Chapter - 5 - Benefit Cost Ratio Method Lecture Slide

Chapter 5 : Evaluating Projects with the
Benefit-Cost Ratio Method

Refer Chapter 10 (Sullivans Book)
The
objective this chapter is to

demonstrate the use of the
benefit-cost ratio for the
evaluation of public projects.
Engineering Economy, Fifteenth Edition

By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
Copyright 2012 by Pearson Education, Inc.

Upper Saddle River, New Jersey 07458
All rights reserved.
PROJECT EVALUATION METHOD

1.Introduction
2.Project Selection
3.The Benefit-Cost Ratio Method
i. Conventional BC Ratio with PW
ii.Modified BC Ratio with PW
iii. Conventional BC Ratio with AW
iv. Modified BC Ratio with AW


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...



Owned, used and financed by citizens of government

units. Some examples are:
Highways
Universities
Hospitals
Sports arenas
Prisons
Public housing
Emergency relief
Utilities
Public projects provide service to citizenry at no profit
Partnerships of public entities and private
enterprise
are more prevalent now as
funding for large public
projects becomes more difficult

2008, McGraw-Hill
All rights reserved

7All rights reserved.
6
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 with A = Pi estimating annual costs
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)


2008, McGraw-Hill
Slide to accompany Blank and
All rights reserved Tarquin Basics of Engineering
7
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

2008, McGraw-Hill
8
Analysis requires estimates as accurate as possible for

costs, benefits, and disbenefits
Description
Costs: expenditures to the
government to build,
maintain, & operate project;
salvage/sales value possible
Benefits: advantages to
public; income and savings

Example
Bridge construction cost
Annual cost of drug abusers
treatment program
New jobs and salary money

Reduced property taxes
Lower transportation costs
due to less gas used
2008, McGraw-Hill
9
Disbenefits: expected undesirable, negative consequences of

project to owners the public; usually these are economic
disadvantages estimable in monetary units
Disbenefits are not always included in the analysis; subject to
political and special interest argumentation


2008, McGraw-Hill
10
Determine viewpoint (perspective) before costs,

benefits, and disbenefits are estimated
Choose one and maintain it throughout

estimation and analysis. Sample viewpoints
Citizen
Tax base
Creation/retention of jobs
Economic development
Specific industry


2008, McGraw-Hill
11
Traditional Construction Contract

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


2008, McGraw-Hill
12
Public-Private Partnership
Often called BOT (Build-Operate-Transfer) contract
Contractor partially or completely responsible for financial
arrangements
Contractor operates and maintains system for
specified time
period. Contract includes these funds
Ownership transferred to government in future. This
stage
is often negotiated in different ways
Profit margin is specified for contractor during time of
involvement


2008, McGraw-Hill
13
Public-Private Partnership
CONTRACTOR SHARES RISK ON FINANCING AND OPERATION
Examples:
Design, finance construct operate nuclear power plant for
15 years
Recondition and operate state hospital for mental health
patients
Organize and operate a municipal security (police) force for
a 20-year period; contract renewable each 5 years


2008, McGraw-Hill
14
For government projects, the owners are

ultimately the taxpayers.
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).




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


B = Benefit
I =Investment = CR (kos tambahan modal)
MV = F= Market Value at the end of useful life
(nilai sisa)
O & M = Operation & Maintenance
CR = Capital Recovery Amount
(kos pemulihan modal, allowance,
salvage value)


Conventional B-C ratio with PW ..darab

dengan (P/A, i, n) kecuali I
Modified B-C ratio with PW ..darab dengan

(P/A, i, n) kecuali I
A project is acceptable when the B-C ratio

is greater than or equal to one.

Conventional B-C ratio with AW ..hanya

I=CR shj perlu darab dgn (A/P, i, n)
Modified B-C ratio with AW .. hanya I=CR shj

perlu darab dgn (A/P, i, n)


Guideline for economic

justification
If B/C 1.0
accept project
If B/C < 1.0 project not acceptable






Kerajaan negeri Johor telah bercadang untuk melebarkan dan

menambah lagi landasan di lapangan terbang Senai bagi
membolehkan lebih banyak kapal terbang menggunakan
kemudahan di lapangan terbang tersebut. Pembesaran landasan
memerlukan tanah baru bernilai RM450 000. Kos pembinaan
untuk landasan tersebut dijangka bernilai RM750 000 dan kos
senggaraan tahunan ialah RM 30 000 setahun. Bagi menyokong
operasi, sebuah terminal kecil perlu dibina dengan kos
permulaan RM80 000. Dua orang pengawal trafik udara
diperlukan dengan kos tahunan ialah RM100 000 setahun bagi
mengawal trafik yang semakin bertambah. Faedah tahunan yang
diperoleh akibat pembesaran landasan ini disenaraikan dalam
jadual berikut:


