B/C
CE 533 - ECONOMIC DECISION
ANALYSIS IN CONSTRUCTION
CHP 7 -Benefit/Cost Analysis
and Public Sector Projects
By
Assoc. Prof. Dr. Ahmet ÖZTAŞ
Gaziantep University
Department of Civil Engineering
1
CHP 7. Benefit/Cost (B/C) Analysis
Topics
1. Public Versus Private Sector Projects
2. Benefit/Cost Analysis
3. Incremental B/C Evaluation of Two or
More Alternatives
4. Using Excel for B/C Analysis
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Learning Objectives
7.1 Public Sector Analysis
7.2 Benefit Cost Analysis
7.3 Alternative Selection
Using the
B/C
Ratio
Approach
7.4 Spreadsheets
3
7.1 Public versus Private Sector Projects
• Public Sector:
• Ownership – by citizens- the public
• Public Sector Projects:
• Provide needed services to the public
and “no profit”
4
7.1 Types of Projects
• Hospitals
• Parks and recreation facilities
• Highways, dams, bridges
• Courts, schools, prisons
• Public housing
• Many other types
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7.1 Characteristics – Compared
Characteristic
Public Sector
Private Sector
Size of
Investment
Larger
Some Large;
medium to
small
Life Estimates
Quite Long:
30-50 years
Shorter:
2-25 years
Annual Cash
No Profit: costs Revenues –
Flow Estimates and benefits
profit cost
estimates
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7.1 Attributes
• Public Sector Projects do not have
“profits”.
• Projects can have certain undesirable
consequences associated
• Thus, can be controversial in nature
• Draw media attention – debated on pros
and cons
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7.1 Estimating for Public Projects: Costs
• Basic elements for public projects:
• Costs
• Construction, operations,
maintenance less est. salvage values
• Initial costs fairly well know
• Future O&M are less known and must
be estimated
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7.1 Estimating: Benefits
• BENEFITS to the public (users) must be
estimated in terms of periodic dollar values
• Very difficult to do
• Benefits = the advantages to the public
stated in $$
• Owners – generally the public
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7.1 Estimating: Disbenefits
• Disbenefits
• Expected undesirable (negative)
consequences to the owners (public)
• Assuming the project is undertaken
• May be indirect economic
disadvantages to the public
• Very hard to estimate and convert to $
amounts
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7.1 General Principle
• For public projects we find:
It is very difficult to estimate and reach
agreement on the economic impacts of
benefits and disbenefits for public sector
projects.
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7.1 Funding Sources – Compared
Characteristic
Public Sector
Funding
Taxes, fees,
bonds, pvt.
funds
Interest Rate
Tends to be
lower
Private Sector
Sale of new
stock, bonds,
loans, ret.
earnings
Higher: At
market cost
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7.1 Funding Public Projects
• Generally low interest charges
• Public entities do not pay taxes
• Project investments basically backed by
public agencies
• Cost-sharing arrangements often exist
• Less perceived risk with public projects
• Interest rate is determined differently than
in the private sector: Called the social
discount rate
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7.1 Additional Comparisons
Characteristic
Selection
criteria
Public Sector
Multiple or
many
Environment of Political arena
the evaluation
(debated,
pressure groups)
Private Sector
Rate of return
or present
value
Primarily
economic
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7.1 Selection Process
• Not as “clean” as in the private sector
• Involves interest and pressure groups
• Often draws media attention
• Involves many different viewpoints:
• Citizen
• The tax base
• Number of students in the school district
• Creation and retention of jobs.
• Economic development potential
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7.1 Evaluation Process
• The viewpoint finally adopted will:
• Determine the estimates of..
• Costs
• Benefits
• Disbenefits
• Note: the viewpoint must be established
before the economic evaluation
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7.2 B/C Analysis – Single Project
• Historical Point
•B/C analysis philosophy was instituted
and promoted by the Flood Control Act of
1936
•Introduced to promote a sense of
objectivity in an analysis
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7.2 B/C Formulations
• Assignable life, N - years
• Estimate costs ($)
• Estimate benefits in ($)
• Estimate disbenefits in ($)
• Assign an interest rate – i (%/year)
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7.2 B/C Formulations
• Then convert all amounts to either a
• Present Worth – PW(i%)
• Annual Worth – AW(i%)
• Future Worth – FW(i%)
• Then calculate a B/C ratio in one of
three ways…..
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7.2 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 )
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7.2 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
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7.2 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
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7.2 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
• There are 3 B/C formula:
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7.2 Conventional B/C Ratio
• 1) Conventional B/C Ratio is:
Benefits - disbenefits B D
B/C
Costs
C
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7.2 Modified B/C Ratio
• 2) Modified B/C ratio: It subtracts the
maintenance and operations (M&O) costs in
the numerator
B / Cmodified
Benefits - disbenefits-M&O costs
Costs
• Initial investment
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7.2 Convention vs. Modified?
