Engineering Economy

Benefit/Cost Ratio

The method of selecting of alternatives that is most commonly used by

government agencies for analyzing the desirability of public projects is the
benefit/cost ratio (B/C ratio). The B/C method of analysis is based n the ratio of
the benefits to cost associated with a particular project.

BENEFITS−DISBENEFITS
B/C =
COST

Benefits are advantages, expressed in terms of pesos which happen to

the owner. On the other hand, when the project under consideration involves
disadvantage to the owner, these are known as disbenefits. The costs are
anticipated expenditure for construction, operation, maintenance, etc. AB/C ratio
greater than or equal to 1.0 indicates that the project under consideration is
economically advantageous.
Public projects are those authorized financed, and operated by federal,
state or local government agencies. The benefit-cost ratio method is used for the
evaluating of such projects. It is also known as the Savings-investment Ratio
(SIR). It involves the calculation of a ratio of benefits to costs. A project is
acceptable when the B-C ratio, is greater than or equal to 1.0.

Definition of Terms:

Project Benefits (B) are defined as the favorable consequence to the

public.

Project Cost (C) represents the monetary disbursement required of the

government.

Project Disbenefits (D) represents the negative consequences of the

project to the public.

Whether evaluating a project in the private sector or in the public sector time
value of money must be considered to account for the timing of cash flows
occurring after the inception of the project.
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Benefit-Cost ratio with present worth

PW (benefits of the proposed project)

B/C =
PW (total cost of the proposed project)

PW (B)
B-C =
I −PW ( SV ) + PW (O∧M )

Where: PW (.) = present worth of (.)

B = benefits of the proposed project
I =initial investment in the proposed project
SV = salvage value
O&M = operating and maintenance cost of the proposed project

Benefit-Cost ratio with Annual Worth

AW (benefits of the proposed project)

B-C =
AW (total cost of the proposed project )

AW (B)
B-C =
CR+ AW (O∧M )

Where: AW (.) = annual worth of (.)

B = benefits of the proposed project
CR = capital recovery amount
= I(A/P, i%, n) - SV (A/F, i%, n)
O&M = operating and maintenance costs of the proposed project

Comparing Alternatives by B/C Ratio Method

When comparing mutually exclusive alternatives with the B-C ratio method
the following steps should be considered.
1. The alternatives are ranked first cost (PW, AW, or FW). The do-nothing
alternative is selected as a base alternative.
2. The B-C ratio is then calculated for the alternative having the lowest
equivalent cost. It is the greater than or equal to 1.0, then it will be the
new alternative; otherwise, do nothing remains as the base alternative.

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 3. The next least equivalent cost alternative is then selected and
determined the increment B–C ratio (∆ B/ ∆C ¿ between this alternative
and baseline.
4. If (∆ B/ ∆C ¿ ≥ 1.0, the nest higher equivalent becomes the new
baseline; otherwise the last baseline alternative is maintained.
5. The increment B-C ratios are determined for each successively higher
equivalent cost alternative until the last alternative has been compared.

Example

A nonprofit educational research organization, is contemplating an

investment of P1,500,000 in grants to develop new ways to teach people the
rudiments of profession. The grants would extend over a ten-year period and
would achieve an estimated savings of P500,000 per year in professors salaries,
student tuition, and other expenses. The program would be an addition to
ongoing and planned activities, thus an estimated P100,000 a year would have to
be released from other program to support the education research a rate of
return of 15% is expected is this a good program?

SOLUTION
BENEFIT = P500,000 per year
DISBENEFIT P100,000 per
COST = P1,500,000 (A/P, 5%,10) = P298,950 per year
P 500,000−P100,000
B/C = = 1.34
P 298,950
The project I justified, since B/C > 1.00.

Example

The national government intends to build a dam and hydroelectric project

in the Cagayan valley t a total cost of 455,500,000. The project will be financed
by soft foreign loan with a rate of interest of 5% per year. The annual cost for
operation, maintenance, distribution facilities and others would total P15,100,000.
Annual revenues and benefits are estimated to be P56,500,000. If the structures
are expected to last for 50 years with no salvage value, determine the B/C ratio
of the project.

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SOLUTION
By the equivalent uniform annual cost method
Annual benefit = P56,500,000
= P455,500,000(A/P,5%50)+P15,100,000
= P40,061,400
P56,500,000
B/C = = 1.410
P 40,061,400
This is a good project, since B/C > 1.0.
By the present worth cost method
PWBENEFIT = P56,500,000 (P/A,%,50) = P1,031 x 106
PWCOST = P455. X 106 + P15.1 x 106 (P/A,5%,50)
= P731.164 x106
6
P1,031 x 10
B/C = 6 = 1.41
P 731.164 x 10
This is a good project, since B/C >1.0
Alternative comparison by Benefit/cost analysis
In computing the benefit cost ratio by eq(11-1) for a given alternative the
benefits and cost used in the calculation represent the differences between the
alternatives.

