Download Cost–benefit analysis

Cost–benefit analysis
Cost–benefit analysis (CBA), sometimes called benefit–cost analysis (BCA), is a
systematic approach to estimating the strengths and weaknesses of alternatives (for
example in transactions, activities, and functional business requirements); it is used to
determine options that provide the best approach to achieve benefits while preserving
savings. The CBA is also defined as a systematic process for calculating and comparing
benefits and costs of a decision, policy (with particular regard to government policy) or (in
general) project.
Broadly, CBA has two main purposes:
1. To determine if an investment/decision is sound (justification/feasibility) – verifying
whether its benefits outweigh the costs, and by how much;
2. To provide a basis for comparing projects – which involves comparing the total
expected cost of each option against its total expected benefits.
Cost-benefit Evaluation Techniques
Net Profit
Difference between total cost and total income
Advantages
 Easy to calculate
Disadvantages

Does not show profit relative to size investment
 Does not consider timing of payments
Payback Period
Time taken to break even
Advantages

Easy to calculate

Gives some idea of cash flow impact
Disadvantages

Ignores overall profitability

Not very useful by itself, but a good measure for cash flow
impact.
Net Present Value
Calculation of present value = (value in year t)/(1+r)^t
In this you assume ‘discount rate’ r=10%

Then Rs. 100 next year = 100/(1.10)^1 = Rs. 91 now Sum of all incoming and
outgoing payments, discounted using an interest rate, to a fixed point in time (the
present).

Present value is the value of which a future amount worth at present

It takes into account the profitability of a project and the timing of the cash flows

Discount rate is the annual rate by which we discount future earning
e.g. If discount rate is 10% and the return of an investment in a year is Rs. 110, the present
value of the investment is Rs. 100.
 Internal Rate of Return
 Net present value in reverse
 Calculate discount rate for which the net present value is 0
Advantages
 Calculates figure which is easily comparable to interest rates
Disadvantages

Difficult to calculate (iterative)

Standard way to compare projects.