1. EVALUATING PROJECTS WITH THE BENEFIT / COST RATIO METHOD
CHAPTER 11
EVALUATING PROJECTS WITH THE
BENEFIT / COST RATIO METHOD

2. Objective of This Chapter
Objectives
To describe characteristics of public projects
To learn how to use the B/C ratio method as a criterion for project selection
Public Projects
Public projects are those authorized, financed, and operated by federal, state, or local governmental agencies

3. Differences Between Private And Public Projects
Purpose
Private Project -- Maximize profit, minimize costs
Public Project -- Offer social benefits (i.e., health, employment) without profit
Capital Sources
Private Project -- Private investors and lenders
Public Project -- Taxation; Private Lenders, bonds
Multiple Purposes
Private Project -- Moderate
Public Project -- More frequently common (i.e., reservoir projects for: flood control, power source, irrigation, recreation)

4. Private And Public Projects-Cont.
Project Life
Private Project – Short -- 5 to 20 years;
Public Project – Long to 60 years
Nature Of Benefits
Private Project-Monetary or near monetary
Public Project-Non-monetary; difficult to equate to monetary terms
Conflict Of Interests
Public Project -- More common for public projects (i.e., intra-agency conflicts)
Private Project--Moderate
Efficiency Measurement
Private Project -- Rate of Return on capital
Public Project – Very difficult, no direct comparison with private projects

5. Benefits, Costs, And Disbenefits
Benefits - The favorable consequences of the project to the project sponsors (i.e., the public for public projects)
Costs -- Monetary disbursements required (i.e., of the government for public projects)
Disbenefits -- The negative consequences of the project to the project sponsors
The Roots Of The Benefit/cost Ratio
The benefit/cost ratio method, which is normally used for the evaluation of public projects, has its roots in federal legislation
Specifically, the Flood Control Act of 1936 requires that for a federally financed project to be justified, its benefits must be in excess of its costs.

6. Difficulties In Evaluating Public Sector Projects
No profit standard as a measure of effectiveness
Difficult to quantify monetary impact of benefits
Profit motive as a stimulus for effectiveness is absent
More legal restrictions with public projects
Greater difficulty in obtaining capital for public projects
Selection of interest rates controversial and politically sensitive

7. B/C Formulations
Conventional
Modified B/C

8. Decision Rule , or B/C IF B/C ratio (=>) 1.00
Conditionally accept the alternative
IF B/C ratio (<) 1.00, conditionally reject the alternative
IF B/C ratio “close” to 1.00 then intangible factors may sway the decision to accept or reject

9. Notes Regarding Signs By convention: Revenues are assigned (+) signs
Costs are assigned (+) signs
Salvage values are subtracted from costs
Disbenefits are treated more than one way
Disbenefit values are subtracted from benefits
Disbenefit values are added to costs
Either approach will result in a consistent analysis – but be consistent through out an analysis

10. Example 11-2, page 471
The city of Bugtussle is considering extending the runways of its Municipal Airport so that commercial jets can use the facility. The land necessary for the runway extension is currently farmland, which can be purchased for $350,000. Construction costs for the runway extension are projected to be $600,000, and the additional annual maintenance costs for the extension are estimated to be $22,500. If the runways extended, a small terminal will be constructed at a cost of $250,000. The annual operating and maintenance costs for the terminal are estimated at $75,000. Finally, the projected increase in flights will require the addition of two air traffic controllers, at an annual cost of $100,000. Annual benefits of the runway extension have been estimated as follows:
$325,000 rental receipts from airlines leasing space
$65,000 airport tax charged to passengers
$50,000 convenience benefits for residents of Bugtussle
$50,000 additional tourism dollars for Bugtussle
Apply B/C ratio method with a study period of 20 years and I = 10%.

11. Solution Conventional B/C using PW: Modified B/C using PW:
B/C = PW(B)/[I + PW (O&M)]
B/C= (P/A,10%,20)/[ (P/A,10%,20)]= 1.44
Modified B/C using PW:
B/C = [PW (B) – PW (O&M]/I
B/C=[490,000(P/A,10%,20) (P/A,10%,20)]/ =2.07
Conventional B/C using AW:
B/C = AW(B)/[CR + AW (O&M)]
B/C = $490,000/[$1,200,000 (A/P, 10%, 20) + $197,500]= 1.448
Modified B/C using AW:
B/C = [AW (B) – AW (O&M]/CR
B/C = [$490,000 + $197,500]/$1,200,000 (A/P, 10%, 20)=2.075

12. Comparison Of Mutually-exclusive Projects By B / C Ratios
When using equivalent worth methods to select among mutually-exclusive alternatives (MEAs), the best alternative selected by maximizing PW, AW, or FW.
When using B / C method, no direct measure of each project’s profit potential is provided.
Use incremental cash flow analysis