Economic Analysis in the Public Sector (Benefit Cost (B/C) Analysis)

Topics: Cost-benefit analysis, Cost, Costs Pages: 6 (1253 words) Published: September 21, 2013
Title: Economic Analysis in the Public Sector (Benefit Cost (B/C) Analysis) 1 Table of Contents

2 Overview of the case
There are two mutually exclusive proposals presents, proposals A and proposals B which is given by Chief Manager of Saksama Sdn. Bhd. to appointed group. The appointed group will be consisting of project engineers, economic/financial advisors and project leaders who will make a final decision between these two respective proposals. Both of the proposals share similar goal which will be initiated to upgrade and improve electrical distribution utility station if approved by Saksama Sdn. Bhd.

The first proposal, Proposal A is suggested to upgrade the overall the existing facility at lower cost and lower overall benefit. On the other hand, Proposal B is found to be more costly as compared to Proposal A but more beneficial to public since it acts as an alternative to build entirely new facility. The new facility will include many of cost saving including more efficient machinery, economy of scale and automation to reduce man power. The disbenefit related to the new facility includes the use of additional public land, the need for more roads and the disruption of traffic transportation. Table 1: Cost and Benefit for Two Proposals

Item/Cost
Proposal A
(x Rm 1,000)
Proposal B
(x Rm 1,000)
Initial Construction Cost
40,000
4,000
Annual Maintenance Cost
1,500
150
Annual Public Benefit
6,500
650
Annual Public Disbenefit
1,500
0
Service Years
30 years
12 years
Note: Assuming that 6% interest rate.
3 Problem Statement
As part of the committee, it is recommended that chief manager of Saksama Sdn. Bhd. used three types of method to determine which proposal will be chosen to improve electrical distribution utility station. The methods are using Conventional B/C analysis method, Modified B/C analysis method and Incremental B/C analysis method. The chief must used these three methods to determine which proposal/alternative to be taken.

A cost benefit analysis is important in deciding whether a project should be undertaken or not. BCA helps in revealing whether that certain project can pass economic struggle now or whether it will be worth in next 5 years due to the regional traffic growth. Hence, by doing BCA can preserve the future of the project at that instance moment. To put this in more understandable words, BCA is simply a decision making tool to obtain important and useful information on desirable and undesirable effects of the projects. It also can outweigh the social benefits of a proposed public activity to social cost.

In addition of that, the incremental analysis is defined as the examination of the differences between alternatives. By emphasizing proposals/alternatives, the decision whether or not differential costs are justified by differential benefits. [1] This method requires a proper ordering of alternatives which is based on the total equivalent costs. For this order, the alternative with smaller Annual Worth (AW) cost will become the defender and the alternative with larger AW cost will be the challenger. For this method, the incremental C (equivalent annual operating costs), B (equivalent annual benefit costs), and D (equivalent annual disbenefit costs) are firstly calculated in order to obtain the B/C (Benefits/ Cost) ratio. Then, if ΔB/C ≥ 1.00, the challenger’s alternative is selected. Otherwise, defender’s alternative will be selected. [2]

4 Solution Methodology
4.1 The Formula
The formulas for each method are shown in Table 2.
Table 2 : Formula for conventional, modified & incremental analysis method. Analysis Method
Formula
Conventional Benefit Cost (B/C)
Conventional B-C ratio with PW and AW:

Conventional B-C ratio with PW, market value included:

Remark: B /C 1 the project is economically acceptable, otherwise it is not. Conventional B/C ratio:
Where;
B = benefits (Primary benefits or benefits – a benefit directly attributable...

References: [1] Incremental analysis. (n.d.) Retrieved on April 07, 2013 from http://www.engr.siu.edu/mining/paul/engr361/readings/Chapter%208.PDF.
[2] Chapter 9 slides. (n.d.) Retrieved on April 07, 2013 from http://ise.tamu.edu/people/faculty/butenko/INEN303/chap9.pdf.
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