Benefit / Cost Ratio Method

Project management

Pragya Pancholi
Srishti Jain
B.Arch, X-Sem.
The Benefit Cost Ratio (BCR), also referred to as Benefit-to-Cost Ratio is an indicator that is typically used
within a cost benefit analysis. In project management, the benefit cost ratio can support the cost-benefit
analysis of a business case.

Benefit Cost Ratio -A benefit-cost ratio (BCR) is a ratio used in a cost-benefit analysis to summarize the
overall relationship between the relative costs and benefits of a proposed project. BCR can be expressed
in monetary or qualitative terms. If a project has a BCR greater than 1.0, the project is expected to deliver
a positive net present value to a firm and its investors.
In simple terms-

Benefit / Cost Ratio = Benefits - Disbenefits

Costs
• Benefits are advantages, expressed in terms of a monetary value to the owner. i.e. Rupees,
dollars, etc.
• Disbenefits are disadvantages, expressed in terms of a monetary value to the owner. i.e.
Rupees, dollars, etc.
• Costs are anticipated expenditures for construction, operation and maintenance, etc.
 • A benefit-cost ratio (BCR) is an indicator showing the relationship between the relative costs
and benefits of a proposed project, expressed in monetary or qualitative terms.
• If a project has a BCR greater than 1.0, the project is expected to deliver a positive net present
value to a firm and its investors.
• If a project's BCR is less than 1.0, the project's costs outweigh the benefits, and it should not
be considered.

What Does a BCR < 1 Indicate?

The present value of the benefits in a series of cash flows is lower than the present value of the
corresponding costs. The lower the BCR, the higher the excess of discounted costs compared to the
discounted benefits.

What Does a BCR = 1 Indicate?

The present value of benefits of a series of cash flows equals the likewise discounted costs. In this
situation there is no profit no loss, this situation is obviously more preferable than options with a BCR
lower than 1 It. However, if there are alternatives with a benefit-to-cost ratio exceeding 1, they are likely
to be favored.

How Is a BCR > 1 Interpreted?

This value range indicates that the discounted benefits exceed the present value of the costs and
investments. The general rule is that the higher the BCR the greater the profit an investment option or
project is expected to generate.
 Advantages and Disadvantages of the Benefit-to-Cost Ratio
Pros
The BCR translates the absolute amounts of
benefits and costs into a ratio
It facilitates the comparison of different investment
or project alternatives
The ratio helps interpret the ‘inherent riskiness’ of
forecasted net cash flows and profitability, e.g. in
cases where small profit margins are prone to a
higher risk while large margins offer a buffer for
price adjustments
It considers the value of cash flows in relation to the
time of their occurrence
Cons
The BCR alone does not indicate the liquidity /
funding aspects of the analyzed options, e.g. an
option may require large investments and expenses
in earlier periods while producing returns in far later
stages
It is subject to various assumptions for the discount
rate, residual value and cash flow forecast. These
assumptions can significantly impact the outcome
of a benefit cost analysis without considering the
inherent insecurities of these parameters
Simply following a rule that above 1.0 means
success and below 1.0 spells failure is misleading
and can provide a false sense of comfort with a
project.
The BCR must be used as a tool in conjunction with
other types of analysis to make a well-informed
decision.
How is Benefit / Cost Ratio Calculated
The BCR Formula - The benefit cost ratio is calculated by dividing the present value of benefits by that of
costs and investments.

where:
The calculation of the BCR requires 3
BCR = Benefit Cost Ratio
input parameters for each period:
PV = Present Value
CF = Cash Flow of a period (classified as benefit and cost, respectively)
• cash flows (benefits),
i = Discount Rate or Interest Rate
• cash flows (costs), and
N = Total Number of Periods
• interest or discount rate.
t = Period in which the Cash Flows occur

Conclusion
The benefit cost ratio is a common indicator of the profitability of a potential investment or project.
While it does not cover all aspects of a cost benefit analysis, it indicates whether an option is beneficial.
As the BCR compares discounted benefits with discounted costs, it offers a good indication of how big a
‘buffer’ between benefits and costs is. However, like all other indicators, the BCR should not be used as
the only basis for project or investment decisions given that it only covers certain aspects of a project
option.
Example -
The present value of the proposed benefits of a project is $17,80,000. The costs which are incurred
upfront are $10,00,000. Calculate the benefit-cost ratio. Should this project be undertaken based on a
benefit-cost ratio?

Solution-