The Cost-Benefit Analysis Process The first step in the process is to compile a comprehensive list of all the costs and benefits associated with the project or decision. Costs should include direct and indirect costs, intangible costs, opportunity costs, and the cost of potential risks.
Thus, this criterion is not much useful to achieve satisfactory results.
The adoption of the B—C criterion favours a large project and makes small and medium size projects less beneficial. Thus, this criterion helps in determining the scale of project on the basis of the maximisation of the difference between B and C. In this criterion, the evaluation of project is done on the basis of benefit-cost ratio.
The higher the benefit cost ratio, more profitable will be the project. The criterion discussed above does not account for the time factor. In fact, the future benefits and costs cannot be treated at par with present benefit and cost. Therefore, project evaluation requires discounting of future benefits and costs because society prefers present to the future.
For this purpose, the economists have derived a number of decision rules or criteria. They are discussed below: This is an important criterion for project evaluation.
If there are number of mutually exclusive projects, then the project with the highest net present value of benefits will be chosen.
The NPV criterion is not accurate method for project evaluation as it neglects the time horizon. Capital investments give benefits after a lapse of some time. Therefore, future benefits and costs cannot be equated with present benefits and costs. So it becomes essential to discount future benefits and costs because society prefers present to future.
The discount factor is expressed as: Only those projects should be selected in which present value of benefits exceeds the present value of costs i. The ratio of present value of benefit to present value of cost should be greater than 1 for the selection of a project i.
The Internal Rate of Return Criterion: The criterion refers to the percentage rate of return implicit in the flows of benefits and costs of projects.
Margin defines the internal rate of return IRR as the discount rate at which present value of return minus cost is zero. The mathematical formula for the computation IRR is IRR In case of mutually exclusive projects, the project to be selected must have highest rate of return. But this criterion has certain limitations which are given below: It is not possible to change the rate of return assumed for the calculation of profitability of project.
It is difficult to calculate rate of return on long gestation project which does not yield benefit for many years. This criterion is not applicable to highly capital intensive projects. It is difficult to calculate IRR in which the entire investment outlay cannot be made in first period.
The use of IRR for public investment does not lead to correct decisions because it is not possible to discount intermediate benefits and costs of public investment at internal rate of return.
It is difficult to make choice between two alternative investments on the basis of their alternative internal rates of return. Layard points out the problem of capital rationing where projects cannot be selected on the basis of ranking in order of the rate of return.
Such projects can only be selected on the basis of their net present value. In fact, IRR depends upon social rate of discount. The choice of project depends upon discount rate if net present values of the projects are given. This can be explained with the help of a diagram 4. At Oq2, the IRR of both projects are equal.
The choice on the basis of changes in discount rate is called Switching and Re-switching. The NPV at the social discount rate and the internal rate of return are two criteria which are frequently used for choosing projects.
For the selection of project, the IRR must be higher than its discount rate i. For complex projects, these two criteria can give different results but mostly they are interchangeable.
NPV criterion is commonly used for project evaluation in private and public sectors.Cost–benefit analysis (CBA), sometimes called benefit costs analysis (BCA), is a systematic approach to estimating the strengths and weaknesses of alternatives (for example in transactions, activities, functional business requirements); it is used to determine options that provide the best approach to achieve benefits while preserving savings.
Child Welfare Inventory and Benefit-Cost Analysis 7 For the benefit-cost analysis, we use a statistical model to monetize benefits from reductions in child maltreatment, out-of-home care, crime, and infant mortality in addition to increases in employment earnings.
Welfare Foundations of Cost Benefit Analysis: The aim of cost benefit analysis is to channel resources into projects which will yield the greatest gain in net benefit to society.
Maximization of net benefit means the maximization of social utility. Cost-effectiveness analysis attempts to determine which practices and policies protect the greatest number of children for the lowest price.
In this type of analysis, key measures of program effectiveness (outcomes) are identified, and different strategies to affect those outcomes are compared. States’ Use of Cost-Benefit Analysis Appendix B: State cost-benefit analysis breakdown 47 leaders seeking to expand their use of cost-benefit analysis and as a baseline for future studies of states’ progress in using rigorous evidence to better inform tough budget and.
Cost-benefit analysis is often used at a macro level to compare programs that achieve different outcomes (for example, deciding whether to fund a child abuse prevention program or a program to reduce youth violence) or to .