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20 Syaaban 1438

ndiana@edu.utm.my
 CONTENTS
6.1 Project Selection

6.2 Benefit and Cost Ration

PROJECT EVALUATION
Benefit and Cost Analysis of a Single
6.3METHOD
Public Project

Dr Nordiana
Benefit andAzlin bintiAnalysis
Cost Ratio Othman of
6.4
Interest and Additional Cost
With Wisdom We Explore ndiana@edu.utm.my
 Aims - TLOs

Able to
demonstrate the
use of the benefit-
cost ratio for the
evaluation of
public projects.

1 Project Evaluation Method

 6.1 Project Selection

2 Project Evaluation Method

 Introduction
In previous chapters
we have examples involved the private sector; where products, systems,
and services are developed and offered by corporations and businesses
for use by individual customers and clients, the government, or other
companies.

In this chapters
we will explore projects that public sector projects
concentrate on government units
and the citizens they serve.

3 Project Evaluation Method

 Project Selection

Public Sector Projects

Areas that are publically owned

Public sector project is and require economic evaluation
a product, service, or system used, includes:
financed, and owned by the public health,
citizens of any government level. criminal justice,
Primary purpose safety,
To provide service to the citizenry transportation,
for the public good at no profit. welfare,
and utilities

4 Project Evaluation Method

 Project Selection

transportation
highways, bridges,
waterways
Hospitals
and clinics Parks and
public health recreation
welfare
Examples of
public sector
Police and fire
protection Courts and
safety prisons
water, electricity, gas, criminal justice
sewer, sanitation
Utilities

5 Project Evaluation Method

 Project Selection

Differences
Characteristic Public Sector Private Sector

Size of Some large; more medium to

Large
investment small
Life estimates Longer (3050+years) Shorter (225 years)
Annual cash No profit; costs, benefits, and Revenues contribute to profits;
flow estimates disbenefits are estimated costs are estimated
Taxes, fees, bonds, private Stocks, bonds, loans, individual
Funding
funds owners
Interest rate Lower Higher, based on cost of capital
Environment of
Politically inclined Primarily economic
the evaluation

6 Project Evaluation Method

 Important terms

Costs estimated expenditures to the government entity for construction,

operation, and maintenance of the project, less any expected salvage value.

Benefits advantages to be experienced by the owners, the public.

Disbenefits expected undesirable or negative consequences to the owners

if the alternative is implemented. Disbenefits may be indirect economic
disadvantages of the alternative.

7 Project Evaluation Method

 Example 1
Identify the following cash flows as a benefit, disbenefit, or cost.
(a) Loss of income to local businesses because of a new freeway
(b) Less travel time because of a loop bypass
(c) $400,000 annual income to local businesses because of tourism created
by a national park
(d) Cost of fish from a hatchery to stock a lake at the state park
(e) Less tire wear because of smoother road surfaces
(f) Decrease in property values due to the closure of a government research
lab
(g) School overcrowding because of a military base expansion
(h) Revenue to local motels because of an extended weekend holiday

7 Project Evaluation Method

 6.2 Benefit and Cost Ration

8 Project Evaluation Method

 Benefit and Cost Ration
relied upon as a fundamental analysis method for public sector projects.
was developed to introduce greater objectivity into public sector
economics
response to the U.S. Congress approving the Flood Control Act of 1936.
There are several variations of the B/C ratio; however, the fundamental
approach is the same.
All cost and benefit estimates must be converted to a common equivalent
monetary unit (PW, AW, or FW) at the discount rate (interest rate).
The B/C ratio is then calculated using one of these relations:

= = =

9 Project Evaluation Method

 Benefit and Cost Ration

The decision guideline is simple:

If B/C 1.0, accept the project as economically justified for the estimates
and discount rate applied.
If B/C < 1.0, the project is not economically acceptable.
If the B/C value is exactly or very near 1.0, noneconomic factors will help
make the decision

10 Project Evaluation Method

 Benefit and Cost Ration

Types of B/C

Conventional Modified

&
Modified C =
C =



C=

11 Project Evaluation Method

 Benefit and Cost Ration

Example 2

The cost of grading and spreading gravel on a short rural road is expected to
be $300,000. The road will have to be maintained at a cost of $25,000 per
year. Even though the new road is not very smooth, it allows access to an
area that previously could only be reached with off-road vehicles. The
improved accessibility has led to a 150% increase in the property values
along the road. If the previous market value of a property was $900,000,
calculate the B/C ratio using an interest rate of 6% per year and a 20-year
study period.

12 Project Evaluation Method

 Benefit and Cost Ration

Example 3
Calculate the B/C ratio for the following cash flow estimates at a discount
rate of 7% per year.

Item Cash flow

FW of benefits, $ 30,8000,000
AW of disbenefits, $ per year 105,000
First cost, $ 1,200,000
M&O costs, $ per year 400,000
Life of project, years 20

13 Project Evaluation Method

 Benefit and Cost Ration

Example 4
A privately funded wind-based electric power generation company in the
southern part of the country has developed the following estimates for a
new turbine farm. The MARR is 10% per year, and the project life is 25
years. Calculate the modified B/C ratio.

Benefits : $20,000 in year 0 and $30,000 in year 5

Savings : $2000 in years 120
Cost : $50,000 in year 0
Disbenefits : $3000 in years 110

14 Project Evaluation Method

 6.3 Benefit and Cost Analysis

Benefit and Cost Ratio Analysis of

6.4
Interest and Additional Cost

14 Project Evaluation Method

 Benefit and Cost Analysis

B I
benefits of initial capital
the project investment

Benefit Costs To be applied in AW

and PW.
CR O&M operating
capital and
recovery maintenance
Disbenefit costs.

15 Project Evaluation Method

 B/C for PW

Conventional B/C with PW Modified B/C with PW

If the market residual value is also included, then

**MV market value

16 Project Evaluation Method

 B/C for AW

Conventional B/C with AW Modified B/C with AW

If considered the disbenefits (D), then

17 Project Evaluation Method

 B/C for AW

Example 5
Extension of runways data is presented below. Consider the interest rate
as 10% and the period as 20 yrs. Apply the B/C ratio method for both
conventional and modified cases using AW methods.
Costs: Benefits:
Farmland reclamation: $350,000 Rental from airlines: $325,000
Construction: $600,000 Airport taxes: $65,000
Terminal building: $250,000 Convenience: $50,000
Annual maintenance: $97,500 Tourism: $50,000
Air-traffic controllers: $100,000

18 Project Evaluation Method

 B/C for AW

Example 6

Determine the new B/C ratio for both conventional and modified cases
using AW methods if the residents figure out that the noise pollution is
equivalent to $100,000 per yr.

19 Project Evaluation Method

 B/C for 2 alternatives
Follow these steps to correctly perform a conventional B/C ratio analysis of
two alternatives.Equivalent values can be expressed in PW, AW, or FW terms.
1. Determine the equivalent total costs for both alternatives.
2. Order the alternatives by equivalent total cost: first smaller, then larger.
Calculate the incremental cost (C) for the larger-cost alternative. This is the
denominator in B/C.
3. Calculate the equivalent total benefits and any disbenefits estimated for both
alternatives. Calculate the incremental benefits (B) for the larger-cost
alternative. This is (B -D) if disbenefits are considered.
4. Calculate the B/C ratio using Equation (B - D)/C.
5. Use selection guideline : select the higher-cost alternative if B/C 1.0.

20 Project Evaluation Method

22 Project Evaluation Method