- 2070 Magh · 2+4 marks
Financial vs economic analysis; both BCR
Short answer
Financial analysis uses market prices and owner viewpoint; economic analysis uses shadow prices and society viewpoint, including externalities. With MARR=10%, 6-year life, conventional B/C=1.12, modified B/C=1.15 (both >1, acceptable).
What is the difference between financial and economic analysis? Determine both types of B/C ratio from the following cash flow. Initial investment = 3,00,000 Annual revenue = 85,000 Annual costs = 15,000 Salvage value = 20% of initial investment Useful life = 6 years MARR = 10%
Financial vs economic analysis
| Basis | Financial analysis | Economic analysis |
|---|---|---|
| Viewpoint | Owner / investor / firm | Society / nation as a whole |
| Measures | Cash revenues and costs actually paid or received | All benefits and costs to society, even if not paid in cash |
| Prices | Market prices | Shadow (economic) prices |
| Taxes, subsidies | Included as real cash flows | Treated as transfers and excluded |
| Externalities | Ignored | Included (pollution, employment, foreign exchange) |
| Interest rate | Company MARR / cost of capital | Social discount rate |
| Aim | Profit and financial viability | Net contribution to national welfare |
Numerical (PW formulation, i = 10%, n = 6)
- Salvage S = 20% × 3,00,000 = Rs 60,000
- Factors: (P/A, 10%, 6) = 4.3553; (P/F, 10%, 6) = 0.5645
yr 0: -3,00,000 yr 1..6: +85,000 revenue, -15,000 cost yr 6: +60,000
- PW(B) = 85,000 × 4.3553 = Rs 370,197
- PW(C: O&M) = 15,000 × 4.3553 = Rs 65,329
- PW(S) = 60,000 × 0.5645 = Rs 33,868
Conventional B/C = PW(B) / [I + PW(C) − PW(S)] = 370,197 / (3,00,000 + 65,329 − 33,868) = 370,197 / 331,460 = 1.117
Modified B/C = [PW(B) − PW(C)] / [I − PW(S)] = (370,197 − 65,329) / (3,00,000 − 33,868) = 304,868 / 266,132 = 1.146
Answer: conventional B/C = 1.12 and modified B/C = 1.15. Both are greater than 1, so the project is acceptable.
✓ Answer checked by Claude Opus 5.5 (high effort)
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