ECONOMICS BENEFIT COST ANALYSIS PRESENTATION

BENEFIT COST ANALYSIS

1. Evaluation of Public Projects Benefit-Cost Analysis (B/C Analysis) 1

2. Public Vs Private Projects A public sector project is a product, service, or system used, financed , and owned by the citizens of any government level. The primary purpose is to provide service to the citizenry for the public good at no profit . Areas such as public health, criminal justice, safety, transportation, welfare , and utilities are publically owned and require economic evaluation. Size of Investment Large Some large; more medium to small Life Estimates Longer (30–50 years) Shorter (2–25 years) Annual Cash Flow estimates No profit; costs, benefits, and Dis-benefits are estimated Revenues contribute to profits; costs are estimated Funding Taxes, fees, bonds, private funds Stocks, bonds, loans, individual owners Interest Rate Lower Higher, Based on cost of capital Characteristics Public Sector Private Sector The benefit/cost (B/C) ratio introduces objectivity into the economic analysis of public sector evaluation

3. B /C Analysis Benefit Cost Analysis, is an economic decision-making approach, used particularly in government and business. It is used in the assessment of whether a proposed project, programme or policy is worth doing, or to choose between several alternative ones. It involves comparing the total expected costs of each option against the total expected benefits, to see whether the benefits outweigh the costs, and by how much. 3 Costs : Estimated expenditures to the government entity for construction, operation, and maintenance of the project, less any expected salvage value. Benefits : Advantages to be experienced by the owners, the public. Disbenefits : Expected undesirable or negative consequences to the owners if the alternative is implemented . Disbenefits may be indirect economic disadvantages of the alternative.

4. B/C Analysis for Single Project All cost and benefit estimates must be converted to a common equivalent monetary unit (PW, AW, or FW) at the discount rate (interest rate). The B/C ratio is then calculated using one of these relations: 4 The Decision Rule

5. 5 B/C Analysis for Single Project (Some other Forms) Salvage values and additional revenues to the government, when they are estimated, are subtracted from costs in the denominator. Generally, disbenefits are subtracted from benefits and placed in the numerator Conventional B/C Ratio Modified B/C Ratio

6. Profitability Index In Private Sector, Revenues are approximately the same as public sector benefits minus disbenefits (B -D) The modified B/C Ratio Using PW The above may be written as   6 If PI > 1.0 , the project is economically acceptable at the discount rate. If PI < 1.0 , the project is not economically acceptable at the discount rate.

7. Problem The Georgia Transportation Directorate is considering a public-private partnership with Young Construction as the prime contractor using a DBOMF contract for a new 22.51-mile toll road on the outskirts of Atlanta’s suburban area. The design includes three 4-mile-long commercial/retail corridors on both sides of the toll road. Highway construction is expected to require 5 years at an average cost of $3.91 million per mile. The discount rate is 4% per year, and the study period is 30 years. Evaluate the economics of the proposal using (a) the modified B/C analysis from the State of Georgia perspective and (b) the profitability index from the Young corporate viewpoint in which disbenefits are not included . Initial investment : $88 million distributed over 5 years; $4 million now and in year 5 and $20 million in each of years 1 through 4. Annual M&O cost : $1 million per year, plus an additional $3 million each fifth year, including year 30. Annual revenue/benefits : Include tolls and retail/commercial growth; start at $2 million in year 1, increasing by a constant $0.5 million annually through year 10, and then increasing by a constant $1 million per year through year 20 and remaining constant thereafter. Estimable disbenefits : Include loss of business income, taxes, and property value in surrounding areas ; start at $10 million in year 1, decrease by $0.5 million per year through year 21 , and remain at zero thereafter. 7

8. Solution (Cash Flows in Million): PW for Investment 8 1 2 3 4 5 6 -- -- -- -- 28 29 30 $4 $20 Each Initial Investment $4     PW of investment = $ 71.89

9. PW for Costs 9 1 2 3 4 5 6 -- -- 10 -- 28 29 30 $1 each $3 each PW of costs = $ 26.87 +01

10. PW for Benefits 10 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 $2 $6.5 $7.5 $16.5 $16.5 Each   2 Athematic Gradient Series 3 Annuities PW of benefits = $ 167.41

11. PW for Disbenefits 11 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 $10 $5.5 $0.5 PW of disbenefits = $ 80.12

12. 12 From Public Project Perspective From Private Project Perspective

13. Incremental B/C Analysis: For Two Mutually Exclusive Alternatives 13 The higher-cost alternative is justified if ∆ B/C is equal to or larger than 1.0. The selection rule is as follows Alternatives are ordered by increasing equivalent total costs

14. Step by S tep Procedure Determine the equivalent total costs for both alternatives . ( using PW , AW, or FW equivalencies) Order the alternatives by equivalent total cost: first smaller, then larger. Calculate the incremental cost ( ∆ C ) for the larger-cost alternative. This is the denominator in ∆ B/C. Calculate the equivalent total benefits and any disbenefits estimated for both alternatives. Calculate the incremental benefits ( ∆ B ) for the larger-cost alternative. This will be ( B-D ) if disbenefi t s are considered. Calculate the B/C ratio using ( B-D )/ C . Use the selection guideline to select the higher-cost alternative if ∆ B/C 1.0. 14

15. Problem The Following data pertains to two alternatives 15 The planning horizon for the transmission mains is 50 years. T he interest (discount) rate is 3% per year, compounded annually , and 1 mile is 5280 feet. Using B/C Analysis select a suitable alternative

16. Solution 16

17. 17 Since ∆ B/C << 1.0, the trench-tunnel option is not economically justified. Thus Open Trench is the selected alternative

18. B/C Analysis of Multiple, Mutually Exclusive Alternatives To select one from three or more mutually exclusive alternatives. Selection Policy: Choose the largest-cost alternative that is justified with an incremental B/C ≥ 1.0 when this selected alternative has been compared with another justified alternative . Procedure Determine the equivalent total cost for all alternatives. Use AW, PW, or FW equivalencies. Order the alternatives by equivalent total cost, smallest first. Determine the equivalent total benefits (and any disbenefits estimated) for each alternative. Calculate the B/C for the first ordered alternative. If B/C<1.0 , eliminate it. By comparing each alternative to DN in order, eliminate all that have B/C <1.0 . The lowest-cost alternative with B/C ≥ 1.0 becomes the defender and the next higher-cost alternative is the challenger for the next step . Calculate incremental costs ( ∆ C) and benefits ( ∆ B) using the relations ∆ C=challenger cost-defender cost ∆ B=challenger benefits-defender benefits 18

19. Calculate the ∆ B/C for the first challenger compared to the defender. If B/C ≥ 1.0 (above), the challenger becomes the defender and the previous defender is eliminated. Conversely, if ∆ B/C<1.0 , remove the challenger and the defender remains against the next challenger. Repeat the above steps until only one alternative remains (selected one) In all the steps above, incremental disbenefits may be considered by replacing ∆ B with ∆ ( B-D ). 19

20. Problem 20 Waterparks of Texas, a very popular water and entertainment park headquartered in New Braunfels, has been asked by four different cities outside of Texas to consider building a park in their area. The following data is being worked out Use incremental B/C analysis at 7% per year and an 8-year study period to advise the board of directors if they should consider any of the offers to be economically attractive. Solution