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
2
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
5
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
6
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
7
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
8
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
9
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
10
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.
11
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
12
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
13
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
14
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
15
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
16
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
17
7.2 B/C Formulations
• Assignable life, N - years
• Estimate costs ($)
• Estimate benefits in ($)
• Estimate disbenefits in ($)
• Assign an interest rate – i (%/year)
18
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…..
19
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 )
20
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
21
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
22
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:
23
7.2 Conventional B/C Ratio
• 1) Conventional B/C Ratio is:
Benefits - disbenefits B  D
B/C 

Costs
C
24
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
25
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.
26
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
27
7.2 Example 7.2
28
7.2 Example 7.2
• Applies all three approaches to the same problem situation
29
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.
30
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
31
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.
32
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.
33
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.
34
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.
35
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
36
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.
37
7.3 Example 7.4 (Incremental B/C)
38
7.3 Example 7.4 (Incremental B/C)
39
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
40
7.3 Example 7.5 (Incremental B/C)
41
7.3 Example 7.5 (Incremental B/C)
42
7.3 Example 7.5 (Incremental B/C)
DN
0
0
-
43
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
44
End of Chapter 7
45