Example

The routes are under consideration for a new highway route A would be
located about five miles from central business district and would require longer
travel distances by local commuter traffic. Route B would pass directly through
the downtown area and although its construction would be higher. It would
reduce the travel time and distance for local commuters.
The costs for two routes are as follows.
ROUTE A ROUTE B
INITIAL COST P200,000,000 P250,000,000
Maintenance/ year P700,000 P1,100,000
Road upkeep cost/year 10,000,000 4,000,000

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 If the roads are assumed to last 30 years w/ no salvage value, which route
should be accepted on the basis of a benefit/cost analysis using an interest rate
of 15%.
solution
EUAC = P200,000,000 (A/P,15%,30) + P700,000 = 31.56X10^4
EUAC = P250,000,000 (A/P,15%,30) + P1,100,000 = 39.175x10^4
Incremental annual benefit = 10x10^4 - 4x10^4 = 6x10^4
Incremental annual cost = EUAC - EUAC
= 8.015x10^4

6 x 104
B/C =
8.015 x 104
Route A should be selected for construction.

Example

Four alternatives for providing electric supply to a small town have been
identified with the ff. annual benefits and cost.
Alternative Annual benefits Annual cost
A 1,528,000 780,000
B 1,398,000 664,000
C 960,000 742,000
D 810,000 420,000
Solution
Comparing alternative A with alternative B
1,528,000−1,398,000
B/C A over B = = 1.12
780,000−664,000
Comparing alternative A with alternative C
1,528,000−960,000
B/C A over C = = 14.95
780,000−742,000
Comparing alternative A with alternative D

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 1,528,000−810,000
B/C A over D = = 1.99
780,000−420,000
Select alternative A.

Problem
To increase accessibility to some beautiful scenery along the coastal line
of Batangas, a new highway is being proposed for construction. The initial cost is
expected to be P9, 600, 000, with annual costs P36, 000. Every three years
minor improvement costing P20, 000 are expected to be made. It is estimated
that income from tourist from foreign countries will be P1, 200, 000 annually.
Using a planning horizon of 30 years and interest rate of 10%, determine if the
highway should be constructed using B-C ratio method.

Problem
To avoid double handling of cargo and to enable larger ships to dock at
the copiers of a coastal city, it becomes necessary to dredge the harbor to a
sufficient depth dredging is estimated to cost P4, 000, 000, but it will decrease
shipping and cargo handling costs by P1.50 per ton. The port is presently
processing 800,000 tons of cargo per year but, this expected to increase by
60,000tons each year for the next 20 years. Maintenance costs of the harbor are
currently P500, 000 a year, increasing P70, 000 each year. If the harbor is
dredged, maintenance will cost P600, 000 per year and increase by P50, 000 per
year each year. Funding for the project is available at 5% interest. Determine the
feasibility of the project using B-C ratio method and assuming a time horizon of
20 years.:

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Problem
A nonprofit government corporation is considering two alternatives for generating
power.

Alternative A. Build a coal-powered generating facility at a cost of

$20,000,000.Annual power sales are expected to be $1,000,000 per
year. Annual O&M costs are $200,000 per year. A benefit of this
alternative is that it is expected to attract new industry, worth $500,000
per year, to the region.

Alternative B. Build a hydroelectric generating facility. The capital

investment, power sales, and operating costs are $30,000,000,
$800,000, and $100,000 per year, respectively. Annual benefits of this
alternative are as follows.

Flood- control saving $600,000

Irrigation $200,000
Recreation $100,000
Ability to attract new industry $400,000

The useful life of both alternatives is 50 years. Using an interest

rate of 5%. Determine which alternative should be selected.

Problems
1.The DPWH is considering the construction of a new highway through a scenic
rural area. The road is expected to cost 50 million with annual upkeep estimated
at 400,000. The improved accessibility is expected to result in additional income
from tourist of 7 million/ year. The road is expected to have a useful life of 25
years. If the rate of interest is 15% should the road be constructed?

2. Det. the B/C ratio for the ff. project.

First cost 100,000
Project life years 5
Salvage value 10,000
Annual benefits 60,000
Annual O&M 22,000
Interest rate 15

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3. Data for two alternatives are as follows:
Alternative
A B
Investment 35,000 50,000
Annual benefit 20,000 25,000
Annual O&M 6,450 13,030
Estimated life years 4 8
Net salvage value 3,500 0
Using an interest rate of 20% which alternative should be chosen?

