cost benefit analysis case study example

Cost-Benefit Analysis for Business Cases (Definition, Steps, Example)

When you prepare a project in line with PMI or other established project management methodologies , you will have to create a project business case. This business case is usually a study on the expected qualitative and financial benefits of a single project or different project options. An essential part of this process is the cost-benefit analysis (sometimes also called benefit-cost analysis).

What Is a Project Business Case?

What is a cost-benefit analysis used for, net present value (npv), benefit-cost ratio (bcr), payback period (pbp / pbp), return on investment (roi), internal rate of return (irr), comparison of approaches – differences between npv vs bcr vs pbp vs roi vs irr, step 1) define the scope and purpose of a cost-benefit analysis, step 2) define the fundamental assumptions, step 3) determine the qualitative advantages and disadvantages of a project or investment option, step 4) develop a forecast of investments, costs and benefits, step 5) choose the methods to assess a project option (e.g. npv, bcr, irr), step 6) calculate the value of the success measures, step 7) consolidate, compare and interpret the results, forecast of cash flows, determination of the discount rate, comparison of npv, bcr, pbp, roi and irr results.

Before a project is initiated, the potential benefits need to be analyzed in a project business case. This document is also the basis for stakeholder decisions and the selection of project options.

The Project Management Institute (PMBOK®, 6 th ed., part 1, p. 30) defines the business case as a ‘documented economic feasibility study’ that outlines the business needs, the current situation, an economic analysis and recommendations. In practice, the structure of business case documents is typically tailored to the requirements and expectations of the stakeholders and the organization. In order to evaluate the economic effects of a project and make different project options comparable, project managers leverage the tools and techniques of the cost-benefit analysis (see next section).

A business case is often accompanied by a benefits management plan (which is also suggested by the PMBOK). This document sets out how the project is going to ensure that the expected benefits will eventually materialize in reality. Both the business case and the benefits management plan are the foundation and input documents of the project charter which is the formal documented authorization and mandate for the initiation of a project.

What Is a Cost-Benefit Analysis?

A cost-benefit analysis is an economic evaluation of investment alternatives and project options with respect to their profitability and liquidity effects. It can also consider non-financial and qualitative aspects which however may or may not be reflected in the forecast of cost and benefits.

Besides forecasting investments, cost and benefits over an individually defined time horizon, a cost-benefit analysis usually involves a number of indicators. These measures aggregate forecasts and assumptions into catchy numbers that can be used for comparison and communication purposes.

Discounting cash flows, determining the amortization time, and calculating return rates are the most common approaches for calculating key performance indicators of a forecast in a cost-benefit analysis. We will cover these approaches in detail in the next section.

There are several reasons for using a cost-benefit analysis. The most obvious one is to determine the expected financial returns and profitability of an investment or a project. Subsequently, different options can be compared with each other based on cost-benefit analyses. This can be the basis for decision-making and the selection of the alternative or option to go for (source). This is a typical step before project initiation and often part of a project business case.

The initial cost-benefit analysis results also serve as a baseline for the measurement of success in an ongoing project. Thus, they help project managers, sponsors and other stakeholders to measure, monitor and manage the value a project is creating against the original expectation.

Although the cost-benefit analysis is not an original risk management technique, its results can be used to assess and consider certain risks of a project. An example is a benefit-cost ratio greater than 1: the closer it gets to 1, the higher the risk that even small deviations from the forecasted benefits lead to a loss-producing project.

On the other side, discounted cash flow-based approaches can be calculated using a risk-adjusted discount rate. This allows taking inherent risk into account when net present values or benefit-cost ratios are calculated.

What Are Common Tools and Techniques of a Cost-Benefit Analysis?

An inevitable part of a project business case and a cost-benefit analysis are certain success measures. While the set of indicators needs to be in line with the organization’s requirements, there are in fact a number of very common indicators that are introduced below.  Although the following list is not exhaustive, it covers the generic types of the most common success measures, namely:

• Net present value (NPV),
• Benefit-cost ratio (BCR),
• Payback period (PBP or PbP),
• Return on investment (ROI),
• Internal rate of return (IRR).

