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CTC 475 Review

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

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CTC 475 Review

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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. CTC 475 Benefit-Cost Analyses

  3. Objectives Why is B/C used? How do public projects differ from private sector projects? What are the disadvantages 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 https://en.wikipedia.org/wiki/Flood_Control_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. B/C Ratio Example

  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: $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) = 5.95 (>1) • Prefer Route B over Route A

  11. Compare C and B (C-B) • Incremental Benefits: $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) = 1.08 (>1) • Prefer Route C over Route B

  12. Annual Worth Method

  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

  24. Use incremental analysis to Evaluate Dam for Irrigation Only versus Dam for Irrigation & Flood Control • Incremental benefits 31-25=6 • Incremental costs = 18.5-14.5=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

  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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