The Benefit-Cost ratio (B / C) directly compares benefits and costs. To calculate the ratio (B / C), first find the sum of the discounted benefits, brought to the present, and divide it by the sum of the discounted costs.
For a conclusion about the viability of a project, under this approach, the comparison of the B / C ratio found compared to 1 should be taken into account, thus we have the following:
- B / C> 1 indicates that the benefits exceed the costs, therefore the project must be considered. B / C = 1 There are no profits here, since the benefits are equal to the costs. B / C <1, shows that the costs are greater than the benefits, should not be considered.
Benefit Cost in Excel:
Benefit Cost in Excel
Project A: B / C <1 (Not taken into account)
Project B: B / C> 1 (If taken into account)
Clearly B's B / C ratio is better than Project A's, so it should be selected.
A benefit / cost ratio of 1.11 means that you are expecting $ 1.11 in profit for every $ 1 in cost.
Note: The salvage value in this method is considered as “Negative cost”, not as a benefit.
Advantage
- Very easy to work. Very used in databases and spreadsheets.
Disadvantages
- A common measure has to be used to also be able to quantify the qualitative benefits. Example: if a project is carried out that benefits the workers, how would the satisfaction of the workers be recorded as a benefit ?, or the increase in productivity due to it. The benefits should be carefully reviewed, because the benefits are easy to double count. Example, if a road is evaluated, it could be taken as benefits the increase of the surrounding properties, and also the reduction of travel time, a fact that is implicit in the location value of the properties.
Bibliography
L. Blank, & A. Tarquin; Economic engineering. McGrawHill Publishing, Mexico, 6th Edition, 2006.
Links:
Vijaya R. Sharma, BENEFIT - COST ANALYSIS, Natural Resource Economics, University of Colorado at Boulder. 11-26-2014.
