Chapter 9 Benefit/Cost Analysis and Public Sector Economics. Characteristics compared. Funding Public Projects. Funding Sources Compared



Similar documents
CHAPTER. Benefit/Cost Analysis and Public Sector Economics MASTER ➀

Case Studies in Engineering Economics for Electrical Engineering Students

BENEFIT-COST ANALYSIS Financial and Economic Appraisal using Spreadsheets

Methods for Project Evaluation

Chapter 8 Benefit/Cost Ratios and Other Measures

Tools for Project Evaluation. Nathaniel Osgood 1.040/1.401J 2/11/2004

The Time Value of Money (contd.)

Choice of Discount Rate

Understanding Financial Management: A Practical Guide Guideline Answers to the Concept Check Questions

Accounts Payable are the total amounts your business owes its suppliers for goods and services purchased.

CASH FLOW STATEMENT & BALANCE SHEET GUIDE

Chapter 18 Working Capital Management

COURSE SUMMARY CASH FLOW $4500

Comparison of Alternatives

Choice of Discount Rate: Basic Theory

Financial Ratios and Quality Indicators

Part II: Evaluating business & engineering assets

Understanding Bank Ratios

Life Insurance Buyer s Guide

CHAPTER 6 NET PRESENT VALUE AND OTHER INVESTMENT CRITERIA

Investment Decision Analysis

Part 7. Capital Budgeting

2) You must then determine how much of the risk you are willing to assume.

Calculating ROI for Automation Projects

COMPONENTS OF THE STATEMENT OF CASH FLOWS

3 More on Accumulation and Discount Functions

Life Insurance Buyer's Guide

Finding the Right Financing Mix: The Capital Structure Decision. Aswath Damodaran 1

Chris Leung, Ph.D., CFA, FRM

CHAPTER 7: NPV AND CAPITAL BUDGETING

- centred on human factors (ie. ergonomics, desire to have a new computer system) - Are there unused computer terminals in the company now?

Capital Investment Analysis and Project Assessment

Statewide Campus Practice Management Seminar. Personal Financial Planning For Informed Physicians

Present Value, Discounted Cash Flow. Engineering Economy

LIFECYCLE COSTING FOR DATA CENTERS: DETERMINING THE TRUE COSTS OF DATA CENTER COOLING

Capital Budgeting OVERVIEW

Home Buying Seminar. A presentation by The Summit Federal Credit Union

Study Unit 6. Managing Current Assets

LCCA Defined (FHWA) LCCA Policy Statement (9/96) LCCA Policy Statement (9/96) Policy Statement Con t... Use of LCCA. CE 4401 Pavement Design

Engineering Economics: Comparing Financial Characteristics of Design Options

Managed funds. Plain Talk Library

ENGINEERING ECONOMICS PROBLEM TITLES

Chapter 9 Net Present Value and Other Investment Criteria Chapter Organization

9. Time Value of Money 1: Present and Future Value

Learning Objectives: Quick answer key: Question # Multiple Choice True/False Describe the important of accounting and financial information.

Prepared by the National Association of Insurance Commissioners. This guide does not endorse any company or policy.

Appendix F Benefit-Cost Analysis of Flood Protection Measures

Two dimensions of pure risk

Chapter 10 The Basics of Capital Budgeting: Evaluating Cash Flows ANSWERS TO END-OF-CHAPTER QUESTIONS

Chapter 13 Money and Banking

MODULE 2. Capital Budgeting

Are you looking at procurement as an end-to-end process?

SAVINGS PRODUCTS AND THE LIFE INSURANCE INDUSTRY IN CANADA

07.02 Texas Higher Education Fair Lending Practices

Borrowing Money for Your Business

CONSTRUCTION EQUIPMENT

SMP Customer Working Group Meeting #3. September 27, 2011

Present Value, Discounted Cash Flow. Engineering Economy

What is Digital Asset Management all about?

U.S. Treasury Securities

STATEMENT OF CASH FLOWS AND WORKING CAPITAL ANALYSIS

Fixed Deferred Annuities

Accounting Is a Language. Financial Accounting: The Balance Sheet BALANCE SHEET. Accounting Information. Assets. Balance Sheet: Layout

Chapter 11 Building Information Systems and and Managing Projects

The Banking System and the Money Supply South-Western/Thomson Learning

Most economic transactions involve two unrelated entities, although


FILING DEADLINE IS MARCH 1, Name on Tax Bill: GPIN: Account: GENERAL INFORMATION AND REQUIREMENTS

