FM-AA-CIA-15 Rev.

0 10-July-2020

Study Guide in ES 14 – ENGINEERING ECONOMICS Module No. 4

STUDY GUIDE FOR MODULE NO. 4

ECONOMIC STUDY METHODS: BENEFIT/COST ANALYSIS &

BREAK-EVEN ANALYSIS
MODULE OVERVIEW

Hello Future Engineer!

After finishing module 3, you were able to differentiate the methods for making economic studies namely
present worth analysis, annual worth analysis, & the rate of return (ROR) method. This Study Guide for
Module 4 will help you to differentiate the other methods for making economic studies namely benefit/cost
analysis & break-even analysis

MODULE LEARNING OBJECTIVES

At the end of this module 4, you should be able to:

1. differentiate the methods for making economy studies namely benefit/cost analysis & break-even analysis

4.1 ECONOMIC STUDY METHODS: BENEFIT/COST ANALYSIS

4. BENEFIT/COST ANALYSIS

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

The B/C ratio introduces objectivity into the economic analysis of public sector evaluation, thus
reducing the effects of politics and special interests. The B/C analysis can use equivalency computations
based on PW, AW, or FW values. Performed correctly, the benefit/cost method will always select the same
alternative as PW, AW, and ROR analyses.

𝐵𝐸𝑁𝐸𝐹𝐼𝑇𝑆 − 𝐷𝐼𝑆𝐵𝐸𝑁𝐸𝐹𝐼𝑇𝑆
𝐵/𝐶 =
𝐶𝑂𝑆𝑇𝑆

Benefits are advantages, expressed in terms of pesos 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.

EXAMPLES

1. A businessman invests in a medium scale business which cost him P47,000. The net annual return
estimated is P14,000 for each of the next 8 years. Compute the b/c ratio if the annual rate of interest
is 18%.
2. A project costs P100,000. The benefit at the end of each year for a period of 5 years is equal to
P40,000. Assuming money is worth 8% with no salvage value, compute the b/c ratio. Is it profitable or
not?
3. A city is considering extending the runways of its municipal airport so that commercial jets can use the
facility. The land necessary for the runway extension is currently a farmland that can be purchased for
$350,000.Construction costs for the runway extension are projected to be $600,000, and the

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Study Guide in ES 14 – ENGINEERING ECONOMICS Module No. 4

additional annual maintenance costs for the extension are estimated to be $22,500. If the runways are
extended, a small terminal will be constructed at a cost of $250,000. The annual operating and
maintenance costs for the terminal are estimated at $75,000. Finally, the projected increase in flights
will require the addition of two air traffic controllers at an annual cost of$100,000. Annual benefits of
the runway extension have been estimated as follows:

$325,000 Rental receipts from airlines leasing space at the facility

$65,000 Airport tax charged to passengers
$50,000 Convenience benefit for residents of the city
$50,000 Additional tourism dollars for the city

Apply the B–C ratio method with a study period of 20 years and at 10% per year to determine
whether the runways should be extended.

4. Refer back to Example 3. In addition to the benefits and costs, suppose that there are disbenefits
associated with the runway extension project. Specifically, the increased noise level from commercial
jet traffic will be a serious nuisance to homeowners living along the approach path to the airport. The
annual disbenefit to the citizens caused by this noise pollution is estimated to be $100,000. Given this
additional information, reapply the conventional B–C ratio, with equivalent annual worth, to determine
whether this disbenefit affects your recommendation on the desirability of this project.

For the solution of these examples, watch the video using this link:

Engineering Economics: Economic Study Methods (Benefit/Cost Analysis)

https://youtu.be/18Cmj29hUss

4.2 ECONOMIC STUDY METHODS: BREAK-EVEN ANALYSIS

Break-even analysis – is performed to determine the value of a variable or parameter of a project or

alternative that makes two elements equal, for example, the sales volume that will
equate revenues and costs. A breakeven study is performed for two alternatives to
determine when either alternative is equally acceptable.
- is a method of determining when costs exactly equal revenue.

f = fixed cost which does not vary with production.

a = an incremental cost which is the cost to produce one additional item. It may also be called the
marginal cost or differential cost.
N = break-even point or quantity produced and sold for break-even.
p = incremental revenue or selling price per unit
R = total revenue
𝑅 = 𝑝𝑁
C= total cost
𝐶 = 𝑓 + 𝑎𝑁

