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01/10/2010 1 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 desir
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  01/10/2010 1 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 2 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 DBC  / B   I M &ODB 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  )DB( C B   I  )M &ODB( 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    01/10/2010 3 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: EUAW  A  = 1,250 (A/P, 10, 20) + 27.50 = 1,250 (0.1175) + 27.50 = 174.375 million EUAW B  = 3,500 (A/P, 10, 20) + 55.00 = 3,500 (0.1175) + 55.00 = 466.250 million Δ  Cost = EUAW B    –  EUAW  A = 466.250  –  174.375 = 291.875 million BENEFIT: EUAW  A  = 425 million EUAW B  = 350 million Δ  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 4 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

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