Module 8: Benefit-Cost Ratio

SI-4251 Ekonomi Teknik

Rani G. K. Pradoto
Outline Module 8
 Benefit – Cost Ratio

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The Benefit – Cost Analysis
 The
most commonly used method for
comparing economic alternatives.
 This
method is often considered as
“supplementary” to present worth analysis.
 Theobjective 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
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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

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B/C Analysis for A Single Project
Conventional B/C
B−D
B/C =
C
Modified B/C
- includes operation & maintenance cost
- initial investment replaces cost as
denominator B − D −O&M
B/C =
I
Calculation can be made in present worth, future
worth
8-5
or annuity SI-4251 Ekonomi Teknik
B - C Analysis for A Single Project
Conventional B-C
B − C = (B − D) − C

Modified B-C
- includes operation & maintenance cost

B − C = (B − D − O & M ) − I

Calculation can be made in present worth, future

worth
8-6
or annuity SI-4251 Ekonomi Teknik
 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.
Conventional method:
Cost C1 = Rp 225 million  225 (A/P, 8, 5)
Cost C2 = Rp 35 million/year = 56.3535
Benefit B1 = Rp 95 million/year 35 = 35
Benefit B2 = Rp 75 million at end of95
5 year  = 95
Disbenefit D = Rp 3.2 million/year 75 (A/F, 8, 5)
= 12.7845
(A/P, 8, 5) = 0.25046 (A/F, 8, 5) = 0.17046
32 = 3.2
B/C = [(95 + 12.7845) – 3.2 - 35]/(56.3535) =
1.2348
B-C = [(95 + 12.7845) – 3.2 - 35] –
8-7 SI-4251 Ekonomi Teknik Muhamad Abduh, Ph.D.
[56.3535] = Rp 13.231 million
 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.
Modified method:
Cost C1 = Rp 725 million  225 (A/P, 8, 5)
Cost C2 = Rp 35 million/year = 56.3535
Benefit B1 = Rp 95 million/year 35 = 35
Benefit B2 = Rp 75 million at end of95
5 year  = 95
Disbenefit D = Rp 3.2 million/year 75 (A/F, 8, 5)
= 12.7845
(A/P, 8, 5) = 0.25046 (A/F, 8, 5) = 0.17046
32 = 3.2
B/C = [(95 + 12.7845) – 3.2]/(56.3535 + 35)
= 1.1448
B-C = [(95 + 12.7845) – 3.2] – [56.3535 +
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35] = Rp 13.231 million
 Comparing two alternatives using B/C
analysis
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
BENEFIT:
Δ Cost = EUAWB – EUAWA = 466.250 – 174.375 = 291.875
million EUAW = 425 million EUAW = 350 million Δ Benefit = 425-350 =
A B
75 million
B/C = 75/291.875 = 0. 2570

B-C
8-9 = 75 – 291.875 =SI-4251
-216.875
Ekonomi Teknik
Selection form Mutually Exclusive
Alternatives
Incremental B/C Analysis
X Y Z
Initial cost - -240,000,000 -320,000,000
250,000,000

Yearly expenses - -123,500,000 -130,000,000

135,000,000

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%
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Selection form Mutually Exclusive
Alternatives (benar)
Incremental B/C Analysis
Y X Z
Initial cost, (I) -240,000,000 -250,000,000 -
320,000,000

Yearly expenses, (C) -123,500,000 -135,000,000 -

130,000,000

Yearly revenues, (B) 381,000,000 390,000,000 420,500,000

UAEW of Salvage value, 52,000,000 45,000,000 202,000,000

(B)
Overall B/C
B–C
Alternative to compare
Incremental
8-11 benefit SI-4251 Ekonomi Teknik
Selection form Mutually Exclusive
Alternatives (benar)
Incremental B/C Analysis
Y X Z
Initial cost, (I) -240,000,000 -250,000,000 -
320,000,000

Yearly expenses, (C) -123,500,000 -135,000,000 -

130,000,000

Yearly revenues, (B) 381,000,000 390,000,000 420,500,000

UAEW of Salvage value,

(B)
Overall B/C >1 <1
B–C
Alternative to compare YES Y to Z
Incremental
8-12 benefit SI-4251 Ekonomi Teknik262,219,000
Homework #8
A ready-mix concrete producer is considering to install a new mixer
system:
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

at rate of return 10% determine which system should be installed

using B/C analysis?

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