Financial Modeling Tutorials
- Excel Modeling
- Financial Functions in Excel
- Sensitivity Analysis in Excel
- Sensitivity Analysis
- Capital Budgeting Techniques
- Time Value of Money
- Future Value Formula
- Present Value Factor
- Perpetuity Formula
- Present Value vs Future Value
- Annuity vs Pension
- Present Value of an Annuity
- Doubling Time Formula
- Annuity Formula
- Present Value of an Annuity Formula
- Future Value of Annuity Due Formula
- Maturity Value
- Annuity vs Perpetuity
- Annuity vs Lump Sum
- Deferred Annuity Formula
- Internal Rate of Return (IRR)
- IRR Examples (Internal Rate of Return)
- NPV vs XNPV
- NPV vs IRR
- NPV Formula
- NPV Profile
- NPV Examples
- Advantages and Disadvantages of NPV
- Mutually Exclusive Projects
- PV vs NPV
- IRR vs ROI
- Break Even Point
- Break Even Analysis
- Breakeven Analysis Examples
- Break Even Chart
- Benefit Cost Ratio
- Payback Period & Discounted Payback Period
- Payback period Formula
- Discounted Payback Period Formula
- Payback Period Advantages and Disadvantages
- Profitability Index
- Feasibility Study Examples
- Cash Burn Rate
- Interest Formula
- Simple Interest
- Simple Interest vs Compound Interest
- Simple Interest Formula
- CAGR Formula (Compounded Annual Growth Rate)
- Growth Rate Formula
- Effective Interest Rate
- Loan Amortization Schedule
- Mortgage Formula
- Loan Principal Amount
- Interest Rate Formula
- Rate of Return Formula
- Effective Annual Rate
- Effective Annual Rate Formula (EAR)
- Compounding Formula
- Compound Interest
- Compound Interest Examples
- Daily Compound Interest
- Monthly Compound Interest Formula
- Discount Rate vs Interest Rate
- Discounting Formula
- Rule of 72
- Geometric Mean Return
- Geometric Mean vs Arithmetic Mean
- Real Rate of Return Formula
- Continuous compounding Formula
- Weighted average Formula
- Average Formula
- EWMA (Exponentially Weighted Moving Average)
- Average Rate of Return Formula
- Mean Formula
- Mean Examples
- Population Mean Formula
- Weighted Mean Formula
- Harmonic Mean Formula
- Median Formula in Statistics
- Range Formula
- Outlier Formula
- Decile Formula
- Midrange Formula
- Quartile Deviation
- Expected Value Formula
- Exponential Growth Formula
- Margin of Error Formula
- Decrease Percentage Formula
- Relative Change
- Percent Error Formula
- Holding Period Return Formula
- Cost Benefit Analysis
- Cost Benefit Analysis Examples
- Cost Volume Profit Analysis
- Opportunity Cost Formula
- Opportunity Cost Examples
- APR vs APY
- Mortgage APR vs Interest Rate
- Normal Distribution Formula
- Standard Normal Distribution Formula
- Normalization Formula
- Bell Curve
- T Distribution Formula
- Regression Formula
- Regression Analysis Formula
- Multiple Regression Formula
- Correlation Coefficient Formula
- Correlation Formula
- Correlation Examples
- Coefficient of Determination
- Population Variance Formula
- Covariance Formula
- Coefficient of Variation Formula
- Sample Standard Deviation Formula
- Relative Standard Deviation Formula
- Standard Deviation Formula
- Standard Deviation Examples
- Effect Size
- Sample Size Formula
- Volatility Formula
- Binomial Distribution Formula
- Hypergeometric Distribution
- Exponential Distribution
- Central Limit Theorem
- Poisson Distribution
- Central Tendency
- Hypothesis Testing
- Gini Coefficient
- Quartile Formula
- P Value Formula
- Skewness Formula
- R Squared Formula
- Adjusted R Squared
- Regression vs ANOVA
- Z Test Formula
- Z Score Formula
- Z Test vs T Test
- F-Test Formula
- Quantitative Research
- Histogram Examples
Benefit-Cost Ratio Definition
A benefit-cost ratio (that is BCR) is used in the cost-benefit analysis as an indicator to depict the relationship between the relative benefits and costs of a proposed investment.
Benefit-Cost Ratio Formula
Given below is the formula to calculate Benefit-Cost Ratio.
- If that investment or the project has a BCR value that is greater than 1 than the project can be expected to return or deliver a positive NPV i.e. net present value to the business or the firm and their investors.
