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Benefit Cost Analysis and Public Sector Economics: Graw Hill

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31 views

Benefit Cost Analysis and Public Sector Economics: Graw Hill

Uploaded by

salmanshahidkhan
Copyright
© Attribution Non-Commercial (BY-NC)
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You are on page 1/ 21

Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display.

ENGINEERING ECONOMY Fifth Edition


Mc
Blank and Tarquin Graw
Hill

CHAPTER IX

Benefit Cost Analysis and


Public Sector Economics

Blank & Tarquin: 5th Edition. Ch. 9 Authored by: Dr. Don Smith, Texas A&M University. 1
Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display.

9.2 B/C Formulations

• Assignable life, N - years


• Estimate costs ($)
• Estimate benefits in ($)
• Estimate disbenefits in ($)
• Assign an interest rate ( i%/year)

Blank & Tarquin: 5th Edition. Ch. 9 Authored by: Dr. Don Smith, Texas A&M University. 2
Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display.

9.2 B/C Formulations

• Then convert all amounts to either a


• Present Worth – PW(i%)
• Annual Worth – AW(i%)
• Then calculate a B/C ratio in one of
three ways…..

Blank & Tarquin: 5th Edition. Ch. 9 Authored by: Dr. Don Smith, Texas A&M University. 3
Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display.

9.2 B/C Ratios: 3 Formats

• Three acceptable formats are:


PW (benefits )
B/C 
PW (cos ts )
AW (benefits )

AW (cos ts )
FW (benefits )

FW (cos ts )

Blank & Tarquin: 5th Edition. Ch. 9 Authored by: Dr. Don Smith, Texas A&M University. 4
Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display.

9.2 Notes Regarding Signs

• By convention:
• Revenues are assigned (+) signs
• Costs are assigned (+) signs
• Salvage values are subtracted from
costs
• Disbenefits are treated more than one
way

Blank & Tarquin: 5th Edition. Ch. 9 Authored by: Dr. Don Smith, Texas A&M University. 5
Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display.

9.2 Handling Disbenefits

1. Disbenefit values are subtracted from


benefits
2. Disbenefit values are added to costs
3. Either approach will result in a consistent
analysis – but be consistent throughout
an analysis

Blank & Tarquin: 5th Edition. Ch. 9 Authored by: Dr. Don Smith, Texas A&M University. 6
Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display.

9.2 Decision Rule

• IF B/C ratio (=>) 1.00


• Conditionally accept the alternative
• IF B/C ratio (<) 1.00, conditionally reject
the alternative
• IF B/C ratio “close” to 1.00, then
intangible factors may sway the decision to
accept or reject

Blank & Tarquin: 5th Edition. Ch. 9 Authored by: Dr. Don Smith, Texas A&M University. 7
Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display.

9.2 Conventional B/C Ratio

• The conventional B/C Ratio is:

Benefits - disbenefits B  D
B/C  
Costs C

Blank & Tarquin: 5th Edition. Ch. 9 Authored by: Dr. Don Smith, Texas A&M University. 8
Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display.

9.2 Modified B/C Ratio

• Modified B/C subtracts the maintenance


and operations costs in the numerator

Benefits - disbenefits-M&O costs


B / Cmodified 
Costs

Blank & Tarquin: 5th Edition. Ch. 9 Authored by: Dr. Don Smith, Texas A&M University. 9
Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display.

9. 2 Convention vs. Modified?

• It makes no difference which approach is


used
• However, the ratio values will differ
(magnitude)
• But, the absolute (accept/reject) decision
will be the same

Blank & Tarquin: 5th Edition. Ch. 9 Authored by: Dr. Don Smith, Texas A&M University. 10
Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display.

9. 2 Benefit-Cost Difference

• B - C difference is not a ratio


• B - C difference is:
• (Benefits – Costs) (as a PW or AW)
• The “B” represents the Net Benefit
B = Benefits – Disbenefits

Blank & Tarquin: 5th Edition. Ch. 9 Authored by: Dr. Don Smith, Texas A&M University. 11
Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display.

Example 9.2

Blank & Tarquin: 5th Edition. Ch. 9 Authored by: Dr. Don Smith, Texas A&M University. 12
Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display.

9. 2 See Example 9-2

• Applies all three approaches to the same


problem situation
• B/C = 0.51 (reject)
• Mod B/C = 0.39 (reject)
• (B - C) = $-1.24 million (< 0…reject)
• Result: Same decision with varying
magnitudes of the ratio

Blank & Tarquin: 5th Edition. Ch. 9 Authored by: Dr. Don Smith, Texas A&M University. 13
Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display.

9.2 Example 9.3

• Given two alternatives


• Bypass construction
• Upgrade construction
• Note: Unequal lives ..use AW
• i is set to 8%

Blank & Tarquin: 5th Edition. Ch. 9 Authored by: Dr. Don Smith, Texas A&M University. 14
Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display.

9.2 Example 9.3 – Continued

• Conventional B/C – Bypass = 1.17


• Conventional B/C – Upgrade = 1.13
• Both B/C ratios are > 0
• Both proposal are economically justified at
8%
• Which one would you select?

Blank & Tarquin: 5th Edition. Ch. 9 Authored by: Dr. Don Smith, Texas A&M University. 15
Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display.

9.2 Uncertain Discount Rate (??)

• What if the value of “i” is uncertain?


• Apply a spreadsheet analysis and play
“what-if”
• What if federal funds are available for the
upgrade and a 4% rate is applied to that
option?
• Changing discount rates can impact the
ratio for that alternative!

Blank & Tarquin: 5th Edition. Ch. 9 Authored by: Dr. Don Smith, Texas A&M University. 16
Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display.

9.3 Alternative Selection Using


Incremental Analysis: 2 Alternatives

• This approach is similar to the material in


Chapter 8
• Requires a proper ordering of the
alternatives
• Order alternatives on the basis of Total
Costs

Blank & Tarquin: 5th Edition. Ch. 9 Authored by: Dr. Don Smith, Texas A&M University. 17
Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display.

9.3 Rank on Total Costs – Rules

1. Determine total equivalent costs for both


alternatives;
2. Order by total costs: Smaller first then
larger
Calculate the incremental cost for the
larger alternative = (C) – This is the
denominator in the B/C ratio

Blank & Tarquin: 5th Edition. Ch. 9 Authored by: Dr. Don Smith, Texas A&M University. 18
Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display.

9.3  (B/C) Approach

3. For both alternatives determine:


• Total equivalent benefits and
disbenefits
• Calculate the (B) for the larger cost
alternative or (B-D) if disbenefits are
involved
4. Calculate the { (B-D)/C } ratio

Blank & Tarquin: 5th Edition. Ch. 9 Authored by: Dr. Don Smith, Texas A&M University. 19
Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display.

9.3 (B/C) Approach

5. If (B/C) (=>) 1.00, go with the higher-


cost alternative
else,
Go with lower-cost alternative!

Blank & Tarquin: 5th Edition. Ch. 9 Authored by: Dr. Don Smith, Texas A&M University. 20
Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display.

9.3 Important Point

• If you are using a PW to determine


equivalency, then you must have an equal-
life model or lowest-common multiple of
lives.
• Or, apply the annual worth on a typical
cycle for the alternatives and the
repeatability assumption applies.

Blank & Tarquin: 5th Edition. Ch. 9 Authored by: Dr. Don Smith, Texas A&M University. 21

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