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KIX2006: ENGINEERING ECONOMICS AND

PROJECT MANAGEMENT
Week 9: Evaluating Projects with the Benefit-Cost Ratio Method

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The objective of Chapter 10 is to demonstrate the
use of the benefit-cost ratio for the evaluation of
public projects.
Chapter 10: Evaluating Projects with the B-C Ratio Method
 10.1 Introduction
 10.2 Perspective and Terminology for Analyzing Public Projects
 10.3 Self-Liquidating Projects
 10.4 Multiple-Purpose Projects
 10.5 Difficulties in Evaluating Public-Sector Projects
 10.6 What Interest Rate Should Be Used for Public Projects?
 10.7 The Benefit-Cost Ratio Method
 10.8 Evaluating Independent Projects by B-C Ratios
 10.9 Comparison of Mutually Exclusive Projects by B-C Ratios

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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 taxpayers
 Decisions made are often politically influenced
 Benefits are often nonmonetary and are difficult to measure
 more...
These elements make engineering economy studies more
challenging.

 The Flood Control Act of 1936 requires that benefits must

exceed costs to justify federally funded projects, this is a
criterion now used in most public projects.
 There can be difficulty defining benefits, and even in
establishing costs.
 Malaysia Development Projects
 MRT
 ECRL
 Pan-Borneo Highway (Malay: Lebuhraya
Pan Borneo), a.k.a.Trans-Borneo Highway
a.k.a.Trans-Kalimantan Highway
(Indonesian: Jalan Lintas Kalimantan)
 NIMP>New Industrial Parks

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10.2 Perspective and Terminology for Analyzing Public
Projects
 For any project, the proper perspective is to consider the net
benefits to the owners of the enterprise.
 For government projects, the owners are ultimately the
taxpayers.
 Benefits are favorable consequences of the project to the
public (owners).
 Costs represent monetary disbursements required of the
government.
 Disbenefits represent negative consequences of a project to
the public (owners).
EXAMPLE 10-1 Benefits and Costs of a Convention Center and
Sports Complex
10.3 Self-liquidating projects
 Self-liquidating projects are expected to repay their costs.
 These projects generally provide utility services (power,
water, toll roads, etc.).
 They earn direct revenue that offset their costs, but they
are not expected to earn profits or pay taxes.
 In some cases, in-lieu payments are made to
governments in place of taxes and fees that would have
been paid had it been under private ownership.
10.4 Multiple- Purpose Projects
 Cost allocations in multiple-purpose, public-sector projects
tend to be arbitrary.
 Some projects naturally have multiple purposes—e.g.,
construction of a dam.
 Some of the costs incurred cannot properly be assigned to
only one purpose.
 Purposes may be in conflict.
 Often support for a public project, and its many purposes,
is politically sensitive.
10.5 Difficulties in Evaluating Public-Sector Projects
 Difficulties inherent in engineering economy studies in the
public sector.
 Profit standard not used to measure effectiveness
 Monetary effect of many benefits is difficult to quantify
 May be little or no connection between the project and the
public (owners).
 Often strong political influence whenever public funds are
used, with little consideration to long-term consequences.
 Public projects are more subject to legal restrictions than
private projects
 The ability of governmental bodies to obtain capital is
more restricted than that of private enterprise
 The appropriate interest rate for discounting benefits and
costs is often controversially and politically sensitive.
10.6 What Interest Rate Should Be Used for Public Projects?
 Selecting the interest rate to use in public projects is
challenging
 Main considerations are
 the rate on borrowed capital,
 the opportunity cost of capital to the governmental agency, and
 the opportunity cost of capital to the taxpayers.
 If money is borrowed specifically for a project, the interest
rate on the borrowed capital is appropriate to use as the
rate
More interest rate considerations…
 The 1997 Office of Management and Budget directive
states that a 7% rate should be used, as an approximation
of the return tax payers could earn from private
investments.
 Another idea is to use a market-determined risk-free rate,
about 3-4% per year.
 Bottom line: there is no simple formula, and it is an
important policy decision at the discretion of the
governmental agency.
10.7 Applying the Benefit-Cost Ratio Method

