Engineering Economic Analysis

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Incremental Benefit-Cost Analysis 499

Public Project

TABLE 16-2 Example Benefits and Disbenefits for Public Investments

New city airport on the

exterior of town

Interstate bypass around

town

New metro subway system

Creation of a city disposal

facility versus sending

waste out of state

Construction of a nuclear

energy generation facility

Primary Benefits

More flights, new businesses

Quicker commute times,

reduced congestion on

surface roads

Faster commute times, less

pollution

Less costly, faster and more

responsive to customers

Cheaper energy costs, new

industry in area

Primary Disbenefits

Increased travel time to airport,

more traffic on outer belt

Lost sales to businesses on

surface roads, lost

agricultural lands

Lost jobs due to bus line closing,

less access to service

(fewer stops)

Objectionable sight and smells,

lost market value to home-

owners, lost pristine forest

land

Perceived environmental risks

of the decision alternatives over their respective life cycles. As with the incremental IRR

method, it isnotproper to simply calculate the BICratio for each alternativeand choose the

one with the highest value. Rather, anincrementalapproach is called for. The incremental

approach used with the IRR method can be slightly augmented for use with the BICratio.

Elements of the Incremental Benefit-Cost Ratio Method

1. Identify all relevant alternatives.Decision makers identify the set of alternatives
   from which a choice is ultimatelymade. In this context it is importantto identifyallrelevant
   and competitive alternatives. Decision rules or models can recommend abestcourse of
   actiononlyfrom the set of identified alternatives. If a better alternative than those in the
   considered set exists, it will never be selected, and the solution will be suboptimal. For
   benefit-cost ratio problems, the "do-nothing" option is always the "base case" from which
   the incremental methodology proceeds..


2. (Optional) Calculate the BICratio of each competing alternative in the set. In this
   optional step one calculates the BICratio of each of the competing alternatives based on
   thetotal cash flows for each alternativeby itself. Once the individualB/C ratios have
   been calculated, the alternatives with a ratioless than 1.0are eliminated from further
   consideration. The alternativeswith a BICratiogreater than 1.0remain in the set of feasible
   alternatives. This step gets the "poor performers" out of the way before the incremental
   procedure is initiated. This step may be omitted, however,because the incremental analysis
   method will eliminate the subpar alternativesin due time.


3. Rank order the projects. The incremental IRR method is used to analyze each of
   the mutually exclusive alternativesof the set, arraying the alternativesin order of increasing
   first cost. However, when one is using the incrementalB/Cratio, the alternatives must be
   ordered according to increasing size of thedenominator of the BIe ratio.(The rank order
   will be the same regardless of whether one uses the present worth, annual worth, or future

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