Chapter 5

Engineering Economy
Chapter 5 : Evaluating Projects with the Benefit-

Cost Ratio Method
Refer Chapter 10 (Sullivan’s Book)
The objective this chapter is to
▶
demonstrate the use of the benefit-
cost ratio for the evaluation of public
projects.
Copyright ©2012 by Pearson Education, Inc.

Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
PROJECT EVALUATION METHOD
1. Introduction
2. Project Selection
3. The Benefit-Cost Ratio Method
i. Conventional BC Ratio with PW
ii.Modified BC Ratio with PW
iii. Conventional BC Ratio with AW
iv. Modified BC Ratio with AW

5.1 Introduction
Public projects are unique in many ways.
▶ Frequently much larger than private ventures
▶ They may have multiple, varied purposes that sometimes
conflict
▶ Often very long project lives
▶ Capital source is ultimately tax payers
▶ Decisions made are often politically influenced
▶ Benefits are often nonmonetary and are difficult to
measure
▶ more...

TABLE 10-1 Some Basic Differences between Private and
Public Projects

Public Sector Projects.
▶ Owned, used and financed by citizens of government units.
Some examples are:
Highways Universities Hospitals Sports
arenas Prisons Public housing
Emergency relief Utilities
Engineering Economy, Fifteenth Edition © 2008, McGraw-Hill Copyright ©2012 by Pearson Education, Inc.
All rights reserved Upper Saddle River, New Jersey 07458 7-
All rights reserved.6
Public Sector Project Characteristics
▶ Size: Usually large compared to private projects with initial

investment distributed over several years
▶ Life: Long-lived (often 30-50+ years); capitalized cost method

is useful.
▶ Cash flows: No profits allowed; estimates are in form of

costs paid by government unit, benefits to the citizenry (can
include revenues or ‘savings’), and disbenefits (descriptions
on later slide)
Copyright ©2012
Slide by PearsonBlank
to accompany Education, Inc.
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling © 2008, McGraw-Hill and Tarquin Basics of Jersey 07458
Upper Saddle River, New 7-
All rights reserved All rights
Engineering Economy, 2008reserved.7
▶ Funding: Public projects use taxes, fees, bonds (and gifts) for
funding; taxes and fees are collected from
‘users’ of project services; funding examples are
federal/state taxes of various sorts, tolls, surcharge
fees.
▶ Interest rate: Called discount rate, it is considerably lower

than for private projects since no profit is considered and
governments are exempt from taxes; typical rates in the 3 to
6% per year range
▶ Alternative selection: Politics and special interest groups make

selection more complex for public projects; B/C method
developed to put more objectivity into the analysis process
Copyright ©2012
Public Sector Project Estimates
Analysis requires estimates as accurate as possible for costs,
benefits, and disbenefits
Description Example
Costs: expenditures to the • Bridge construction cost
government to build, maintain, & • Annual cost of drug abusers’
operate project; salvage/sales value treatment program
possible
Benefits: advantages to public;
income and savings
• New jobs and salary money
• Reduced property taxes
• Lower transportation costs due to
less gas used
Copyright ©2012
Public Sector Project Estimates
Disbenefits: expected undesirable, negative consequences of
project to owners – the public; usually these are economic
disadvantages estimable in monetary units
Disbenefits are not always included in the analysis; subject
to political and special interest argumentation
Copyright ©2012
Engineering Economy, 2008reserved.
10
Types of Public Project Contracts
❑ Traditional Construction Contract
➢ Government funding via taxes, user fees and bonds

➢ Constructed through fixed price or cost plus contract with a profit
margin specified for contractor
➢ Owned and operated by government unit
CONTRACTOR SHARES NO RISK ON FINANCING OR OPERATION
Copyright ©2012
11
❑ Public-Private Partnership
➢ Often called BOT (Build-Operate-Transfer) contract
➢ Contractor partially or completely responsible for financial
arrangements
➢ Contractor operates and maintains system for specified time period.
Contract includes these funds
➢ Ownership transferred to government in future. This stage is often
negotiated in different ways
➢ Profit margin is specified for contractor during time of involvement
CONTRACTOR SHARES RISK ON FINANCING AND OPERATION
Copyright ©2012
12
5.2 Perspective and Terminology for Analyzing
Public Projects
For government projects, the owners are ultimately the
taxpayers.
▶ Project Benefits are favorable consequences of the project

to the public (owners).
▶ Project Costs represent monetary disbursements required

of the government.
▶ Disbenefits represent negative consequences of a project

to the public (owners).

FINAL EXAMINATION
SEMESTER I
SESSION 2013/2014
Q1a Justify each of the following cash flows whether a benefit, disbenefit, or
cost.

i. RM1 million per year maintenance of road by local authority. (2 marks)
ii. Expenditure of RM90 million for construction of a new UTHM interchange
to reduce traffic congestion. (2 marks)
iii. Decrease of RM500,000 per year in car accident repairs because of good
street lighting maintenance. (2 marks)
iv. RM650,000 per year loss of revenue by villagers because of housing
development project right-of-way purchases. (2 marks)
v. RM500,000 extra expenses of travel agency in petrol payment due to
petrol subsidy reduction. (2 marks)

