Environmental Economics
EC 145E
UCI
Dr. Bresnock
Sample Benefit-Cost Problems
1.
A proposed state computer system is designed to facilitate motor vehicle licensing by
speeding the processing of licenses and eliminating duplicative functions.
The system is
expected to cost $5,000,000 to implement.
In another state, the same vendor proposed a
similar system at an identical cost, but actual implementation was more complex than
anticipated and thus final costs turned out to be $6,500,000.
The vendor now claims that
this previous experience should allow costs to be reduced, so they optimistically estimate
costs at $4,250,000.
All costs can be considered as initial costs and need not be discounted.
The system's benefits result from reduced staff time.
In the most optimistic case, 90,000
hours would be saved each year for the five-year expected life of the system.
The expected
value for annual savings is 70,000 hours, and a pessimistic estimate is 50,000 hours.
For
each hour saved, the state's total cost is $20.
However, this is an optimistic estimate of the
potential dollar savings, since some staff positions may not be eliminated even though the
time demands are reduced.
Thus, a savings of only $14 is expected for each hour.
Critics
of the system have claimed that few workers will actually be replaced, so that actual savings
are $7 per hour.
(a)
Perform a variable-by-variable sensitivity analysis of this project, computing
benefit-cost ratios with an interest rate of 8 percent.
Please present all calculations,
and summarize your results in an organized table or matrix.
(b)
The governor has defined three scenarios for possible consideration of those that are
possible.
They are:
(1)
Initial costs are $5,000,000, with annual savings of 70,000 hours at $14 per
hour for five years.
(2)
Initial costs are $6,500,000, with annual savings of 70,000 hours at $20 per
hour for five years.
(3)
Initial costs are $4,250,000, with annual savings of 70,000 hours at $14 per
hour for five years.
Using a 4 percent interest rate, which of these scenarios produces a desirable project?
Use the present worth factors below to compute your answers to these problems.
Environmental Economics
Dr. Bresnock
Sample Benefit-Cost Problems