MSci261-2007-Ch_10-11 - Benefit-cost analysis Sensitivity...

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Chapter 10 1 Chapter 10, 11 Chapter 10, 11 MSci 261: Engineering Economics: Financial Management for Engineers Spring 2007 Instructor: Bon Koo Benefit-cost analysis Benefit-cost analysis Sensitivity analysis Sensitivity analysis
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Chapter 10 2 1. Benefit cost analysis 1. Benefit cost analysis Benefit cost analysis (BCA) is a method of project evaluation widely used in many areas This method is used in both the public sector and private sector Private sector: Market price usually reflects private benefits and costs. This is the issue we have learned up to this point. Public sector (government, city, etc.): Need to consider the overall social benefits and costs, rather than private values. For example, logging results in flooding; upstream chemical firms with downstream fisheries,… We should be clear about whose benefit (i.e., who are users) and whose cost (i.e., who should pay) in the analysis. This can sometimes be ambiguous depending on the viewpoint.
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Chapter 10 3 1.1. Identifying and measuring values 1.1. Identifying and measuring values Costs Examples: capital costs, operating and administration costs Relatively straightforward to identify and measure Benefits Some benefits are easy to estimate: cash inflow from bridge But, many other benefits (and some costs) are difficult to measure: e.g., clean air, pollution, congestion, safety, etc. The goods and services that are not traded in the market (i.e., non-market goods) can be challenging to evaluate. How to measure the benefits for these cases? Contingent valuation; Hedonic price
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Chapter 10 4 1.2. Benefit cost ratios (BCR) 1.2. Benefit cost ratios (BCR) We use either PW or AW in the BCR calculation Conventional BCR (BCR) BCR = PW (user’s benefits)/PW (sponsor’s costs) A project is considered desirable if BCR > 1. Modified BCR (BCRM) BCRM = PW (user s benefits) PW (sponsor s op. costs) PW (sponsor’s capital costs) BCRM provides a measure of the net gain per dollar invested by the project sponsor. A project is desirable if BCRM > 1.
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Chapter 10 5 Example 1-1: BCR Example 1-1: BCR The University Plaza plans to pave its parking lot. The PW of the expected benefits is $3,000,000, and the construction cost is expected to be $500,000. The PW of expected maintenance costs over the lifetime of the project is $50,000. The PW of the inconvenience cost during the construction is $75,000. What is the benefit-cost ratio?
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