Lecture 12. Options Strategies

MEASURING ECONOMIC IMPACTS OF PROJECTS AND PROGRAMS

Life insurance. Life insurance. Premiums and your profile. How much is enough Term vs. cash-value

Expected default frequency

Financial Planning Questionnaire

Department of Humanities. Sub: Engineering Economics and Costing (BHU1302) (4-0-0) Syllabus

KURT D. PANOUSES, P.A. ATTORNEYS AND COUNSELORS AT LAW 310 Fifth Avenue Indialantic, FL (321) FAX: (321)

How To Get A Home Equity Line Of Credit

Financial Statements and Ratios: Notes

Topics in Chapter. Key features of bonds Bond valuation Measuring yield Assessing risk

Planning for Capital Investments

Chapter 13 Money and Banking

Homework (Chapter 11)

CARNEGIE MELLON UNIVERSITY CIO INSTITUTE

Life Insurance Buyer s Guide

2. CAPITAL BUDGETING TECHNIQUES

CHAPTER 4 DISCOUNTED CASH FLOW VALUATION

Life Insurance Buyer s Guide

Chapter 6 Interest rates and Bond Valuation Pearson Prentice Hall. All rights reserved. 4-1

Key Points to Borrowing Money

Valuation of Your Early Drug Candidate. By Linda Pullan, Ph.D. Toll-free USA Worldwide

Why Use Net Present Value? The Payback Period Method The Discounted Payback Period Method The Average Accounting Return Method The Internal Rate of

What is a business plan?

Personal. Buy a Car, Not a Con

Exercise 1 for Time Value of Money

PrinciplesofAccounting II Lesson #5


CHAPTER 21. Working Capital Management

CHAPTER 9 NET PRESENT VALUE AND OTHER INVESTMENT CRITERIA

Chapter 10. What is capital budgeting? Topics. The Basics of Capital Budgeting: Evaluating Cash Flows

Understanding Leverage in Closed-End Funds

Transcription:

Public Sector Projects Chapter 9 Benefit/Cost Analysis and Public Sector Economics INEN 303 Sergiy Butenko Industrial & Systems Engineering Texas A&M University Public Sector: Ownership by citizens- the public Public Sector Projects: Provide needed services to the public at no profit Types of Projects Characteristics compared Hospitals Characteristic Public Sector Private Sector Parks and recreation facilities Highways, Dams, Bridges Size of Investment Larger Some Large; more medium to small Courts, prisons, schools Public Housing Many others Life Estimates Annual Cash Flow estimates Quite Long 30 50 years No Profit: costs, benefits and disbenefits Shorter: 2-25 years Revenues profit, cost estimates Funding Sources Compared Funding Public Projects Characteristic Public Sector Private Sector Generally low interest charges Funding Taxes, fees, bonds, private funds Sale of new stock, bonds, loans, Public entities do not pay taxes Project investments basically backed by public agencies Interest Rate Tends to be lower Higher: At market cost Cost sharing arrangements often exist Less perceived risk with public projects

Estimating Costs for Public Projects Costs Construction, operations, maintenance less estimated salvage values Initial costs fairly well known Future O&M are less known and must be estimated Estimating Benefits and Disbenefits Benefits to the owners (the public) must be estimated in terms of periodic dollar values Disbenefits are expected undesirable (negative) consequences to the owners (public) May be indirect Very hard to estimate and convert to $ amounts Determination of an Interest Rate Selection Process Determined differently than in the private sector Called the social discount rate Some times standardized by govt. agencies Not as clear as in the private sector i.e., not solely based on economic measures (PW or AW) Involves special interest and pressure groups Selection criteria hence need to be prioritized Evaluation Process The viewpoint adopted (city budget, economic development, citizen welfare, environment protection) dictates the goal of the project Viewpoint adopted will help categorizing and estimating costs, benefits and disbenefits Thus, the viewpoint must be established before the economic evaluation See Example 9.1 B/C Analysis Single Project The conventional B/C Ratio is: B/C = [ PW(benefits) PW(disbenefits)]/PW(costs) Equivalently, AW or FW can be used. Calculated at the social discount rate (interest rate).

