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Cost Engineering and Analysis

by: Charley Wintheiser DVM

Cost Engineering and Analysis C E 406

Charley Wintheiser DVM

GPA 3.96

Jeremy Redman

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Jeremy Redman
Class Notes
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This 8 page Class Notes was uploaded by Charley Wintheiser DVM on Monday October 5, 2015. The Class Notes belongs to C E 406 at California State University - Long Beach taught by Jeremy Redman in Fall. Since its upload, it has received 25 views. For similar materials see /class/218764/c-e-406-california-state-university-long-beach in Civil Engineering at California State University - Long Beach.

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Date Created: 10/05/15
CE406 Chapter 9 102705 Benefit I Cost Analysis in Public Sector Public Sector projects are owned used and financed by the citizens Examples of public works projects Hospitals parks utilities schools sports arenas freeways food stamps emergency relief Typically Public Sector projects are Largescale Long life spans 3050 years No profits any expenses are paid by public and any revenue goes back to public For example Saints may move to LA In order to do so they would need an updated football arena This would be a huge project and something that might fall in the realm of the Public Sector In addition to the football arena local infrastructure roads freeways etc will have to be modified to alleviate congestion To do economic analysis we often have to estimate Costs expenditures to the government entity for construction operation and maintenance less any salvage value Benefits advantages to be experienced by the owners the public Disbenefits undesirable or negative consequences to the owners of the alternative is implemented May be indirect economic disadvantages of the alternative In order to determine whether such a project is worthwhile or not we conduct a BenefitCost Analysis Identify all user39s benefits favorable outcomes and disbenefits unfavorable outcomes arising from the project 2 Quantify as much as possible these benefits and disbenefits in dollar terms so that benefits and costs can be compared 3 Identify sponsor39s costs and quantify them 4 Determine the equivalent net benefits and net costs at the base period 5 Accept project if the equivalent net benefits exceed the equivalent net costs Thus we can say that B gt C or BCgt1 Page 1 of 8 CE406 Chapter 9 102705 Benefits What are benefits and disbenefits of a project eg a new highway will alleviate congestion allowing people to get to work faster New businesses will spring up along the highway gas stations restaurants However because of a decrease in traffic along the old route some businesses there may be lost B benefits disbenefits for simplicity we define benefits as either primary or secondary primary directly attributable to the project secondary indirectly attributable eg govt wants to build a superconductor lab primary benefit new technologies and applications to US businesses secondary benefit international trade of these technologies and the increase in local economy due to the presence of a large scientific population Costs Identify and classify the expenditures required and any savings to be realized C initial capital expenditures operating and maintenance costs Since we are going to have a ratio B C the sign convention changes and we take costs as positive values and revenues in the cost term as negative values eg a new toll highway will have construction costs resurfacing costs and revenues in the forms of tolls MARR Typically the projects we are looking at with this kind of analysis are public and thus the rate of return is different than for private ventures The purpose of government spending is not the same as private industry ie make money The interest rate we apply for public projects is called the Social Discount Rate Two possibilities for social discount rate 1 social discount rate should reflect only the prevailing government borrowing rate for projects with no private counterparts reservoirs dams noncommercial access roads the rate is set at the rate that government borrows money 2 social discount rate should represent the rate that could have been earned had the funds not been removed from the private sector if public projects are Page 2 of 8 CE406 Chapter 9 102705 financed by borrowing money at the expense of private investment then that money could have earned a better return in the private market Public projects similar to private projects should be evaluated at the composite rate of return The second view is what the federal govt support the Office of Management and Budget has established a social discount rate of 10 B PW bn Ci PWC n0 where bn and cn represent the benefits and costs at end of period n N is the project life at this point for a single project to be viable B C gt 1 We refer to this value as BCi Example Company is evaluating a project with a first cost of 500000 split evenly between period 0 and 1 Annual revenue of 120000 and 0ampM costs of 30000 begin at the end of year 2 and continues for 10 years There is no salvage value at the end of 11 years Using i 10 calculate BC revenue benefits start in yr 2 and end in yr 11 B 120000PA1010PF101 670316 C 250000 250000PF101 30000PA1010PF101 644851 B C 104 It is important how these expressions