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CTC 475 Review Evaluating alternatives Ranking Method (PW, AW, FW)

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1 CTC 475 Review Evaluating alternatives Ranking Method (PW, AW, FW)
Incremental Method (PW, AW, FW, IRR, ERR, SIR) Put alternatives in order of initial investment Determine cash difference of first 2 alternatives Determine whether incremental benefits outweigh incremental costs Compare winner to next alternative

2 Benefit-Cost Analyses
CTC 475 Benefit-Cost Analyses

3 Objectives Know why B/C ratio is used
Know how public projects differ from private sector projects Know the pitfalls of using B/C ratio

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

5 Differences from private sector projects
Big initial costs (millions) Long lives (50, 100 years) Multiple-uses (lake might be used for recreation, flood control, irrigation, power generation) Difficult to define cash flow ($ value on aesthetics?)

6 Public projects Standard method for evaluation is the B/C ratio
Flood Control Act of 1936 – Benefits must exceed costs Act_of_1936

7 B/C ratio Benefits-Public benefits associated with the project
Costs-Government costs associated with the project Disbenefits-Unfavorable consequences to the public associated with the project Many times it is difficult to quantify benefits and disbenefits.

8 Total Govt. Annualized Costs (initial and O&M)
B/C Ratio Example Alt. Initial Cost Total Govt. Annualized Costs (initial and O&M) Total Public Annualized Costs (accidents, time of travel, operating costs) Route A $417,000 $677,000 $16,973,000 Route B $1,023,000 $1,243,000 $13,605,000 Route C $1,734,000 $2,103,000 $12,678,000

9 B/C ratio? There are no defined benefits, so you can’t directly determine B/C ratio However, spending extra money does lower total public costs Need to use incremental method

10 Compare B and A (B-A) Incremental Benefits: Incremental Costs:
$16,973,000-$13,605,000=$3,368,000 per year Incremental Costs: $1,243,000-$677,000=$566,000 per year B/C (B-A) = (>1) Prefer Route B over Route A

11 Compare C and B (C-B) Incremental Benefits: Incremental Costs:
$13,605,000-$12,678,000=$927,000 per year Incremental Costs: $2,103,000-$1,243,000=$860,000 per year B/C (C-B) = (>1) Prefer Route C over Route B

12 Total Govt. Annualized Costs (initial and O&M)
Annual Worth Method Alt. Total Govt. Annualized Costs (initial and O&M) Total Public Annualized Costs (accidents, time of travel operating costs) Total Costs Route A $677,000 $16,973,000 $17,650,000 Route B $1,243,000 $13,605,000 $14,848,000 Route C $2,103,000 $12,678,000 $14,781,000

13 Considerations Point of view Selecting MARR
Assessing benefit-cost factors Overcounting Unequal lives Tolls & fees Multiple-Use Projects Problems with B/C ratio

14 1. Point of View Individual Particular government agency Local area
Regional area Entire nation

15 2. Choosing MARR Public projects are funded by taxes, bonds, tolls. Making a profit is not government’s motive: Use zero? Use rate paid by government for borrowed money? Use rate that private investors use?

16 3. Determining Benefit-Cost Factors
How far do you go in determining benefit- costs? Short-term benefits to local economy? Secondary benefits? How do you put a price tag on aesthetics, wildlife, views, etc.?

17 4. Overcounting Must be careful and not count twice
Wages lost through disability Company’s cost of disability insurance

18 5. Unequal Lives How do you calculate salvage values for public works projects?

19 6. Tolls, Fees and User Charges
Tolls and user fees effect B/C ratio, but not necessarily B-C Example: EUAC=$20,000 for public facility 10,000 people per year attend facility Person receives $3 of benefits per event

20 Without User Fee B/C=($3*10,000)/$20,000=1.5
B-C=$30,000-$20,000=$10,000 per year

21 With User Fee Fee of $1.50 is charged Net benefits are only $1.50
Govt. Cost is reduced by $15,000 Govt. Cost is $5,000 per year B/C=($1.5*10,000)/$5,000=3 B-C=$15,000-$5,000=$10,000 per year

22 7. Multiple-Use Project For incremental costs you can sometimes expand a public project to provide multiple benefits

23 Example Project PW Costs (millions) PW Benefits (millions) B/C ratio
Dam& Res. For Irrigation $14.5 $25 1.72 Dam & Res. For Flood Control $9 $6 0.67 Dam & Reservoir for Irrigation & Flood Control $18.5 $31 1.68

24 Use incremental analysis to Evaluate Dam for Irrigation Only versus Dam for Irrigation & Flood Control Incremental benefits 31-25=6 Incremental costs = =4 Incremental B/C ratio = 1.5 >1 means that it’s worth spending the extra money to derive both benefits

25 Problems with B/C Don’t make the mistake of ranking B/C ratios
In previous example, ranking would have given us the wrong answer (see next slide)

26 Example Project PW Costs PW Ben. B/C ratio B-C
Dam& Res. For Irrigation $14.5 $25 1.72 $10.5 Dam & Res. For Flood Control $9 $6 0.67 -$3 Dam & Reservoir for Irrigation & Flood Control $18.5 $31 1.68 $12.5

27 Other Problems with B/C Ratio
Benefits/Costs must be determined objectively Don’t play games to get the result you want

28 Other types of Analysis
Sometimes you can’t measure a project in terms of $ alone Reliability, performance, availability, maintainability may be important Defense and space systems may use other methods than consideration of costs alone

29 Next lecture Breakeven Problems


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