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Benefit/Cost Analysis and Public Sector Projects

Hello Class,

We are now in chapter 7 of an 8 chapter course. So if you made it this far you are most
likely to complete the course, hopefully with a good grade, As I have said before this
course will be invaluable to you in years to come. Hopefully you can see some of that
now and how it applies to your personal life as well.

This chapter introduces public sector alternatives and their economic consideration.
There are substantial differences in how we treat the economic evaluation. Public sector
projects can also be a collaboration of government and private. In this day and age this
is becoming more prevalent. When we complete this chapter identify the differences
between public and private as far as economics are concerned. We will also be doing
benefit/cost (B/C) analyzation for single projects You will be able to to select the best
among alternative solutions to the problem. Finally we will use a spreadsheet to perform
a B/C.

Public sector projects differ in that provide a service to the community at no profit.

There is a table on page 183 that is well worth your time to read. It gives some of the
items that make public sector projects different for economic purposes, like an infinite
life.

1. Costs estimated expenditures to the government entity for construction,


operation and maintenance of the project, less any salvage
2. Benefits advantages to be experienced by the owners, the public, Benefits
can include revenues and savings
3. Disbenefits expected undesirable consequences that are inherent to owners
if the alternative is selected. The examples in this chapter include straight
forward identification of benefits and costs. This is not aleays the case in
public projects.
4. Funding Usually if the form of taxes, bonds, private funds.
5. Interest rates Are generally lower than in the private sector.
6. Selection criteria Multiple criteria again is broader than in the private sector
and are primarily based on MARR
7. Environment This can be very political and sometimes be the primary
mover.

The viewpoint of the public sector analysis must be determined before cost, benefit and
disbenefit estimates are made.
In problem #1, page 186 it is necessary to list the economic benefits, with estimates,
before we define the alternatives to the project. There is a lot of subjectivity to these
projects. You would start with a barnstorming method to develop the alternatives.
Sometimes this is not clear. One reason that a public project partnership,(PPP) is
beneficial is that the private sector usually is concerned with cost and profit. The public
sector is not interested in profit. So when the two combine some interesting alternatives
can develop. It might also mean that the contractor will build, maintain and run the
project for several years before they turn over ownership to the public sector. Engineers
are involved in a wide range of public projects. Generally they are broken down into 2
categories:

1. Policy making These can include such things as strategy development. This
can include a contractor being hired to do a feasibility study or to develop a 10
year master plan for a college. This is typical of a PPP. 7.1.2 goes into further
depth as far as the possible options in this area.
2. Planning This includes project development and oversight. Again 7.1.2 goes
into definitive detail.

Of course any of these projects assumes that the engineer, or engineering firm comply
with the code of ethics. Refer to chapter one for a summary of these. An example is that
when an architectural firm develops the plan, they can specify a certain window that
only one manufacturer can supply, or give a general specification so that many
manufacturers open to bid on. I have seen where specs are so tight that they preclude
all but one manufacturer to provide the goods in the spec. Usually that manufacturer
has a relationship with the architect. (clearly a violation of the code). Sometimes there
is only one manufacturer that can meet the general standard. This is true in some very
sophisticated equipment.

Benefit/Cost Analysis of a single project.

The development of Benefit/Cost analysis has several possible scenarios. However, it


was developed to introduce more objectivity into public sector projects. The B/C is
calculated using one of these relations.
PW of venefits AW of benfits FW of Benefits
B/C = PW of costs = AW of Costs = FW of Costs

The sign convention for B/C analysis is positive signs, so costs are positive while
salvage is negative and subtracted from costs.Disbenefits are generally subtracted from
benefits and placed in the numerator.

The different formats are shown below:


If B/C 1.0 Accept the project as economically feasible for the estimates
and the discount rate applied.

If the B/C is < 1.0 The project is not economically acceptable.

The conventional B/C ratio most widely used subtracts disbenfits from benefits:
benefitsdisbenefits BD
B/C = Cost = C

Modified B/C ratio adds Maintenance and operating costs to the numerator.
BenefitsdisbenefitsM & 0
Modified B/C = initial investment

Salvage value is included in the denominator with a negative sign

Problem 7.2 is straight forward. Just make sure that you list all the variables correctly
and it is only a division problem. Make sure that you use A/P to get your answer.

Incremental B/C Evaluation of Two or more Alternatives.

Incremental B/C incremental analysis is very similar to the ROR analysis in chapter 6.
The incremental B/C ratio, B/C is based upon PW, AW, or FW equivalency.

If B/C 1 select the larger cost alternative.

Otherwise select the lower cost alternative.

Note that the decision is based on incrementally justified total cost not incremental
justified initial cost. Like ROR B/C requires equal service comparison. When they are of
unequal lives it is necessary to use the LCM method of adjustment. Ordering of
alternatives is done by total costs in the denominator of the equation.

You have two other considerations in the B/C analysis, usage costs estimates or direct
benefits estimates. Usage cost estimates have implied benefits based on the difference
in costs between alternatives. Direct benefits have alternatives have benefit amounts
estimated.

Usage Costs Evaluate alternatives only against each other

Direct Benefit First evaluate against do nothing, then against each other.

The following procedure is used for comparing multiple, mutually exclusive alternatives
using the B/C ratio.

1. For each alternative, determine the equivalent PW, AW or FW values for costs C,
benefits B, and disbenefits D, if considered.
2. Order the alternatives by increasing equivalent cost. For direct benfit alternatives
, add DN as the first alternative.
3. 3. Determine the incremental costs and benefits between the first two ordered
alternatives. (That is 2 3) over their LCM of lives. For usage cost alternatives,
incremental benefits are determined as the difference in usage costs.
B = usage cost of 2 usage cost of 1
4. Calculate the incremental conventional B/C ratio.
a. B/C = ( B D)/C
5. If B/C =1 eliminate 1, 2 is the survivor otherwise 1 is the survivor.
6. Continue to compare alternatives using steps 2 through 5 until only one
alternative is left.

Do example 7.3 and 7.4

Using Spreadsheet for B/C Analysis

Formatting a spreadsheet to apply incremental B/C procedure for mutually exclusive


alternatives is basically the same as ROR.(section 6.8). Once all estimates are
expressed in PW, AW, or FW equivalents using spreadsheet functions, the alternatives
are ordered by Increasing Total Equivalent Costs. Then, use the incremental B/C ratios
from equation 7.5. are used to select the best alternative.

Public Sector economics are substantially different from those in the private sector. For
public sector projects, the initial cost is high, the expected life is long and the sources
for capital are usually a combination of taxes, user fees, bond issues and private
lenders. It is very difficult to make accurate estimates of benefits and disbenefits. The
discount rates are generally lower than for corporate projects.