CHAPTER 7

Benefit/Cost Analysis and Public Sector

Economics
 Public Sector
A public sector project is a product, service, or system
used, financed, and owned by the citizens of any
government level. The primary purpose is to provide
service to the citizenry for the public good at no profit.
• Hospitals and clinics
• Parks and recreation
• Utilities: water, electricity, gas, sewer, sanitation
• Economic development projects
• Schools: primary, secondary, community colleges, universities
• Convention centers
• Sports arenas
• Transportation: highways, bridges, waterways
 Public Sector
A public sector project is a product, service, or system
used, financed, and owned by the citizens of any
government level. The primary purpose is to provide
service to the citizenry for the public good at no profit.
• Police and fi re protection
• Courts and prisons
• Food stamp and rent relief programs
• Job training
• Public housing
• Emergency relief
• Codes and standards
 Benefit/Cost Analysis
• Costs—estimated expenditures to the government entity
for construction, operation, and maintenance of the
project, less any expected salvage value.
• Benefits—advantages to be experienced by the owners,
the public.
• Disbenefits—expected undesirable or negative
consequences to the owners if the alternative is
implemented. Disbenefits may be indirect economic
disadvantages of the alternative.
 Benefit/Cost Analysis
The benefit/cost ratio is relied upon as a fundamental analysis method for public sector
projects. The B/C analysis was developed to introduce greater objectivity into public sector
economics, and as one response to the U.S. Congress approving the Flood Control Act of
1936.
B/C = Annu al Benefit-To-Cost ratio =
C = annual cost =

where: FC = first cost

SV = salvage value
n = useful life
OM = annual operation and maintenance
i = interest rate
B = annual benefits
Note: B/C should be greater than 1 for the project to be justifiable.
 Benefit/Cost Analysis
Benefit / Cost without given Salvage Value:
B/C =

Where: Present Value of Benefits =

Present Value of Cost = FC

= annual benefit
OM = annual maintenance cost
FC = First/Initial Cost
r = interest rate
n = useful life
 Example
1. A machine has an initial cost of P40,000 and an annual
maintenance cost of P5,000. Its useful life is 10 years and
salvage value of P8,000. The annual benefit from
purchasing the machine is P16,000. The effective annual
interest rate is 10%. What is the machine's benefit cost
ratio?
 Solution
Let: C = annual equivalent cost
C=
C=
C = P6,007.85
B/C =
B/C =
B/C = 1.83
 Bond Value
Bond Value - Is a certificate of indebtedness of a corporation
usually for a period of not less than 10 years and guaranteed by a
mortgage on certain assets of the corporation or its subsidiaries.
P = Present Value of bond =

where: A = periodic dividend = Fr

P = present value of bond
F = face or par value
r = bond rate per period
n = no. of periods
i = investment rate per period
C = redeemable value ( usually equal to par value)
 Examples
1. A man wants to make 14% nominal interest compounded
semi-annually on a bond investment. How much should the
man be willing to pay now for a 12%, P10,000 bond that will
mature in 10 years and pays interest semi-annually.

2. A $1000 face-value bond pays dividends of $110 at the

end of each year. If the bond matures in 20 years, what is
the approximate bond value at an interest rate of 12% per
year, compounded annually?
 Solutions
1. A = Periodic Divident = (F)(r)
A = (P10,000)( = P600
P=
where: i=
n = 10(2) = 20 years
C = F = P10,000
P=

P = 8,940.60
 Solutions
2. P =
P = (110)
P = 925.31