Assuming there is no change in inventory. The break-even point can be found from:
𝐶𝑜𝑠𝑡, 𝐶 = 𝑟𝑒𝑣𝑒𝑛𝑢𝑒, 𝑅
𝑓 + 𝑎𝑁 = 𝑝𝑁
𝑓 = 𝑝𝑁 − 𝑎𝑁
𝑓
𝑁=
𝑝−𝑎

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Study Guide in ES 14 – ENGINEERING ECONOMICS Module No. 4

EXAMPLE

1. General Electric Company which manufacture electric motor has a capacity of producing 150 motors
a month. The variable costs are P4,000 per month, the average selling price of the motor is P750.00
per motor. Fixed cost of the company amount to P78,000.00 per month which includes all taxes.
Determine the number of motors to be produced per month to break-even and the sales volume in
pesos at this point. How does the monthly production compare with the current break-even point?

2. A plywood manufacturer produces a piece of plywood at a labor cost of P0.50 and material at P3.00.
The fixed charges on business are P50,000 a month and the variable cost is P0.50 a piece. If one
plywood sells for P6.00 each, how many pieces must be produced each month for the manufacturer
to break-even?

3. A certain operation is now performed by hand, the labor cost per unit is P0.54 and the annual fixed
charge for tool used is estimated at P100 per year. A machine that is being considered for this job will
cost P2,400, have a salvage value of P100 at any time and a fixed annual cost of P200.00. With it,
labor cost is P0.22 per unit. For what number of units of product per year at zero interest and life of
six years for the machine will the annual cost of the two methods break-even?

4. A small aerospace company is evaluating two alternatives: the purchase of an automatic feed
machine and a manual feed machine for a finishing process. The auto feed machine has an initial
cost of $23,000, an estimated salvage value of $4000, and a predicted life of 10 years. One person
will operate the machine at a rate of $12 per hour. The expected output is 8 tons per hour. Annual
maintenance and operating cost is expected to be $3500.

The alternative manual feed machine has a first cost of $8000, no expected salvage value, a5-year
life, and an output of 6 tons per hour. However, three workers will be required at $8 per hour each.
The machine will have an annual maintenance and operation cost of $1500. All projects are expected
to generate a return of 10% per year. How many tons per year must be finished to justify the higher
purchase cost of the auto feed machine?

For the solution of these examples, watch the video using this link:

Engineering Economics: Break-Even Analysis

https://youtu.be/vLDQG85ySuw

LEARNING ACTIVITY 4-1

As you go through this module and after you watched the videos provided, solve the following:

1. The national government intends to build a dam and hydroelectric project in the Cagayan Valley at a total
cost of P455,500,000. 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
P15,100,000. Annual revenues and benefits are estimated to be P56,500,000.

If the structures are expected to last for 50 years with no salvage value. Determine the b/c ratio of the
project. Should the national government continue with the project?

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Study Guide in ES 14 – ENGINEERING ECONOMICS Module No. 4

2. A firm has the capacity to produce 1,000,000 units of a product per year. At present, it is able to produce
and sell 600,000 units yearly at a total income of P720,000.00. Annual fixed costs are P250,000 and the
variable costs per unit is P0.70.
a. Give the firm's annual profit or loss for this production.
b. Give the number of units that should be sold annually to break even

(Your answer in this learning activity will be compiled in your Assignment 4 to be submitted on an announced
date)

REFERENCE/S

Sta. Maria, Hipolito B.

Engineering economy
c2000 Published by National Book Store, Mandaluyong City

Besavilla, Venancio I. Jr.

Engineering Mathematics Vol. 2
c1998, Philippines

INSTRUCTIONS

Format of Assignment:
I. Cover Page (no borderline):
a. Pangasinan State University
b. Urdaneta Campus
c. College of Engineering and Architecture
d. Civil Engineering Department
e. __ Sem AY 20__ - 20__
f. Subject Code and Subject Title
g. Assignment Number
h. Title of Topics
i. Submitted by:
j. Submitted to:
II. Body (with borderline):
Handwritten problems and solutions

Take a picture of your Assignment with your ID. Using CamScanner, DOC Scanner, or any pdf converting
app, Assignments should be submitted as soft copy in pdf format. Soft copy should be turned-in in MS Teams
(or private message on MS Teams or messenger if technical difficulties arise in turning in). Files should be
named as COURSE CODE_SECTION_SURNAME, GIVEN NAME_ASSIGNMENT NUMBER

Prepared By:

DIANNE C. OLIVER, CE
Faculty, Civil Engineering Department

PANGASINAN STATE UNIVERSITY 4