Chapter - 5 - Benefit Cost Ratio Method Lecture Slide

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

Refer Chapter 10 (Sullivan’s Book)
 The objective this chapter is to
demonstrate the use of the
benefit-cost ratio for the
evaluation of public projects.
Copyright ©2012 by Pearson Education, Inc.

Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
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
Engineering Economy, Fifteenth Edition © 2008, McGraw-Hill Copyright ©2012 by Pearson Education, Inc.
All rights reserved Upper Saddle River, New Jersey 07458 7-
All 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)
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Slide by Pearson
to accompany BlankEducation,
and Inc.
Upper Saddle River, New
© 2008, McGraw-Hill Tarquin Basics of Engineering Jersey 074587-
All rights reserved Economy, 2008 All rights reserved.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
Copyright ©2012
Slide by Pearson
and Inc.
Analysis requires estimates as accurate as possible
for costs, benefits, and disbenefits
Description Example
Costs: expenditures to the • Bridge construction cost
government to build, • Annual cost of drug abusers’
maintain, & operate treatment program
project; salvage/sales
value possible
Benefits: advantages to
• New jobs and salary money
public; income and
• Reduced property taxes
savings
• Lower transportation costs
due to less gas used
Copyright ©2012
Slide by Pearson
and Inc.
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
Copyright ©2012
Slide by Pearson
and Inc.
All rights reserved Economy, 2008 All rights reserved.
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
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and Inc.
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
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and Inc.
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
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and Inc.
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
Copyright ©2012
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and Inc.
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

Q1a Justify each of the following cash flows whether a benefit, disbenefit, or
cost.
i. RM1 million per year maintenance of road by local authority. (2 marks)

ii. Expenditure of RM90 million for construction of a new UTHM interchange
to reduce traffic congestion. (2 marks)
iii. Decrease of RM500,000 per year in car accident repairs because of good
street lighting maintenance. (2 marks)
iv. RM650,000 per year loss of revenue by villagers because of housing
development project right-of-way purchases. (2 marks)
v. RM500,000 extra expenses of travel agency in petrol payment due to
petrol subsidy reduction. (2 marks)

Q1 b. JAY Corporation is considering a new project to construct
a new jetty near Danga Bay for the use of gateway tourism’s
ferry to and from Singapore and Indonesia. Also included in the
project is to build custom and immigration facilities. The land
acquisition is estimated to be RM1.2 million. Construction cost
for the jetty and other facilities is expected to be RM1.8 million
with an additional annual maintenance cost of RM 90,000.
Finally, the projected increase in marina travelers will require an
additional jetty traffic controller with an annual cost of
RM50,000. Market value of some assets at the end of useful life
is estimated RM20,000. Annual benefits of the jetty have been
estimated as in Table Q1.

Table Q1: Annual benefits of the JAY Corporation Jetty project
Rental receipts from ferry & boats RM300,000
Jetty charges to passengers RM240,000
Convenience benefit to the local RM60,000
community
Additional tourism income to state RM120,000
of Johor
Apply the B-C ratio method for both conventional and modified cases
using PW and AW methods with the study period of 10 years and a
MARR of 15% per year to determine whether JAY Corporation should
proceed with the jetty project.
(30 marks)

Q4. Your company are invited to propose a new multipurpose
transportation terminal in southern region state as a hub for
air, sea and land transportation. Also included in the project is
to build custom and immigration facilities. The land acquisition
is estimated to be RM30 million. Construction cost for the
terminal and other facilities is expected to be RM 86 million
with an additional annual maintenance cost of RM 9 million. The
custom and immigration facilities building and sophisticated
equipment should also be considered with a cost of RM 27
million and RM 6 million per year maintenance expenditures.

(a) Determine the value of Total Cost, Benefit and Disbenefit
from the above statement. (9 marks)
(b) Apply the B-C ratio method for both conventional and
modified cases using PW and AW methods with the study
period of 20 years and a MARR of 20% per year to
determine whether the project should be proceed.
(16 marks)


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Chapter 5 : Evaluating Projects with the Benefit-

Cost Ratio Method

Copyright ©2012 by Pearson Education, Inc.

Copyright ©2012 by Pearson Education, Inc.

Copyright ©2012 by Pearson Education, Inc.

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

 Cash flows: No profits allowed; estimates are in

 Interest rate: Called discount rate, it is

 Alternative selection: Politics and special interest

 Choose one and maintain it throughout estimation

 Government funding via taxes, user fees and bonds

CONTRACTOR SHARES NO RISK ON FINANCING OR

CONTRACTOR SHARES RISK ON FINANCING AND

Copyright ©2012 by Pearson Education, Inc.

Copyright ©2012 by Pearson Education, Inc.

Copyright ©2012 by Pearson Education, Inc.

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

A project is acceptable when the B-C ratio is

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

Copyright ©2012 by Pearson Education, Inc.

If B/C ≥ 1.0 accept project

Copyright ©2012 by Pearson Education, Inc.

i. RM1 million per year maintenance of road by local authority. (2 marks)

Copyright ©2012 by Pearson Education, Inc.

Copyright ©2012 by Pearson Education, Inc.

Copyright ©2012 by Pearson Education, Inc.

Copyright ©2012 by Pearson Education, Inc.

Copyright ©2012 by Pearson Education, Inc.

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