CTC 475 Review Comparing Alternatives Comparing Alternatives Ranking (PW,AW,FW) Ranking (PW,AW,FW) Incremental (PW,AW,FW,IRR,ERR,SIR) Incremental (PW,AW,FW,IRR,ERR,SIR) Supplementary Analyses Supplementary Analyses Breakeven, Sensitivity, Probability Breakeven, Sensitivity, Probability Selecting and Selling the Project Selecting and Selling the Project

CTC 475 Projects in the Public Sector

Objectives Understand the major differences between public/private projects Understand the major differences between public/private projects Know the common errors when using B/C ratio Know the common errors when using B/C ratio

Public Projects Cultural Development Cultural Development (education, historic, recreation) (education, historic, recreation) Economic Services Economic Services (transportation, power generation) (transportation, power generation) Natural Resources Natural Resources (pollution control, flood control, wildlife management) (pollution control, flood control, wildlife management) Protection Protection (military services, police/fire) (military services, police/fire)

Differences from Private Sector Projects Big initial cost (millions) Big initial cost (millions) Long lives (>=50 years) Long lives (>=50 years) Multiple-use concept (lake—boaters, fishermen, flood control, irrigation, power) Multiple-use concept (lake—boaters, fishermen, flood control, irrigation, power) Difficult to define cash flows (recreation, aesthetics, historic, cultural) Difficult to define cash flows (recreation, aesthetics, historic, cultural)

Basic Steps for Analysis 1. Define alternatives 2. Define planning horizon 3. Develop cash flow profiles 4. Specify MARR 5. Compare alternatives (B/C ratio) 6. Perform supplementary analyses 7. Select preferred alternative

B/C B/C (same as SIR) = PW(+)/PW(-) B/C (same as SIR) = PW(+)/PW(-) B-C (present worth method) B-C (present worth method) Use incremental analysis if using B/C

Example of Defining Alternatives and Developing Cash Flow Profiles Steps 1 and 3 (planning horizon is the same)

Example-Public Project Initial Cost Annualized Govt. Cost Annualized Public Costs Route A $416,800$676,800$16,973,000 Route B $1,023,400$1,243,400$13,605,200 Route C $1,733,800$2,102,800$12,678,500

Explanations 1. Annual govt. costs includes annualized initial cost and annual O&M costs 2. Annual public costs are annualized costs for safety, time, and vehicle operation 3. Note that we don’t need the planning horizon to do our analysis

Compare B & A (B-A) Incremental benefits Incremental benefits -$13,605,00-(-$16,973,000)=$3,367,800 -$13,605,00-(-$16,973,000)=$3,367,800 Benefit because we’re reducing public costs Benefit because we’re reducing public costs Incremental Costs Incremental Costs $1,243,400-$676,800=$566,600 $1,243,400-$676,800=$566,600 Incremental B/C Incremental B/C $3,367,800/$566,600=5.9 $3,367,800/$566,600=5.9 Spending the extra money to lower public costs is economically feasible Spending the extra money to lower public costs is economically feasible

Compare C & B (C-B) Incremental benefits Incremental benefits -$12,678,500-(-$13,605,200)=$926,700 -$12,678,500-(-$13,605,200)=$926,700 Benefit because we’re reducing public costs Benefit because we’re reducing public costs Incremental Costs Incremental Costs $2,102,800-$1,243,400=$859,400 $2,102,800-$1,243,400=$859,400 Incremental B/C Incremental B/C $926,700/$859,400=1.08 $926,700/$859,400=1.08 Spending the extra money for Alt. C to lower public costs is economically feasible Spending the extra money for Alt. C to lower public costs is economically feasible

Use Ranking (AW) Route Total Annual Costs Rank A$17,649,8003 B$14,848,6002 C$14,781,3001

Considerations Point of view Point of view Selecting the MARR Selecting the MARR Over-counting Over-counting Unequal lives Unequal lives Tolls & fees Tolls & fees Multiple-use Projects Multiple-use Projects Problems w/ B/C ratio Problems w/ B/C ratio

Point of View Individual Individual Particular govt. organization Particular govt. organization Local Area Local Area Regional Area Regional Area Entire nation Entire nation

Selecting the MARR Use zero for tax money Use zero for tax money Use society’s time preference rate Use society’s time preference rate Use rate paid by govt. for borrowed money Use rate paid by govt. for borrowed money Opportunity cost for private investors Opportunity cost for private investors Opportunity costs foregone by govt. agencies Opportunity costs foregone by govt. agencies

Overcounting For public projects it’s easy to count something twice For public projects it’s easy to count something twice Calculate wages lost (individual viewpoint) Calculate wages lost (individual viewpoint) Put $ on disability accidents (company’s viewpoint) Put $ on disability accidents (company’s viewpoint)

Unequal Lives Planning horizon usually coincides with the longest-lived alternative Planning horizon usually coincides with the longest-lived alternative If shortest life is chosen it is difficult to put a $ value on residual (salvage) value for the projects w/ the longer lives If shortest life is chosen it is difficult to put a $ value on residual (salvage) value for the projects w/ the longer lives

Tolls, Fees and User Charges Tolls, fees and user charges impact the B/C ratio (but not B-C) Tolls, fees and user charges impact the B/C ratio (but not B-C)

Fees—Example Problem On board On board

Multiple-Use Projects For incremental costs a public project can be expanded to provide multiple benefits For incremental costs a public project can be expanded to provide multiple benefits Each project alone may not have been economically feasible Each project alone may not have been economically feasible

Multiple-Use Example problem on board Example problem on board

Problems w/ B/C Ratio Difficult to determine whether there is a benefit to the public or a cost savings to the government Difficult to determine whether there is a benefit to the public or a cost savings to the government Also, is it a disbenefit or an actual cost? Also, is it a disbenefit or an actual cost? Affect’s B/C ratio but not B-C Affect’s B/C ratio but not B-C

B/C ratio problems Example on board Example on board

Other Analyses Money alone is sometimes not the only consideration Money alone is sometimes not the only consideration Reliability Reliability Performance Performance Availability Availability Maintainability Maintainability

Reliability Example On-Board On-Board

Next lecture ATCF (After-Tax Cash Flows) ATCF (After-Tax Cash Flows) Taxes/Depreciation Taxes/Depreciation