These success measures allow project managers to conduct a balanced cost-benefit analysis that covers different aspects such as profitability, liquidity and riskiness of project options. At the same time, these indicators are comparatively simple to calculate and easy to understand in the course of stakeholder communication .

The NPV represents the present value of a series of cash flows. The calculation involves the discounting of net cash flows with a discount rate. This rate is part of the set of assumptions required for applying the net present value method.

The underlying series of cash flows begins with the initial investment as an outflow, followed by net cash flows for each period of the time horizon of the forecast. Future cash flows and a remaining value (or salvage value), as well as disposal costs or further returns expected in subsequent periods, are reflected in a residual value.

Read more in our article on the net present value and use our NPV calculator to determine the value of your project options and investment alternatives.

What Is the Net Present Value (NPV) & How Is It Calculated?

Net Present Value (NPV) Calculator

The benefit-cost ratio compares the present values of all benefits with the present value of all costs expected in a project or investment. A value greater than 1 indicates a profitable project with a total return exceeding the discount rate. A value of less than 1 suggests that the forecasted series of cash flows is not a profitable option.

Read more in our article on the benefit-cost ratio and use our BCR calculator to determine the value of your project options and investment alternatives.

What Is the Benefit Cost Ratio (BCR)? Definition, Formula, Example.

Benefit Cost Ratio (BCR) Calculator

The payback period determines the period in which the cumulative cash flows of a project turn positive for the first time. At that point, the initial investment has been ‘paid back’.

The series of cash flows usually starts with an investment (an outflow, hence a negative number), followed by positive and/or negative net cash flows. These can be even, i.e. the net cash flow remains constant for the entire forecast horizon, or uneven with different values among the periods of a forecast.

When determining the payback period, the generic approach does not use any discount rates or other adjustments which may be inaccurate for long-term forecasts. However, there are a number of modified PbP approaches that can be used to resolve this disadvantage.

Read more in our article on the payback period and use our PbP calculator to determine the value of your project options and investment alternatives.

Payback Period Calculator – PbP for Even & Uneven Cash Flows

The basic formula of the ROI is a division of expected constant returns by the investment amount. It is usually calculated for only one period. However, there are several variants of the return on investment method, including a cumulative and annualized ROI (for multiple periods).

Return on Investment (Single & Multi-Period ROI): Formulae, Examples, Calculator

The internal rate of return is determined by using a net present value calculation. The IRR is the discount rate that would lead to an NPV of 0 if applied to the individual forecast. The resulting rate is the fictive interest or return rate of an investment.

Internal Rate of Return (IRR) vs. ROI – What Are the Differences?

IRR Calculator: Internal Rate of Return (IRR) of Projects

How to Do a Cost-Benefit Analysis in 7 Steps

Follow these 7 steps to prepare a cost-benefit analysis. You will need some input data, as set out in the individual steps, a calculator and a fundamental understanding of the aforementioned indicators. You can download this checklist which will help you gather the required information and data.

The following steps refer to both the qualitative and the financial aspects of a cost-benefit analysis.

First things first: before you start assessing different project options or investment alternatives, make sure that you develop and agree on a clear definition of the scope and purpose of the analysis.

The scope describes what exactly you are going to evaluate. This may refer to high-level project options, single investments or other types of endeavors that are selected for the analysis. For a proper cost-benefit analysis, it should be clear which components are expected to be included (e.g. indirect / internal costs and benefits) and which are not (e.g. direct or indirect taxes).

Determining the purpose of the analysis relates to the expected result type. It clarifies whether solely economic aspects are to be considered, or whether qualitative criteria are also relevant and part of this analysis. A project manager should also be aware of whether profitability, liquidity or risk is the organization’s most relevant consideration.

Examples of cost-benefit analyses that may not solely focus on economic criteria are non-profit projects or social projects run by governments or NGOs.

Before you start, make sure that the basic assumptions of the analysis are known and will be considered in subsequent steps. Assumptions may range from implementation scenarios, headcount, resource needs, etc. to agreed expectations regarding the discount rate and the organization’s target profitability.

Make sure that you are incorporating and addressing all the criteria deemed important by the organization. If you compare different project options, it is crucial that the assumptions are used consistently among all the alternatives you are comparing.

If different or even contradicting types of assumptions are requested, you should consider assessing them separately and in different scenarios.

