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.)
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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.
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Benefit Cost Analysis

Steps: 1. Define the planning horizon.

2. Specify the Discount Rate (MARR) to be used.

3. Develop the cost and benefit-disbenefit profiles in monetary terms. 4. Compare the benefits to costs using a specified measure of worth, such as annual equivalent or present worth. 5. 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
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Example
A city library is to be expanded to include meeting rooms, more electronic volumes, computer facilities, and electronic check-in and check-out. The cost of the expansion will be $700,000 and the new equipment will cost another $175,000. Maintenance and renewal of the new addition and equipment will run approximately $100,000/year. The library is projected to be in operation for 20 years, with a residual value of 40% of first cost for the physical facilities. There is no salvage value for the equipment. Discount is 8%. An estimated 150,000 people will visit the library each year. How much additional benefit per person, per year, must the library visitors perceive in order to justify the expansion?
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Perspective Matters
Suppose the library charged an annual fee Suppose the entire county sponsored The equation
B/C = (Benefits Disbenefits) to public (Initial Investment) by sponsor

What is the viewpoint of a user? What is the viewpoint of a non-user?

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Incremental B/C Analysis

MUST be used when there are multiple alternatives to choose from! The equation is still
B/C = (Benefits Disbenefits) to the public (Costs) to sponsoring agency

You can use Incr. NPW or Incr. EAW whichever is easier in a particular problem.
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Incremental B/C Analysis

Steps: 1. Define the set of feasible, mutually exclusive, public sector alternatives to be compared. 2. Define the planning horizon. 3. Develop the cost and benefit-disbenefit profiles in monetary terms for each alternative.

4. Specify the MARR to be used.

5. Order the alternatives from smallest to largest Cost 6. Compare the alternatives using a specified measure of worth, such as annual equivalent, capitalized cost, or present worth (with matching lifetimes).
If the B/C ratio is: >1 1 higher cost project is justified lower cost project is still justified
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Incremental Benefit Cost Analysis Example

A Benefits Disbenefits Costs BD C E G: C E: A E: 174 4 100 1.7 B 180 60 120 C 136 10 90 D Not Feasible 80 8 80 E 136 10 70 F 178 2 110 1.6 G 89 14 50 1.5

1.0 1.4 0.9 1.8 Cost Order: G E C A F B

G DN: (From feasibility, (B D) / C = 1.5

(136 89) (10 14) = 51 = 2.55 (70 50) 20 (136 136) (10 10) = 0 = 0

Upgrade to G
Upgrade to E Keep Proj. E Upgrade to A

(90 70)
(100 70)

20
30

(174 136) (4 10) = 44 = 1.47

Incremental Benefit Cost Analysis Example

A Benefits Disbenefits Costs BD C F A: B A: 174 4 100 1.7 B 180 60 120 C 136 10 90 D Not Feasible 80 8 80 E 136 10 70 F 178 2 110 1.6 G 89 14 50 1.5

1.0 1.4 0.9 1.8 Cost Order: G E C A F B

(178 174) (2 4) = 6 = 0.6 (110 100) (120 100) 10 (180 174) (60 4) = 50 = 2.5 20

Keep Proj. A Best is Proj A

Bonus Problem: B/C Build-Up Example

Snack Fridge Viability

Data:
110 IE & EngM students 48% will use snack fridge instead of going home Users average (2) drinks & (1) snack each week Mark-up is 10%, drink price is $.50, snacks $.75 School year averages 32 weeks Fridge costs $495, lasts 8 yrs, 8% cpd annually

If they save time & $$ on snacks & drinks, they can buy books , study more, and expect one of them to win a $5 500 national scholarship every 4 years. But the vending company will quit donating $300 per year to their Tech Society Perform a B/C analysis IE student perspective