Benefit-Cost Ratio (BCR) - Corporate Finance Institute

The benefit-cost ratio (BCR) is a profitability indicator used in cost-benefit analysis to determine the viability of cash flows generated from an asset or ... Benefit-CostRatio(BCR)Aprofitabilityindicatorusedincost-benefitanalysistodeterminetheviabilityofcashflowsgeneratedfromaprojectorassetHome›Resources›Knowledge›Finance›Benefit-CostRatio(BCR)WhatistheBenefit-CostRatio(BCR)?Thebenefit-costratio(BCR)isaprofitabilityindicatorusedincost-benefitanalysistodeterminetheviabilityofcashflowsgeneratedfromanassetorproject.TheBCRcomparesthepresentvalueofallbenefitsgeneratedfromaproject/assettothepresentvalueofallcosts.ABCRexceedingoneindicatesthattheasset/projectisexpectedtogenerateincrementalvalue. FormulafortheBenefit-CostRatioTheformulaforthebenefit-costratioisoutlinedbelow:  Where:CF=Cashflowi=Discountraten=Numberofperiodst=Periodthatthecashflowoccurs Althoughtheformulaabovemayappearcomplicated,thecalculationissimplythediscountedcashinflowsdividedbythediscountedcashoutflows.Thediscountrateusedreferstothecostofcapital,whichcanbethecompany’srequiredrateofreturnRequiredRateofReturnTherequiredrateofreturn(hurdlerate)istheminimumreturnthataninvestorisexpectingtoreceivefortheirinvestment.Essentially,therequiredrateofreturnistheminimumacceptablecompensationfortheinvestment’slevelofrisk.,thehurdlerate,ortheweightedaveragecostofcapital. SummaryThebenefit-costratioisusedtodeterminetheviabilityofcashflowsfromanassetorproject.Thehighertheratio,themoreattractivetheproject’srisk-returnprofile.Poorcashflowforecastingoranincorrectdiscountratewouldleadtoaflawedbenefit-costratio. ExampleoftheBenefit-CostRatioCashflowprojectionsforaprojectareprovidedbelow.TherelevantdiscountrateDiscountRateIncorporatefinance,adiscountrateistherateofreturnusedtodiscountfuturecashflowsbacktotheirpresentvalue.Thisrateisoftenacompany’sWeightedAverageCostofCapital(WACC),requiredrateofreturn,orthehurdleratethatinvestorsexpecttoearnrelativetotheriskoftheinvestment.is10%. Question:Whatisthebenefit-costratiooftheproject?Answer: Thebenefit-costratiowouldbecalculatedas$97,670.72/$33,625.09=2.90. InterpretingtheBenefit-CostRatioThehighertheBCR,themoreattractivetherisk-returnprofileoftheproject/asset.ThevaluegeneratedbytheBCRindicatesthedollarvaluegeneratedperdollarcost.Forexample,theBCRof2.90intheprecedingexamplecanbeinterpretedas“Foreach$1ofcostintheproject,theexpecteddollarbenefitsgeneratedis$2.90.”ThefollowingshowsthevaluerangeoftheBCRanditsgeneralinterpretation:   AdvantagesoftheBenefit-CostRatioKeyadvantagesofthebenefit-costratioinclude:Itisausefulstartingpointindeterminingaproject’sfeasibilityandwhetheritcangenerateincrementalvalue.Iftheinputsareknown(cashflows,discountrate),theratioisrelativelyeasytocalculate.TheratioconsidersthetimevalueofmoneyTimeValueofMoneyThetimevalueofmoneyisabasicfinancialconceptthatholdsthatmoneyinthepresentisworthmorethanthesamesumofmoneytobereceivedinthefuture.Thisistruebecausemoneythatyouhaverightnowcanbeinvestedandearnareturn,thuscreatingalargeramountofmoneyinthefuture.(Also,withfuturethroughthediscountrate.Theratioindicatesthevaluegeneratedperdollarofcosts. LimitationsoftheBenefit-CostRatioKeylimitationsofthebenefit-costratioinclude:ThereliabilityoftheBCRdependsheavilyonassumptions.Poorcashflowforecastingoranincorrectdiscountratewouldleadtoaflawedratio.Theratioitselfdoesnotindicatetheproject’ssizeorprovideaspecificvalueonwhattheasset/projectwillgenerate.Forexample,bothprojectsbelowshowaBCRof2,butpresentvaluecashflowsaresignificantlydifferent:  