are stated There are many many different types net BC ratio written as B C l where l is the initial costs and C is recurring costs PW index PWCFt CFO so cash flows future years and divided by the year 0 flow How do we compare different projects We use incremental BICRatio analysis wait for applause Steps 1 Eliminate those alternatives with BC lt 1 2 Arrange remaining alternatives in increasing order of C smallest to largest 3 Compute difference for each term B C Page 3 of 8 CE406 Chapter 9 102705 ABB Ba ACC Ca AB 4 BC ba BCW z E U1 If BCiba gt 1 then chose alternative B the difference if less than 1 chose alternative A 6 Move down the list like the challenger defender we did last week Addendums If delta l C39 0 then we cannot use benefitcost ratio In this case we select the alternative with the largest B value With unequal service lives instead of PW analysis on all terms we use AW analysis Let39s consider a flood control project in 1000 Channel Dam and Reservoir No Flood control Improvements First Cost 1500 2500 0 Flood Damage First Year 220 50 500 Increasing Gradient 10 5 8 0ampM first year 70 95 increasing gradient 5 8 Annual Benefit to Fisheries 29 Disbenefit to recreation 20 Disbenefit to agriculture 21 Assume a study period of 25 years and an i value of 11 Rank according to first cost NFC lt Cl lt DampR Let39s determine BCicinfc What are benefits of improving channel cost of floods decreases from 500 to 220 in first year Some recreation is lost Del B 220 500PA1125 10 8PG1125 20PA1125 207006 Del C 15000 700PA1125 50PG 1125 23887 Del B Del C 207006 23887 0885 This tells us that the added benefits of Page 4 of 8 CE406 Chapter 9 102705 improving the channel a decrease in flood damage do not outweigh the costs associated with improving the channel construction maintenance loss of recreation land Let39s determine BCidrnfc Del B 50 500PA1125 5 8PG1125 29PA1125 21 PA1125 403678 Del C 25000 950PA1125 80PG 1125 377875 Del B Del C 403678 377875 107 Therefore the added expense of building and maintaining the dam results in a benefit to the region in terms of reduced flooding and increased fishing We can think of the BIO as in terms of a benefit per cost So a BIG of 1 07 intuitively tells us that every 1 spent on construction and maintenance yields 107 in benefits namely a reduction in flooding Depending on how we look at projects we can have different opinions on whether something is a cost or a disbenefit Consider the following A city wishes to issue a 5 M bond to purchase greenbelt to preserve land and protect against flooding The following cash flows are expected Annual cost of 5 M bond over 15 years at 6 interest rate Annual maintenance upkeep and program management Annual parks development budget Annual loss in commercial development State sales tax rebates not realized Annual municipal income from park use Savings in flood control projects Property damage not experienced due to flooding ooxlocn4gtwM x We have several points of view we can take when classifying these as costs benefits and disbenefits viewpoint of the public purchasing and operating the park is our goal Cost 1 2 3 Benefit 6 7 8 Disbenefit 4 5 Page 5 of 8 CE406 Chapter 9 102705 viewpoint of City Budget balance our revenues and expenditures cost 1 2 3 5 5 now becomes a cost to the budget rather than a disbenefit to the citizens benefit 6 7 8 disbenefit 4 Consider Upgrade to existing hospital facility Design A Design B construction cost 10 M 15 M maintenanceyr 35000 55000 patient usage cost 450000 200000 discount rate is 5 and the hospital life is estimated at 30 years patient usage cost is the cost to patients above insurance to use the facility In this case the costs are disbenefits to the public so we account for them Cost construction maintenance Let39s determine AW of costs for each project A 35000 10M AP 530 685000 B 55000 15M AP 530 1030750 B has larger AW cost DEL C awb awa 345250 DEL B awb awa 200000 450000 250000 del B del C 250000 345250 072 Let39s consider projects with long life spans infinite Army corps wants to build dam with an infinite lifespan 6 locations are available assume i 6 per year Start by looking at BC for each alternative Since this is an infinite lifespan project we must use CAPITALIZED COST A Pi Page 6 of 8 CE406 Chapter 9 102705 11 we eliminate all but E and F We do incremental analysis on the choices rankfrom low to high cost E F del CC 660000300000 360000 del B 700000 350000 350000 del B del CC 097 so no go Let39s say that a new site becomes available G initial cost 10 M annual benefit 700000 10 M 6 600000 G E B C 700000 600000 117 compare this with option E del CC 600000 300000 300000 del B 700000 350000 350000 B C 117 Therefore we chose G Must still check against F del CC 660000 600000 60000 del B 700000 700000 0 B C 0 therefore we stay with G In this case we pay for F to get same economic benefit no go problems 11 16 25 33 Page 7 of 8 CE406 Chapter 9 102705 Chapter 10 We have now seen 5 different way to evaluate projects and chose the best one PW AW FW ROR BC PW AW FW to be used evaluate alternatives in private sector Don39t often worry about FW Alternatives with Equal lives AW or PW public sector BC based on AW or PW Unequal lives of alternatives AW public sector BC based on AW Long to infinite AW or PW using capitalized cost A Pi public sector BC based on AW Page 8 of 8


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