EVALUATING PROJECTS WITH THE

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CHAPTER 11

• EVALUATING PROJECTS WITH THE
• BENEFIT / COST RATIO METHOD

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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

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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)

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Private And Public Projects-Cont.

• Project Life
• Private Project Short -- 5 to 20 years
• Public Project Long -- 20 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

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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.

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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

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B/C Formulations

• Conventional
• Modified B/C

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Decision Rule

• , or B/C
• IF B/C ratio (gt) 1.00
• Conditionally accept the alternative
• IF B/C ratio (lt) 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

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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

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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
• 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.

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Solution

• Conventional B/C using PW
• B/C PW(B)/I PW (OM)
• B/C 490000(P/A,10,20)/1200000-197500(P/A,10,20
  ) 1.44
• Modified B/C using PW
• B/C PW (B) PW (OM/I
• B/C490,000(P/A,10,20)-197500(P/A,10,20)/12000
  00 2.07
• Conventional B/C using AW
• B/C AW(B)/CR AW (OM)
• 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 (OM/CR
• B/C 490,000 197,500/1,200,000 (A/P, 10,
  20)2.075

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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 projects profit potential is provided.
• Use incremental cash flow analysis