• Virtually all the examples and problems of previous chapters have

involved the private sector, where products, systems, and services are
developed and offered by corporations and businesses for use by individual
customers and clients, the government, or other companies.
• Now we will explore projects that concentrate on government units and the
citizens they serve. These are called public sector projects.

• Upon reflection, it is surprising how much of what we use on a daily or as-

• Often alternatives developed to serve public needs require large initial

• The long lives of public projects often prompt the use of the capitalized
cost method, where infinity is used for n and annual costs are calculated as
A = P(i). As n gets larger, especially over 30 years, the differences in
calculated A values become small. For example, at i = 7%, there will be a
very small difference in 30 and 50 years, because (A/P,7%,30) = 0.08059
and (A/P,7%,50) = 0.07246.
• There are significant differences in the characteristics of private and public
sector alternatives. They are summarized here.
• Public sector projects (also called publicly owned) do not have profits;
they do have costs that are paid by the appropriate government unit; and
they benefit the citizenry.
• Public sector projects often have undesirable consequences, as interpreted
by some sectors of the public. It is these consequences that can cause
public controversy about the projects.
• The economic analysis should consider these consequences in monetary
terms to the degree estimable. (Often in private sector analysis, undesirable
consequences are not considered, or they may be directly addressed as
costs).
• To perform a benefit/cost economic analysis of public alternatives, the
costs (initial and annual), the benefits, and the disbenefits, if considered,
must be estimated as accurately as possible in monetary units.
• It is difficult to estimate and agree upon the economic impact of benefits and
disbenefits for a public sector alternative. For example, assume a short bypass
around a congested area in town is recommended.
• How much will it benefit a driver in dollars per driving minute to be able to
bypass five traffic lights while averaging 35 miles per hour, as compared to
currently driving through the lights averaging 20 miles per hour and stopping at
an average of two lights for an average of 45 seconds each?
• The bases and standards for benefi ts estimation are always difficult to establish
and verify.
• Relative to revenue cash flow estimates in the private sector, benefi t estimates
are much harder to make, and vary more widely around uncertain averages.
• And the disbenefits that accrue from an alternative are even harder to estimate.
• In fact, the disbenefi t itself may not be known at the time the evaluation is
performed.
• The capital used to finance public sector projects is commonly acquired from
taxes, bonds, and fees.
• Taxes are collected from those who are the owners—the citizens (e.g., federal
gasoline taxes for highways are paid by all gasoline users, and health care costs
are covered by insurance premiums).
• This is also the case for fees, such as toll road fees for drivers.
• Bonds are often issued: U.S. Treasury bonds, municipal bond issues, and
special-purpose bonds, such as utility district bonds.
• Private lenders can provide up-front financing. Also, private donors may
provide funding for museums, memorials, parks, and garden areas through
gifts.
• Because many of the financing methods for public sector projects are classified as
low-interest, the interest rate is virtually always lower than for private sector
alternatives.
• Government agencies are exempt from taxes levied by higher-level units. For
example, municipal projects do not have to pay state taxes. (Private corporations
and individual citizens do pay taxes.)
• Many loans are very low-interest, and grants with no repayment requirement from
federal programs may share project costs. This results in interest rates in the 4% to
8% range.
• As a matter of standardization, directives to use a specific interest rate are
beneficial because different government agencies are able to obtain varying types
of funding at different rates.
• This can result in projects of the same type being rejected in one state or city but
accepted in another. Standardized rates tend to increase the consistency of
economic decisions and to reduce gamesmanship.
• The determination of the interest rate for public sector evaluation is as important as
the determination of the MARR for a private sector analysis. The public sector
interest rate is identified as i; however, it is referred to by other names to
distinguish it from the private sector rate. The most common terms are discount
rate and social discount rate.
• Multiple categories of users, economic as well as noneconomic interests, and
special-interest political and citizen groups make the selection of one
alternative over another much more difficult in public sector economics.
• Seldom is it possible to select an alternative on the sole basis of a criterion such
as PW or ROR. It is important to describe and itemize the criteria and selection
• method prior to the analysis.
• This helps determine the perspective or viewpoint when the evaluation is
performed. Viewpoint is discussed below.

