9 benefit to cost ratio method

1. Building Economy ARE 431
Dr. Mohammad A. Hassanain 1
Benefit/Cost Ratio Method
2
Benefit/Cost Ratio Method
‰The Benefit/Cost (B/C) method is based on the ratio of
the annual benefits to the annual costs for a particular
project.
‰It is used to compare between investment options
based on a range of benefits, disbenefits, and costs to
the owner.
‰Benefits
are advantages, expressed in terms of a
monetary value to the owner. i.e. riyals, dollars,
etc.
‰Disbenefits
are disadvantages, expressed in terms
of a monetary value to the owner. i.e. riyals,
dollars, etc.
‰Costs
are anticipated expenditures for
construction, operation and maintenance, etc.

2. Building Economy ARE 431
Dr. Mohammad A. Hassanain 2
3
Benefit/Cost Ratio Method
‰Examples of Benefits, Disbenefits, and Costs:
Disbenefit$250,000 annual loss to farmer due to loss of highway
right-of-way
Cost$150,000 annual upkeep of highway
Benefit$100,000 annual income to local residents from
tourists due to the construction of new highway
CostExpenditure of 11 million dollars for a new highway
ClassificationItem
4
Benefit/Cost Ratio Method
‰The formula used for benefit to cost ratio analysis is:
B/C =
Benefits - Disbenefits
Costs
‰If the B/C ratio is 1.0, this means that the extra
benefit(s) of the higher cost alternative justify the
higher cost.
‰If the B/C ratio is 1.0, this means that the extra cost
is not justified and the lower cost alternative is
selected.
≥
<

3. Building Economy ARE 431
Dr. Mohammad A. Hassanain 3
5
Benefit/Cost Ratio Method
‰An alternative method that can be used to compare
between projects, is to subtract the costs from the
benefits, that is B - C
‰If B - C is 0, this means that the project is
acceptable.
‰If B - C ratio is 0, this means that the project is
rejected.
≥
<
6
Benefit/Cost Ratio Method
‰Example:
Two routes are considered for a new highway, Road
A, costing $4,000,000 to build, will provide annual
benefits of $750,000 to local businesses. Road B
would cost $6,000,000 but will provide $700,000 in
benefits.
The annual cost of maintenance is $300,000 for Road
A and $320,000 for Road B. If the service life of Road
A is 20 years, and for Road B is 30 years, which
alternative should be selected if the interest rate is
8%?

4. Building Economy ARE 431
Dr. Mohammad A. Hassanain 4
7
Benefit/Cost Ratio Method
‰Tabulate the given data:
$700,000$750,000Annual Benefits
30 years20 yearsService Life
Annual Maintenance Cost
Initial Cost
Given Data
$320,000$300,000
$6,000,000$4,000,000
Road BRoad A
B/C =
Benefits - Disbenefits
Costs
99
?
8
Benefit/Cost Ratio Method
EUAC for Road A= $4,000,000 (A/P, 8%, 20) + $300,000
= $4,000,000 (0.10185) + $300,000
= $707,000
EUAC for Road B= $6,000,000 (A/P, 8%, 30) + $320,000
= $6,000,000 (0.08883) + $320,000
= $552,980
B/C =
Benefits - Disbenefits
Costs
99
?

5. Building Economy ARE 431
Dr. Mohammad A. Hassanain 5
9
Benefit/Cost Ratio Method
B/C for Road A= $750,000 / $707,000 = 1.06
B/C for Road B= $700,000 / $552,980 = 1.26
Choose Road B
B/C =
Benefits - Disbenefits
Costs
99
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