Gather and document the pros and cons of each and every option you are assessing. Group them into categories and compare them among each other, e.g. in a structure similar to our table in the previous section.

Depending on the type of project, you may wish to consider converting qualitative aspects into financial benefits or cash flow equivalents. This could be done for qualitative advantages that are indirectly affecting financial cash flows. Examples are increasing process efficiency, customer satisfaction and engagement as well as improved quality of products and services.

This may however not be working for other types of advantages and disadvantages. For instance, social and ecological considerations ( source ) as well as long-time effects such as brand image may not be convertible into cash flows of a mid-term forecast.

Come up with a forecast of future benefits and costs (or cash inflows and outflows), investment amounts and other financial considerations.

Depending on the complexity of the options that you are analyzing, you may want to involve subject matter experts to create or validate estimates.

This step usually requires a number of assumptions on a granular level. You should therefore develop an understanding of the uncertainty inherent in this forecast. If you are in doubt, you better create different scenarios (e.g. a base and a worst case) to reflect situations where things turn out differently than expected.

A cost benefit analysis can be performed with different tools and techniques. Net present value, benefit-cost ratio , payback period, return on investment and internal rate of return are the most common methods to assess economic effects from projects, investments and initiatives. Refer to the above-mentioned introduction and read the detailed articles on these measures. Eventually, you will come up with a set of indicators that is suitable for the individual situation.

If you have selected the indicators, you need to apply them to the forecasts that you have developed in a previous step. You will find the formulas in the detailed articles on those methods . When calculating the success measures, apply every method in a consistent manner to all options. This will ensure the comparability and thus the integrity of the results.

As a last step, consolidate all the aspects and results that you have produced in the course of the analysis. You can do this by creating a table that contains the calculated values, the qualitative pros and cons and a ranking of each of the options.

If you are working in scenarios, you will probably want to breakdown each option into the different scenarios (e.g. best, middle, worst case) that you have used previously.

At the completion of the cost-benefit analysis, you should have a clear view on the economic and qualitative aspects of the alternatives you are comparing. Ideally, you are able to recommend a certain option or discard others at this point.

Example: Assessing Project Options with NPV, BCR and PbP

In this illustrative example, we will compare 3 different project options for the implementation of a new IT system with each other. For illustrative purposes, the analysis focuses on the economic aspects only, not taking qualitative and strategic considerations into account.

In order to perform the cost-benefit analysis with all three options, the project manager has obtained estimates of the investments , running and maintenance costs and expected benefits. The benefits consist of both savings from more efficient processes and increased revenue given that the new software improves the way customers are served. The following table shows the consolidated forecast of the three alternatives.

One could be tempted to simply calculate the sum of the cash flows. However, this is not an accurate approach to deal with cash flows occurring at different points in time. We will nevertheless use the simple sum in the result table for comparison purposes.

If one of the more accurate approaches such as NPV and BCR are used, a discount rate is necessary to perform the calculation. This discount rate can be a market interest rate which may be risk- or time-adjusted. In organizations and projects, more common alternatives are either the company’s target return rate or the cost of capital. In this example, the organization expects a return of 12% on all investments which will be used as a discount rate accordingly.

The following table compares the results of the different methods applied to this example. Refer to the dedicated articles on each of these indicators for the respective illustrated step-by-step calculation.

Based on the economic cost-benefit analysis, Option 3 seems to be the most promising one in all measures except ROI. Although the simple sum of its net cash flows is the lowest in this comparison, it creates the highest net present value and the highest internal rate of return. This is because the period when expenses and benefits occur is considered in the NPV. It also comes with the highest benefit-cost ratio. Thus, there is a certain buffer if the benefits do not materialize in the way it was initially expected. With a payback period of 4.71, this option achieves a full amortization in less than 5 years which can be a reasonable time horizon for many organizations.

Option 2 which has the highest sum of non-discounted cash flows does in fact not even yield the required return rate of 12%. As this rate has been used as a discount rate, both the BCR and the NPV indicate a non-profitable investment.

Note that the ROI, as well as the annualized ROI, are not accurate for these examples. Refer to the detailed ROI calculation for further explanations. We have not included the Disconted Payback Period (DPP) as it is not mentioned in the PMBOK. You can find the DPP for the above case study in this article though.

