William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling: Upper Saddle River, New Jersey 07458 All Rights Reserved. by

CHAPTER 5
Copyright ©2012 by Pearson Education, Inc.

Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
All rights1reserved.
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
The objective this chapter is to demonstrate
the use of the benefit-cost ratio for the
evaluation of public projects.

All rights reserved.
CONTENT
5.1 Introduction
5.2 Project Selection
5.3 The Benefit-Cost Ratio Method
• Conventional BC Ratio with PW
• Modified BC Ratio with PW
• Conventional BC Ratio with AW
• Modified BC Ratio with AW

5.1 Introduction
Public projects are unique in many ways:

• Frequently much larger than private ventures
• They may have multiple, varied purposes that sometimes conflict
• Often very long project lives
• Capital source is ultimately tax payers
• Decisions made are often politically influenced
• Benefits are often nonmonetary and are difficult to measure more...

5.2 Project Selection

5.2.1 Public Sector Projects
• Owned, used and financed by citizens of government units.

Some examples are:
Public Public Sports

Highways
University hospitals arenas
Public
Prisons Utilities Schools
housing

Engineering Economy, Fifteenth Edition © 2008, McGraw-Hill
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling All rights reserved
5.2.2 Public Sector Project Characteristics
} Size: Usually large compared to private projects with initial investment

distributed over several years
} Life: Long-lived (often 30-50+ years); capitalized cost method is useful.
} Cash flows: No profits allowed; estimates are in form of costs paid by
government unit, benefits to the citizenry (can include revenues or
‘savings’), and disbenefits (descriptions on later slide)

5.2.2 Public Sector Project Characteristics (Cont)
} Funding: Public projects use taxes, fees, bonds (and gifts) for funding;
taxes and fees are collected from ‘users’ of project services; funding
examples are federal/state taxes of various sorts, tolls, surcharge fees.
} Interest rate: Called discount rate, it is considerably lower than for
private projects since no profit is considered and governments are
exempt from taxes; typical rates in the 3 to 6% per year range
} Alternative selection: Politics and special interest groups make
selection more complex for public projects; B/C method developed to
put more objectivity into the analysis process

5.2.3 Types of Public Project Contracts
q Traditional Construction Contract

Ø Government funding via taxes, user fees and bonds
Ø Constructed through fixed price or cost plus contract with a profit
margin specified for contractor
Ø Owned and operated by government unit
CONTRACTOR SHARES NO RISK ON FINANCING OR OPERATION

5.2.3 Types of Public Project Contracts (Cont)
q Public-Private Partnership
Ø Often called BOT (Build-Operate-Transfer) contract
Ø Contractor partially or completely responsible for financial arrangements
Ø Contractor operates and maintains system for specified time period.
Contract includes these funds
Ø Ownership transferred to government in future. This stage is often
negotiated in different ways
Ø Profit margin is specified for contractor during time of involvement
CONTRACTOR SHARES RISK ON FINANCING AND OPERATION

5.2.4 Terminology for Analyzing Public Projects
• Analysis requires estimates as accurate as possible for costs, benefits,
and disbenefits
Description Example
Costs Expenditures to the government to build, •Bridge construction cost

maintain, & operate project; salvage/sales •Annual cost of drug abusers’ treatment
value possible program
Benefits Advantages to public; income and savings •New jobs and salary money
•Reduced property taxes
•Lower transportation costs due to less gas
used
Disbenefits Expected undesirable, negative consequences •Extra maintenance costs
of project to owners – the public; usually
these are economic disadvantages estimable
in monetary units

5.2.4 Terminology for Analyzing Public Projects
} Project Benefits are favorable consequences of the project to the

public (owners).
} Project Costs represent monetary disbursements required of the

government.
} Disbenefits represent negative consequences of a project to the public

(owners).

Justify each of the following cash flows whether a benefit,
disbenefit, or cost.
i. RM1 million per year maintenance of road by local
authority.
ii. Expenditure of RM90 million for construction of a new
UTHM interchange to reduce traffic congestion.
iii. Decrease of RM500,000 per year in car accident repairs Final Examination
because of good street lighting maintenance. Semester I
Session 2013/2014
iv. RM650,000 per year loss of revenue by villagers because
of housing development project right-of-way purchases.
v. RM500,000 extra expenses of travel agency in petrol
payment due to petrol subsidy reduction.

