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Cost Benefit Analysis

Cost–benefit analysis (CBA), is a systematic process for calculating and comparing benefits and costs of a project, decision or government policy. CBA has been established primarily as a tool for use by governments in making their social and economic decisions. CBA is a decision making device for evaluating activities that are not priced by the market. To determine if it is a sound investment/decision (justification/feasibility), To provide a basis for comparing projects. It involves comparing the total expected cost of each option against the total expected benefits, to see whether the benefits outweigh the costs, and by how much.

they may undertake a cashflow analysis or a full financial appraisal of the project. a “gut feel” for the right choice. Not only are they expected to consider the profitability (or at least neutrality) of the costing but must also include consideration of the social cost and benefits of their choices. They decide to do an analysis of the choices or it may be a combination of both of these. For a company  Being concerned with the profit earning capacity and income flow.   .Cost Benefit Analysis  For an individual  They might rely on intuition. For the Government  Decision making for governments is much harder.

Cost Benefit Analysis Issues  Is the project worthwhile financially?  Is it the best option?  Should it be undertaken at all? .

Cost Benefit Analysis Costs of a project can be divided into three areas :  Social cost:  being the sum total of costs involved as the result of an economic action Those that affect the decisions of the performers (ie production costs including. lands and capital) Resulting from damage to buildings or decline of property values through smoke emanating from a factory.  Private costs:   External Costs:  . labour. materials. etc.

Cost Benefit Analysis .

and estimating the costs and benefits involves.Cost Benefit Analysis Measurement Problems  Difficulties encounter in measuring intangible costs such as foul atmosphere or intangible benefits such as a peaceful neighbourhood. .  Affects by Market condition.  OR calculating the correct rate for future value as well as accounting for additional benefits and costs associated. Time Problems  Tackling future time problems by discounting future costs and benefits.  Assuming several other costs & benefits associated with the activities. state of economy etc.  Uneven distribution of benefit to community.

social and other tangible costs  Establish total benefits to be obtained from project by way of sales of goods and services including value of social benefits.Method  Identify all possible alternatives.e.  Establish Cost of project during the year including capital. operating and maintenance costs. year to year basis.  Prepare table showing life of the project i.  Cost calculated at rate of interest such that NPV=Zero  Ranking in order of [benefit-cost] or [benefit / cost] .

000. Inflation in the interim period is estimated to be 5%.704. Let us assume this will be in seven years time and the value of this benefit is $100.7352 x $0.000. . Discounted to present value = 0.000. We will keep the same inflation rate for ease of comparision.000 Benefit  The dam will not start to provide benefits until the water is used for irrigation and crop yields improve.Example of Costs and Benefits of the dam Costs  The dam is completed in five years at a cost of $200.2 billion = $156.000 per year in future values.

1 billion = $71.Example of Costs and Benefits of the dam Let us first assume a calculation period for the CBA only covers seven years: Discounted to present value = 0.000  Conclusion: Based on a seven year timespan Costs = $157 million Benefits = $71 million Conclude that Project is not acceptable .068.71068 x $0.

000 Conclusion: Based on a seven year timespan Costs = $157 million Benefits = $265 million Conclude that Project is acceptable .000 x 0.Example of Costs and Benefits of the dam  Let us consider a ten year time span: Benefit: Discount $ x 0.000 in year 7 = $100.000.000 x in year 8 = $100.000.000 x 0.64460 in year 10 = $100.67683 in year 9 = $100.61391 Total present value = 265.

evaluate and structure the advantages and disadvantages over time of alternative solutions to given problems.Feasibility Study and Analysis What is Feasibility Study?  A feasibility study is a report designed to highlight.  The appraisal of the viability of property development schemes. .

Feasibility Study and Analysis Main techniques    Payback period Residual Discounted cashflow Net Present Value  Internal Rate of Return  .