Maintenance cost – growing year by year Consideration – Initial cost + overall life cycle cost of the project Important problem for Civil Engineer – selection of option for equipment – whether to purchase or hire Reason to consider Economic Decision Making - Large projects involve heavy expenses

1. Prepared By
Prof. Ashish Makwana
Civil Engg. Dept.
Prof. Ashish Makwana 1

2. PRESENTATION
OUTLINE…
• Introduction
• Economic decision making
• Economic decision making – Method of evaluation
• Effect of taxation on comparison of alternatives
• Effect of inflation on cash flow
• Evaluation of public project
• Benefit / cost ratio
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3. INTRODUCTION
• Maintenance cost – growing year by year
• Consideration – Initial cost + overall life cycle cost
of the project
• Important problem for Civil Engineer – selection of
option for equipment – whether to purchase or
hire
• Reason to consider Economic Decision Making -
Large projects involve heavy expenses
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4. ECONOMIC DECISION MAKING
Situation encountered in the construction project-
• Comparison of designs
• Economic design for production maintenance
• Economy and location of project
• Economy and standardization and simplification
Engineer has to select the competitive alternative in
above situation.
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5. ECONOMIC DECISION MAKING –
METHOD OF EVALUATION
1. Out of pocket commitment
2. Payback period
3. Average annual rate of return
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6. 1. Out of pocket commitment
Final decision: Selection of steel or wood for ?
STEEL: Precast concrete factory produce = 1,50,000 sleepers
per year
Steel form work including labour cost = Rs. 6 lacks/year
Fixing and removing the steel form work charge = Rs. 10
• Out of pocket commitment for STEEL =
Rs.6,00,000 * 1,50,000 * 10 = Rs.21,00,000 …(1)
WOODEN: Wooden form work per month = Rs. 75,000
Fixing and removing the wooden form work charge = Rs. 9
• Out of pocket commitment for WOODEN =
Rs.75,000 * 12 + 1,50,000 * 9 = Rs.22,50,000 …(2)
So, select STEEL material form work because cost is less
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7. 2. Payback period
Final decision: Selection Excavator - EX1 or EX2?
Both brands are available for down payment of Rs.3 lakhs
Both brands can be used for four years.
Ex-1
Down payment = Rs.3 Lacks
Give return Rs.50,000 for first year; Rs.1,00,000 for second
year, Rs.1,50,000 for third year and Rs.2,00,000 for forth year
• Payback period for EX-1 = Initial investment of 3year
required
• Sure to get benefit Rs.2,00,000
Ex-2
Give return Rs.1,50,000 for each year
• Payback period for EX-2 = Initial 2years required
• Sure to get benefit Rs.3,00,000
So, Advisable to employ the take Ex-2.
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8. 3. Average annual rate of return
Final decision: Selection Excavator - EX1 or EX2 based
on less value of Average annual rate of return
For, EX1
=(50,000 + 1,00,000 + 1,50,000 + 2,00,000)/4
=1,25,000
For, EX2
= (1,50,000 + 1,50,000 + 1,50,000 + 1,50,000)/4
= 1,50,000
Average annual rate of return in EX-2 is higher than
EX-1.
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9. EFFECT OF TAXATION ON
COMPARISON OF ALTERNATIVES
• Rates of taxes vary from time to time
• Sometimes incentives and relief in taxes are
provided by the government
• Purpose of concept – Companies often take
advantages of such schemes and use
available funds in a manner so as to optimize
their interests
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10. Sr. No. Item Description Company A Company B Remarks
1 Gross earnings Rs.200 lakh Rs.200 lakh …
2 Admissible expense (AE) Rs.75 lakh Rs.50 lakh …
3 Pre-tax profits Rs.125 lakh Rs.150 lakh (1) - (2)
4 Tax payable Rs.50 lakh Rs.60 lakh At 40 % of (3)
5 Net profit Rs.75 lakh Rs.90 lakh (3) - (4)
Effect of Taxation on Comparison of Alternatives
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11. EFFECT OF INFLATION
ON CASH FLOW
• Inflation: It is defined as the increase in price
level resulting in decrease in purchasing
power of money.
• In India, it is normal practice to use 12% as
discount rate.
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12. EFFECT OF INFLATION ON CASH FLOW (continued..)
Modified discount rate
=
1 +
interest rate %
100
1 +
interest rate %
100
− 1 ∗ 100
Modified discount rate =
1 + 0.12
1 + 0.08
− 1 ∗ 100
If interest rate 12% and inflation rate 8%, the
modified rate is -
• As per IRC: SP: 61- 2004, formulae is given-
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13. EVALUATION OF PUBLIC PROJECTS
• The objective of private projects is to
maximize the profits while adhering to the
contractual requirements of the projects.
• The benefits accursed from public projects
should at least recover the cost of the
projects.
• The projects funded by state / central
government are known as public projects.
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14. EVALUATION OF PUBLIC PROJECTS (continued..)
Objectives of evaluation of public projects –
• To check the viability of the project
economically.
• To select the most viable project from a set
of economically viable project.
• To rank the economically viable alternatives
for a given situation.
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15. BENEFIT / COST RATIO
• One of the most commonly used criteria to
evaluate public projects is benefit/cost ratio.
i.e. B/C ratio.
B
C ratio =
Benefit to public
cost to the government
B/C ratio Meaning
More
than 1
Benefit outweighs cost and thus, the investment is justified.
1.5 Each rupee in cost yields Rs.1.5 in benefits over the life time of the
project.
Less
than 1
Benefit accursed from the project is less than the cost required to be
invested and thus the investment is not justifiable.
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16. Benefit/Cost criteria
• Minimum investment
• Maximum benefit
• Aspiration level
• Highest B/C ratio
• Maximum advantage of benefits over cost (B-C)
• Largest investment that has a B/C ratio greater
than 1.
• Maximum incremental advantage of benefit
over cost.
• Maximum incremental benefit/cost ratio.
• Largest investment that has an incremental B/C
ratio greater than 1.Prof. Ashish Makwana 16

17. THANK YOU
Prof. Ashish Makwana 17