Evaluation of Public Alternatives

 In evaluating alternatives of private organizations, the criterion is to

select the alternative with the maximum profit. The profit
maximization is the main goal of private organizations while
providing goods/services as per specifications to their customers.
 But the same criterion cannot be used while evaluating public
alternatives. Examples of some public alternatives are constructing
bridges, roads, dams, establishing public utilities, etc.
 The main objective of any public alternative is to provide
goods/services to the public at the minimum cost. In this process, one
should see whether the benefits of the public activity are at least equal
to its costs. If yes, then the public activity can be undertaken for
implementation. Otherwise, it can be cancelled.
 This is nothing but taking a decision based on Benefit-Cost ratio (BC)
given by
 The benefits may occur at different time periods of the public activity.
For the purpose of comparison, these are to be converted into a
common time base (present worth or future worth or annual
equivalent).
 Similarly, the costs consist of initial investment and yearly operation
and maintenance cost. These are to be converted to a common time
base as done in the equivalent benefits.
 Now the ratio between the equivalent benefits and equivalent costs is
known as the “Benefit-Cost ratio”. If this ratio is at least one, the
public activity is justified; otherwise, it is not justified.
EXAMPLE
1.In a particular locality of a state, the vehicle users take a
roundabout route to reach certain places because of the presence of a
river. This results in excessive travel time and increased fuel cost. So,
the state government is planning to construct a bridge across the river.
The estimated initial investment for constructing the bridge is birr
4,000,000. The estimated life of the bridge is 15 years. The annual
operation and maintenance cost is birr 150,000. The value of fuel
savings due to the construction of the bridge is birr 600,000 in the
first year and it increases by birr 50,000 every year thereafter till the
end of the life of the bridge. Check whether the project is justified
based on BC ratio by assuming an interest rate of 12%, compounded
annually.
 2. Two mutually exclusive projects are being considered for
investment. Project A1 requires an initial outlay of birr 3,000,000
with net receipts estimated as birr 900,000 per year for the next 5
years. The initial outlay for the project A2 is birr 6,000,000, and net
receipts have been estimated at birr 1,500,000 per year for the next
seven years. There is no salvage value associated with either of the
projects. Using the benefit cost ratio, which project would you select?
Assume an interest rate of 10%.
Exercise :
1. 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
2. A project to extend irrigation canals into an area that was recently
cleared of mesquite trees (a nuisance tree in Texas) and large weeds is
projected to have a capital cost of $2,000,000. Annual maintenance
and operation costs will be $100,000 per year. Annual favorable
consequences to the general public of $820,000 per year will be offset
to some extent by annual adverse consequences of $400,000 to a
portion of the general public. If the project is assumed to have a 20-
year life, what is the B/C ratio at an interest rate of 8% per year?
 3. In a particular locality of a state, presently, the vehicle users take a
roundabout route to reach certain places because of the presence of a
river. This results in excessive time of travel and increased fuel cost.
So, the state government is planning to construct a bridge across the
river. The estimated initial investment for constructing the bridge is
birr 4,000,000. The estimated life of the bridge is 15 years. The
annual operation and maintenance cost is birr 250,000. The value of
fuel savings due to the construction of the bridge is birr 600,000 in
the first year and it increases by birr 50,000 every year thereafter till
the end of the life of the bridge. Check whether the project is justified
based on BC ratio by assuming an interest rate of 20%, compounded
annually.
4.Two mutually exclusive projects are being considered for
investment. Project A1 requires an initial outlay of birr 5,000,000
with net receipts estimated to be birr 1,100,000 per year for the next
eight years. The initial outlay for the project A2 is birr 8,000,000, and
net receipts have been estimated at birr 2,000,000 per year for the
next eight years. There is no salvage value associated with either of
the projects. Using the BC ratio, which project would you select?
Assume an interest rate of 15%.