Module 8: Benefit-Cost Ratio

SI-4251 Ekonomi Teknik

Rani G. K. Pradoto
Outline Module 8
 Benefit – Cost Ratio

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The Benefit – Cost Analysis
 The most commonly used method for comparing
economic alternatives.
 This method is often considered as “supplementary”
to present worth analysis.
 The objective is to determine whether the benefit
(gained) in return to any cost (spent) is favorable.
 Basically it is desired that we will gain more than
we have spent.
 Benefit – Cost > 0  B/C > 1.0
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Classification
 Benefit (B)  all favorable return/gain or
advantages
 Disbenefit (D) negative benefit, any negative (loss)
result
 Cost (C)  all things that one pays/expends in
order to have return

 Benefit  income from an investment, e.g., interest

 Disbenefit loss of value or (initial) income due to an
investment
 Cost  expenditure

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B/C Analysis for A Single Project
Conventional B/C
B D
B/C 
C
Modified B/C
- includes operation & maintenance cost
- initial investment replaces cost as denominator
B  D O& M
B/C 
I
Calculation can be made in present worth, future worth or annuity
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B - C Analysis for A Single Project
Conventional B-C
B C  (B  D) C

Modified B-C
- includes operation & maintenance cost

B C  (B  D O & M )  I

Calculation can be made in present worth, future worth or annuity

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Exercise
A new machine having an initial investment of Rp 225 million and additional Rp 35 million a year
for maintenance and operation cost, is estimated to generate Rp 95 million per year in revenue.
On the other hand, installation of this new machine will cost the company to lose Rp 3.2 million
per year from selling by product. The machine can latter be sold for Rp 75 million at the end of
5 year and the rate of return is set at 8%. Do the benefit cost analysis.

Conventional method:
Cost C1 = Rp 225 million  225 (A/P, 8, 5) = 56.3535
Cost C2 = Rp 35 million/year  35 = 35
Benefit B1 = Rp 95 million/year  95 = 95
Benefit B2 = Rp 75 million at end of 5 year  75 (A/F, 8, 5) = 12.7845
Disbenefit D = Rp 3.2 million/year  32 = 3.2
(A/P, 8, 5) = 0.25046 (A/F, 8, 5) = 0.17046

B/C = [(95 + 12.7845) – 3.2 - 35]/(56.3535) = 1.2348

B - C = [(95 + 12.7845) – 3.2 - 35] – [56.3535] = Rp 13.231 million
8-7 SI-4251 Ekonomi Teknik Muhamad Abduh, Ph.D.
Exercise
A new machine having an initial investment of Rp 225 million and additional Rp 35 million a year
for maintenance and operation cost, is estimated to generate Rp 95 million per year in revenue.
On the other hand, installation of this new machine will cost the company to lose Rp 3.2 million
per year from selling by product. The machine can latter be sold for Rp 75 million at the end of
5 year and the rate of return is set at 8%. Do the benefit cost analysis.

Modified method:
Cost C1 = Rp 725 million  225 (A/P, 8, 5) = 56.3535
Cost C2 = Rp 35 million/year  35 = 35
Benefit B1 = Rp 95 million/year  95 = 95
Benefit B2 = Rp 75 million at end of 5 year  75 (A/F, 8, 5) = 12.7845
Disbenefit D = Rp 3.2 million/year  32 = 3.2
(A/P, 8, 5) = 0.25046 (A/F, 8, 5) = 0.17046

B/C = [(95 + 12.7845) – 3.2]/(56.3535 + 35) = 1.1448

B - C = [(95 + 12.7845) – 3.2] – [56.3535 + 35] = Rp 13.231 million
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Comparing two alternatives using B/C
analysis
Overpass A Tunnel B
Initial cost 1,250 million 3,500 millions
Yearly maintenance cost 27.50 million 55 million
Road user cost per year 425 million 350 million
Useful life 20 years 20 years
Interest rate 10%
COST:
EUAWA = 1,250 (A/P, 10, 20) + 27.50 = 1,250 (0.1175) + 27.50 = 174.375 million
EUAWB = 3,500 (A/P, 10, 20) + 55.00 = 3,500 (0.1175) + 55.00 = 466.250 million
Δ Cost = EUAWB – EUAWA = 466.250 – 174.375 = 291.875 million

BENEFIT:
EUAWA = 425 million EUAWB = 350 million Δ Benefit = 425-350 = 75 million

B/C = 75/291.875 = 0. 2570

B-C = 75 – 291.875 = -216.875
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Selection form Mutually Exclusive
Alternatives
Incremental B/C Analysis
X Y Z
Initial cost - 250,000,000 -240,000,000 -320,000,000
Yearly expenses - 135,000,000 -123,500,000 -130,000,000
Yearly revenues 390,000,000 381,000,000 420,500,000
Salvage value 45,000,000 52,000,000 202,000,000
period 5 5 5
Interest rate 12%

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Selection form Mutually Exclusive
Alternatives (benar)
Incremental B/C Analysis
Y X Z
Initial cost, (I) -240,000,000 -250,000,000 -320,000,000
Yearly expenses, (C) -123,500,000 -135,000,000 -130,000,000
Yearly revenues, (B) 381,000,000 390,000,000 420,500,000
UAEW of Salvage value, (B) 52,000,000 45,000,000 202,000,000
Overall B/C
B–C
Alternative to compare
Incremental benefit
Incremental cost
Incremental B/C
Decision

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Selection form Mutually Exclusive
Alternatives (benar)
Incremental B/C Analysis
Y X Z
Initial cost, (I) -240,000,000 -250,000,000 -320,000,000
Yearly expenses, (C) -123,500,000 -135,000,000 -130,000,000
Yearly revenues, (B) 381,000,000 390,000,000 420,500,000
UAEW of Salvage value, (B)
Overall B/C >1 <1
B–C
Alternative to compare YES Y to Z
Incremental benefit 262,219,000
Incremental cost 101,176,800
Incremental B/C 2.5
Decision Z

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Homework #8
A ready-mix concrete producer is considering to install a new mixer system:

Operating characteristics System A System B System C

Installed cost ($) 2,250,000 2,950,000 2,750,000
Annual Operating cost ($) 320,000 495,000 401,500
Annual production (cm) 10,500 21,200 19,900
Unit price ($/cm) 122.50 122.50 122.50
Overhaul cost ($/ 2 years) 220,000 245,000 295,000
Salvage value ($) 221,500 308,000 367,500
Useful life (year) 3 4 4

at rate of return 10% determine which system should be installed using B/C
analysis?

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