 The consideration of the time value of money means this

is really a ratio of discounted benefits to discounted costs.
 Recommendations using the B-C ratio method will result
in identical recommendations to those methods previously
presented.
 B-C ratio is the ratio of the equivalent worth of benefits to
the equivalent worth of costs.
 Two commonly use B-C Ratio are PW and AW.
B-C ratio with PW
 Conventional B-C ratio with PW:
𝑃𝑃𝑃𝑃 𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏 𝑜𝑜𝑜𝑜 𝑡𝑡𝑡𝑡𝑡 𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝 𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝
𝐵𝐵 − 𝐶𝐶 =
𝑃𝑃𝑃𝑃 𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡 𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐 𝑜𝑜𝑜𝑜 𝑡𝑡𝑡𝑡𝑡 𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝 𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝
𝑃𝑃𝑃𝑃(𝐵𝐵)
= (10 − 1)
𝐼𝐼 − 𝑃𝑃𝑃𝑃 𝑀𝑀𝑀𝑀 + 𝑃𝑃𝑃𝑃(𝑂𝑂&𝑀𝑀)
𝑤𝑤𝑤𝑤𝑤𝑤𝑤𝑤𝑤 𝑃𝑃𝑃𝑃 � = 𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝 𝑤𝑤𝑤𝑤𝑤𝑤𝑤𝑤𝑤 𝑜𝑜𝑜𝑜 � ;
𝐵𝐵 = 𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏 𝑜𝑜𝑜𝑜 𝑡𝑡𝑡𝑡𝑡 𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝 𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝;
𝐼𝐼 = 𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖 𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖 𝑖𝑖𝑖𝑖 𝑡𝑡𝑡𝑡𝑡 𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝 𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝;
A project is
𝑀𝑀𝑀𝑀 = 𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚 𝑣𝑣𝑣𝑣𝑣𝑣𝑣𝑣𝑣𝑣 𝑎𝑎𝑎𝑎 𝑡𝑡𝑡𝑡𝑡 𝑒𝑒𝑒𝑒𝑒𝑒 𝑜𝑜𝑜𝑜 𝑢𝑢𝑢𝑢𝑢𝑢𝑢𝑢𝑢𝑢𝑢𝑢 𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙; acceptable when the
𝑂𝑂&𝑀𝑀 = 𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝 𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑡𝑡 ′ 𝑠𝑠 𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜 & 𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚 𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐.
𝑩𝑩 − 𝑪𝑪 𝒓𝒓𝒓𝒓𝒓𝒓𝒓𝒓𝒓𝒓 ≥ 𝟏𝟏.
 Modified B-C ratio with PW:
𝑃𝑃𝑃𝑃 𝐵𝐵 − 𝑃𝑃𝑃𝑃 𝑂𝑂&𝑀𝑀
𝐵𝐵 − 𝐶𝐶 = 10 − 2
𝐼𝐼 − 𝑃𝑃𝑃𝑃 𝑀𝑀𝑀𝑀
B-C ratio with AW
 Conventional B-C ratio with AW:
𝐴𝐴𝐴𝐴 𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏 𝑜𝑜𝑜𝑜 𝑡𝑡𝑡𝑡𝑡 𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝 𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝
𝐵𝐵 − 𝐶𝐶 =
𝐴𝐴𝐴𝐴 𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡 𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐 𝑜𝑜𝑜𝑜 𝑡𝑡𝑡𝑡𝑡 𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝 𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝
𝐴𝐴𝐴𝐴(𝐵𝐵)
= (10 − 3)
𝐶𝐶𝐶𝐶 + 𝐴𝐴𝐴𝐴(𝑂𝑂&𝑀𝑀)
𝑤𝑤𝑤𝑤𝑤𝑤𝑤𝑤𝑤 𝐴𝐴𝐴𝐴 � = 𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 𝑤𝑤𝑤𝑤𝑤𝑤𝑤𝑤𝑤 𝑜𝑜𝑜𝑜 � ;
𝐵𝐵 = 𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏 𝑜𝑜𝑜𝑜 𝑡𝑡𝑡𝑡𝑡 𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝 𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝;
𝐶𝐶𝐶𝐶 = 𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐 𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟 𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎;
A project is
𝑂𝑂&𝑀𝑀 = 𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝 𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑡𝑡 ′ 𝑠𝑠 𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜 & 𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚 𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐. acceptable when the
𝑩𝑩 − 𝑪𝑪 𝒓𝒓𝒓𝒓𝒓𝒓𝒓𝒓𝒓𝒓 ≥ 𝟏𝟏.
 Modified B-C ratio with AW:
𝐴𝐴𝐴𝐴 𝐵𝐵 − 𝐴𝐴𝐴𝐴 𝑂𝑂&𝑀𝑀
𝐵𝐵 − 𝐶𝐶 = 10 − 4
𝐶𝐶𝐶𝐶
EXAMPLE 10-2 Equivalence of the B−C Ratio Formulations

