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8/9/2019 111Ch 9 - Benefit Cost Analysis
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© 2012 by McGraw-Hill, New York, N.Y All Rights Reserve!-1
Lecture slides to accompany
Engineering Economy 7th edition
Leland Blank
Anthony Tarquin
Chapter 9
Benefit/CostAnalysis
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LEARNN! "#TC"$E%
1. Explain diference in public vs private sectorprojects
2. Calculate B/C ratio or single project
3. Select better o two alternatives using B/Cet!od
". Select best o ultiple alternatives using B/Cet!od
#. $se cost%efectiveness anal&sis to evaluateprojects
'. (escribe !ow et!ical coproises a& enterpublic
sector projects
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&ifferences' (u)lic *s (ri*ate (ro+ectsCharacteristic (u)lic (ri*ate#i$e o% &'vest(e't )arge #(all, (ei*(, large
)i%e )o'ger +"0 - 0 years #horter +2 / 2 years
A''*al No ro%it 3ro%it
*'i'g 4a5es, %ees, bo's, etc. #tocks, bo's, loa's,
etc.
&'terest rate )ower Higher
#electio' criteria M*ltile criteria 3ri(arily R6R
7'viro'(e't o% eval*atio' 3olitically i'cli'e 7co'o(ic
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Cash ,lo- Classifications in B/C Analysis
$ust identify cash flo-s as either )enefits. dis)enefits. or costs
BenefitsB011Ad*anta2es to the public
&is)enefts &011&isad*anta2es to the public
Costs C011E3penditures )y the government Note: Savings to government are subtracted from costs
Con*entional B/C ratio 4 B 5 &0/C
$odified B/C ratio 4 6B 5 &0 5 C/ nitial n*estment(rofita)ility nde3 4 NC,/ nitial n*estment
Note 8' All ter(s (*st be e5resse in same units +i.e. 39, A9, or 9
Note ' Do not *se (i'*s sig' ahea o% costs
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B/C Analysis 5 %in2le (ro+ect
Con*entional B/C ratio 4B 1 &
C
$odified B/C ratio 4 B 5 & 5 $:"C
f B/C ; 8.
accept pro+ect<
other-ise. re+ect
( 4 (= of initial in*est
(= of NC,t
&enominator is
initial in*estment
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B 4 >87?.@@@
E3ample B/C Analysis 5 %in2le (ro+ect
A flood control pro+ect -ill ha*e a first cost of >8 million -ith an annualmaintenance cost of >@.@@@ and a 8@ year life Reduced flood dama2e is
e3pected to amount to >87?.@@@ per year Lost income to farmers is estimated
to )e >?.@@@ per year At an interest rate of D per year. should the
pro+ect )e undertaken
%olution' 75ress all val*es as A a' the' %i' ;< ratio=
& 4 >?.@@@
C 4 8.@@.@@@A/(.D.8@0 F >@.@@@ 4 >[email protected]
B/C 4 87?.@@@ 5 ?.@@@0/[email protected]
4 @? I8@
Do not build project
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Alternati*e %election #sin2 ncremental B/C
Analysis 5 T-o or more Alternati*es
80 &etermine equivalent total cost for each alternati*e
(2) Order alternatives by increasing total cost G0 dentify ! D for eac" alternative. if 2i*en. or 2o to step ?
(#) $alculate %$ for eac" alternative and eliminate all &it" %$'*
(+) Determine incremental costs and benefits for first t&o alternatives(,) $alculate -%$. /f 0*1 "ig"er cost alternative becomes defender
() 3epeat steps + ! , until only one alternative remains
(rocedure similar to R"R analysis for multiple alternati*es
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Cost Effecti*eness Analysis
Service sector projects ri(arily i'volve intan2i)les, notphysical facilities@ e5a(les i'cl*e health care, sec*rity
rogra(s, creit car services, etc.
