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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
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Benefit-Cost Analyses
CTC 475 Benefit-Cost Analyses
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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
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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)
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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?)
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Public projects Standard method for evaluation is the B/C ratio
Flood Control Act of 1936 – Benefits must exceed costs Act_of_1936
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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.
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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
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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
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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
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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
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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
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Considerations Point of view Selecting MARR
Assessing benefit-cost factors Overcounting Unequal lives Tolls & fees Multiple-Use Projects Problems with B/C ratio
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1. Point of View Individual Particular government agency Local area
Regional area Entire nation
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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?
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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.?
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4. Overcounting Must be careful and not count twice
Wages lost through disability Company’s cost of disability insurance
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5. Unequal Lives How do you calculate salvage values for public works projects?
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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
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Without User Fee B/C=($3*10,000)/$20,000=1.5
B-C=$30,000-$20,000=$10,000 per year
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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
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7. Multiple-Use Project For incremental costs you can sometimes expand a public project to provide multiple benefits
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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
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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
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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)
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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
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Other Problems with B/C Ratio
Benefits/Costs must be determined objectively Don’t play games to get the result you want
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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
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Next lecture Breakeven Problems
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