1 by assoc. prof. dr. ahmet ÖztaŞ gaziantep university department of civil engineering ce 533 -...
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By
Assoc. Prof. Dr. Ahmet ÖZTAŞ
Gaziantep UniversityDepartment of Civil Engineering
CE 533 - ECONOMIC DECISION ANALYSIS IN CONSTRUCTION
CHP 7 -Benefit/Cost Analysis and Public
Sector Projects
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CHP 7. Benefit/Cost (B/C) Analysis
1. Public Versus Private Sector Projects
2. Benefit/Cost Analysis
3. Incremental B/C Evaluation of Two or More Alternatives
4. Using Excel for B/C Analysis
Topics
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Learning Objectives
7.1 Public Sector Analysis
7.2 Benefit Cost Analysis
7.3 Alternative Selection
7.4 Spreadsheets
Using theB/C
RatioApproach
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7.1 Public versus Private Sector Projects
• Public Sector:
• Ownership – by citizens- the public
• Public Sector Projects:
• Provide needed services to the public and “no profit”
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7.1 Types of Projects
• Hospitals
• Parks and recreation facilities
• Highways, dams, bridges
• Courts, schools, prisons
• Public housing
• Many other types
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7.1 Characteristics – Compared
Characteristic Public Sector Private Sector
Size of Investment
Larger Some Large; medium to small
Life Estimates
Quite Long: 30-50 years
Shorter:2-25 years
Annual Cash Flow Estimates
No Profit: costs and benefits
Revenues – profit cost estimates
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7.1 Attributes
• Public Sector Projects do not have “profits”.
• Projects can have certain undesirable consequences associated
• Thus, can be controversial in nature
• Draw media attention – debated on pros and cons
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7.1 Estimating for Public Projects: Costs
• Basic elements for public projects:
• Costs
• Construction, operations, maintenance less est. salvage values
• Initial costs fairly well know
• Future O&M are less known and must be estimated
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7.1 Estimating: Benefits
• BENEFITS to the public (users) must be estimated in terms of periodic dollar values
• Very difficult to do
• Benefits = the advantages to the public stated in $$
• Owners – generally the public
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7.1 Estimating: Disbenefits
• Disbenefits
• Expected undesirable (negative) consequences to the owners (public)
• Assuming the project is undertaken
• May be indirect economic disadvantages to the public
• Very hard to estimate and convert to $ amounts
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7.1 General Principle
• For public projects we find:
It is very difficult to estimate and reach agreement on the economic
impacts of benefits and disbenefits for public sector projects.
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7.1 Funding Sources – Compared
Characteristic Public Sector Private Sector
Funding Taxes, fees, bonds, pvt. funds
Sale of new stock, bonds, loans, ret. earnings
Interest Rate Tends to be lower
Higher: At market cost
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7.1 Funding Public Projects
• Generally low interest charges
• Public entities do not pay taxes
• Project investments basically backed by public agencies
• Cost-sharing arrangements often exist
• Less perceived risk with public projects
• Interest rate is determined differently than in the private sector: Called the social discount rate
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7.1 Additional Comparisons
Characteristic Public Sector Private Sector
Selection criteria
Multiple or many
Rate of return or present value
Environment of the evaluation
Political arena
(debated, pressure groups)
Primarily economic
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7.1 Selection Process
• Not as “clean” as in the private sector
• Involves interest and pressure groups
• Often draws media attention
• Involves many different viewpoints:
• Citizen
• The tax base
• Number of students in the school district
• Creation and retention of jobs.
• Economic development potential
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7.1 Evaluation Process
• The viewpoint finally adopted will:
• Determine the estimates of..
• Costs
• Benefits
• Disbenefits
• Note: the viewpoint must be established before the economic evaluation
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7.2 B/C Analysis – Single Project
• Historical Point
•B/C analysis philosophy was instituted and promoted by the Flood Control Act of 1936
•Introduced to promote a sense of objectivity in an analysis
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7.2 B/C Formulations
• Assignable life, N - years
• Estimate costs ($)
• Estimate benefits in ($)
• Estimate disbenefits in ($)
• Assign an interest rate – i (%/year)
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7.2 B/C Formulations
• Then convert all amounts to either a
• Present Worth – PW(i%)
• Annual Worth – AW(i%)
• Future Worth – FW(i%)
• Then calculate a B/C ratio in one of three ways…..
