It is about the benefits by cost ratio which depends up on the economic impact

1. ENGINEERING ECONOMICS
Chapter 9
Economic Analysis in Public Sector
9.1 Social Costs & Social Benefits
9.2 Benefit Cost Analysis (B/C Ratio)
Rajesh Bhattarai
Paschimanchal Campus
Ashad 17, 2078
Class No. 19

2. 2
Benefit-Cost Analysis
The objective of private investment is to increase
the net worth of the company.
In the public sector, government spend a lot of
money in projects such as education, road
construction, hydro-power plants etc. to increase
net public benefits.
Benefit-Cost Analysis is a decision-making tool
for systematically developing useful information
about the desirable or undesirable effects of a
public project.
Benefit-Cost Analysis tries to determine whether
the social benefits are greater than social costs.

3. 3
There are three types of benefit-Cost
Analysis problems
1. to maximize benefits over any costs
2. to maximize net benefits when
benefits and costs vary
3. to minimize costs to get a certain
level of benefits

4. Benefit-Cost Ratio Analysis
1. Identify users' benefits from the project
2. Quantify, as much as possible, in Rupee term
3. Identify sponsors' costs
4. Quantify, as much as possible, in Rupee term
5. Determine the equivalent benefits and costs at the
base period using the social interest rate
4

5. 5
Social benefits and Social costs
Social Benefits
1. Benefits due to reduction of deaths
2. Benefits due to reduction of damage to property
3. Primary users' disbenefits
Social Costs
1. Primary Sponsors' costs
2. Primary Sponsors' savings
B -C should be positive
2 1
1
B B 
 B DB
1
 S
1
C  C

6. Benefit-Cost Ratio Analysis
6. If BC (i) >1 we should accept a public project
sponsor's costs (C) consist of the equivalent capital expenditure ( I )
and the equivalent annual operating costs (C') accrued in each
successive period
6

7. Net B/C Ratio
• considers only the initial capital expenditure as a
cash outlay, and uses annual net benefits.
If we are to accept a project, the B'C(i) must be greater
than 1
some analysts prefer this measure because, it indicates
the net benefit (B') expected per dollar invested
7

8. Example
A public project being considered by a local government
has the following estimated benefit-cost profile
Assume that i = 10%, N = 5.
Compute B, C, I, C', BC(10%) and B'C(10%).
8

9. 9

10. Benefit-Cost Ratio
10
Net Benefit-Cost Ratio
Project is economically viable or profitable

11. Relationship Between
B/C Ratio and NPW
Both gives same result
11

12. 12
Incremental Analysis based on BC(i)
Consider three investment projects, A1, A2, and A3. Each
project has the same service life, and the present worth of
each component value (B, I, and C') is computed at 10% as
follows.
(a) If all three projects are independent, which projects would
be selected based on BC(i) and B'C(i) criteria, respectively?
(b) If the three projects are mutually exclusive, whichproject
would be the best alternative? Show the sequence of calculations
required to produce the correct results, using (1) the aggregate BIC
ratio, and (2) the netted BIC ratio.

13. Solution
(a) Since PW(i)1, PW(i)2, and PW(i)3 are positive,
all projects would be acceptable if they were
independent.
Also, BC(i) and B'C(i) values for each project are greater
than 1, so the use of either ratio will lead to the same
accept-reject conclusion under the NPW criterion.
13
A1 A2 A3
BC (i)=B/I+C’ 12/(5+4)=1.33 35/(20+8)=1.25 21/(14+1)=1.40
B’C(i)=B-C’/I (12-4)/5=1.60 (35-8)/20=1.35 (21-1)/14=1.43

14. (b) If these projects are mutually exclusive, we must
use the principle of incremental analysis.
1. Remove any alternatives with a BIC ratio less than 1
2. Arrange the remaining alternatives in the increasing
order of the denominator (I + C').
Thus, the alternative with the smallest denominator should
be first (j), the alternative with the next smallest second (k),
and so forth.
14

15. 15
3. Compute the incremental differences for each term (B,
I, and C') for the paired alternatives j, k) in the list.
Select A1 and A3 as they have least denominator(cost)
4. Compute the BC(i) on incremental investment by evaluating
Since the ratio is greater than 1, we prefer A3 over A1.Therefore,
A3 becomes the "current best" alternative.