This example refers to the economic aspects of a cost-benefit analysis. In practice, you would want to consider and analyze the qualitative pros and cons as well.

A proper project business case usually requires a financial cost-benefit analysis. While there are a number of calculation methods that help compare and evaluate different project options, you should be aware of the risks and weaknesses ( source ).

Financial models and indicators are always an abstraction of the reality and forecasts may or may not be met in reality. Therefore, all the methods introduced above rely on assumptions. In some cases, it may even be only one single figure turning it into a loss-producing or profitable option (e.g. a perpetuity in the NPV).

So, make sure you understand these dependencies, work with different scenarios if sensible and maintain a comprehensive and honest communication with the stakeholders. Read our detailed articles on cost-benefit analysis methods to learn more about these methods and use this checklist when doing a cost-benefit analysis.

10 Cost-Benefit Analysis Examples

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Cost-benefit analysis refers to an assessment of the benefits of a particular course of action, weighed against the costs incurred.

This type of analysis is useful for identifying the best path forward among a range of possible options, each with their own pros and cons. It is most commonly used in economics.

Cost-benefit analysis has two main applications: 

• Determining the soundness of a decision.
• Providing a basis for comparing alternative decisions (see: opportunity cost analysis ). 

A simple example of a cost-benefit analysis would involve an investor weighing up whether to buy real estate or stocks. Each has its own strengths and weaknesses, and they would need to consider their own context to determine which has the greatest cost-benefit (i.e. benefits per dollar).

Definition of Cost Benefit Analysis

Cost-benefit analysis (or benefit-cost analysis) is a systematic approach to deciding between alternatives based on their costs and benefits.

It may be used to compare completed or potential courses of action. It is often used to evaluate business or policy decisions, economic transactions, project investments, and so on. 

Cost-benefit analysis identifies and places monetary values on the costs of programs.

Furthermore, it requires weighing those costs against the monetary value of program benefits (Riegg Cellini & Edwin Kee, 2015).

Often, this is achieved through calculating the benefit-cost ratio of a particular course of action, calculated as follows:

Benefit-Cost Ratio (BCR) = Present Value of Expected Benefits / Present Value of Expected Costs

This formula helps to determine whether the benefits outweigh the costs. A BCR greater than 1 indicates that the project’s benefits are expected to be greater than its costs, and vice versa.

Cost-benefit analysis proceeds by a ten-step process (Boardman et al., 2011; Riegg Cellini & Edwin Kee, 2015):

• Analysis Framework Setting: Decide on the type of analysis to be undertaken, such as a cost-benefit analysis or a cost-effectiveness analysis.
• Stakeholder Identification: Recognize whose costs and benefits should be accounted for. Considerations include which stakeholders are affected and who should have standing in the program or policy.
• Costs and Benefits Categorization: Identify and categorize all costs and benefits associated with the program or policy.
• Lifetime Costs and Benefits Projection: Project how costs and benefits will evolve over the lifespan of the program, if applicable.
• Cost Monetization: Assign a monetary value to all or most costs to facilitate comparisons.
• Benefit Quantification: Quantify benefits in terms of monetary units. The goal is to assign a dollar value to every major output or benefit, taking into consideration varying beneficiary groups and program objectives.
• Discounting Costs and Benefits: Discount future costs and benefits to their present values to account for the time value of money.
• Net Present Value Calculation: Compute the net present value (NPV) which represents the difference between the present value of cash inflows and the present value of cash outflows.
• Sensitivity Analysis: Test the sensitivity of the analysis to specific assumptions, determining how different values of an independent variable impact the particular dependent variable under consideration.
• Recommendation Generation: Based on the results of the cost-benefit analysis, make a suitable recommendation. If the program has a positive net present value, especially after a worst-case sensitivity analysis, the policy should be implemented as it would increase social welfare. Conversely, a program with a negative net present value should be rejected (Riegg Cellini & Edwin Kee, 2015).

The concept of cost-benefit analysis and its fundamental formulas are quite simple, but actually carrying out a cost-benefit analysis can be extremely challenging. 

10 Examples of Cost Benefit Analysis

1. investment decisions.