4. There are 5 alternatives for improvement of a road. Determine which

alternative should be chosen if the highway department is willing to invest money
as long there is B/C ratio at least 1.0

Alternatives Annual Benefits Annual Cost

E P4,200,000 P3,400,000
D P3,300,000 P2,700,000
C P2,800,000 P2,100,000
B P1,300,000 P1,400,000
A P900,000 P1,000,000

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ACCOUNTING PRINCIPLES

Accounting is the process of recording all the transactions of the company

which affect any investment of capital so that at any given time results of the
investment may be known.

Bookkeeping is the systematic recording of all business transactions in

financial.

After a decision to invest capital in a project has been made and the
capital has been invested, those who supply and manage the capital want to
know the financial results. Financial accounting and cost accounting are the
procedures that provide these necessary services in a business organization.

All accounting is based on the fundamental accounting equation, which is

Assets = liabilities + owner’s equity

Assets ate these things of monetary value that the firm possesses
Liabilities are those things of monetary value that the firm owes
Owner’s Equity is the worth of what the firm owes to its
stockholders

Balance Sheet

This fundamental accounting equation defines the format of the balance

sheet
Which is the two most common accounting equation defines the format of the
balance sheet position of the firm at any given point in time

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Typical Form of Balance Sheet

BALANCE SHEET
Name of Company
Date

ASSETS:
Current Assets
Cash on hand and in banks………………………………………………..
Notes and Accounts Receivable…………………………………………...
Notes receivable customers………………………………………..
Accounts receivable customers……………………………………
Other receivable (give details)……………………………………..
Less: reserve for bad debts…………………………………………
Inventories (goods and materials on hand)………………………………
Total Current Assets…………………………………………………
Fixed Assets
Land
Building or Manufacturing plant ---------------------------
Less Reserve for depreciation ----------------
Properties other than buildings ----------------------------
Less Reserve for depreciation ------------------____________
Total Fixed Assets -------------------------
Prepaid Expenses
These includes amount paid in advance -----------
For insurance, rental, interest, supplies, etc ------- _____________
Total Prepaid Expenses ------------------
Other Assets
Sinking funds -------------------------------------------------------
Investments in securities such as bonds, etc -------
Goodwill -------------------------------------------------------------
Patents, franchises, licenses --------------------------------
Other intangibles --------------------------------------------------
Miscellaneous (give details) ----------------------------------- _____________
Total of Other Assets -----------------------
TOTAL ASSETS --------------- _____________

LIABILITIES:
Current Liabilities
Notes Payable ----------------------------------------------------
Accounts Payables ----------------------------------------------
Accrued Expenses (taxes, wages, interest, etc) ---------
Declared and unpaid dividends ----------------------------------

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 Other current liabilities (give details) -------------------------- ____________
Total Current Liabilities ----------------------

Fixed Liabilities
Mortgage payable --------------------------------------------------
Indebtedness in the form of bonds ----------------------------
Reserve for expansion ---------------------------------------------
Other long term liabilities (give details) ----------------------- ____________
Total Fixed Liabilities --------------------------
Prepaid Income
Advance payment on orders from the company -------
Other income paid in advance to the company -------- __________
Total Prepaid Income --------------------
TOTAL LIABILITIES ----------------------------------------------

OWNERSHIP
Preferred Shares ………………………………………………………..
Common Shares …………………………………………………………
Undivided Surplus ( retained earnings )………………………
TOTAL OWNERSHIP …………………………..
TOTAL : LIABILITIES - OWNERSHIP ………………………………

INCOME STATEMENT
Another Important accounting relationship is
Revenue – Expenses = Profit (or loss)
This relationship defines the format of the income statement (also known
as a profit and loss statement), which summarizes the revenue and expense
result of operation over a period of time.

Example of Form of Income Statement

Income Statement
Company
For the year ending December 31. ____

Income Form Sales

Gross Income -----------------
Less : Return and allowances
Net Sales --------------
Cost of Good Sold
Merchandise inventory at beginning of the year
Purchases and freight
Less : Purchases return and allowances

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 Cost of Merchandise available for sale
Merchandise inventory at year end
Cost of goods sold
Gross Profit
Operating Expenses:
Selling expenses :
Sale salaries and commissions
Advertising
Other selling expenses (depreciation of sales equipment
Bad debts, delivery expense , insurance on sales
Equipment, etc.)
General and Administrative Expenses:
Office Salaries
Other expenses (rent, telephone, light, taxes, insurance
Depreciation, office supplies, etc)
Total Operating Expenses -------------------------------

Net Operating Profit

Non-Operating income and Expenses
Non-operating income (interest, rent, etc)
Non-operating expenses (interest, sales, discount, etc)
Net Profit -------------------------------------------

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