- If BCR value is less than 1, then the project cost can be expected to higher than the returns and therefore, it should be discarded.
Examples of Benefit-Cost Ratio
The following are examples of benefit-cost ratio
Benefit-Cost Ratio Example #1
EFG ltd is working upon the renovation of its factory in the upcoming year and for they expect an outflow of $50,000 immediately and they expect the benefits out of the same for $25,000 for the next 3 years. The inflation rate that is currently prevailing is 3%. You are required to assess whether the decision to renovate will be profitable by using a BCR.
To do the cost-benefit analysis first, we need to bring both costs and benefit in today’s value. Since the outflow of $50,000 is immediate and hence that would remain the same.
Now since the gains are in future value, we need to discount them back by using a discount rate of 3%.
Therefore, Benefit-Cost Ratio can be calculated as using the below formula as,
The formula for Calculating BCR = PV of Benefit expected from the Project / PV of the cost of the Project
4.9 (1,067 ratings)
= 70715.28 /-50,000.00
Since the Benefit-Cost ratio is greater than 1, the renovation decision appears to be beneficial.
Benefit-Cost Ratio Example #2
Sunshine private limited has recently received an order where they will sell 50 tv sets of 32 inches for $200 each in the first year of the contract, 100 air condition of 1 tonne each for $320 each in the second year of the contract and in third year they will sell 1,000 smartphones valuing at $500 each. But in order to fulfill this requirement they need to increase the production and for that they are looking for cash flow of $35,000 to hire people on contract and all this will be deposited in a separate escrow account create specifically for this purpose and cannot be withdrawn for any other purpose but company will earn a 2% rate on the same for the next 3 years as the same will be paid at the end of 3rd year to the contract employees.
Further, the cost of production that will be incurred in the 1st year will be $6,500, in the 2nd year it will be 75% of the gross revenue earned and in the last year will be 83% of the gross revenue as per the estimates. You are required to calculate the benefit-cost ratio and advise whether the order is worthful? Assume the cost of the project is 9.83%.
To do the cost-benefit analysis first, we need to bring both costs and benefit in today’s value. Since here the costs are also incurred in different years we need to discount them as well.
Before discounting, we need to compute total cash flows for the entire project life.
There is no cash outflow or inflow in the 0 years as the company is making a deposit and in fact its earning interest on the same at the rate of 3% and in the final year, the company will make payment of $35,000 which has been included in the cash outflow.
Now we can discount the cash flows at 9.83% and arrive at the discounted benefit and discounted cost per below:
Therefore, Benefit-Cost Ratio can be calculated as using the below formula as,
Benefit-cost ratio = PV of Benefit expected from the Project /PV of the cost of the Project
= 414783.70 / -365478.43
Since it is greater than 1, the mega order appears to be beneficial.
Advantages of Benefit-Cost Ratio
- The benefit of using benefit-cost ratio (BCR) is that it helps to compare various projects in a single term and helps to decide faster which projects should be preferred and which projects should be rejected.
- It compares benefit and cost at the same level that is it considers the time value of money before giving any outcome based on absolute figures as there could be a scenario that project appears to be lucrative without considering time value and when we consider time value the benefit-cost ratio goes less than 1.
Disadvantages of Benefit-Cost Ratio
- The major limitation of the BCR is that since it reduces the project to mere a number when the failure or success of the projector of expansion or of investment etc. relies upon various variables and other factors and those can be weakened by events which are unforeseen.
The following points must be noted before making a decision based upon the Benefit-Cost Ratio.
- Simply following a rule that success means above 1 and failure or reject decision would mean BCR below 1 can be misleading and will lead to a misfit with the project in which heavy investment is made.
- Hence, the BCR should be used as a conjunctive tool with different types of analysis as the use of NPV, IRR, other qualitative factors and then make a good decision.
We can conclude that if the investment has a BCR which is greater than one, the investment proposal will deliver a positive NPV and on another hand it shall have an IRR that would be above the discount rate or the cost of project rate which will suggest that the Net Present Value of the investment’s cash flows will outweigh the Net Present Value of the investment’s outflows and the project can be considered.
- If the Benefit Cost Ratio (BCR) is equal to one, the ratio will indicate that the NPV of investment inflows will equal investment’s outflows.
- Lastly, if investment’s BCR is not more than one, the investment’s outflow shall outweigh the inflows or the benefits and the project should not be taken into consideration.
This has been a guide to Benefit-Cost Ratio and its definition. Here we discuss the formula to calculate Benefit-Cost Ratio (BCR) along with examples. advantages and its limitations. You can learn more about excel modeling from the following articles –