• It makes no difference which approach is
used
• However, the ratio values will differ
(magnitude)
• But, the same absolute (accept/reject)
decision will be taken.
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7.2 Benefit-Cost Difference
• 3) B – C 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
• Benefits – Disbenefits
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7.2 Example 7.2
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7.2 Example 7.2
• Applies all three approaches to the same problem situation
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7.2 Example 7.2
• B/C = 0.51 (reject)
• Mod B/C = 0.39 (reject)
• (B-C) = $-0.24 million (< 0…reject)
• Result: Same decision with varying magnitudes of the ratio.
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7.3 Incremental B/C for Multiple Projects
• Select from two or more mutually exclusive
alternatives
• Same approach as that in Chapter 6, Section
6.6
• Remember, the Do Nothing alternative
always exists and should be evaluated as an
alternative.
• Requires a proper ordering of alternatives
• Order alternatives on the basis of Total Costs
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7.3 Incremental B/C for Multiple Projects
If (B/C) (=>) 1.00, select the higher- cost
alternative
Otherwise select the lower-cost alternative!
If you are using a PW to determine
equivalency, then you must have an equallife model or LCM of lives.
Or, apply AW on a typical cycle for the
alternatives and the repeatability
assumption applies.
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7.3 Incremental B/C for Multiple Projects
There are 2 types of benefits:
1) Usage cost estimates, 2) Direct benefit estimates.
Before conducting the incremental evaluation,
classify alternatives.
Usage cost: implied benefits based on the difference
in costs between alternatives. Evaluate these
alternatives only against each other.
Direct benefit: Benefit amounts estimated. First
evaluate against DN, then, against each other.
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7.3 Incremental B/C for Multiple Projects
A procedure for comparing multiple, mutually excluive
alternatives using conventional B/C ratio:
• For eachalternative, determine the
equivalent PW, AW or FW for costs C and
benefits [or (B-D) if disbenefits are
considered];
• Order alternatives by increasing total
equivalent costs. For direct benefit
alternatives, add DN as the first alternative
•
Determine the incremental cost (C) and
benefits (B) between first two alternatives.
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7.3 Incremental B/C for Multiple Projects
For usage cost alternative,
B = usage cost of 2 - usage cost of 1
4. Calculate incremental conventional B/C ratio using
below equation
B/C = (B-D)/C
5.
If (B/C) => 0, eliminate 1; 2 is survivor.
otherwise
1 is survivor.
6.
Continue to compare alternatives using step 2
through 5 until one alternative remains as survivor.
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7.3 Example 7.3 (Incremental B/C)
XXXXXXXXXXXXXXX
800,000
the addition is estimated at 30 years.
Use conventional B/C ratio ananlysis to select A or B.
1,050,000
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7.3 Example 7.3 (Incremental B/C)
1) AW1= 10,000(A/P,5%,30)+35= 685,500
AW2= 15,000(A/P,5%,30)+55= 1,030,750
2) Add DN and order: DN, 1, 2.
3) Compare 1-to-DN which is alt. 1
4) Calculate incremental (B/C) ratio
B/C = 800,000/685,500 = 1.17
5) Since 1.17 > 1.0 design 1 is survivor.
6) Compare 2-to-1:
B = 1,050,000 - 800,000= 250,000
C = 1,030,750 - 685,500= 345,250
B/C = 250,000/ 345,250 = 0.72 < 1.0
Design 2 eliminated, and design 1 is selection for bid.
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7.3 Example 7.4 (Incremental B/C)
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7.3 Example 7.4 (Incremental B/C)
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7.3 Example 7.4 (Incremental B/C)
• 4 Alternatives { 1,2,3, and 4}
• Ranked on total cost as shown
• Analysis Summary:
• (2 -1) B/C = 2.24 …Go with {2}
• (3-2) B/C =0.62…Reject 3, stay with
{2}
• (4-2) B/C = 1.83 Go with 4, final
winner
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7.3 Example 7.5 (Incremental B/C)
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7.3 Example 7.5 (Incremental B/C)
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7.3 Example 7.5 (Incremental B/C)
DN
0
0
-
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Chapter Summary
• B/C is primarily a public-sector analysis
technique
• Uses PW or AW with a social cost of
capital interest rate (specified before the
analysis is conducted)
• B/C ratio greater than 1 indicates
economic desirability
• Results may depend upon viewpoints that
define costs and benefits
• Applied within the political arena
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End of Chapter 7
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