analysis is based on the ratio of the benefits to costs
associated with a particular project.

B/C = benefits - disbenefits

costs

Benefits are advantages, expressed in terms of birr which happen to the owner. On the other hand, when the project
under consideration involves disadvantages to the owner, these are known as disbenefits. The costs are the
anticipated expenditures for construction, operation, maintenance, etc. A B/C ratio greater than or equal to 1.0
indicates that the project under consideration is economically advantageous.

PROBLEM (6-1) A nonprofit educational research organization, is contemplating an investment of 1,500,000 Birr in
grants to develop new ways to teach people the rudiments of profession. The grants would extend over a ten-year
period and would an estimated savings of 500,000 Birr per year period and would achieve an estimated savings of
500,000 Birr per year in professor’s salaries, student tuition, and other expenses. The program would be an addition to
ongoing and planned activities, thus an estimated 100,000 Birr a year would have to be released from other program to
support the educational research. A rate of return of 15% is expected. Is this is good program?

Solution:

1. Write the given:

Benefit = 500,000 per year

Disbenefit = 100,000 per year
Cost = 1,500,000 (A/P, 15%, 10) = 298,950 Birr per year

B/C = 500,000 – 100,000 = 1.34

298,950

The project is justified, since B/C > 1.00

PROBLEM (6-2) The National Government intends to build a dam and hydroelectric project in the Gilgel Gibe at a total
cost of 455,500,000 Birr. The project will be financed by soft foreign loan with a rate of interest of 5% per year. The
annual cost for operation, maintenance, distribution facilities and others would total 15,100,000. Annual revenues and
benefits are estimated to be 56,500,000.
If the structures are expected to last for 50 years with no salvage value, determine the B/C radio of the project.

Solution:

1. By the equivalent uniform annual cost method

Annual benefit = 56,500,000
EUAC = 455,500,000 (A/P, 5%, 50) + 15,100,000
= 40,061,400

B/C = 56,500,000 = 1.41

40,061,400

1
Chapter 7 – Benefit-Cost Ratio
Engineering Economics

This is a good project, since B/C > 1.0

By the present worth cost method

PWbenefit = 56,500,000 (P/A, 5%, 50) = 1,031 x 106

PWcost = 455.5 x 106 + 15.1 x 106 (P/A, 5%, 50)

6
= 731.164 X 10

6
BC = _1,031 x 10 _ = 1.41
731.164 x 106

This is a good project, since B/C > 1.0. (Ans.)

Analysis Comparison by Benefit/Cost Analysis

In computing the benefit/cost ratio by Problem 7-1 for a given alternative the benefits and costs used in the calculation
represent the differences between the alternatives.

PROBLEM (7-3) Two routes are under consideration for a new highway. Route A would be located about five miles
from the central business district and would require longer travel distances by local commuter traffic. Route B would
pass directly through the down town area and, although its construction cost would be higher, it would reduce the
travel time and distance for local commuters. The costs for the two routes are as follows:

Route A Route B
Initial cost 200,000,000 250,000,000
Maintenance per year 700,000 1,100,000
Road-user cost per year 10,000,000 4,000,000

If the roads are assumed to last 30 years with no salvage value, which route should be accepted on the basis of a
benefit/cost analysis using an interest rate of 15%.

Solution:
1. By the B/C method
EUACA = 200,000,000 (A/P, 15%, 30) + 700,000 = 31.16 X 106
EUACB = 250,000,000 (A/P, 15%, 30) + 1,100,000 = 39.175 X 106
Incremental annual cost = EUACB - EUACA
6 6
= 39.175 x 10 – 31.16 x 10
6
= 8.015 x 10
6
B/C = incremental benefit = __6 x 10 __ = 0.7486
6
8.015 x 10
Route A should be selected for construction. (Ans.)

2
Chapter 7 – Benefit-Cost Ratio
Engineering Economics

PROBLEM (7-4) Four alternatives for providing construction supply to a small town have been identified with the
following annual benefits and costs:

Alternative Annual benefits Annual costs

A 1,528,000 780,000
B 1,398,000 664,000
C 960,000 742,000
D 810,000 420,000

Select the best alternative using the B/C ratio analysis.

Solution:

1. Comparing alternative A with alternative B.

B/C of A over B = 1,528,000 – 1,398,000 = 1.12

780,000 – 664,000

Alternative A is preferred over alternative B.

Comparing alternative A with alternative C.

B/C of A over C = 1,528,000 – 810,000 = 1.99

780,000 – 420,000

Alternative A is preferred over alternative D.

Select alternative A. (Ans)