A company is trying to decide between two alternative investments, so it decides to conduct a cost-benefit analysis to compare the two.

• Total costs of the first alternative: $100,000
• Total benefits of the first alternative: $120,000
• Total costs of the second alternative: $150,000
• Total benefits of the second alternative: $200,000

The basic formula to use to decide between the two alternatives is the following:

Benefit-Cost Ratio = Expected Benefits / Total Costs

• Benefit-Cost Ratio of the first alternative: 120,000/100,000=6/5
• Benefit-Cost Ratio of the second alternative: 200,000/150,000=4/3

The Benefit-Cost Ratio of the second alternative is larger than that of the first, so the second investment will be more profitable for the company. 

2. Real Estate Development Options

A construction company needs to compare two potential real estate development projects. The company doesn’t have the resources to engage in both, so it has to choose. 

Each project has a different number of housing units that need to be constructed, how many of those will be sold and how many will be rented also differs. The rental prices, construction costs, sale prices, personnel costs, durations, and financing costs of each project also differ. 

A cost-benefit analysis will have to take account of each relevant parameter to estimate how much each project will cost in total and how profitable each will be. The two projects can then be compared based on the cost-benefit ratio of each (Castle, 2018). 

3. Weighing whether to Buy new Equipment

A company wants to decide whether to make a new equipment purchase. The company wants to know whether this new purchase might save money in the long term, so it conducts a cost-benefit analysis. 

• Total costs of the new equipment: $100,000
• Annual benefits of the new equipment: $25,000

So the company will make a profit after the fourth year. The company then has to decide whether this is worth it. 

4. Whether to Hire more Workers

A company decides to conduct a cost-benefit analysis of hiring 10 new workers. 

• Total costs: $200,000
• Total benefits: $250,000

The company can generate an extra $50,000 each year, so they should go through with the decision and hire 10 new workers.

5. Public Infrastructure Decisions

A city council is deciding between building a new public park or a community center. A cost-benefit analysis is carried out for each option:

• Total costs of the public park: $500,000 Estimated societal benefits of the park (increased property value, improved health, etc.): $700,000
• Total costs of the community center: $750,000 Estimated societal benefits of the community center (education, community cohesion, etc.): $900,000
• Benefit-Cost Ratio of the public park: 700,000/500,000=7/5 Benefit-Cost Ratio of the community center: 900,000/750,000=6/5

The public park has a higher Benefit-Cost Ratio and could therefore be a more favorable option, despite the community center having higher absolute benefits.

6. Healthcare Investment

A hospital is considering investing in new MRI technology or in a specialized heart disease treatment program.

• Total costs of the MRI technology: $2,000,000 Estimated patient benefits of MRI technology: $2,500,000
• Total costs of the heart disease program: $1,500,000 Estimated patient benefits of heart disease program: $2,200,000
• Benefit-Cost Ratio of MRI technology: 2,500,000/2,000,000=5/4 Benefit-Cost Ratio of the heart disease program: 2,200,000/1,500,000=44/30

Despite the heart disease program having a lower absolute benefit, it has a higher Benefit-Cost Ratio and might be a better investment for the hospital.

7. Education Policy Choices

A school district is deciding between implementing a new online learning system or hiring additional teaching staff. A cost-benefit analysis helps in decision making:

• Total costs of online learning system: $300,000 Estimated benefits of online learning system (increased learning efficiency , accessibility, etc.): $450,000
• Total costs of hiring additional staff: $400,000 Estimated benefits of additional staff (improved student-teacher ratio, individual attention, etc.): $550,000
• Benefit-Cost Ratio of online learning system: 450,000/300,000=3/2 Benefit-Cost Ratio of additional staff: 550,000/400,000=11/8

Despite the additional staff providing higher absolute benefits, the online learning system has a higher Benefit-Cost Ratio, making it a more efficient investment.

8. Software Upgrade Decision

A tech company is weighing the costs and benefits of upgrading their existing software versus purchasing a new one.

• Total costs of upgrading existing software: $10,000 Estimated benefits of upgrading existing software: $20,000
• Total costs of purchasing new software: $25,000 Estimated benefits of new software: $40,000
• Benefit-Cost Ratio of upgrading existing software: 20,000/10,000=2/1 Benefit-Cost Ratio of new software: 40,000/25,000=8/5

Upgrading the existing software has a higher Benefit-Cost Ratio, indicating it might be a more cost-effective choice for the company.

