MSREE Lecture 10 Amrit Nakarmi Economics of Energy Projects CES 07 Aug 2011

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Benefit Cost Analysis

The objective of private investment is to increase the

net worth of the company In the public sector, government spend a lot of money on projects such as education, health, infrastructure road construction, airport construction, water pipeline, irrigation systems, and hydropower plants etc.

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Benefit Cost Analysis

Benefit cost Analysis is a decision-making tool for

systematically developing useful information about desirable or undesirable effects of a public project. Benefit-cost Analysis tries to determine whether the social benefits are greater than social costs.

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Benefit Cost Analysis

There are three types of benefit cost Analysis To maximize benefits over any costs To maximize net benefits when benefits and costs vary To minimize costs to get a certain level of benefits

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Framework of Benefit cost Analysis

Identify users benefits from the projects Quantify, as much as possible, benefits in Rupee term Identify sponsors costs Quantify, as much as possible, social costs in Rupee term Determine the equivalent benefits and costs at the base period using social interest rate Accept the project if the equivalent users benefits exceed the sponsors costs
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Social Benefits
Benefits due to reduction of deaths
Benefits due to reduction of damage to property Primary users disbenefits (need to be deducted)

B =B1 + B2- DB

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Social Costs
Primary sponsors costs
Primary sponsors savings ( need to be deducted)

C =C1 + C2- S

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Benefit Cost Ratio

We need to consider social benefits and costs of

primary effects and secondary effects B C should be positive

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Benefit Cost Ratio

If B and C are the present values of benefits and costs, then B = Bn (1+i)-n C = Cn (1+i)-n The sponsors costs consist of the equivalent capital (I) and equivalent annual operating costs (C), then

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Benefit Cost Ratio

I = cn (1+i)-n C = Cn (1+I)-n Here, C =I+C BC(i) = B/C= B/(1+C)>1 An alternative measure, net B/C =(B C)/I>1, where I>0

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Incremental Analysis
For selecting public projects from mutually exclusive

projects, we must do incremental analysis. Computing the incremental differences for each of B, I, and C B =Bk Bj I =Ik Ij C =Ck Cj

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Incremental Analysis
BC (i)k-j = B/(I+ C) >1, then select project k If I+ C =0, we cannot use this formula

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Assignments (chapter 17)

Page: 822 17.1 to 17.4, 17.6, 17.7, 17.9

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