1. Benefit-Cost Analysis (c) 2001 Contemporary Engineering Economics

2. Chapter 12Benefit-Cost Analysis • Framework of Benefit- Cost Analysis • Valuation of Benefits and Costs • Benefit-Cost Ratios • Incremental B-C Analysis (c) 2001 Contemporary Engineering Economics

3. Benefit-Cost Analysis • The Benefit-cost analysis is commonly used to evaluate public projects. • Benefits of a nonmonetary nature need to be quantified in dollar terms as much as possible and factored into the analysis. • A broad range of project users distinct from the sponsor should be considered—benefits and disbenefits to all these users can (and should) be taken into account. (c) 2001 Contemporary Engineering Economics

4. Framework of Benefit-Cost Analysis • Identifying all the users and sponsorsof the project. • Identifying all the benefits and disbenefits of the project. • Quantifying all benefits and disbenefits in dollars or some other unit of measure. • Selecting an appropriate interest rate at which to discount benefits and costs to a present value. (c) 2001 Contemporary Engineering Economics

5. Benefit-Cost Ratio Criterion If this BC ratio exceeds1, the project can be justified (c) 2001 Contemporary Engineering Economics

6. Definition of Benefit-Cost Ratio bn=Benefit at the end of period n, cn=Expense at the end of period n, An= bn – cn N = Project life i =Sponsor’s interest rate (discount rate) (c) 2001 Contemporary Engineering Economics

7. Breakdown of the Sponsor’s Cost Equivalent capital investment at n = 0 Equivalent O&M costs at n = 0 (c) 2001 Contemporary Engineering Economics

8. Example 12.1 BC Analysis Benefits (bn) $30 $30 K = 1 N = 5 $20 $20 $5 $5 $5 $5 $10 $10 Recurring costs (cn) Investment (cn) (c) 2001 Contemporary Engineering Economics

9. Solution: (c) 2001 Contemporary Engineering Economics

10. Relationship between B/C Ratio and NPW B > (I + C’) B – (I+ C’) > 0 PW(i) = B – C > 0 (c) 2001 Contemporary Engineering Economics

11. Incremental Analysis Based on BC(i) (c) 2001 Contemporary Engineering Economics

12. Example 12.2 Incremental Benefit-Cost Ratios (c) 2001 Contemporary Engineering Economics

13. Solution (c) 2001 Contemporary Engineering Economics

14. Summary • A benefit-cost analysis is commonly used to evaluate public projects: • Difficulties involved in public project analysis include the following: • Identifying all the users who can benefit from the project. • Identifying all the benefits and disbenefits of the project. • Quantifying all benefits and disbenefits in dollars or some other unit of measure. • Selecting an appropriate interest rate at which to discount benefits and costs to a present value. (c) 2001 Contemporary Engineering Economics

15. The B/C ratio is defined as: The decision rule is if BC(i) > 1, the project is acceptable. • The net B/C ratio is defined as The net B/C ratio expresses the net benefit expected per dollar invested. The same decision rule applies as for the B/C ratio. (c) 2001 Contemporary Engineering Economics