What is Benefit-Cost Ratio?

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The benefit-cost ratio (BCR) is a ratio used in a cost-benefit analysis to summarize the overall relationship between the relative costs and benefits of a proposed project. BCR can be expressed in monetary or qualitative terms. If a project has a BCR greater than 1.0, the project is expected to deliver a positive net present value to a firm and its investors.

Definition

The Benefit-Cost Ratio (BCR) is a ratio used in cost-benefit analysis to summarize the overall relationship between the relative costs and benefits of a proposed project. BCR can be expressed in monetary or qualitative terms. If a project's BCR is greater than 1.0, it is expected to yield a positive net present value benefit to the company and its investors.

Origin

The concept of the Benefit-Cost Ratio originated in the mid-20th century as economists and decision-makers sought more effective ways to evaluate the economic feasibility of projects. It was initially used for public project evaluations and later expanded to private investments and business decisions.

Categories and Features

The Benefit-Cost Ratio can be categorized into quantitative and qualitative types. Quantitative BCR is typically expressed in monetary terms, allowing for direct comparison of financial benefits and costs of projects. Qualitative BCR considers non-monetary factors such as social impact and environmental benefits. The main features of BCR are its simplicity and intuitiveness, enabling quick assessment of a project's economic feasibility. However, it has limitations, such as ignoring the time value of money and risk factors.

Case Studies

A typical case is a city government considering building a new subway line. BCR analysis revealed a BCR of 1.5, indicating that for every dollar spent, an expected return of 1.5 dollars would be gained. Another case involves a company planning to develop new software, with BCR analysis showing a BCR of 0.8, suggesting the project may not be economically viable.

Common Issues

Common issues investors face when using BCR include accurately estimating costs and benefits and dealing with uncertainty and risk. A common misconception is that a BCR greater than 1 always indicates a good investment, overlooking other factors such as the project's long-term impact and strategic value.

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