$ost4effectiveness analysis ($E5) co(bi'es (o'etary cost
esti(ates with 'o'-(o'etary be'e%its esti(ates to get
cost1effecti*eness ratio CER0
CER 4 equi*alent total costs/effecti*eness measure
4 C/E
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CER 1 ndependent (ro+ects
(rocedure is as follo-s'+1 eter(i'e total cost B e%%ective'ess (eas*re a' calc*late 7R
+2 6rer roCects= s(allest to largest 7R
+" eter(i'e c*(*lative cost o% roCects a' co(are to b*get, b
+8 *' all roCects s*ch that b is 'ot e5ceee.
ro( the 7Rs show' below, eter(i'e which independent
rogra(s sho*l be selecte i% the b*get li(it is D00,000.
(ro2ram CER. >/2raduate (ro2ram Cost. >
A 120" "0,000 ; >2 !?,000
2010 12:,000
1?"0 ":,000
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CER 1 ndependent (ro+ects ContJd
6irst1 3an7 programs according to increasing $E3:
(ro2ram CER. >/2raduate (ro2ram Cost. >
; >2 !?,000
A 120" "0,000
1?"0 ":,000 2010 12:,000
Ne8t1 select programs until budget is not e8ceeded:
Select programs and 5 at total cost of 9#*1***
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CER 5 $utually E3clusi*e (ro+ects
(rocedure is as follo-s'+1 6rer alter'atives s(allest to largest e%%ective'ess (eas*re, E
+2 alc*late 7R %or %irst alter'ative, the e%e'er
+" alc*late i'cre(e'tal cost +E B i'cre(e'tal e%%ective'ess +E7
a' i'cre(e'tal (eas*re +E< +E7 %or challe'ger
+8 &% +E< +E7 F <7e%e'er ,challe'ger beco(es e%e'er@ otherwise, no dominance is rese't a' both alter'atives are retai'e
+ &% o(i'a'ce was rese't i' ste +8, eli(i'ate e%e'er a' co(are
'e5t alter'ative to 'ew e%e'er er stes +" a' +8. &% o(i'a'ce 'ot
rese't, c*rre't challe'ger beco(es 'ew e%e'er agai'st 'e5t challe'ger,
b*t ol e%e'er is still viable.
+: o'ti'*e stes +" thro*gh + *'til o'ly 1 alt or 'o'-o(i'ate alts re(ai'
+> Aly b*get li(it +or other criteria to eter(i'e which o% re(ai'i'g
'o'-o(i'ate alter'atives ca' be %*'e
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CER 5 $utually E3clusi*e (ro+ects
ro( the cost a' e%%ective'ess val*es show' below, eter(i'e which
mutually exclusive alternative sho*l be selecte.
Cost C0 Effecti*eness E0 CER
(ro2ram >/person -ins/person >/-in
A 2200 8 0
; 1800 2 >00
:?:0 > !?0
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CER 5 $E (ro+ects ContJd
Order programs according to increasing effectiveness measure1 E:
Cost C0 Effecti*eness E0 CER
(ro2ram >/person -ins/person >/-in
; 1800 2 >00 A 2200 8 0
:?:0 > !?0
%olution'
; vs N= <7; 1800<2 >00
A vs ;= E<7 +2200 / 1800<+8 / 2 800 eli(i'ate ;
vs A= E<7 +:?:0 / 2200<+> / 8 1" 'o o(i'a'ce.
$ust use other criteria to select either A or C
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Ethical Considerations
7'gi'eers are ro*ti'ely i'volve i' two areas
where ethics (ay be co(ro(ise=
(u)lic policy makin2 / de*elopment of strate2y
(u)lic plannin2 - de*elopment of pro+ects
En2ineers must maintain inte2rity and impartiality and
al&ays adhere to code of ethics
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;< (etho *se i' public sector roCect eval*atio'
%ummary of mportant (oints
a' *se 39, A9, or 9, b*t (*st be consistent with *'its %or ;,, a'
or (*ltile (*t*ally e5cl*sive alter'atives, co(are two at a ti(e
a' eli(i'ate alter'atives *'til only one remains
or i'ee'e't alter'atives, co(are each agai'st &N a' select
all t"at "ave %$ ; *
CEA analysis co(bi'es cost a' nonmonetary measures
7thical co'sieratio's are especially prevalent i' *blic sector roCects