ECON 416 Midterm Flashcards
BCR
Benefit-Cost Ratio
(sum of Benefits)/ (Sum of Cost)
How do we know if a project is worthwhile using BCR?
If BCR A Project is worthwhile if BCR > 1 (Benefits > Costs)
A Project is NOT worthwhile if BCR < 1 (Benefits < Costs)
If BCR = 1, the project is marginally acceptable (but in a world with uncertainty, it probably won’t
go for it) and if it does occur we would do a sensitivity analysis/
How are operating costs applied in BCR calculations?
Usually, operating costs are seen as a cost.
Sometimes, operating costs are seen as a negative benefit
Formula for BCR using operating costs
BCR = B/(C + T)
so if BCR > 1, B = C + T + X, for some X >
BCRM formula (modified BCR formula)
(B – T)/C
If BCR > 1, we can re-write BCRM as [(C + T + X) – T]/C
*BCRM = (C + X) / C = C/C + X/C = 1 + X/C
*Since X>0 and C>0, X/C > 0 and so BCRM > 1
* When BCR > 1, BCRM >
What calculation do we use to choose between two mutually exclusive projects?
incremental analysis
Where we check the Extra Benefits against the EXTRA cost
If IBCR(X – Y) > 1, the jump in cost from Y to X is worth it. If not, it isn’t.
In case of a tie, pick the project with higher B or lowest C.
What is the standard procedure for independent projects?
- order by BCR
- buy projects in that order until there’s not enough to buy the next
consider all affordable combinations of projects (this can get messy) and
pick the permutation with highest Net Present Value
Two rules for dominated projects
1) If two projects have the same cost, but different benefits, the project
with the lower benefit is dominated.
2) Benefits must increase with costs
What is a dominanated project
project is one that is strictly and obviously inferior to another project under consideration.
- Checking for dominated projects is a time-saving ‘pre-screen’ that
avoids unnecessary calculation
Can we use incremental BCR for independent projects?
It is incorrect to use incremental BCR analysis when the projects under
consideration are independent.
The reason is that the algorithm requires you to discard an alternative in each iteration of the loop. Therefore only good when projects are mutually exclusive.
What do we give up by lending money today?
Interest income- if we saved the money
Investment income- if we invested the money
Forgoing utility -if we were to use that money for something else like going for beers
If you lent money that you borrowed, then you are foregoing the opportunity not to pay interest on that money .
