Benefit Cost Analysis

• Typically used for public projects

The goal is to determine if benefits exceed costs: Benefit / Cost Ratio > 1 The goal is NOT to maximize B/C Ratio.
Interest rates used are typically lower than those used by businesses. • Typically 4% - 8% (6.5% is typical) • OMB requires 10% (except water proj.)
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even NFW – whichever is easier in a particular problem. 2 .Benefit Cost Analysis The challenge is to quantify the benefits and costs. The equation… B/C = (Benefits – Disbenefits) to the public (Costs) to sponsoring agency You can use NPW. EAW.

3. such as annual equivalent or present worth. 5. Specify the Discount Rate (MARR) to be used. If the B/C ratio is: >1 project is justified =1 barely justified – political <1 not justified 6. Define the planning horizon. 2. Compare the benefits to costs using a specified measure of worth.Benefit Cost Analysis Steps: 1. Develop the cost and benefit-disbenefit profiles in monetary terms. Repeat steps 3 – 5 for alternative viewpoints 3 . 4.

The cost of the expansion will be $700. Maintenance and renewal of the new addition and equipment will run approximately $100.Example A city library is to be expanded to include meeting rooms.000 people will visit the library each year. must the library visitors perceive in order to justify the expansion? 4 . with a residual value of 40% of first cost for the physical facilities.000/year. and electronic check-in and check-out. more electronic volumes. There is no salvage value for the equipment. The library is projected to be in operation for 20 years. How much additional benefit per person. Discount is 8%. per year.000.000 and the new equipment will cost another $175. computer facilities. An estimated 150.

Perspective Matters Suppose the library charged an annual fee Suppose the entire county sponsored The equation… B/C = (Benefits – Disbenefits) to public (Initial Investment) by sponsor What is the viewpoint of a user? What is the viewpoint of a non-user? 5 .

7 .Incremental B/C Analysis MUST be used when there are multiple alternatives to choose from! The equation is still… B/C = (Benefits – Disbenefits) to the public (Costs) to sponsoring agency You can use Incr. EAW – whichever is easier in a particular problem. NPW or Incr.

3. capitalized cost. public sector alternatives to be compared. 2. Specify the MARR to be used. If the B/C ratio is: >1 ≤1 higher cost project is justified lower cost project is still justified 8 . Develop the cost and benefit-disbenefit profiles in monetary terms for each alternative. Order the alternatives from smallest to largest Cost 6. Define the set of feasible. such as annual equivalent. Define the planning horizon. 5. Compare the alternatives using a specified measure of worth. or present worth (with matching lifetimes).Incremental B/C Analysis Steps: 1. mutually exclusive. 4.

6 G 89 14 50 1.7 B 180 60 120 C 136 10 90 D Not Feasible 80 8 80 E 136 10 70 F 178 2 110 1.5 (136 – 89) – (10 – 14) = 51 = 2.9 1.Incremental Benefit Cost Analysis Example A Benefits Disbenefits Costs B–D C E – G: C – E: A – E: 174 4 100 1.47 .4 0.5 1.8 Cost Order: G E C A F B G – DN: (From feasibility.55 (70 – 50) 20 (136 – 136) – (10 – 10) = 0 = 0 Upgrade to G Upgrade to E Keep Proj. (B – D) / C = 1. E Upgrade to A (90 – 70) (100 – 70) 20 30 (174 – 136) – (4 – 10) = 44 = 1.0 1.

5 1.8 Cost Order: G E C A F B (178 – 174) – (2 – 4) = 6 = 0.5 20 Keep Proj.Incremental Benefit Cost Analysis Example A Benefits Disbenefits Costs B–D C F – A: B – A: 174 4 100 1.7 B 180 60 120 C 136 10 90 D Not Feasible 80 8 80 E 136 10 70 F 178 2 110 1. A Best is Proj A .9 1.4 0.0 1.6 (110 – 100) (120 – 100) 10 (180 – 174) – (60 – 4) = – 50 = – 2.6 G 89 14 50 1.

drink price is $. lasts 8 yrs.Bonus Problem: B/C Build-Up Example  Snack Fridge Viability Data: 110 IE & EngM students 48% will use snack fridge instead of going home Users average (2) drinks & (1) snack each week Mark-up is 10%.75 School year averages 32 weeks Fridge costs $495. 8% cpd annually If they save time & $$ on snacks & drinks.50. study more. and expect one of them to win a $5 500 national scholarship every 4 years. But the vending company will quit donating $300 per year to their Tech Society Perform a B/C analysis – IE student perspective . they can buy books . snacks $.

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