Solving Typical FE Problems

What to do: Find the Benefit/Cost Ratio

How to do it: The benefit/cost ratio (B/C) is an economic analysis technique used commonly, especially by
governmental agencies. In its purest form, the numerator B consists of economic consequences to
the people (i.e., benefits and disbenefits), while the denominator C consists of consequences to the
government (i.e., costs and savings). The units in the calculation can be present worth, annual worth,
or future worth dollars, as long as they are the same in the numerator and denominator. A B/C ratio
equal to or greater than 1 indicates that the project is economically attractive. If disbenefits are
involved, they are substracted from the benefits; if government savings are involved, they are
subtracted from the costs. The general B/C is:

In B/C analysis, costs are not preceded by a minus sign.

Example #21: A federal agency is considering expanding a national park by adding recreational
facilities. The initial cost of the project will be $1.5 million, with an annual upkeep cost of $50,000.
Public benefits have been valued at $300,000 per year, but disbenefits of $200,000 (initial cost) have
also been recognized. The park is expected to be permanent. At an interest rate of 6% per year, the
B/C ratio is closest to:

a. 0.71
b. 2.06
c. 2.50
d. 3.57

Solution: Annual dollars will be used (arbitrarily chosen over PW or FW) to determine the B/C ratio.
Use A = Pi to convert present worth estimates to annual worth values.

Instead of dividing the benefits by the cost to obtain a B/C ratio, the costs could be substracted from
the benefits (B - C) to obtain the difference between them. If this procedure is followed, a (B - C)
difference of zero or greater indicates economic attractiveness.