𝑌𝑌𝑌𝑌𝑌𝑌 𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛 𝑡𝑡𝑡𝑡 𝑘𝑘𝑘𝑘𝑘𝑘𝑘𝑘:

MV

O&M

CR

Benefits

continued on next slide

EXAMPLE 10-2 (continued) Equivalence of the B−C Ratio Formulations

𝐴𝐴𝐴𝐴(𝐵𝐵)
𝐵𝐵 − 𝐶𝐶𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐 =
𝐶𝐶𝐶𝐶 + 𝐴𝐴𝐴𝐴(𝑂𝑂&𝑀𝑀)

𝐴𝐴𝐴𝐴 𝐵𝐵 − 𝐴𝐴𝐴𝐴 𝑂𝑂&𝑀𝑀

𝐵𝐵 − 𝐶𝐶𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚 =
𝐶𝐶𝐶𝐶

𝑃𝑃𝑃𝑃(𝐵𝐵)
𝐵𝐵 − 𝐶𝐶𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐 =
𝐼𝐼 − 𝑃𝑃𝑃𝑃 𝑀𝑀𝑀𝑀 + 𝑃𝑃𝑃𝑃(𝑂𝑂&𝑀𝑀)

𝑃𝑃𝑃𝑃 𝐵𝐵 − 𝑃𝑃𝑃𝑃 𝑂𝑂&𝑀𝑀

𝐵𝐵 − 𝐶𝐶𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚 =
𝐼𝐼 − 𝑃𝑃𝑃𝑃 𝑀𝑀𝑀𝑀
EXAMPLE 10-3 B−C Ratio of the Proposed Bypass

𝑌𝑌𝑌𝑌𝑌𝑌 𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛 𝑡𝑡𝑡𝑡 𝑘𝑘𝑘𝑘𝑘𝑘𝑘𝑘:

Pause and solve
Stillwater has initiated discussions on attracting rail service. A depot
would need to be constructed, which would require $500,000 in land and
$5.2 million in construction costs. Annual operating and maintenance
costs for the facility would be $150,000, and personnel costs would be
an additional $120,000. Other assorted costs would be born by the
railroad and federal authorities. Annual benefits of the rail service are
estimated as listed below.
$1,300,000 Railroad annual payments
$200,000 Rail tax charged to passengers
$180,000 Convenience benefits to local residents
$120,000 Additional tourism dollars for Stillwater
Apply the B-C ratio method, with a MARR of 8% per year and 20 year
study period, to determine if the rail service should be established.
10.7.1 Disbenefits (D) in the B-C ratio
 Disbenefits (D) can be included in the B-C ratio in either
the numerator or denominator, as shown with AW below.
𝐴𝐴𝐴𝐴 𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏 − 𝐴𝐴𝐴𝐴 𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑
𝐵𝐵 − 𝐶𝐶 =
𝐴𝐴𝐴𝐴 𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐
𝐴𝐴𝐴𝐴 𝐵𝐵 −𝐴𝐴𝐴𝐴 𝐷𝐷
= 10 − 5
𝐶𝐶𝐶𝐶+𝐴𝐴𝐴𝐴 𝑂𝑂&𝑀𝑀
or
𝐴𝐴𝐴𝐴 𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏
𝐵𝐵 − 𝐶𝐶 =
𝐴𝐴𝐴𝐴 𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐 + 𝐴𝐴𝐴𝐴 𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑
𝐴𝐴𝐴𝐴 𝐵𝐵
= 10 − 6
𝐶𝐶𝐶𝐶+𝐴𝐴𝐴𝐴 𝑂𝑂&𝑀𝑀 +𝐴𝐴𝐴𝐴 𝐷𝐷
EXAMPLE 10-4 Including Disbenefits in a B−C Analysis
10.7.2 Added benefits vs. reduced cost

