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Benefit Cost Analysis

Benefit Cost Analysis. Typically used for public projects The goal is to determine if benefits exceed costs: Benefit / Cost Ratio > 1 The goal is NOT to maximize B/C Ratio. Interest rates used are typically lower than those used by businesses. Typically 4% - 8% (6.5% is typical)

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Benefit Cost Analysis

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  1. Benefit Cost Analysis • Typically used for public projects • The goal is to determine if benefits exceed costs: • Benefit / Cost Ratio > 1 • The goal is NOT to maximize B/C Ratio. • Interest rates used are typically lower than those used by businesses. • Typically 4% - 8% (6.5% is typical) • OMB requires 10% (except water proj.)

  2. Benefit Cost Analysis The challenge is to quantify the benefits and costs. The equation… B/C = (Benefits – Disbenefits) to the public (Costs) to sponsoring agency You can use NPW, EAW, even NFW – whichever is easier in a particular problem – Hint: Choose EAW or Capitalized Cost to avoid equal lifetime issues!

  3. Benefit Cost Analysis • Steps: • Define the planning horizon. • Specify the Discount Rate (MARR) to be used. • Develop the cost and benefit-disbenefit profiles in monetary terms. • Compare the benefits to costs using a specified measure of worth, such as annual equivalent or present worth. • If the B/C ratio is: • > 1 project is justified • = 1 barely justified – political • < 1 not justified • 6. Repeat steps 3 – 5 for alternative viewpoints

  4. Cost-Benefit Profiles • Primary Benefits – (Users) measurable: • Prevention of costs / savings from implementation • Time savings from implementation • Secondary Benefits – (Users) difficult to measure: • Environment conservation / improvement • Pain & suffering avoidance • Disbenefits – (Users) quantified: • Time lost due to requirements • User fees for Operation & Maintenance • Costs – (Sponsor): • First costs & Salvage • Sponsor Operation & Maintenance (– Revenue) • Operation fees paid by users (+ Revenue)

  5. Quantification Examples • Benefits due to reduction in deaths: • Number of deaths avoided • Average income stream of victims • Benefits due to reduction in property damage: • Number of incidents • Average property damage per incident • Disbenefits due to user fees: • Average number of users • Average fee charged • Disbenefits due to delay time: • Number affected • Average delay duration • Average wage rate of patrons • Costs(+ Revenues due to user fees): • Average number of users • Average fee charged

  6. Vehicle Inspection Program Ex. • State inspects motor vehicles as part of licensing system. Vehicles not passing inspection must be repaired prior to license renewal. • Primary Benefits (Users): • Reduction in deaths due to accidents • Reduction in property damage due to accidents • Secondary Benefits (Users): • Pollution avoidance costs • Savings to accident victims families • Avoidance of pain & suffering • Disbenefits (Users): • Cost of inspection fees • Opportunity cost of time to bring car to inspection • Opportunity cost of time waiting for inspection • Vehicle usage costs for inspection process

  7. Vehicle Inspection Program Ex. • Sponsor Costs (State): • Capital recovery costs of inspection facilities • Operating costs of inspectors & admin. staff • Sponsor Revenues (State): • Inspection revenues (user fees) • Quantifying Benefits: • Deaths avoided • 304 victims of fatal accidents avoided • Income stream lost: $571 106 per victim • Property damage avoided • 37 910 total accidents avoided annually • 63% of accidents are property only • Average property damage: $1 845 per accident • Total Benefits to Users: $217 680 913 / year

  8. Vehicle Inspection Program Ex. • Quantifying Disbenefits: • Cost of inspection fees • 5 136 224 vehicles inspected annually • $5 fee per inspection • Opportunity cost of time to bring vehicle to inspection • 5 136 224 vehicles inspected annually • 1.02 hours of inspection travel per car (round trip) • Average wage rate: $14.02 per hour • Opportunity cost of time waiting for inspection • Average waiting time: 9 minutes (0.15 hr) • 5 136 224 vehicles inspected annually • Average wage rate: $14.02 per hour • Vehicle usage costs for inspection process • 5 136 224 vehicles inspected annually • Operating cost per mile: $0.35 • Average round trip to station: 20 miles • Total Disbenefits to Users: $145 886 225 / year

  9. Vehicle Inspection Program Ex. • Quantifying Sponsor Costs: • Capital recovery of facilities costs • Similar facilities annual cost: $46 376 703 per yr • Operating costs for inspectors & admin • Annual operating costs: $10 665 600 per year • Revenue from inspection fees • 5 136 224 vehicles inspected annually • $5 fee per inspection • Total Costs to Sponsor: $31 361 083 / year • IS IT WORTH IT? • B/C = B – D = 217 680 913 – 145 886 165 = 2.29 • C31 361 183 • Economically Justified, Politically …

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