Chapter 9

Benefit/Cost Analysis
 Public versus Private Projects

Characteristic Public Private

Size of Investment Large Small, medium, large
Life Longer (30 – 50+ years) Shorter (2 – 25 years)
Annual Cash Flow No profit (benefits) Profit-driven (revenues)
Funding Taxes, fees, bonds, etc. Stocks, bonds, loans, etc.
Interest rate Lower Higher (cost of capital)
Selection criteria Multiple criteria Primarily based on ROR
Environment of Politically inclined Primarily economic
evaluation
 Types of Contracts

• Fixed Price (lump sum) Govt often

funds, designs,
• Cost Reimbursable (cost-plus) and operates

• Design-build Contracts (BOT)

• Can be Design-Build-Operate-Maintain-
Finance (DBOMF) contract
• Developed through public-private
partnerships (PPP)
• Turnkey approach to a project
 Benefit/Cost Analysis

• Developed to maintain greater

objectivity into public sector projects
• When performed correctly, the B/C
analysis will always select the same
alternative as PW, AW, and ROR
analyses
 Definitions

• Costs (C): estimated expenditures to the

government entity for construction,
operation, and maintenance of the
project, less any expected salvage value
• Benefits (B): advantages to be expected
by the owners, the public
• Disbenefits (D): expected undesirable
consequences or disadvantages to the
owners if the alternative is implemented.
 Three Types of B/C Ratio

1. Conventional B/C Ratio = (B-D)/C

2. Modified B/C Ratio =
[(B-D)/C] / initial investment

3. Profitability Index (PI) =

(net cash flow) / (initial investment)
 Differences

• Conventional B/C Ratio = (B-D)/C

Here D are subtracted from B and not added to costs

• Modified B/C Ratio =

[(B-D)/C] / initial investment
Here all estimates associated with the project are
include once operational.
Maintenance & Operation (M&O) are included in D
 For Single Project

B - D
Conventional B/C ratio = If B/C ≥ 1.0,
C
accept project;
B – D – M&O otherwise, reject
Modified B/C ratio =
C
Denominator is
PW of NCFt initial investment
PI =
PW of initial investment
If PI ≥ 1.0,
accept project;
otherwise, reject
 Example

A flood control project will have a first

cost of $1.4 million with an annual
maintenance cost of $40,000 and a 10
year life. Reduced flood damage is
expected to amount to $175,000 per
year. Lost income to farmers is estimated
to be $25,000 per year. At an interest
rate of 6% per year, should the project
be undertaken?
 Summary

• B/C method used in public sector

project evaluation
• All benefits and disbenefits should be
expressed in monetary units
• Public projects do not necessarily
expect a profit
• Often public work is contracted to
private sector for implementation
 Practice Problems

• 9.1 • 9.20
• 9.4 • 9.24
• 9.8 • 9.58
• 9.9 • 9.61
• 9.12 • 9.62
• 9.16