Incremental benefit-cost ratio analysis:-

The incremental benefit-cost ratio analysis is used to select the best alternative from a set of mutually exclusive alternatives. Similar to incremental rate of return analysis, in this method also the incremental cash flow between the alternatives i.e. the differences in benefits and costs between the alternatives are calculated and then the ratio of the equivalent worth of incremental benefits to that of incremental costs is found out. In this method, the alternative with large cost is selected, if the incremental benefits justify the extra cost associated with it. In other words if the incremental B/C ratio is greater than or equal to 1.0, then the larger cost alternative is selected. If incremental B/C ratio is less than 1.0, then lower cost alternative is selected. While comparing the mutually exclusive alternatives, the alternative with maximum B/C ratio (on its total cash flow) should not be selected as the best alternative at first instance because the maximization of B/C ratio may not guarantee that, best alternative is selected. However after carrying out the incremental B/C ratio analysis, the selection of the best alternative may match with the alternative with maximum B/C ratio on its total cash flow.
The incremental benefit-cost ratio analysis for comparison of mutually exclusive alternatives is carried out in the following steps;

1. First, all the alternatives are arranged in increasing order of equivalent worth of costs. The equivalent worth of cost of alternatives may be determined either by present worth method, annual worth method or future worth method.
   
   
2. The alternative with lowest equivalent cost is now compared with do-nothing alternative (initial base alternative). In other words the B/C ratio of lowest equivalent cost alternative on its total cash flow is calculated. If calculated B/C ratio is greater than or equal to 1.0, then the lowest equivalent cost alternative becomes the new base alternative. On the other hand if B/C ratio is less than 1.0, then this alternative is removed from further analysis and the acceptability of the next higher equivalent cost alternative as base alternative is found in the same manner as that was carried out for the alternative with lowest equivalent cost. This process is continued till the base alternative (acceptable alternative for which B/C ratio is greater than or equal to 1.0) is obtained. If no alternative is obtained in this manner, then do-nothing alternative is selected i.e. none of the alternatives are selected, if this is an option.
   
   
3. Now the incremental benefit, DB and incremental cost, DC (i.e. difference in benefits and costs) between next higher equivalent cost alternative and the base alternative are calculated and then incremental B/C ratio (DB/DC) i.e. ratio of the equivalent worth of incremental benefits to that of incremental costs is obtained. If the incremental B/C ratio (DB/DC) is greater than or equal to 1.0, then the base alternative is removed from further analysis and the next higher equivalent cost alternative becomes the new base alternative.  On the other hand if DB/DC is less than 1.0, then the higher equivalent cost alternative is eliminated form further analysis and base alternative remains the as the base. Then the incremental B/C ratio is calculated between the next higher equivalent cost alternative and the base alternative. This process is continued till the last alternative is compared and in this way the best alternative is selected which justifies the extra cost associated with it from the incremental benefits.