CTC 475 Review CTC 475 Review

Comparing AlternativesComparing Alternatives Ranking (PW,AW,FW)Ranking (PW,AW,FW) Incremental (PW,AW,FW,IRR,ERR,SIR)Incremental (PW,AW,FW,IRR,ERR,SIR)

Supplementary AnalysesSupplementary Analyses Breakeven, Sensitivity, ProbabilityBreakeven, Sensitivity, Probability

Selecting and Selling the ProjectSelecting and Selling the Project

CTC 475 CTC 475

Projects in the Public SectorProjects in the Public Sector

ObjectivesObjectives

Understand the major differences Understand the major differences between public/private projectsbetween public/private projects

Know the common errors when using Know the common errors when using B/C ratioB/C ratio

Public ProjectsPublic Projects

Cultural Development Cultural Development (education, historic, recreation)(education, historic, recreation)

Economic Services Economic Services (transportation, power generation)(transportation, power generation)

Natural Resources Natural Resources (pollution control, flood control, wildlife (pollution control, flood control, wildlife

management)management) Protection Protection

(military services, police/fire)(military services, police/fire)

Differences from Private Sector Differences from Private Sector ProjectsProjects

Big initial cost (millions)Big initial cost (millions) Long lives (>=50 years)Long lives (>=50 years) Multiple-use concept (lake—boaters, Multiple-use concept (lake—boaters,

fishermen, flood control, irrigation, fishermen, flood control, irrigation, power)power)

Difficult to define cash flows Difficult to define cash flows (recreation, aesthetics, historic, (recreation, aesthetics, historic, cultural)cultural)

Basic Steps for AnalysisBasic Steps for Analysis

1.1. Define alternativesDefine alternatives

2.2. Define planning horizonDefine planning horizon

3.3. Develop cash flow profilesDevelop cash flow profiles

4.4. Specify MARRSpecify MARR

5.5. Compare alternatives (B/C ratio)Compare alternatives (B/C ratio)

6.6. Perform supplementary analysesPerform supplementary analyses

7.7. Select preferred alternativeSelect preferred alternative

B/CB/C

B/C (same as SIR) = PW(+)/PW(-)B/C (same as SIR) = PW(+)/PW(-) B-C (present worth method)B-C (present worth method)

Use incremental analysis if using B/CUse incremental analysis if using B/C

Example of Defining Example of Defining Alternatives and Developing Alternatives and Developing

Cash Flow ProfilesCash Flow Profiles

Steps 1 and 3 (planning Steps 1 and 3 (planning horizon is the same)horizon is the same)

Example-Public ProjectExample-Public Project

Initial CostInitial Cost AnnualizeAnnualized Govt. d Govt. CostCost

Annualized Annualized Public Public CostsCosts

Route ARoute A $416,800$416,800 $676,800$676,800 $16,973,00$16,973,0000

Route BRoute B $1,023,40$1,023,4000

$1,243,40$1,243,4000

$13,605,20$13,605,2000

Route CRoute C $1,733,80$1,733,8000

$2,102,80$2,102,8000

$12,678,50$12,678,5000

ExplanationsExplanations

1.1. Annual govt. costs includes Annual govt. costs includes annualized initial cost and annual annualized initial cost and annual O&M costsO&M costs

2.2. Annual public costs are annualized Annual public costs are annualized costs for safety, time, and vehicle costs for safety, time, and vehicle operationoperation

3.3. Note that we don’t need the Note that we don’t need the planning horizon to do our analysisplanning horizon to do our analysis

Compare B & A (B-A)Compare B & A (B-A)

Incremental benefitsIncremental benefits -$13,605,00-(-$16,973,000)=$3,367,800 -$13,605,00-(-$16,973,000)=$3,367,800 Benefit because we’re reducing public Benefit because we’re reducing public

costscosts Incremental CostsIncremental Costs

$1,243,400-$676,800=$566,600$1,243,400-$676,800=$566,600 Incremental B/CIncremental B/C

