Cost-Benefit Analysis

Economic feasibility

 A process of identifying the financial benefits and costs associated with a

development project.

 Economic feasibility is often referred to as cost–benefit analysis.

 During project initiation and planning, it will be impossible for you to precisely
define all benefits and costs related to a particular project.
Cost-Benefit Analysis
 One goal of a cost–benefit analysis is to accurately determine the total cost of
ownership (TCO) for an investment.
 Total cost of ownership (TCO)
 The cost of owning and operating a system, including the total cost of acquisition, as
well as all costs associated with its ongoing use and maintenance.
 One-time cost
 A cost associated with project start-up and development or system start up.
 Recurring cost
 A cost resulting from the ongoing evolution and use of a system.
Cost-Benefit Analysis

 When conducting an economic cost–benefit analysis, a worksheet should be created for capturing
these expenses. For very large projects, one-time costs may be staged over one or more years.

 Recurring costs refer to those costs resulting from the ongoing evolution and use of the system.
Examples of these costs typically include the following:

• Application software maintenance

• Incremental data storage expenses
• Incremental communications
• New software and hardware leases
• Supplies and other expenses (e.g., paper, forms, data center personnel)
Understanding cost benefit analysis

 to evaluate all the potential costs and revenues that a company might generate

from the project
 determine whether the project is financially feasible or if the company should
pursue another project.
 to understand your situation, identify your goals, and create a framework to mold
your scope. 
Cost Benefit Ratio Formula

 This is a simplified version of the cost-benefit ratio formula.

 Cost Benefit Ratio= Sum of Present Value Benefits / Sum of Present Value Costs

 Here’s how you should interpret the result of the cost-benefit ratio formula.

 If the result is less than 1: The benefit-cost ratio is negative, therefore the project isn’t
a good investment as its expected costs exceed the benefits.
 If the result is greater than 1: The cost-benefit ratio is positive, which means the
project will generate financial benefits for the organization and it’s a good investment.
The larger the number, the most benefits it’ll generate.
 Cost-Benefit Analysis Example
 Now let’s put the formulas reviewed above into practice. After using project cost estimation methods and evaluating past-
project data, the apartment management company concludes that:

 The project costs are $65,000. They’re paid upfront, so it’s not necessary to calculate their present value
 The project is expected to generate $100,000 in profit for the next 3 years
 The rate of return based on inflation data is 2%
 Next, we’ll need to calculate the present value of the benefits expected to be earned in the future using the present value
formula:

 PV= ($100,000 / (1 + 0.02)^1) + ($100,000 / (1 + 0.02)^2) + ($100,000 / (1 + 0.02)^3)=$288,000

 Now we need to use this cost value to find the cost-benefit ratio. Here’s how it would be calculated in this case:

 Cost-Benefit Ratio: 288,000/65,000= 4.43

Cost-Benefit Analysis Example

 Since we obtained a positive benefit-cost ratio, we can conclude that the project will be profitable for
this company. This result implies that the project will generate about $4,43 dollars per each $1 spent to
cover expenses.

 This is a simple cost-benefit analysis that relies on the cost-benefit ratio to establish the profitability of
this project. In other scenarios, you might also need to calculate the return on investment (ROI), internal
rate of return (IRR), net present value (NPV) and the payback period (PBP). In addition, it’s advisable to
conduct a sensitivity analysis to evaluate different scenarios and how those affect your cost-benefit
analysis.
 Cost–benefit analysis Techniques

Analysis Technique Description

Net Present Value (NPV) NPV uses a discount rate determined from the company’s cost of
capital to establish the present value of a project. The discount rate is used to
determine the present value of both cash receipts and outlays.

Return on Investment (ROI) ROI is the ratio of the net cash receipts of the project divided by the cash
outlays of the project. Trade-off analysis can be made among projects
competing for investment by comparing their representative ROI ratios.

Break-Even Analysis (BEA) The objective of the break-even analysis is to discover at what point (if ever)
benefits equal costs (i.e., when breakeven occurs)
 Net Present Value

where PVn is the present value of Y dollars n years from now when i is the discount rate. From
our example, the present value of the three payments of $1500 can be calculated as
 Net Present Value
 where PV1, PV2, and PV3 reflect the present value of each $1500 payment in years 1, 2, and 3,
respectively.
 To calculate the net present value (NPV) of the three $1500 payments, simply add the present values
calculated previously
(NPV = PV1 = PV2 = PV3 = 1363.65 = 1239.60 = 1126.95 = $3730.20).
 In other words, the seller could accept a lump-sum payment of $3730.20 as equivalent to the three
payments of $1500, given a discount rate of 10 percent.
ROI
ROI Example
 https://www.projectmanager.com/blog/cost-benefit-analysis-for-projects-a-step-
by-step-guide