What is the Cost-Benefit Analysis Formula?

The term “cost-benefit analysis” refers to the analytical technique that compares the
benefits of a project with its associated costs. In other words, all the expected benefits
out a project are placed on one side of the balance and the costs that have to be
incurred are placed on the other side. The cost-benefit analysis can be executed either
using “benefit-cost ratio” or “net present value”.

The formula for a benefit-cost ratio can be derived by dividing the aggregate of the
present value of all the expected benefits by an aggregate of the present value of all
the associated costs, which is represented as,

Cost-Benefit Analysis Formula,

Benefit-Cost Ratio = ∑PV of all the Expected Benefits / ∑PV of all the Associated
Costs
The formula for net present value can be derived by deducting the sum of the present
value of all the associated costs from the sum of the present value of all the expected
benefits, which is represented as,

Net Present Value = ∑PV of all the Expected Benefits – ∑PV of all the Associated
Costs

Explanation
The formula for cost-benefit analysis can be calculated by using the following steps:

Step 1: Firstly, Calculate all the cash inflow from the subject project, which is either
revenue generation or savings due to operational efficiency.

Step 2: Next, Calculate all the cash outflow into the project, which are the costs
incurred in order to maintain and keep the project up and running.

Step 3: Next, Calculate the discounting factor based on the current pricing of assets
with a similar risk profile.
Step 4: Next, based on the discounting factor, calculate the present value of all the
cash inflow and outflow. Then, add up the present value of all the cash inflow as ∑PV
of all the expected benefits and outflow as ∑PV of all the associated costs.

Step 5: Now, the formula for a benefit-cost ratio can be derived by dividing aggregate
of the present value of all the expected benefits (step 4) by aggregate of the present
value of all the associated costs (step 4) as shown below.

Benefit-Cost Ratio = ∑PV of all the Expected Benefits / ∑PV of all the Associated
Costs

Step 6: Now, the formula for net present value can be derived by deducting the sum
of the present value of all the associated costs (step 4) from the sum of the present
value of all the expected benefits (step 4) as shown below.

Net Present Value = ∑PV of all the Expected Benefits – ∑PV of all the Associated
Costs

Relevance and Use of Cost-Benefit Analysis

Formula
The importance of cost-benefit analysis lies in the fact that it is used for assessing the
feasibility of an opportunity, comparing projects, appraising opportunity cost and
building real-life scenario-based sensitivity testing. In this way, this technique helps in
ascertaining the accuracy of an investment decision and provides a platform for its
comparison with similar proposals.