""'-500 ECONOMIC ANALYSIS IN THE PUBLIC SECTOR
worth of costs to form thedenominator.) To form the list thedenominator of the BICratio
(cost portion of the ratio) is first calculated for each of the feasible alternatives and then
placed into an ascending rank order from low to high cost. The "do-nothing" alternative
always becomes the first on the orderedlist.- Identify the increment under consideration.In this step the increment under con-
sideration is identified.The firstincrement taken under considerationis alwaysthat of going
from the do-nothing option to the first of the feasible alternatives.As the analysis proceeds,
any identified increment is always in reference to some previouslyjustified alternative.
S. Calculate the BICratio on the considered incremental cash flows. Upon identify_
ing the increment under consideration, it is necessary to calculate theincrementalbenefits
as well as theincrementalcosts.This step is accomplishedby findingthe cash flows that
represent the difference (.6.) between the two alternatives under consideration. For two
alternatives X andY,the incremental benefits (.6.B)and incremental costs (.6.C)of going
from Alternative X to AlternativeYmust be determined. The increment can b.e written
as (X --+Y) to signifygoing from Xto Yor as(Y- X) to signify thecash flows
of Y minus cash flows ofX. Both modes identify the incremental costs and benefits of
investing in alternativeY,where X is a previouslyjustified (or base) alternative:The .6.B
and .6.Cvalues are used to calculate the overallincremental BIC ratio (.6.B/.6.C)of the
increment. - Use the incremental BIC ratio to make a decision.The incrementalB/C ratio
(.6.BI.6.C) calculated in Step 5 is evaluated as follows: if the ratio.is greater than 1.0, then
the increment is desirable or justified; if the ratio is less than 1.0, it is not desirable, or
is not justified. If an increment is accepted, the alternative associated with that additional
increment of investment becomes the base from which the next increment is formed. In
the case of an increment that is not justified, the alternative associated with the additional
increment is rejected and the previously justified alternative is maintained as the base for
formation of the next increment. - Iterate to Step 4 until all increments (projects) have been considered.The incre-
mental method requires that the entire list of ranked feasible alternativesbe evaluated. All
pairwise comparisons are made such that the additional increment being considered is ex-
amined with respect to a previouslyjustified alternative.The incremental method continues
until all alternatives have been evaluated. - Select the appropriaie alternative from the sei of mutually exclusive competing
projects. Mter all alternatives (and associated increments) have been considered, the in-
cremental BICratio method calls for selection of the alternative that isassociated with the
last justified increment.In this way, it is assured that a maximum investment is made such
that each ratio of equivalentworth of incremental benefitsto equivalentworth of incremen-
tal costs is greater than 1.0. (A common error in applying the incrementalB/Cmethod is
selecting the alternative with thelargestincremental BICratio, which is inconsistent with
the objective of maximizing investment size with incremental BICratios above 1.0.)
Both the conventional and modified versions of theB/C ratio can be used with the
incremental BICratio methodologyjust described,but the two versionsshouldnot be mixed
in the same problem. Such an approach could affect the rank ordei and cause confusion
and errors. Instead,oneof the two versions should beconsistentlyused throughout the
analysis.--- -- --