$3,367,800/$566,600=5.9$3,367,800/$566,600=5.9 Spending the extra money to lower public Spending the extra money to lower public

costs is economically feasiblecosts is economically feasible

Compare C & B (C-B)Compare C & B (C-B)

Incremental benefitsIncremental benefits -$12,678,500-(-$13,605,200)=$926,700 -$12,678,500-(-$13,605,200)=$926,700 Benefit because we’re reducing public Benefit because we’re reducing public

costscosts Incremental CostsIncremental Costs

$2,102,800-$1,243,400=$859,400$2,102,800-$1,243,400=$859,400 Incremental B/CIncremental B/C

$926,700/$859,400=1.08$926,700/$859,400=1.08 Spending the extra money for Alt. C to Spending the extra money for Alt. C to

lower public costs is economically feasiblelower public costs is economically feasible

Use Ranking (AW)Use Ranking (AW)

RouteRoute Total Annual Total Annual CostsCosts

RankRank

AA $17,649,800$17,649,800 33

BB $14,848,600$14,848,600 22

CC $14,781,300$14,781,300 11

ConsiderationsConsiderations

Point of viewPoint of view Selecting the MARRSelecting the MARR Over-countingOver-counting Unequal livesUnequal lives Tolls & feesTolls & fees Multiple-use ProjectsMultiple-use Projects Problems w/ B/C ratioProblems w/ B/C ratio

Point of ViewPoint of View

IndividualIndividual Particular govt. organizationParticular govt. organization Local AreaLocal Area Regional AreaRegional Area Entire nationEntire nation

Selecting the MARRSelecting the MARR

Use zero for tax moneyUse zero for tax money Use society’s time preference rateUse society’s time preference rate Use rate paid by govt. for borrowed Use rate paid by govt. for borrowed

moneymoney Opportunity cost for private investorsOpportunity cost for private investors Opportunity costs foregone by govt. Opportunity costs foregone by govt.

agenciesagencies

OvercountingOvercounting

For public projects it’s easy to count For public projects it’s easy to count something twicesomething twice Calculate wages lost (individual Calculate wages lost (individual

viewpoint)viewpoint) Put $ on disability accidents (company’s Put $ on disability accidents (company’s

viewpoint)viewpoint)

Unequal LivesUnequal Lives

Planning horizon usually coincides Planning horizon usually coincides with the longest-lived alternativewith the longest-lived alternative

If shortest life is chosen it is difficult If shortest life is chosen it is difficult to put a $ value on residual (salvage) to put a $ value on residual (salvage) value for the projects w/ the longer value for the projects w/ the longer liveslives

Tolls, Fees and User ChargesTolls, Fees and User Charges

Tolls, fees and user charges impact Tolls, fees and user charges impact the B/C ratio (but not B-C)the B/C ratio (but not B-C)

Fees—Example ProblemFees—Example Problem

On boardOn board

Multiple-Use ProjectsMultiple-Use Projects

For incremental costs a public project For incremental costs a public project can be expanded to provide multiple can be expanded to provide multiple benefitsbenefits

Each project alone may not have Each project alone may not have been economically feasiblebeen economically feasible

Multiple-Use Multiple-Use

Example problem on boardExample problem on board

Problems w/ B/C RatioProblems w/ B/C Ratio

Difficult to determine whether there Difficult to determine whether there is a benefit to the public or a cost is a benefit to the public or a cost savings to the governmentsavings to the government

Also, is it a disbenefit or an actual Also, is it a disbenefit or an actual cost?cost?

Affect’s B/C ratio but not B-CAffect’s B/C ratio but not B-C

B/C ratio problemsB/C ratio problems

Example on boardExample on board

Other AnalysesOther Analyses

Money alone is sometimes not the Money alone is sometimes not the only considerationonly consideration ReliabilityReliability PerformancePerformance AvailabilityAvailability MaintainabilityMaintainability

Reliability ExampleReliability Example

On-BoardOn-Board

Next lectureNext lecture

ATCF (After-Tax Cash ATCF (After-Tax Cash Flows)Flows)

Taxes/DepreciationTaxes/Depreciation