Comparing NPV and BCR

Comparing NPV and BCR

It should be noted that although both NPV and BCR will provide the same positive or negative outcome for an alternative, where a number of options are considered, the two methods will not always give the same preferred outcome. This is important as the choice of calculating the outcome of the CBA using only one of these methods could result in the CBA not considering an alternative that actually offers a positive outcome.

For example, consider a project seeking to increase education and business investment in a deprived area of a city. Two alternatives have been considered for this project (not including a ‘do nothing’ approach).

Alternative 1 involves building a brand new business park and youth enterprise development in the heart of the deprived area. The total present value of the costs associated with the alternative equal £70m. The total present value of the benefits is equal to £100m.

Alternative 2 involves renting a number of derelict shops in the deprived area, and using these to establish a youth training centre, and to encourage local investment by refitting and modernising the interiors of the shops. The total present value of the costs in this project alternative is equal to £7m. The total present value of the benefits is equal to £12m.

Calculating the NPV and BCR for these alternatives gives the following results.

Project Alternative 1

Costs = £70m

Benefits = £100m

NPV = £100m - £70m = £34m

BCR = 100m/70m = 1.43

Project Alternative 2

Costs = £7m

Benefits = £12m

NPV = £12m - £7m = £5m

BCR = 12m/7m = 1.7

From this simple example it can be seen that while both alternatives provide a net positive outcome, the NPV and BCR methods of obtaining results provide slightly different outcomes. Using NPV suggests project alternative 1 provides the better outcome as the NPV of £34m is greater than the NPV of alternative 2 (£5m). However, using the BCR method alternative 2 would be chosen as a BCR of 1.7 is greater than the BCR of 1.43.

In this case the overall result of the CBA may be determined by considering the costs involved in alternative 1 which are much greater, or may be determined by considering the overall much greater benefits (in monetary terms) obtained by choosing alternative 1.

Presenting both sets of results may therefore be most appropriate to the researcher to provide the client or decision maker with the most information with which to make their final decision. CBA Builder Simple and Advanced calculate CBA outcomes using both methods. However, some analysts (and textbooks) argue that the BCR can confuse and provide inaccurate information as it is a ratio and therefore ignores the overall monetary value of the benefits associated with an alternative. In addition, the BCR is more sensitive to willingness-to-pay.

For example, a project has costs of £2m and benefits of £5m. The benefits consist of benefits for one group that equal £8m, and another group which equal -£3m. If the negative willingness-to-pay, that is the value of the benefits for the group with the negative outcome, is considered as a cost rather than a negative benefit this does not impact the net benefits (i.e. they remain £3m), but does reduce the value of the BCR from 2.5 (£5m/£2m) to 1.6 (£8m/£5m). For these reasons some analysts suggest that ignoring the BCR, and focusing on the NPV offers the most accurate method of obtaining results.

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