Benefit-Cost Analysis: Non-Profit Motive in Public Economy

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NON-PROFIT MOTIVE IN PUBLIC

ECONOMY
Benefit-Cost In general, most private organizations and corporations exist for
profit. The principal motive of economy studies for private projects
Analysis
is the maximizing of profits. Analysis of several alternatives is made
to determine which one will contribute the maximum net profit. No
expenditure is justified unless it can be considered as an acceptable
investment. On the other hand, government or public organizations
spend money to create an advantage for the public or a segment of
it. For example, the benefits to be derived from the construction of
Enmar T. Tuazon, ECE, ECT a highway may consist of savings in time consumed because of
higher speeds, in reduction of accidents because the highway is
built in accordance with highway standards, in lesser maintenance
and repair costs of vehicles because the surface is smooth, and in
shorter distances because the route is direct. Likewise,
expenditures for other projects like bridges, waterworks, dams,
airports, libraries, schools, flood controls, and all other public works
projects cause benefits to the people. The basic purpose of
government organizations is to provide a benefit needed by people.
FINANCING OF PUBLIC PROJECTS Comparison of Costs and Benefits

• With the exception of self-liquidating projects, the 1. Net Present Value (NPV)
basic source of capital needed to finance public 2. Rate of Return Method (ROR) – Internal/External
projects is taxes. It is reasonable to expect that
public funds obtained from taxes should be 3. Benefit-Cost Ratio (B/C)
invested with a financial efficiency at least equal to 4. The B – C Criterion
that which a private person would earn with those
funds.
Benefit-Cost Ratio (B/C) Method Benefit-Cost Ratio (B/C) Method

• The comparative worth of highway projects is • When quantifying the B/C ratio, the analyst must
expressed by the ratio of annual benefits which know that benefits include all the advantages,
happen to the owners. When the project involves minus the disadvantages, to the users, and that
disadvantages to the owners, these are called costs mean all the expenditures, minus any savings,
disbenefits. Costs are the anticipated expenditures that will be incurred by the government. A plan
for construction, maintenance, operation, and with many valuable benefits may also include some
other costs. For public projects, it is convenient to inescapable disadvantages to the user, in which
think of the public as the owners, and the national case they must be regarded as negative benefits
government as the one which incurs the costs. and subtracted.
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Benefit-Cost Ratio (B/C) Method Benefit-Cost Ratio (B/C) Method

• The procedure for a benefit-cost economy study,
𝐵𝑒𝑛𝑒𝑓𝑖𝑡𝑠 − 𝐷𝑖𝑠𝑏𝑒𝑛𝑒𝑓𝑖𝑡𝑠 like that for a rate-of-return solution, involves two
𝐵𝑒𝑛𝑒𝑓𝑖𝑡𝑠 − 𝐶𝑜𝑠𝑡 𝑅𝑎𝑡𝑖𝑜 = sets of computations. First, the benefit-cost ratios
𝐶𝑜𝑠𝑡𝑠
for each alternative are found, and those plans that
fail to attain a B/C ratio of unity are rejected. Next,
the B/C ratio for each increment of added in-
𝐴𝑛𝑛𝑢𝑎𝑙 𝐵𝑒𝑛𝑒𝑓𝑖𝑡𝑠 𝑓𝑟𝑜𝑚 vestment is computed, each plan being compared
𝐼𝑚𝑝𝑟𝑜𝑣𝑒𝑚𝑒𝑛𝑡𝑠 against the preceding acceptable plan. The
𝐵𝑒𝑛𝑒𝑓𝑖𝑡𝑠 − 𝐶𝑜𝑠𝑡 𝑅𝑎𝑡𝑖𝑜 =
𝐴𝑛𝑛𝑢𝑎𝑙 𝐶𝑜𝑠𝑡𝑠 𝑜𝑓 alternative that reaches the prescribed B/C ratio
𝐼𝑚𝑝𝑟𝑜𝑣𝑒𝑚𝑒𝑛𝑡𝑠
(usually 1.0) on both the total and increment of
investment is the most acceptable on the basis of
the assumed interest rate.
The B – C Criterion The B – C Criterion

As mentioned before, For a project to be acceptable, the difference (B - C)
B = net benefits = all the advantages, less the between the net benefits and net costs must be
disadvantages to the user. positive, that is, the benefits must exceed the costs.
It is obvious that if BCC, then the project should not
C = net costs = all disbursements, less any savings to be implemented.
the investor.
Where several alternatives are to be compared by
this criterion, the quantity (B - C) is calculated for
each alternative, and the one with the maximum
value is selected.
Sample Problem 1 Sample Problem 2

To increase accessibility to some beautiful scenery A government project has the following estimates:
along the Pan-Philippine Highway, a new highway is • Annual benefits P500,000
being pro-posed for construction. The initial cost is
expected to be P9,600,000, with an annual • Annual disbenefits 450,000
maintenance cost of P36,000. Every three years, • Annual costs 350,000
minor improvements costing P20,000 are expected • Annual savings 340,000
to be made. It is estimated that income from tourists
from foreign countries will be P1,200,000 annually. a. Calculate the B/C ratio.
Using a planning horizon of 30 years and interest rate b. Mistakenly treating disbenefits as costs and
of 10%, determine if the highway should be savings as benefits, determine the B/C ratio.
constructed. Analyze by (a) the (B - C) criterion, and
(b) the B/C method. c. Calculate (B - C)
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Sample Problem 3
• A nonprofit educational research organization, is con-
templating an investment of P1,500,000 in grants to
develop new ways to teach people the rudiments of
profession. The grants would extend over a ten-year
period and would achieve an estimated benefit of
P500,000 per year in professors` salaries, student
tuition, and other expenses. The program would be an
addition to ongoing and planned activities, thus an
estimated P100,000 a year would have to be released
from other program to support the educational
research as disbenefit. Interest of 15% is expected. Is
this a good program?
a. B/C method
b. B – C Criterion

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16/08/2019

NON-PROFIT MOTIVE IN PUBLIC

FINANCING OF PUBLIC PROJECTS Comparison of Costs and Benefits

Benefit-Cost Ratio (B/C) Method Benefit-Cost Ratio (B/C) Method

Benefit-Cost Ratio (B/C) Method Benefit-Cost Ratio (B/C) Method

The B – C Criterion The B – C Criterion

Sample Problem 1 Sample Problem 2

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