Benefit-Cost Ratio (BCR) Formula: Definition and Examples

The benefit-cost ratio formula, or BCR, is a financial metric that professionals use to assess the costs and benefits of a project to determine ... FindjobsCompanyreviewsFindsalariesUploadyourresumeSigninSigninEmployers/PostJobStartofmaincontent CareerGuideCoronavirusJobResourcesFindingaJobMoreResumes&CoverLettersInterviewingStartingaNewJobResumeSamplesPay&SalaryCareerDevelopmentCareerPathsCoverLetterSamplesCoronavirusJobResourcesFindingaJobResumes&CoverLettersInterviewingStartingaNewJobMoreResumeSamplesPay&SalaryCareerDevelopmentCareerPathsCoverLetterSamplesCareerGuideCareerDevelopmentBenefit-CostRatio(BCR)Formula:DefinitionandExamplesBenefit-CostRatio(BCR)Formula:DefinitionandExamplesByIndeedEditorialTeamMarch15,2021TwitterLinkedInFacebookEmailCopytoClipboardThebenefit-costratioformulaisatoolthatprofessionalsusetomeasurethecostsofapotentialprojectagainstitsexpectedbenefits.Byaccountingforallthecostandbenefitvariables,theformulacanhelpyoudeterminewhetheraprojectisfinanciallyviable.Inthisarticle,wediscusswhatthebenefit-costratioformulais,whyit'shelpfulandhowtouseit,includinganexampletoassistyouwithyourowncalculations.Whatisthebenefit-costratioformula?Thebenefit-costratioformula,orBCR,isafinancialmetricthatprofessionalsusetoassessthecostsandbenefitsofaprojecttodetermineitsviability.CompaniesanalyzeaproposedprojectwiththeBCRtoseetherelationshipbetweenthecoststocompletetheprojectandtheexpectedbenefitsovertime.YoucanexpressBCRvalueseitherasmonetaryorqualitative.WhenaprojecthasaBCRvaluehigherthanone,afirmanditsinvestorscanexpecttheprojecttodeliverapositivenetpresentvalueandaninternalrateofreturnabovethediscountrate.Thismeansthatthecashflowfromtheprojectismorethanthecostoftheproject,sotheprojectisagoodfinancialconsideration.WhenaprojecthasaBCRvaluelowerthanone,thecashflowbenefitsarelessthanthecost,meaningtheprojectcostsmorethanitwillreturnfinancially.YoucanwritetheBCRformulaasthepresentvalueofallthebenefitsyouexpectfromaprojectdividedbythepresentvalueofallthecostsyouexpecttoincur.Whenwritingthebenefit-costratioformulamathematically,itlookslikethis:BCR=PVofexpectedbenefits/PVofexpectedcostsWhere:PV=PresentvalueRelated:NPVandIRR:DefinitionandExamplesWhentousethebenefit-costratioformulaThemostcommonusefortheBCRiswhenanalyzingtheoverallfiscalvalueofanewprojectincapitalbudgeting.Sincecapitalbudgetingoftenincludesprojectswhereyouassumptionsandwherequantitativedatamaybeuncertain,thereisoftenalargevarietyofpotentialBCRoutcomes.TheBCRcanprovidearoughideafortheviabilityofaproject,itsinternalrateofreturn,whetheritexceedsthediscountrateandtheweighted-averagecostofcapital.Related:CapitalBudgeting:Definition,ImportanceandDifferentMethodsBenefitsofusingthebenefit-costratioformulaWhileit'sadvisabletousemultipleindicatorsandmeasureswhenassessingprojectviability,theBCRisspecialbecauseofitsabilitytoshowabsoluteamountsofcostandbenefits.TheBCRformulahelpscompareprojectalternativesordifferenceinvestments.Itcanhelpinvestorstodeterminetheriskinvolvedinaprojectbyforecastingwhetherthereisasmallprofitmarginwithahigherriskoralargerprofitmarginwithalowerrisk.SinceyoucancalculatetimeperiodsaspartoftheBCR,youcanalsousetheformulatoidentifycashflowinrelationtotime.Related:TheImportanceofProjectManagementHowtocalculatethebenefit-costratioYoucancalculatetheBCRformulausingthefollowingsteps:1.FindthepresentvalueofexpectedbenefitsYoucanfindthepresentvalue(PV)ofexpectedbenefitsinaperiodbydeterminingallthecashinflowsandmonetarybenefitsyouexpectfromtheproject,suchasincrementalrevenue,sales,costsavings,increasedvalueofassetsorreceivedinterestpayments.Forexample:PVofexpectedbenefits=$1,0002.FindthepresentvalueofexpectedcostsLocatethepresentvalue(PV)ofexpectedcostsinaperiodbydeterminingallthecashoutflowsyouexpectfromtheproject,suchasinitialinvestments,administrativecosts,disposalcosts,productionexpensesandanyothercoststoforcompletingtheproject.Forexample:PVofexpectedcosts=$5003.FindthediscountingrateBasedontheopportunitycostortheavailablemarketinformation,determinethediscountingrateorinterestrate.Thiscanrepresentthetargetreturnrate,thecapitalcostrateortheriskadjustedmarketinterestrate.Whentherearemultipleperiods,eachperiodwillusethediscountratetothepoweroftheperiod.Forexample:Discountingrate=2%or0.02Numberofperiods=34.InputthenumbersintotheformulaInputthevalueslistaboveintotheBCRformula.Rememberthatwhentherearemultipleperiods,eachperiodwillusethediscountratetothepoweroftheperiod.BCR=PVofexpectedbenefits/PVofexpectedcoststothepowerofeachperiodWhenusingtheexamplenumbersabove,theformulalookslikethis:BCR=($1,000/(1+0.02)1)+($1,000/(1+0.02)2)+($1,00/(1+0.02)3)/$5005.ComputetheformulaSolveforthePVofexpectedbenefitsusingbasicmathematicalrules.BCR=($1,000/(1+0.02)1)+($1,000/(1+0.02)2)+($1,00/(1+0.02)3)/$500BCR=($980.40)+($961.20)+($942.30)/$500BCR=$2,883.90/$500BCR=$5.776.EvaluatetheBCRSincetheBCRvalueisaboveoneinthisexample,thecashflowfromtheprojectismorethanthecostoftheproject,sotheprojectisagoodfinancialconsideration.Forevery$1theprojectcosts,thereshouldbe$5.77inbenefits.Relate**d:[WhatIsCostofCapital?ExamplesandHowToCalculate**](https://www.indeed.com/career-advice/career-development/what-is-cost-of-capital)Exampleofabenefit-costratioformulaHereisanexampleofanorganizationusingtheBCRformula:VillaHomeswantstoassesstheprofitabilityofanewprojectinwhichitbuildsacommunitycenterinsideagrowingneighborhood.Assumethatthecompanyleasestheequipmentitneedsfor$100,000,thattheinflationrateis4%andthatthecompanyexpectstoseea$200,000annualprofitincreaseoverthenextthreeyears.VillaHomescanusetheBCRformulatocalculatetheoverallvalueofthisnewproject.VillaHomesfirstinputstheabovevaluesintotheBCRformulaforallthreeyearslikethis:($200,000/(1+0.04)1)+($200,000/(1+0.04)2)+($200,00/(1+0.04)3)/$100,000Next,itsolvesforthePVofexpectedbenefits:($200,000/(1+0.04)1)+($200,000/(1+0.04)2)+($200,00/(1+0.04)3)=$555,118Finally,VillaHomesdividesbythePVofexpectedcosts:$555,018/$100,000=$5.55VillaHomesconsidersthisprojectagoodfinancialdecisionbecausetheBCRisaboveone.ThisBCRtellsVillaHomesthatforevery$1itspendstobuildthenewcommunitycenter,itcanexpecttosee$5.55inbenefits,meaningthecashflowfromtheprojectismorethanthecostoftheproject.RelatedArticlesWhyIsHumanResources(HR)Important?TipsforManagingandDeductingBusinessTravelExpensesAdvertisingvs.PublicRelations(PR):4KeyDifferences