FinalThoughtsAlthoughthebenefit-costratioisasimpletooltogaugetheattractivenessofaprojectorasset,itshouldnotbethesoledeterminantofaproject’sfeasibility.Otherratiosandfurtheranalysisarerecommended.TheBCRisextremelysensitivetothecashflowforecastsanddiscountrates.Ifyouthinktheunderlyingassumptionsareincorrectorbiased,thebenefit-costratioshouldnotbereliedon. MoreResourcesCFIistheofficialprovideroftheCommercialBanking&CreditAnalyst(CBCA)™ProgramPage-CBCAGetCFI'sCBCA™certificationandbecomeaCommercialBanking&CreditAnalyst.Enrollandadvanceyourcareerwithourcertificationprogramsandcourses.certificationprogram,designedtotransformanyoneintoaworld-classfinancialanalyst.Inordertohelpyoubecomeaworld-classfinancialanalystandadvanceyourcareertoyourfullestpotential,theseadditionalresourceswillbeveryhelpful:AnalysisofFinancialStatementsAnalysisofFinancialStatementsHowtoperformAnalysisofFinancialStatements.Thisguidewillteachyoutoperformfinancialstatementanalysisoftheincomestatement,HurdleRateHurdleRateDefinitionAhurdlerate,whichisalsoknownasminimumacceptablerateofreturn(MARR),istheminimumrequiredrateofreturnortargetratethatinvestorsareexpectingtoreceiveonaninvestment.Therateisdeterminedbyassessingthecostofcapital,risksinvolved,currentopportunitiesinbusinessexpansion,ratesofreturnforsimilarinvestments,andotherfactorsProfitabilityRatiosProfitabilityRatiosProfitabilityratiosarefinancialmetricsusedbyanalystsandinvestorstomeasureandevaluatetheabilityofacompanytogenerateincome(profit)relativetorevenue,balancesheetassets,operatingcosts,andshareholders'equityduringaspecificperiodoftime.TheyshowhowwellacompanyutilizesitsassetstoproduceprofitWACCWACCWACCisafirm’sWeightedAverageCostofCapitalandrepresentsitsblendedcostofcapitalincludingequityanddebt.FinancialAnalystTrainingGetworld-classfinancialtrainingwithCFI’sonlinecertifiedfinancialanalysttrainingprogramBecomeaCertifiedFinancialModeling&ValuationAnalyst(FMVA)®CFI'sFinancialModelingandValuationAnalyst(FMVA)®certificationwillhelpyougaintheconfidenceyouneedinyourfinancecareer.Enrolltoday!!Gaintheconfidenceyouneedtomoveuptheladderinahighpoweredcorporatefinancecareerpath. LearnfinancialmodelingandvaluationinExceltheeasyway,withstep-by-steptraining. CorporateFinanceInstituteBacktoWebsite0searchresultsfor‘’Peoplealsosearchfor:excelFreefreecoursesBalancesheetaccountingIRRDCFExploreOurCertificationsFinancialModeling&ValuationAnalyst(FMVA)®LearnmoreCommercialBanking&CreditAnalyst(CBCA)™LearnmoreCapitalMarkets&SecuritiesAnalyst(CMSA)®LearnmoreCertifiedBusinessIntelligence&DataAnalyst(BIDA)™LearnmoreResourcesExcelShortcutsPCMacListofExcelShortcuts Excelshortcuts-Itmayseemsloweratfirstifyou'reusedtothemouse,butit'sworththeinvestmenttotakethetimeand...FreeFinancialModelingGuideACompleteGuidetoFinancialModeling Thisresourceisdesignedtobethebestfreeguidetofinancialmodeling! Wewillbreakdownthemostimportant...SQLDataTypesWhatareSQLDataTypes? TheStructuredQueryLanguage(SQL)comprisesseveraldifferentdatatypesthatallowittostoredifferenttypesofinformation...StructuredQueryLanguage(SQL)WhatisStructuredQueryLanguage(SQL)? StructuredQueryLanguage(SQL)isaspecializedprogramminglanguagedesignedforinteractingwithadatabase....SeeAllResourcesSeeAllPopularCoursesFree!FMVA®-PrepCourses3.5hExcelCrashCourse-SpreadsheetFormulasforFinanceFMVA®-Required5.5hBuildinga3StatementFinancialModelFMVA®-Required7.5hBusinessValuationModelingPartIFMVA®-Required2.5hScenario&SensitivityAnalysisinExcelFMVA®-Required6hDashboards&DataVisualizationFMVA®-Electives11hLeveragedBuyoutLBOModelingSeeAllCoursesSeeAllRecentSearchesSuggestionsFreeCoursesExcelCoursesFinancialModeling&ValuationAnalyst(FMVA)®NameEmailIagreetoCFI’sTermsand ConditionsPleaseverifythatyouareahumanbycompletingtheCAPTCHAtocontinue.TakeAssessmentAlreadyhaveanaccount?Loginhere.