Cost-benefit analysis is a comprehensive project appraisal technique used by both public and private organizations to aid in complex investment decisions. It Assesses the input costs and output benefits by means of a market approach. This process involves identifying, comparing & ranking options using multiple criteria. Some projects still proceed even when a conventional development appraisal gives a negative residual figure because Conventional appraisal only considers the cost of land, construction, maintenance, professional fees NOT Value to individuals, cities, Time, life etc.
CBA referred as modified form of an ‘Environmental Impact Assessment’ or ‘Environmental Impact Study’. CBA used for Capital budgeting and help to make fundamental decisions to be reached about the type and extent of investment. Profit maximization is the key objective and Primarily used on government funded schemes. It quantifies all factors including various social benefits & disadvantages.
Examples of cost-benefit analysis projects
- Infrastructure such as transport e.g.: airports, roads
- Health care development
- Water irrigation
- Energy supply
Note: It is used mainly on environmentally sensitive projects.
Aims of a Cost-Benefit analysis
- To Set out factors which need to be taken into account when making economic choices for a project
- To identify Whether a particular project is worthwhile financially or not.
- To find out which is the best of several alternative projects to undertake (initially or in specific order)
- To confirm when to undertake the project
Process of Cost-Benefit Analysis
It is realized that, it is very difficult to quantify the monetary value of the following items
- Value of leisure time
- Value of human life
- Aesthetic and social value judgment
- Environmental considerations
- Cost and value generally (discounted rates)
Types of cost-benefit analysis
- Economic analysis involving real cash flows that affect the investor – Direct & It is similar to life cycle cost analysis (https://basiccivilengineering.com/2020/11/value-management-and-life-cycle-costing.html)
- Social analysis involving real and theoretical cash flows that affect the overall welfare of society – Indirect
Social cost-benefit analysis
It Uses concept of collective utility to measure the effect of an investment project on the community. Intangibles and externalities are assessed in monetary terms and included in the cash flow forecast even though in many cases there is no market valuation available as a source for the estimates. It takes into account both welfare and financial issues so projects delivering the maximum benefit can be identified. Due to amount of research & estimation required, this technique only used on large & complex projects.
Valuation of Benefits
To understand the CBA analysis calculations in detail, meaning of NPV need to be understood. It is the acronym for net present value. Net present value is a calculation that compares the amount invested today to the present value of the future cash receipts from the investment. In other words, the amount invested is compared to the future cash amounts after they are discounted by a specified rate of return.
The valuation of benefits and costs should reflect preferences revealed by choices which have been made. For example, improvements in transportation frequently involve saving time. The question is how to measure the money value of that time saved. The value should not be merely what transportation planners think time should be worth or even what people say their time is worth.
The impact of a project is the difference between what the situation in the study area would be with and without the project. This that when a project is being evaluated the analysis must estimate not only what the situation would be with the project but also what it would be without the project.
Note – A detailed worked example shall be published very soon for the better understanding of cost-benefit analysis.