5.3 The Benefit-Cost (B-C) Ratio Method
• The consideration of the time value of money means this is really a

ratio of discounted benefits to discounted costs.
• B-C ratio is the ratio of the equivalent worth of benefits to the
equivalent worth of costs.
• Conventional BC Ratio with PW
• Modified BC Ratio with PW
• Conventional BC Ratio with AW
• Modified BC Ratio with AW

Symbol
B = Benefit
I =Investment
MV = F= Market Value at the end of useful life
O & M = Operation & Maintenance
CR = Capital Recovery Amount = I-MV

5.2.1 B-C ratios for Present Worth (PW)
Conventional B-C ratio with PW
Modified B-C ratio with PW
• A project is acceptable when the B-C ratio is greater than or equal to one.

5.2.2 B-C ratios for Annual Worth (AW)
Conventional B-C ratio with AW
Modified B-C ratio with AW
• A project is acceptable when the B-C ratio is greater than or equal

to one.

Guideline for economic justification
If B/C ≥ 1.0 accept project
If B/C < 1.0 project not acceptable

Exercise
JAY Corporation is considering a new project to construct a new

jetty near Danga Bay for the use of gateway tourism’s ferry to and
from Singapore and Indonesia. Also included in the project is to
build custom and immigration facilities. The land acquisition is
Final Examination estimated to be RM1.2 million. Construction cost for the jetty and
Semester I other facilities is expected to be RM1.8 million with an additional
Session 2013/2014 annual maintenance cost of RM 90,000. Finally, the projected
increase in marina travelers will require an additional jetty traffic
controller with an annual cost of RM50,000. Market value of some
assets at the end of useful life is estimated RM20,000. Annual
benefits of the jetty have been estimated as in Table Q1.

Table Q1: Annual benefits of the JAY Corporation Jetty project
Rental receipts from ferry & boats RM300,000
Jetty charges to passengers RM240,000
Convenience benefit to the local community RM60,000
Additional tourism income to state of Johor RM120,000
Apply the B-C ratio method for both conventional and modified cases using PW and AW
methods with the study period of 10 years and a MARR of 15% per year to determine
whether JAY Corporation should proceed with the jetty project.
(30 marks)

Your company are invited to propose a new multipurpose transportation
terminal in southern region state as a hub for air, sea and land
transportation. Also included in the project is to build custom and
immigration facilities. The land acquisition is estimated to be RM30
million. Construction cost for the terminal and other facilities is expected
to be RM 86 million with an additional annual maintenance cost of RM 9
million. The custom and immigration facilities building and sophisticated
Final Examination equipment should also be considered with a cost of RM 27 million and
Semester I RM 6 million per year maintenance expenditures.
Session 2014/2015 i. Determine the value of Total Cost, Benefit and Disbenefit from the
above statement.
ii. Apply the B-C ratio method for both conventional and modified
cases using PW and AW methods with the study period of 20 years
and a MARR of 20% per year to determine whether the project
should be proceed.


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CHAPTER 5

Copyright ©2012 by Pearson Education, Inc.

Copyright ©2012 by Pearson Education, Inc.

Copyright ©2012 by Pearson Education, Inc.

Public projects are unique in many ways:

Copyright ©2012 by Pearson Education, Inc.

Copyright ©2012 by Pearson Education, Inc.

• Owned, used and financed by citizens of government units.

Public Public Sports

Copyright ©2012 by Pearson Education, Inc.

} Size: Usually large compared to private projects with initial investment

Copyright ©2012 by Pearson Education, Inc.

Copyright ©2012 by Pearson Education, Inc.

q Traditional Construction Contract

CONTRACTOR SHARES NO RISK ON FINANCING OR OPERATION

Copyright ©2012 by Pearson Education, Inc.

Copyright ©2012 by Pearson Education, Inc.

Costs Expenditures to the government to build, •Bridge construction cost

Copyright ©2012 by Pearson Education, Inc.

} Project Benefits are favorable consequences of the project to the

} Project Costs represent monetary disbursements required of the

} Disbenefits represent negative consequences of a project to the public

Copyright ©2012 by Pearson Education, Inc.

Copyright ©2012 by Pearson Education, Inc.

• The consideration of the time value of money means this is really a

Copyright ©2012 by Pearson Education, Inc.

Copyright ©2012 by Pearson Education, Inc.

Modified B-C ratio with PW

Copyright ©2012 by Pearson Education, Inc.

Modified B-C ratio with AW

• A project is acceptable when the B-C ratio is greater than or equal

Copyright ©2012 by Pearson Education, Inc.

If B/C ≥ 1.0 accept project

If B/C < 1.0 project not acceptable

Copyright ©2012 by Pearson Education, Inc.

JAY Corporation is considering a new project to construct a new

Copyright ©2012 by Pearson Education, Inc.

Rental receipts from ferry & boats RM300,000

Jetty charges to passengers RM240,000

Convenience benefit to the local community RM60,000

Additional tourism income to state of Johor RM120,000

Copyright ©2012 by Pearson Education, Inc.

Copyright ©2012 by Pearson Education, Inc.

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