7.

2 BENEFIT/COST ANALYSIS OF A
SINGLE PROJECT
The benefit/cost ratio, a basic analysis tool for public-sector
initiatives, was created to provide objectivity to the field of public-
sector economics. It was created in response to the United States. The
1936 Flood Control Act was enacted. The B/C ratio comes in a variety of
forms, but the essential concept remains the same. At the discount
rate, all cost and benefit estimations must be converted to a common
equivalent monetary unit (PW, AW, or FW) (interest rate). The B/C ratio
is then calculated using one of these relations:

PW = PRESENT WORK
AW = ANNUAL WORK
FW = FUTURE WORK
 The B/C value would change considerably were disbenefits
added to costs. For example, if the numbers 10, 8, and 5 are used to
represent the PW of benefits, dis- benefits, and costs, respectively,
Equation [7.2] results in B/C (10 - 8)/5 = 0.40. The incorrect placement
of disbenefits in the denominator results in B/C 10/ (8 + 5) = 0.77,
which is approximately twice the correct B/C value.

CORRECT INCORRECT
B 10−8 B 10
= =0.40 = =0.77
C 5 C (8+5)

Benefits = 10, Disbenefits = 8, Cost = 5

Clearly, then, the method by which disbenefits are handled
affects the magnitude of the B/C ratio. However, no matter whether
disbenefits are (correctly) subtracted from the numerator or
(incorrectly) added to costs in the denominator, a B/C ratio of less than
1.0 by the first method will always yield a B/C ratio less than 1.0 by the
second method, and vice versa.

The modified B/C ratio places benefits (including income and

savings), dis- benefits, and maintenance and operation (M&O) costs in
the numerator. The denominator includes only the equivalent PW, AW,
or FW of the initial investment.

Salvage value is included in the denominator with a negative

sign. The modified B/C ratio will obviously yield a different value than
the conventional B/C method. However, as discussed above with
disbenefits, the modified procedure can change the magnitude of the
ratio but not the decision to accept or reject the project. The benefit
and cost difference measure of worth, which does not involve a ratio, is
based on the difference between the PW, AW, or FW of benefits
(including income and savings) and costs, that is, B - C. If (B - C) ≥ 0, the
project is acceptable. This method has the advantage of eliminating the
discrepancies noted above when disbenefits are regarded as costs,
because B represents net benefits.
Thus, for the numbers 10, 8, and 5 the same result is
obtained regardless of how disbenefits are treated.

BASE FROM THIS EXAMPLE THE PROJECT IS NOT ACCEPTABLE

-3 ≥ 0

SOLUTION
Benefit = $1,500,000 per year
Disbenefit = $200,000 per year
Cost = $15,000,000 (A/P,6%,10) = $2,038,019 per year
M and Q cost = $500,000 per year

B 1,500,000−200,000 1,300,000
= = =0.51
C 2,038,019+500,000 2,538,019

B 1,500,000−200,000−500,000
= =0.39
C 2,038,01 9

B−C=( 1,500,000−200,000 )−( 2,038,019−500,000 )=$−2.4 million

EXAMPLE 2

SOLUTION:
BENEFIT = $175,000
DISBENEFIT = $25,000
COST = $1,400,000 (A/P,6%,10) = $190,215
M and Q cost = $40,000
B 175,000−25,000 150,000
= = =0.65
C 190,215+ 40,000 230,215

0.65 ≤ 1.0 DO NOT BUILD THE PROJECT

THIS IS THE FORMULA TO GET THE A/P, P/A, F/A