16. 5. Compare the selected alternative with the next one on the list by
computing the incremental benefit-cost ratio. Continue the process
until you reach the bottom of the list. The alternative selected during
the last pairing is the best.
Therefore, we need to compare A2 and A3 as follows:
The incremental B/C ratio again exceeds 1, and therefore we prefer
A2 over A3.
16

17. Using the net B/C (B'C(i)) ratios:
If we had to use the net BIC ratio on this incremental investment
decision, we would obtain the same conclusion.
Since all B'C(i) ratios exceed 1, there will be no do-nothing alternative.
By comparing the first pair of projects on this list, we obtain
Project A3 becomes the current best.
Next, comparing A2 and A3 yields
Therefore, A2 becomes the best choice by the net BIC criterion.
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18. Exam 2076
Consider the three investment projects A,B and C , each projects has the same service
life and the present worth of each component value (B, I and C’) is computed at 10% is
as follows:
i) If all the projects are independent, which projects would be selected based on
benefit cost ratio.
ii) If the three projects are mutually exclusive, which projects would be the best
alternative? Use the B/C ratio on incremental investment.
Description A B C
Initial Cost (I) 5000 20000 14000
Total Benefits (B) 12000 35000 21000
Total O & M Costs (C’) 4000 8000 1000
PW(i) NRs. 3000 NRs. 7000 NRs. 6000

19. 19
Tutorial:Ex. 075
A city government is considering two types of mutually exclusive town-
dump sanitary system. Design A requires an initial outlay of NRs.
400,000, with annual operating and maintenance costs of NRs.
500,000 for the next 15 years: design B calls for an investment of
NRs. 3,000,000 with annual operating and maintenance costs of NRs.
800,000 per year for the next 15 Years. The residents would gain
benefits equivalent to NRs. 85,000 per year. The interest rate is 8%, and
there is no salvage value associated with either system.
a) Using the benefit cost ratio which system should be selected?
b) Using the net benefit cost ratio which system should be selected?
c) If a new design(Design C) , which requires an initial outlay of NRs.
3,500,000 and annual operating and maintenance cost of NRs.
650,000 is proposed, would your decision given in part a) change?
Use benefit cost ratio analysis.

20. Tutorial:Ex. 072
Particulars X Y Z
Initial Cost 8,000,000 10,000,000 15,000,000
Annual Power sales
Revenue
1,000,000 1,200,000 1,800,000
Annual Flood Control
Savings
250,000 350,000 500,000
Annual Irrigation
Benefits
350,000 450,000 600,000
Annual Recreation
Benefits
100,000 200,000 350,000
Annual O & M Costs 200,000 250,000 350,000
The estimated benefits and cost expected to be derived from the three
alternatives under consideration are listed in the above table:
At the interest rate is 10% and the life of the projects is estimated to be 40
years
a) Find the B/C ratio of each project
b) Find the Net B/C ratio of each project
c) Select the best alternatives based on incremental benefit cost ratio method

21. Tutorial
Three public investment alternatives with the same service life are available: A,B & C.
Their respective initial investments , total benefits , and total costs are given in present
worth as follows (in million NRs.)
Select the best alternative based on incremental benefit-cost ratio method. Discuss the
result.
A B C
Initial Cost (I) 100 300 200
Total Benefits (B) 400 700 500
Total O & M Costs (C’) 100 200 150

22. Tutorial
Government of Nepal is planning to invest in single irrigation project among the three
available choices of irrigation projects in the coming year. The details of the available
choices of the projects are given below (all costs are given in thousands NRs.)
The interest rate is 10% and the life of each of the project is 30 Years.
Select the best alternative based on incremental benefit-cost ratio method. Discuss
the result.
Kabeli Betrawati Sunkoshi
Initial Cost (I) 18000 20000 25000
Total Benefits (B) 3700 4250 5200
Total O & M Costs (C’) 1200 1250 1350

23. Tutorial
A city which operates automobile parking facilities is evaluating aproposal
that it erect and operate a structure for parking in a city's downtown area.
Three designs for a facility to be built on available sites have been identified.
(All dollar figures are in thousands.)
At the end of the estimated service life, whichever facility had been
constructed would be torn down and the land would be sold. It is estimated
that the proceeds from the resale of the land will be equal to the cost of
clearing the site. If the city's interest rate is known to be 10%, which
design alternative would be selected based on the benefit-cost criterion?