 As with the different types of ratios, the question arises if

classifying certain cash flows as either added benefits or
reduced costs.
 As before, while the numerical value of the ratio may
change, there is no impact on project acceptability
regardless of how the cash flows are handled.
 10.7.2 Added benefits vs. reduced cost

Let B=the equivalent annual worth of the project benefits,

C= the equivalent annual worth of the project costs,
X= the equivalent annual worth of a cash flow
(either an added benefit or a reduced cost) not included in either B or C.

𝐵𝐵+𝑋𝑋
If X is classified as an added benefit, then 𝐵𝐵 − 𝐶𝐶 = .
𝐶𝐶
𝐵𝐵
Alternatively, if 𝑋𝑋 is classified as a reduced cost, then 𝐵𝐵 − 𝐶𝐶 = .
𝐶𝐶−𝑋𝑋
Assuming that the project is acceptable, that is, 𝐵𝐵 − 𝐶𝐶 ≥ 1.0,
𝐵𝐵+𝑋𝑋
≥ 1.0, which indicates that 𝐵𝐵 + 𝑋𝑋 ≥ 𝐶𝐶, and
𝐶𝐶
𝐵𝐵
≥ 1.0, which indicates that 𝐵𝐵 ≥ 𝐶𝐶 − 𝑋𝑋,
𝐶𝐶−𝑋𝑋
Which can be restated as 𝐵𝐵 + 𝑋𝑋 ≥ 𝐶𝐶.
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EXAMPLE 10-5 Added Benefit versus Reduced Cost in a Bridge Widening Project

You need to know:

𝐵𝐵
𝐶𝐶
𝑋𝑋

reduced cost:
𝐵𝐵
𝐵𝐵 − 𝐶𝐶 =
𝐶𝐶 − 𝑋𝑋

added benefit:
𝐵𝐵+𝑋𝑋
𝐵𝐵 − 𝐶𝐶 = 𝐶𝐶
28
Selecting projects
 If projects are independent, all projects that have a B-C
ratio ≥ to one, may be selected.
 For projects that are mutually exclusive, a B-C
ratio greater than one is required, but selecting the project
that maximizes the B-C ratio does not guarantee that the
best project is selected.
Incremental B-C analysis for mutually exclusive projects.

 Incremental analysis must be used in the case of B-C and

mutually exclusive projects.
 Rank alternatives in order of increasing total equivalent
worth of costs.
 With “do nothing” as a baseline, begin with the lowest
equivalent cost alternative and determine the incremental B-
C ratio (∆𝐵𝐵/∆𝐶𝐶), selecting the alternative with the higher
equivalent cost if the ratio is greater than one.
31
Which, if any, of the MEA projects below should be selected
using B-C analysis? Assume a 20 year study period &
MARR=10%.
A B C
Investment
Annual O&M
MV (20 yrs.)
Benefit/yr.
PW(10%)-costs
PW(10%)-benefits
B-C ratio
𝑃𝑃𝑃𝑃(𝐵𝐵)
𝐵𝐵 − 𝐶𝐶 =
𝐼𝐼 − 𝑃𝑃𝑃𝑃 𝑀𝑀𝑀𝑀 + 𝑃𝑃𝑃𝑃(𝑂𝑂&𝑀𝑀)
Incremental analysis