5.3 The benefit-cost ratio method
▶ The consideration of the time value of money means this
is really a ratio ofdiscounted benefits todiscounted
costs .
▶ B-C ratio is the ratio of the equivalent worth of benefits

to the equivalent worth of costs.
◦ . Conventional BC Ratio with PW
◦ Modified BC Ratio with PW
◦ Conventional BC Ratio with AW
◦ Modified BC Ratio with AW

Symbol
Benefit Cost Ratio Method (B-C Ratio)
B = Benefit
I =Investment
MV = F= Market Value at the end of useful life
(nilai sisa)
O & M = Operation & Maintenance
CR = I-MV
Capital Recovery Amount
(kos pemulihan modal, allowance,
salvage value)

Two B-C ratios for Present Worth (PW)
Tips : All must multiple with (P/A, i, n) except I
Conventional B-C ratio with PW
Modified B-C ratio with PW
A project is acceptable when the B-C ratio is greater than or equal

to one.
B-C ratios for annual worth (AW)
Tips: only CR must multiple with (A/P, i, n)
Conventional B-C ratio with AW
Modified B-C ratio with AW
A project is acceptable when the B-C ratio is greater than or equal

to one. Copyright ©2012 by Pearson Education, Inc.
Guideline for economic justification
If B/C ≥ 1.0 accept project

If B/C < 1.0project not acceptable

i=10%
N=25
FINAL EXAMINATION
SEMESTER I
SESSION 2013/2014
Q1 b. JAY Corporation is considering a new project to construct a new jetty

near Danga Bay for the use of gateway tourism’s ferry to and from
Singapore and Indonesia. Also included in the project is to build custom and
immigration facilities. The land acquisition is estimated to be RM1.2 million.
Construction cost for the jetty and other facilities is expected to be RM1.8
million with an additional annual maintenance cost of RM 90,000. Finally,
the projected increase in marina travelers will require an additional jetty
traffic controller with an annual cost of RM50,000. Market value of some
assets at the end of useful life is estimated RM20,000. Annual benefits of
the jetty have been estimated as in Table Q1.

Table Q1: Annual beneﬁts of the JAY Corporation
Jetty project
Rental receipts from ferry & boats RM300,000
Jetty charges to passengers RM240,000
Convenience benefit to the local RM60,000
community
Additional tourism income to state of RM120,000
Johor
Apply the B-C ratio method for both conventional and

modiﬁed cases using PW and AW methods with the study
period of 10 years and a MARR of 15% per year to determine
whether JAY Corporation should proceed with the jetty
project.
(30 marks)

FINAL EXAMINATION
SEMESTER I
SESSION 2014/2015
Q4. Your company are invited to propose a new multipurpose transportation

terminal in southern region state as a hub for air, sea and land
transportation. Also included in the project is to build custom and
immigration facilities. The land acquisition is estimated to be RM30 million.
Construction cost for the terminal and other facilities is expected to be RM
86 million with an additional annual maintenance cost of RM 9 million. The
custom and immigration facilities building and sophisticated equipment
should also be considered with a cost of RM 27 million and RM 6 million per
year maintenance expenditures.
▶

(a) Determine the value of Total Cost, Benefit and Disbenefit
from the above statement. (9 marks)
(b) Apply the B-C ratio method for both conventional and
modified cases using PW and AW methods with the study
period of 20 years and a MARR of 20% per year to
determine whether the project should be proceed.
(16 marks)

THANK YOU


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Engineering Economy

Chapter 5 : Evaluating Projects with the Benefit-

Copyright ©2012 by Pearson Education, Inc.

Copyright ©2012 by Pearson Education, Inc.

Copyright ©2012 by Pearson Education, Inc.

Copyright ©2012 by Pearson Education, Inc.

▶ Size: Usually large compared to private projects with initial

▶ Life: Long-lived (often 30-50+ years); capitalized cost method

▶ Cash flows: No profits allowed; estimates are in form of

▶ Interest rate: Called discount rate, it is considerably lower

▶ Alternative selection: Politics and special interest groups make

➢ Government funding via taxes, user fees and bonds

CONTRACTOR SHARES NO RISK ON FINANCING OR OPERATION

CONTRACTOR SHARES RISK ON FINANCING AND OPERATION

▶ Project Benefits are favorable consequences of the project

▶ Project Costs represent monetary disbursements required

▶ Disbenefits represent negative consequences of a project

Copyright ©2012 by Pearson Education, Inc.

Copyright ©2012 by Pearson Education, Inc.

▶ B-C ratio is the ratio of the equivalent worth of benefits

Copyright ©2012 by Pearson Education, Inc.

Copyright ©2012 by Pearson Education, Inc.

Conventional B-C ratio with PW

Modified B-C ratio with PW

A project is acceptable when the B-C ratio is greater than or equal

Conventional B-C ratio with AW

Modified B-C ratio with AW

A project is acceptable when the B-C ratio is greater than or equal

If B/C ≥ 1.0 accept project

Copyright ©2012 by Pearson Education, Inc.

Q1 b. JAY Corporation is considering a new project to construct a new jetty

Copyright ©2012 by Pearson Education, Inc.

Apply the B-C ratio method for both conventional and

Copyright ©2012 by Pearson Education, Inc.

Q4. Your company are invited to propose a new multipurpose transportation

Copyright ©2012 by Pearson Education, Inc.

Copyright ©2012 by Pearson Education, Inc.

Copyright ©2012 by Pearson Education, Inc.

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