01/10/2010

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Module 8: Benefit-Cost Ratio
SI-4251 Ekonomi Teknik
Muhamad Abduh, Ph.D.
Outline Module 8
Benefit Cost Ratio

Muhamad Abduh, Ph.D. 8-2 SI-4251 Ekonomi Teknik
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
Muhamad Abduh, Ph.D. 8-3 SI-4251 Ekonomi Teknik
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

Muhamad Abduh, Ph.D. 8-4 SI-4251 Ekonomi Teknik
01/10/2010
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B/C Analysis for A Single Project
Conventional B/C


Modified B/C
- includes operation & maintenance cost
- initial investment replaces cost as denominator
Muhamad Abduh, Ph.D. 8-5 SI-4251 Ekonomi Teknik
C
D B
C / B

I
M & O D B
C / B

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

B - C Analysis for A Single Project
Conventional B-C


Modified B-C
- includes operation & maintenance cost
Muhamad Abduh, Ph.D. 8-6 SI-4251 Ekonomi Teknik
Calculation can be made in present worth, future worth or annuity

C ) D B ( C B
I ) M & O D B ( C B
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.
Muhamad Abduh, Ph.D. 8-7 SI-4251 Ekonomi Teknik
Conventional method:
Cost C1 = Rp 725 million
Cost C2 = Rp 35 million/year
Benefit B1 = Rp 95 million/year
Benefit B2 = Rp 75 million at end of 5 year
Disbenefit D = Rp 3.2 million/year
225 (A/P, 8, 5) = 56.3535
35 = 35
95 = 95
75 (A/F, 8, 5) = 12.7845
3 2 = 3.2
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
(A/P, 8, 5) = 0.25046 (A/F, 8, 5) = 0.17046
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.
Muhamad Abduh, Ph.D. 8-8 SI-4251 Ekonomi Teknik
Modified method:
Cost C1 = Rp 725 million
Cost C2 = Rp 35 million/year
Benefit B1 = Rp 95 million/year
Benefit B2 = Rp 75 million at end of 5 year
Disbenefit D = Rp 3.2 million/year
225 (A/P, 8, 5) = 56.3535
35 = 35
95 = 95
75 (A/F, 8, 5) = 12.7845
3 2 = 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
Muhamad Abduh, Ph.D. 8-9 SI-4251 Ekonomi Teknik
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
Cost = EUAWB EUAWA = 466.250 174.375 = 291.875 million

BENEFIT:
EUAWA = 425 million EUAWB = 350 million Benefit = 350 (-425) = 75 million

B/C = 75/291.875 = 0. 2570
B-C = 75 291.875 = -216.875
Selection form Mutually Exclusive
Alternatives
Incremental B/C Analysis

Muhamad Abduh, Ph.D. 8-10 SI-4251 Ekonomi Teknik
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%
Selection form Mutually Exclusive
Alternatives
Incremental B/C Analysis

Muhamad Abduh, Ph.D. 8-11 SI-4251 Ekonomi Teknik
X Y Z
Initial cost, (I) - 270,000,000 -240,000,000 -320,000,000
Yearly expenses, (C) - 135,000,000 -123,500,000 -130,000,000
Yearly revenues, (B) 390,000,000 381,000,000 420,500,000
UAEW of Salvage value, (B)
Overall B/C
B C
Alternative to compare
Incremental benefit
Incremental cost
Incremental B/C
Decision
Selection form Mutually Exclusive
Alternatives
Incremental B/C Analysis

Muhamad Abduh, Ph.D. 8-12 SI-4251 Ekonomi Teknik
X Y Z
Initial cost, (I) - 270,000,000 -240,000,000 -320,000,000
Yearly expenses, (C) - 135,000,000 -123,500,000 -130,000,000
Yearly revenues, (B) 390,000,000 381,000,000 420,500,000
UAEW of Salvage value, (B) 7,083,000 8,184,800 31,794,800
Overall B/C 0.97 1.107 1.007
B C -7,917,000 25,684,800 2,294,800
Alternative to compare NO Y to Z
Incremental benefit 64.11
Incremental cost 86.50
Incremental B/C 0.74116
Decision Stay with Y
01/10/2010
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Homework #8
A ready-mix concrete producer is considering to install a new mixer system:








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


Muhamad Abduh, Ph.D. 8-13 SI-4251 Ekonomi Teknik
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