9. Environmental Policy

A government is considering investing in a renewable energy project or continuing to support fossil fuel-based energy production. A cost-benefit analysis is needed:

• Total costs of renewable energy project: $1,000,000
• Estimated societal benefits of renewable energy (lower pollution, sustainability, etc.): $1,300,000

Total costs of fossil fuel support: $800,000 Estimated societal benefits of fossil fuel support (job retention, immediate energy supply): $900

10. Whether to add a New Service

A software company is planning to speed up its delivery dates. But doing so would require hiring three additional coders, which requires investments like buying new furniture, and computers, and leasing additional workspace (Castle, 2018). 

• Assume that the yearly revenue is $100,000 but it will increase by 50% as the capacity increases. 
• Assume that each coder earns $10 per hour. 

A cost-benefit analysis will have to take the following costs and benefits into account:

• Rental cost per year: $15,000
• Furniture costs: $10,000
• Hiring costs per year: $23,040
• Hardware & software costs: $10,000
• Downtime costs: $10,000
• 10% annual revenue increase: $50,000

Summing up the costs, we can see that they amount to more than $68,000, so the costs of the project would be larger than their benefits. 

Cost-Benefit Analysis vs Cost-Effectiveness Analysis

In economics, cost-benefit analysis is related to cost-effectiveness analysis:

• Cost-effectiveness analysis: this compares the relative costs and outcomes (instead of benefits) of different decisions. It aims to be more holistic. 
• Cost-benefit analysis: this tends to assign a monetary value to a course of action to identify the best course to pursue (Bleichrodt & Quiggin, 1999). 

Riegg Cellini and Edwin Kee (2015) define the two as follows:

“Cost-effectiveness analysis is a technique that relates the costs of a program to its key outcomes or benefits. Cost-benefit analysis takes that process one step further, attempting to compare costs with the dollar value of all (or most) of a program’s many benefits. These seemingly straightforward analyses can be applied anytime before, after, or during a program implementation, and they can greatly assist decision makers in assessing a program’s efficiency.

For a General List of Analysis Examples, See Here

Cost-benefit analysis is an essential part of doing business as it helps businesses to identify the most efficient and productive ways to dedicate resources and time in order to achieve optimal outcomes for both the company and the client. By calculating the benefit-cost ratio, we can directly compare two options.

However, it’s important to note that a cost-effectiveness analysis may provide a more holistic overview that considers outcomes (such as human impact) rather than just costs.

Bleichrodt, H., & Quiggin, J. (1999). Life-cycle preferences over consumption and health: When is cost-effectiveness analysis equivalent to cost–benefit analysis? Journal of Health Economics , 18 (6), 681–708. https://doi.org/10.1016/S0167-6296(99)00014-4

Boardman, A., Greenberg, D., Vining, A., & Weimer, D. (2011). Cost-Benefit Analysis: Concepts and Practice, 4th edition .

Castle, K. (2018, February 13). Cost Benefit Analysis Example and Steps (CBA Example). Projectcubicle . https://www.projectcubicle.com/cost-benefit-analysis-example/

Riegg Cellini, S., & Edwin Kee, J. (2015). Cost-Effectiveness and Cost-Benefit Analysis. In Handbook of Practical Program Evaluation (pp. 636–672). John Wiley & Sons, Ltd. https://doi.org/10.1002/9781119171386.ch24

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How to Do a Cost-Benefit Analysis & Why It’s Important

• 05 Sep 2019

Are you unsure whether a particular decision is the best one for your business? Are you questioning whether a proposed project will be worth the effort and resources that will go into making it a success? Are you considering making a change to your business, marketing, or sales strategy, knowing that it might have repercussions throughout your organization?

The way that many businesses, organizations, and entrepreneurs answer these, and other, questions is through business analytics —specifically, by conducting a cost-benefit analysis.

Access your free e-book today.

What Is A Cost-Benefit Analysis?

A cost-benefit analysis is the process of comparing the projected or estimated costs and benefits (or opportunities) associated with a project decision to determine whether it makes sense from a business perspective.