Maklumat
Nilai setahun
(RM)
Sewa ruang kpd syarikat penerbangan
325 000
Cukai lapangan terbang yg dikenakan kpd penumpang
65 000
Faedah yg dinikmati penduduk sekitar
50 000
Peningkatan pendapatan penduduk selaras dgn bertambahnya

kedatangan pelancong
50 000
JUMLAH FAEDAH 490 000
Dengan andaian landasan terbang dpt bertahan selama 30thn

dan kadar faedah 10% setahun, buat penilaian cadangan
tersebut dgn menggunakan kaedah nisbah B/C konvensional
dan nisbah B/C terubahsuai pada nilai kesetaraan PW dan AW.


UTM bercadang untuk melabur sebanyak RM1.5 Juta untuk

menampung satu penyelidikan tentang kaedah baru pengajaran.
Projek yg mempunyai jangkahayat 15 tahun tersebut dapat
menjimatkan kos gaji, yuran pelajar dan lain-lain bayaran
universiti bernilai RM500 000. Universiti menggunakan kadar
pulangan 6% setahun terhadap pelaburan yang dijalankan.
Projek tersebut memerlukan kos operasi sebanyak RM50 000
setahun. Oleh kerana aktiviti kajian dilakukan dlm masa yg sama
dgn penyelidikan yg lain, sebanyak RM200 000 telah
dikurangkan drp aktiviti kajian penyelidikan yg lain. Guna
analisis faedah-kos berikut utk menilai kewajaran program
pembiayaan ini dlm masa 15 tahun:
(a)Nisbah B/C konvensional
(b)Nisbah B/C Terubahsuai
(c)Nilai bersih faedah kos (B-C)




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Chapter 5 : Evaluating Projects with the

Benefit-Cost Ratio Method

objective this chapter is to

Engineering Economy, Fifteenth Edition

Copyright 2012 by Pearson Education, Inc.

PROJECT EVALUATION METHOD

Engineering Economy, Fifteenth Edition

Copyright 2012 by Pearson Education, Inc.

Frequently much larger than private ventures

Copyright 2012 by Pearson Education, Inc.

Engineering Economy, Fifteenth Edition

Copyright 2012 by Pearson Education, Inc.

Owned, used and financed by citizens of government

Engineering Economy, Fifteenth Edition

Copyright 2012 by Pearson Education, Inc.

Size: Usually large compared to private projects with

Life: Long-lived (often 30-50+ years); capitalized cost

Cash flows: No profits allowed; estimates are in form

Engineering Economy, Fifteenth Edition

Copyright 2012 by Pearson Education, Inc.

Funding: Public projects use taxes, fees, bonds (and

Interest rate: Called discount rate, it is

Alternative selection: Politics and special interest

Copyright 2012 by Pearson Education, Inc.

Analysis requires estimates as accurate as possible for

Engineering Economy, Fifteenth Edition

New jobs and salary money

Disbenefits: expected undesirable, negative consequences of

Engineering Economy, Fifteenth Edition

Copyright 2012 by Pearson Education, Inc.

Determine viewpoint (perspective) before costs,

Choose one and maintain it throughout

Engineering Economy, Fifteenth Edition

Copyright 2012 by Pearson Education, Inc.

Traditional Construction Contract

Engineering Economy, Fifteenth Edition

Copyright 2012 by Pearson Education, Inc.

Engineering Economy, Fifteenth Edition

Copyright 2012 by Pearson Education, Inc.

CONTRACTOR SHARES RISK ON FINANCING AND OPERATION

Engineering Economy, Fifteenth Edition

Copyright 2012 by Pearson Education, Inc.

For government projects, the owners are

Engineering Economy, Fifteenth Edition

Copyright 2012 by Pearson Education, Inc.

Engineering Economy, Fifteenth Edition

Copyright 2012 by Pearson Education, Inc.

The consideration of the time value of money

. Conventional BC Ratio with PW

Engineering Economy, Fifteenth Edition

Copyright 2012 by Pearson Education, Inc.

Engineering Economy, Fifteenth Edition

Copyright 2012 by Pearson Education, Inc.

Conventional B-C ratio with PW ..darab

Modified B-C ratio with PW ..darab dengan

A project is acceptable when the B-C ratio

Copyright 2012 by Pearson Education, Inc.

Conventional B-C ratio with AW ..hanya

Modified B-C ratio with AW .. hanya I=CR shj

Engineering Economy, Fifteenth Edition

Copyright 2012 by Pearson Education, Inc.

Guideline for economic

Engineering Economy, Fifteenth Edition