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7.2 B/C Ratios: 3 Formats
( )/
(cos )
PW benefitsB C
PW ts
( )
(cos )
AW benefits
AW ts
• Three acceptable formats are:
( )
(cos )
FW benefits
FW ts
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7.2 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
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7.2 Handling Disbenefits
1. Disbenefit values are subtracted from benefits
2. Disbenefit values are added to costs
3. Either approach will result in a consistent analysis – but be consistent throughout an analysis
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7.2 Decision Rule
• 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
• There are 3 B/C formula:
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7.2 Conventional B/C Ratio
• 1) Conventional B/C Ratio is:
- disbenefits/
Benefits B DB C
Costs C
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7.2 Modified B/C Ratio
• 2) Modified B/C ratio: It subtracts the maintenance and operations (M&O) costs in the numerator
modified
Benefits - disbenefits-M&O costs/
CostsB C
• Initial investment
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7.2 Convention vs. Modified?
• It makes no difference which approach is used
• However, the ratio values will differ (magnitude)
• But, the same absolute (accept/reject) decision will be taken.
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7.2 Benefit-Cost Difference
• 3) B – C difference:
• B-C difference is not a ratio
• B-C difference is:
• (Benefits – Costs) (as a PW or AW)
• The “B” represents the Net Benefit
• Benefits – Disbenefits
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7.2 Example 7.2
• B/C = 0.51 (reject)
• Mod B/C = 0.39 (reject)
• (B-C) = $-0.24 million (< 0…reject)
• Result: Same decision with varying magnitudes of the ratio.
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7.3 Incremental B/C for Multiple Projects
• Select from two or more mutually exclusive alternatives
• Same approach as that in Chapter 6, Section 6.6
• Remember, the Do Nothing alternative always exists and should be evaluated as an alternative.
• Requires a proper ordering of alternatives
• Order alternatives on the basis of Total Costs
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7.3 Incremental B/C for Multiple Projects
If (B/C) (=>) 1.00, select the higher- cost alternativeOtherwise select the lower-cost alternative! If you are using a PW to determine equivalency, then you must have an equal- life model or LCM of lives. Or, apply AW on a typical cycle for the alternatives and the repeatability assumption applies.
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7.3 Incremental B/C for Multiple Projects
There are 2 types of benefits: 1) Usage cost estimates, 2) Direct benefit estimates.Before conducting the incremental evaluation, classify alternatives.Usage cost: implied benefits based on the difference in costs between alternatives. Evaluate these alternatives only against each other.Direct benefit: Benefit amounts estimated. First evaluate against DN, then, against each other.
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A procedure for comparing multiple, mutually excluive alternatives using conventional B/C ratio:
• For eachalternative, determine the equivalent PW, AW or FW for costs C and benefits [or (B-D) if disbenefits are considered];
• Order alternatives by increasing total equivalent costs. For direct benefit alternatives, add DN as the first alternative
• Determine the incremental cost (C) and benefits (B) between first two alternatives.
7.3 Incremental B/C for Multiple Projects
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For usage cost alternative,
B = usage cost of 2 - usage cost of 1
4. Calculate incremental conventional B/C ratio using below equation
B/C = (B-D)/C
5. If (B/C) => 0, eliminate 1; 2 is survivor. otherwise
1 is survivor.
6. Continue to compare alternatives using step 2 through 5 until one alternative remains as survivor.
7.3 Incremental B/C for Multiple Projects
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7.3 Example 7.3 (Incremental B/C)
the addition is estimated at 30 years. Use conventional B/C ratio ananlysis to select A or B.
XXXXXXXXXXXXXXX 800,000 1,050,000
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7.3 Example 7.3 (Incremental B/C)
1) AW1= 10,000(A/P,5%,30)+35= 685,500
AW2= 15,000(A/P,5%,30)+55= 1,030,7502) Add DN and order: DN, 1, 2.3) Compare 1-to-DN which is alt. 14) Calculate incremental (B/C) ratio
B/C = 800,000/685,500 = 1.175) Since 1.17 > 1.0 design 1 is survivor.6) Compare 2-to-1:
B = 1,050,000 - 800,000= 250,000 C = 1,030,750 - 685,500= 345,250 B/C = 250,000/ 345,250 = 0.72 < 1.0 Design 2 eliminated, and design 1 is selection for
bid.
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7.3 Example 7.4 (Incremental B/C)
• 4 Alternatives { 1,2,3, and 4}
• Ranked on total cost as shown
• Analysis Summary:
• (2 -1) B/C = 2.24 …Go with {2}
• (3-2) B/C =0.62…Reject 3, stay with {2}
• (4-2) B/C = 1.83 Go with 4, final winner
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Chapter Summary
• B/C is primarily a public-sector analysis technique
• Uses PW or AW with a social cost of capital interest rate (specified before the analysis is conducted)
• B/C ratio greater than 1 indicates economic desirability
• Results may depend upon viewpoints that define costs and benefits
• Applied within the political arena