Question

A state highway department is considering a bypass loop that is expected to save motorists $821,000 per year in gasoline and other automobile-related expenses. However, local businesses will experience revenue losses estimated to be $131,000 each year. The cost of the loop will be $8,900,000. Calculate the conventional B/C ratio using an interest rate of 7% per year and a 10-year project period.

Answer 1

B/C ratio, also known as the benefit-cost ratio is an indicator which explains the viability of any proposed project. If a project has BCR greater than 1.0, it is expected to deliver positive net present value.

BCR can be calculated by the following formula

= proposed total cash benefits / proposed total cash cost

The cash benefit in the formula is replaced by the net present value of the projected benefits calculated using the discounted cash flow method.

Projected benefits per year for the next 10 years = $ 821,000-$ 131,000 = $ 690,000
NPV of the projected benefits @ 7% =

= $ 4,846,271

Proposed cost = $8,900,000

therefore conventional B/C ratio = $4,846,271 / $8,900,000 = 0.544525