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