Conventions Revenues and costs are assigned (+) signs, i.e., only magnitudes are considered Salvage values carry a negative sign and included with equivalent cost calculation (i.e. subtracted from costs) Decision Rule IF B/C ratio 1.00, conditionally accept the alternative IF B/C ratio < 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 Modified B/C Ratio Conventional vs. Modified? Modified B/C subtracts the Maintenance and operations (M&O) costs in the numerator The modified B/C ratio = [ PW(benefits) PW(disbenefits) PW(M&O costs)]/pw(intial investment) It makes no difference which approach is used However, the ratio values will differ (magnitude) But, the accept/reject decision will be the same Note: Do not use this ratio unless you re explicitly asked to Benefit-Cost Difference See Example 9.2 B-C cost difference is defined as: = PW(Benefits) PW(Disbenefits) PW(Costs) (or AW, FW) Reject if B-C < 0 Does this look familiar? Applies all three approaches to the same problem situation B/C = 0.51 (reject) Mod B/C = 0.39 (reject) (B-C) = $-1.24 million (reject) Result: Same decision

Example 9.3 Example 9.3, continued Given two alternatives Bypass construction Upgrade construction Unequal lives use AW to compare discount rate is set to 8% Conventional B/C Bypass = 1.17 Conventional B/C Upgrade = 1.13 Both B/C ratios are > 1 Both proposals are economically justified at 8% Which one would you select? Alternative Selection using Incremental Analysis: 2 Alternatives This approach is similar to the material in Chapter 8 Requires a proper ordering of the alternatives Order alternatives on the basis of Total Equivalent Costs Rank on Total Costs - Rules 1. Determine total equivalent costs, benefits and disbenefits (PW, AW or FW) for both alternatives- AW is preferred as one can compare unequal life alt. (under repeatability assumptions as before) 2. Order by total costs: Smaller AW(cost) first (defender) then larger AW(cost) (challenger) Note: This ranking is based not just on initial cost it is on total equivalent cost! Incremental B/C Approach 3. Calculate the incremental equivalent C,B,D: C = AW(challenger costs) AW(defender cost) should be > 0 and is the denominator in the B/C ratio B = AW(challenger benefits) AW(defender benefits) D = AW(challenger disbenefits) AW(defender disbenefits) 4. Calculate the B/C ratio: ( B - D)/ C Incremental B/C Approach 5. If B/C 1.00 go with the challenger alternative else, Go with defender alternative!

An Important Point Example 9.4 Design A Design B If one is using a PW to determine equivalent B, D, C, then you must have an equal life model or lowest common multiple of lives. Or, apply the annual worth on a typical cycle for the alternatives and the repeatability assumption applies. Construction cost, $ Building Maintenance cost, $/year Patient usage cost, $/year 10,000,000 35,000 450,000 15,000,000 55,000 200,000 Patient usage cost is the amount paid by patients over the insurance coverage. Discount rate is 5% and life is 30 years Example 9.4 There are no individual benefits benefit to the patient exists when switching from lower cost A to higher cost B (equiv. costs on next slide) So A is the defender and B is the challenger Treat usage cost as a disbenefit Calculate B, D and C as challenger equiv. defender equiv., Example 9.4, -contd AW A = 10,000,000(A/P,5%,30) + 35,000 = $685,500 AW B = 15,000,000(A/P,5%,30) + 55,000 = $1,030,750 C = AW B AW A = $345,250 D = usage(b-a) = $200,000 - $450,000 = -$250,000 B = 0 ( B- D)/ C = 0.72 Incremental B/C for Multiple Projects Select from three or more mutually exclusive alternatives Same approach as that in Chapter 8, Section 8.6 Remember, the Do Nothing if acceptable, should be evaluated as an alternative. Steps for Multiple Incremental Analysis 1. Using either PW or AW determine the total equivalent cost for all options. If unequal lives, apply AW 2. Create the rankings based upon lowest to highest total equivalent cost of the alternatives 3. Determine the total equivalent benefits for each alternative

Steps - continued Multiple Alternatives. 4. The lowest cost option is the first Defender and the next higher cost alternative is the first challenger Compute the B/C ratio on the increment If B/C < 1, eliminate the Challenger else eliminate the Defender. Current winner becomes new Defender 5. Compare the new defender to the next higher cost challenger and repeat the analysis. 6. Continue through the alternative until there are no more challengers. 7. The last champion is the winner See Example 9.5 Chapter 9 Summary 4 Alternatives { 1,2,3, and 4} Ranked on total cost as shown Analysis Summary: (2-1) B/C = 2.24 Go with {2} (3-2) B/C =0.62 Reject 3, stay with {2} (4-2) B/C = 1.83 Go with 4, final winner B/C is primarily a public sector analysis technique Uses PW or AW with a social cost of capital interest rate (specified before the analysis is conducted) B/C ratio greater than 1 indicates economic desirability of an alternative Chapter 9 Summary cont. Very difficult to estimate $ values for benefits and disbenefits Results may depend upon viewpoints that define costs and benefits Selection from multiple alternatives is based on a ranking followed by a pair-wise comparisonelimination procedure