∆(B-A) ∆(C-B)
Investment
Annual O&M
MV (20 yrs.)
Benefits/yr.
PW(10%)-costs
PW(10%)-benefits
B-C ratio
Conclusion
EXAMPLE 10-6 Inconsistent Ranking Problem When B−C Ratios Are Inappropriately Compared
EXAMPLE 10-7 Incremental B−C Analysis of Mutually Exclusive Projects

continued on next slide

EXAMPLE 10-7 (continued) Incremental B−C Analysis of Mutually Exclusive Projects

continued on next slide

EXAMPLE 10-7 (continued) Incremental B−C Analysis of Mutually Exclusive Projects
EXAMPLE 10-8 B−C Analysis with Unequal Project Lives

continued on next slide

EXAMPLE 10-8 (continued) B−C Analysis with Unequal Project Lives
Pause and solve
Tempe is considering four mutually exclusive public-works projects.
Their costs and benefits are presented in the table below. Each project
has a useful life of 50 years and the MARR is 12% per year. Which of
the projects, if any, should be selected?
A B C D

Capital Investment $23,000,000 $18,000,000 $31,000,000 $26,000,000

Annual O&M Cost 1,800,000 1,200,000 2,100,000 2,000,000

Market Value 2,400,000 2,200,000 4,000,000 3,100,000

Annual Benefit 5,000,000 4,500,000 6,500,000 5,800,000

 Solution:
Useful life = 50 years;
MARR = 12% / year

A B C D
Capital Investment $23,000,000 $18,000,000 $31,000,000 $26,000,000
Annual O&M Cost 1,800,000 1,200,000 2,100,000 2,000,000
Market Value 2,400,000 2,200,000 4,000,000 3,100,000
Annual Benefit 5,000,000 4,500,000 6,500,000 5,800,000
PW (12%)-C
PW(12%)-B
B-C ratio
Solution :
Useful life = 50 years; MARR = 12% per year
Arrange the investment first! 𝐵𝐵 < 𝐴𝐴 < 𝐷𝐷 < 𝐶𝐶

∆𝑨𝑨 − 𝑩𝑩 ∆𝑫𝑫 − 𝑩𝑩 ∆𝑪𝑪 − 𝑩𝑩

Capital Investment $5,000,000 $8,000,000 $13,000,000
Annual O&M Cost $600,000 $800,000 $900,000
Market Value $200,000 $900,000 $1,800,000

Annual Benefit $500,000 $1,300,000 $2,000,000

PW (12%)-C

PW(12%)-B

B-C ratio

Conclusion
Problem 10-13
A nonprofit government corporation is considering two alternatives for generating power:
Alternative A. Build a coal-powered generating facility at a cost of $20,000,000. Annual
power sales are expected to be $1,000,000 per year. Annual operating and maintenance
costs are $200,000 per year. A benefit of this alternative is that it is expected to attract a
new industry, worth $500,000 per year, to the region.
Alternative B. Build a hydroelectric generating facility. The capital investment, power sales,
and operating costs are $30,000,000, $800,000, and $100,000 per year, respectively.
Annual benefits of this alternative are as follows: Alternative B benefits
Flood-control savings $600,000
Irrigation $200,000
Recreation $100,000
Ability to attract new industry $400,000
The useful life of both alternatives is 50 years. Using an interest rate of 5%, determine
which alternative (if either) should be selected according to the conventional B-C ratio
method.
43
 A B
Capital Investment 20,000,000 30,000,000
Annual Sales 1,000,000 800,000
Annual O&M 200,000 100,000
Annual Benefits 500,000 1,300,000

44
Problem 10-18
Two municipal cell tower designs are being considered by the
city of Newton. If the city expects a modified benefit-cost ratio of
1.0 or better, which design would you recommend based on the
data that follows?
Assume repeatability. The city’s cost of capital is 10% per year.
Verizon Cellgene
Initial Investment (first-cost) $75,000 $175,000
Useful life in years 6 12
Market value at end of useful life $20,000 $37,500
Annual benefits from operation $28,800 $38,800
Annual operating expenses $9,800 $11,300
45
46
Some criticisms of B-C analysis.
 B-C is often used as an “after-the-fact” justification tool.
 Distributional inequities (one group benefits, another pays
the cost) may not be accounted for.
 Qualitative information is often ignored.
 Bottom line: these are largely reflective of the inherent
difficulties in evaluating public projects rather than the B-C
method itself.
 End of Slides

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