engineering eco
hno1411
park_8.pptxPark 8
Benefit-Cost Analysis
Benefit-Cost Analysis
Benefit-cost analysis is a decision-making tool for systematically developing useful information about the desirable and undesirable effects of public projects
3 Goals:
Maximize the benefits for any given set of costs (or budgets)
Maximize the net benefits when both benefits and costs vary
Minimize costs in order to achieve any given level of benefits
Evaluation of Public Projects
General framework of benefit-cost analysis:
Identify all users’ benefits (favorable outcomes) and disbenefits (unfavorable outcomes expected to arise from the project.
Quantify, as well as possible, these benefits and disbenefits in dollar terms so that different benefits and he respective costs of attaining them may be compared.
Identify the sponsor’s costs and quantify them.
Evaluation of Public Projects
General framework of benefit-cost analysis (cont.)
Determine the equivalent net benefits and net costs at the base period; use a discount rate appropriate for the project.
Accept the project if the equivalent users’ net benefits exceed the equivalent sponsor’s net costs.
Users’ Benefits
In identifying the user’s benefits, we need to classify each as primary (directly attributable) or secondary (indirectly attributable) benefits.
B = benefits - disbenefits
Sponsor’s Costs
Cost to the sponsor is determined by identifying and classifying the expenditures (capital investment and annual operating costs) required and any savings (revenues) that may reduce the sponsor’s costs.
Sponsor’s costs = capital costs + operating and maintenance costs - revenues
Social Discount Rate
The social discount rate is an interest rate selected, like a MARR, in order to determine equivalent benefits as well as the equivalent costs.
Federal government often uses a discount of 7%, where many state and city governments use discount rates that range from 3% to 8% depending on the nature of the project.
Benefit-Cost Ratio
The benefit-cost ratio is defined as:
BC(i) = B/C = B/(I + C’), where I + C’ > 0
To accept a project, BC(i) must be higher than 1.
The values of B, C’, and I must be expressed in present-worth equivalents (or annual equivalents)
Incremental B/C Ratio Analysis
When choosing among mutually exclusive public projects, we need to use the incremental-investment approach in comparing alternatives:
Compute the incremental differences for B, I, and C’ and take the B/C ratio based on those differences.
Eliminate any alternatives with a B/C ratio less than 1.
Arrange the remaining alternatives in increasing order of the denominator (I + C’) for j and k
Incremental B/C Ratio Analysis
Compute the incremental differences for B, I, and C’ for the paired alternatives (j,k)
B = Bk-Bj
I = Ik – Ij
C’ = C’k = C’j
Compute BC(i) on incremental investment by evaluating
BC(i) k-j = B / I + C’
Continue comparing alternatives; the alternative selected during the last pairing is the best one.
Profitability Index
The profitability index attempts to identify the relationship between the costs and benefits of a proposed project through the use of a ratio.
Unlike the cost-benefit ratio, the profitability index (PI) considers only the initial capital expenditure as cash outlay, and annual net benefits are used:
Profitability Index
PI(i) = (B – C’) / I , where I > 0
The profitability index measures the bang for the buck invested, as the values on the profitability index increase, so does the financial attractiveness of the proposed project.