• There are often public meetings and debates associated with public sector
projects to accommodate the various interests of citizens (owners).
• Elected officials commonly assist with the selection, especially when pressure
is brought to bear by voters, developers, environmentalists, and others.
• In these joint ventures, the public sector (government) is responsible for the funding
and service to the citizenry, and the private sector partner (corporation) is
responsible for varying aspects of the projects as detailed below. The government
unit cannot make a profit, but the corporation(s) involved can realize a reasonable
profit; in fact, the profit margin is usually written into the contract that governs the
design, construction, and operation of the project.
• Traditional methods of contracting were fixed-price (historically called lump-sum)
and cost reimbursable (also called cost-plus).
• In these formats, a government unit took responsibility for funding and possibly
some of the design elements, and later all operation activities, while the contractor
did not share in the risks involved—liability, natural disasters, funding shortfalls,
etc.
• More recently, the PPP has become the arrangement of choice for most large public
projects.Commonly these are called design-build contracts, under which contractors
take on more and more of the functions from design to operation.
• The most reliance is placed upon a contractor or contractors with a DBOMF
contract, as described below.
• When the financing activity is not managed by a contractor, the contract is a
DBOM; it is also common to develop a design-build contract.
• In virtually all cases, some forms of design-build arrangements for public projects
are made because they offer several advantages to the government and citizens
served:
• Cost and time savings in the design, build, and operate phases.
• Earlier and more reliable (less variable) cost estimates
• Reduced administrative responsibilities for the owner
• Better efficiency of resource allocation of private enterprise
• Environmental, liability, and safety issues addressed by the private sector,
where there usually is greater expertise
• Many of the projects in international settings and in developing countries utilize the
public-private partnership. There are, of course, disadvantages to this arrangement.
• One risk is that the amount of funding committed to the project may not cover the
actual build cost because it is considerably higher than estimated. Another risk is
that a reasonable profi t may not be realized by the private corporation due to low
usage of the facility during the operate phase.
• To prevent such problems, the original contract may provide for special subsidies
and loans guaranteed by the government unit. The subsidy may cover costs plus
(contractually agreed-to) profit if usage is lower than a specified level. The level
used may be the breakeven point with the agreed-to-profit margin considered.
• The benefit/cost ratio is relied upon as a fundamental analysis method for public
sector projects.
• The B/C analysis was developed to introduce greater objectivity into public sector
economics, and as one response to the U.S. Congress approving the Flood Control
Act of 1936.
• There are several variations of the B/C ratio; however, the fundamental approach is
the same.
• All cost and benefit estimates must be converted to a common equivalent monetary
unit (PW, AW, or FW) at the discount rate (interest rate).
• The B/C ratio is then calculated using one of these relations:

• Present worth and annual worth equivalencies are preferred to future worth values.
• The sign convention for B/C analysis is positive signs; costs are preceded by a sign.
• Salvage values and additional revenues to the government, when they are estimated,
are subtracted from costs in the denominator.
• Disbenefits are considered in different ways depending upon the model used.
• Most commonly, disbenefits are subtracted from benefits and placed in the
numerator.
• Thus, for the numbers 10, 8, and 5, the same result is obtained regardless of how
disbenefits are treated.

• Before calculating the B/C ratio by any formula, check whether the alternative with
the larger AW or PW of costs also yields a larger AW or PW of benefits.
• It is possible for one alternative with larger costs to generate lower benefits than
other alternatives, thus making it unnecessary to further consider the larger-cost
alternative.
• By the very nature of benefits and especially disbenefits, monetary estimates are
difficult to make and will vary over a wide range. The extensive use of sensitivity
analysis on the more questionable parameters helps determine how sensitive the
economic decision is to estimate variation.
• This approach assists in determining the economic and public acceptance risk
associated with a defined project. Also, the use of sensitivity analysis can alleviate
some of the public’s concerns commonly expressed that people (managers,
engineers, consultants, contractors, and elected officials) designing (and promoting)
the public project are narrowly receptive to different approaches to serving the
public’s interest.
 The proposal is not
justified economically
since both measures are
less than 1.0.
• This relation can be slightly rewritten to form the profitability index (PI),
which can be used to evaluate revenue projects in the public or private
sector.
• For years t = 1, 2, . . . , n ,

• Note that the denominator includes only first cost (initial investment)
items, while the numerator has only cash flows that result from the
project for years 1 through its life. measure. When used solely for a
private sector project, the disbenefits are usually omitted, whereas they
should be estimated and included in the modified B/C version of this
measure for a public project.
• The evaluation guideline for a single project using the PI is the same as
for the conventional B/C or modified B/C.
• To perform a correct incremental B/C analysis, it is required that each alternative be
compared only with another alternative for which the incremental cost is already
justified.
• This same rule was used for incremental ROR analysis.

• If two alternatives, A and B, have equal initial investments and lives, but B has a
larger equivalent annual cost, then B must be incrementally justified against A.
• If this convention is not correctly followed, it is possible to get a negative cost value
in the denominator, which can incorrectly make B/C < 1 and reject a higher-cost
alternative that is actually justified.
• Follow these steps to correctly perform a conventional B/C ratio analysis of two
alternatives.
• Equivalent values can be expressed in PW, AW, or FW terms.

• When the B/C ratio is determined for the lower-cost alternative, it is a comparison
with the donothing (DN) alternative.
• If B/C < 1.0, then DN should be selected and compared to the second alternative.
• If neither alternative has an acceptable B/C value and one of the alternatives does
not have to be selected, the DN alternative
•
• The procedure necessary to select one from three or more mutually exclusive
alternatives using incremental B/C analysis is essentially the same as that of Section
9.3.
• The procedure also parallels that for incremental ROR analysis in Section 8.6. The
selection guideline is as follows:
• The terms defender and challenger alternative are used in this procedure, as in
ROR-based analysis. The procedure for incremental B/C analysis of multiple
alternatives is as folxlows: