Benefit-Cost Ratio (BCR) The Benefit-Cost Ratio (BCR) is a simple metric used in cost–benefit analysis to compare the present value of a project's expected benefits to the present value of its costs. It helps evaluate whether a project is likely to create net economic value. Key points
* Formula: BCR = NPV(benefits) / NPV(costs)
* BCR > 1.0: benefits exceed costs (project likely viable)
* BCR = 1.0: benefits equal costs (break-even)
* BCR < 1.0: costs exceed benefits (project likely not viable)
* Use BCR alongside other metrics (NPV, IRR, sensitivity analysis) because it simplifies complex outcomes to a single number.
How BCR is calculated
1. Forecast the project’s cash inflows (benefits) and outflows (costs) over its life.
2. Choose an appropriate discount rate (e.g., WACC, social discount rate) and discount all cash flows to present value.
3. Sum the discounted benefits to get NPV(benefits) and the discounted costs to get NPV(costs).
4. Divide NPV(benefits) by NPV(costs).
Notes:
Include terminal values, salvage or remediation costs where applicable.
If a cost is paid upfront, its present value equals the payment amount (no discounting required).
* If benefits or costs occur in future periods, discount them before calculating the ratio. Explore More Resources
Example A company plans renovations expected to increase annual profit by $100,000 for three years. Inflation/discount rate = 2%. The company leases equipment for $50,000 paid upfront. Discounted benefits:
Year 1: 100,000 / 1.02 = 98,039
Year 2: 100,000 / 1.02^2 = 96,119
* Year 3: 100,000 / 1.02^3 = 94,216
Sum NPV(benefits) ≈ 288,374 Explore More Resources
NPV(costs) = 50,000 (paid upfront) BCR = 288,374 / 50,000 ≈ 5.77 Explore More Resources
Interpretation: expected benefits are roughly 5.8 times the costs, indicating strong economic upside under the assumptions used. Limitations and cautions
* Oversimplifies outcomes: compresses multiple risks, timings, and qualitative effects into one number.
* Sensitive to assumptions: forecast accuracy, discount rate, and omitted externalities can materially change results.
* Ignores scale: a high BCR on a very small project may be less valuable than a modest BCR on a very large project.
* Should not replace comprehensive analysis: combine with NPV, IRR, risk-adjusted scenarios, and sensitivity/stress testing.
Practical advice
* Use BCR as an initial screening tool to rank projects by benefit efficiency.
* Always perform sensitivity analysis on key inputs (discount rate, cash flows).
* Consider distributional effects and non-monetary benefits or costs that may not be captured in cash flows.
* Evaluate projects with multiple metrics to inform balanced decision-making.
Bottom line BCR is a useful, easy-to-understand ratio that summarizes whether a project’s discounted benefits exceed its discounted costs. It is most effective when used with other financial and qualitative analyses to account for uncertainties and broader impacts. Explore More Resources