W10_Folakemi_Public Sector Project Evaluation Using Benefit-Cost Analysis

1.      Problem recognition, definition and evaluation

The Ministry of Youth, Sports and Social Development of a state is considering different projects for the purpose of promoting youth development and/or sports in 2013. The Permanent Secretary has identified four different projects that can be set up in 2013 to achieve this objective. The objective of this write up is to determine whether or not to embark on these projects by using the benefit- cost ratio analysis and the external rate of return method. The mutually exclusive projects will NOT be compared; therefore the incremental B-C analysis method will not be used.

2.      Development of the feasible alternatives

The four projects being considered by the department are:

1.  Establishment of a rehabilitation home for juvenile delinquents  (Project A)
2. Establishment of a rehabilitation and vocational training center for destitute and handicapped persons (Project B)
3. Identification and design of an open space for recreational purposes (Project C)
4. Establishment of a citizenship and leadership training center for youth (Project D)

3.      Development of the outcomes for each alternative

A review of literature revealed that some of the methods that can be used to evaluate the projects are:

• The External Rate of Return (ERR) of the project, which should be greater than the MARR, i.e. the Minimum Attractive Rate of Return. The ERR is the interest rate that equates the net cash outflows discounted to time zero at E% compounding period to the net cash inflows compounded to period N at E%.
• The Benefit-Cost ratio method: This involves the calculation of the ratio of equivalent worth of benefits to equivalent worth of costs.

 

4.      Selection of criteria

The projects will be evaluated using two techniques i.e. External Rate of Return (ERR) and Benefit-Cost ratio method. In the ERR method, all cash inflows and outflows expected from the project are discounted using an appropriate interest rate called the external reinvestment rate per period (E). E=MARR, i.e. the Minimum Attractive Rate of Return. The assumed MARR for this government agency is 7%.

The B-C ratio, also known as the savings-investment ratio (SIR) by some governmental agencies, must be greater than or equal to 1.0 for a project to be acceptable.

Table 1 - Analysis of Alternatives (Dollars)

 

5.      Analysis and comparison of the alternatives

Table 2. External Rate of Return (ERR) of Projects

 

All the projects are viable as the ERR of each one is higher than the MARR. Establishment of a rehabilitation and vocational training center for destitute and handicapped persons is the most economically viable out of the four projects while the identification and design of an open space for recreational purposes is the least viable.

Table 3. Benefit-Cost Ratio (B-C) of Projects

 

Conventional B-C Ratio = Total Annual Benefits ÷ Annual Costs

Based on B-C ratio, the only acceptable project of the four is the establishment of a rehabilitation and vocational training center for destitute and handicapped persons. This is the only project that has a B-C ratio that is greater than 1.

6.      Selection of the preferred alternative

Based on the two different methods used in evaluating the projects, the following table shows the list of projects in order of economic viability from the most viable to the least.

Table 4. Projects by Economic Viability

 

7.      Performance Monitoring & Post Evaluation of Result

The ERR and B-C method produced similar results in terms of ranking of the projects. However the ERR shows that all the projects are economically viable (ERR>MARR), while the B-C method indicates that only Project B should be considered. It may be useful to evaluate the projects using qualitative methods and also using the B-C ratio method for mutually exclusive projects.

8.      References

• Mind Tools (n.d) Cost-Benefit Analysis: Deciding quantitatively whether to go ahead. Mind Tools: Essential Skills for an excellent career. Retrieved from: http://www.mindtools.com/pages/article/newTED_08.htm
• Sullivan, W. G., Wicks, E.M., & Koelling, C.P. (2012). Engineering Economy (15th ed.) (pp 200-214, 450-460) New Jersey, NJ. Pearson Higher Education, Inc.
• The Chinese University of Hong Kong. (2011, November 16). Public projects and benefit-cost ratio method. Retrieved from:  http://www1.se.cuhk.edu.hk/~seem2440/Lecture_Notes/Chapter_9.pdf