Generally speaking, cost-benefit analysis involves tallying up all costs of a project or decision and subtracting that amount from the total projected benefits of the project or decision. (Sometimes, this value is represented as a ratio.)

If the projected benefits outweigh the costs, you could argue that the decision is a good one to make. If, on the other hand, the costs outweigh the benefits, then a company may want to rethink the decision or project.

There are enormous economic benefits to running these kinds of analyses before making significant organizational decisions. By doing analyses, you can parse out critical information, such as your organization’s value chain or a project’s ROI .

Cost-benefit analysis is a form of data-driven decision-making most often utilized in business, both at established companies and startups . The basic principles and framework can be applied to virtually any decision-making process, whether business-related or otherwise.

Related: 5 Business Analytics Skills for Professionals

Steps of a Cost-Benefit Analysis

1. establish a framework for your analysis.

For your analysis to be as accurate as possible, you must first establish the framework within which you’re conducting it. What, exactly, this framework looks like will depend on the specifics of your organization.

Identify the goals and objectives you’re trying to address with the proposal. What do you need to accomplish to consider the endeavor a success? This can help you identify and understand your costs and benefits, and will be critical in interpreting the results of your analysis.

Similarly, decide what metric you’ll be using to measure and compare the benefits and costs. To accurately compare the two, both your costs and benefits should be measured in the same “common currency.” This doesn’t need to be an actual currency, but it does frequently involve assigning a dollar amount to each potential cost and benefit.

2. Identify Your Costs and Benefits

Your next step is to sit down and compile two separate lists: One of all of the projected costs, and the other of the expected benefits of the proposed project or action.

When tallying costs, you’ll likely begin with direct costs , which include expenses directly related to the production or development of a product or service (or the implementation of a project or business decision). Labor costs, manufacturing costs, materials costs, and inventory costs are all examples of direct costs.

But it’s also important to go beyond the obvious. There are a few additional costs you must account for:

• Indirect costs: These are typically fixed expenses, such as utilities and rent, that contribute to the overhead of conducting business.
• Intangible costs: These are any current and future costs that are difficult to measure and quantify. Examples may include decreases in productivity levels while a new business process is rolled out, or reduced customer satisfaction after a change in customer service processes that leads to fewer repeat buys.
• Opportunity costs: This refers to lost benefits, or opportunities, that arise when a business pursues one product or strategy over another.

Once those individual costs are identified, it’s equally important to understand the possible benefits of the proposed decision or project. Some of those benefits include:

• Direct: Increased revenue and sales generated from a new product
• Indirect: Increased customer interest in your business or brand
• Intangible: Improved employee morale
• Competitive: Being a first-mover within an industry or vertical

3. Assign a Dollar Amount or Value to Each Cost and Benefit

Once you’ve compiled exhaustive lists of all costs and benefits, you must establish the appropriate monetary units by assigning a dollar amount to each one. If you don’t give all the costs and benefits a value, then it will be difficult to compare them accurately.

Direct costs and benefits will be the easiest to assign a dollar amount to. Indirect and intangible costs and benefits, on the other hand, can be challenging to quantify. That does not mean you shouldn’t try, though; there are many software options and methodologies available for assigning these less-than-obvious values.

4. Tally the Total Value of Benefits and Costs and Compare

Once every cost and benefit has a dollar amount next to it, you can tally up each list and compare the two.

If total benefits outnumber total costs, then there is a business case for you to proceed with the project or decision. If total costs outnumber total benefits, then you may want to reconsider the proposal.

Beyond simply looking at how the total costs and benefits compare, you should also return to the framework established in step one. Does the analysis show you reaching the goals you’ve identified as markers for success, or does it show you falling short?

If the costs outweigh the benefits, ask yourself if there are alternatives to the proposal you haven’t considered. Additionally, you may be able to identify cost reductions that will allow you to reach your goals more affordably while still being effective.

Related: Finance vs. Accounting: What's the Difference?

Pros and Cons of Cost-Benefit Analysis

There are many positive reasons a business or organization might choose to leverage cost-benefit analysis as a part of their decision-making process. There are also several potential disadvantages and limitations that should be considered before relying entirely on a cost-benefit analysis.

Advantages of Cost-Benefit Analysis

A data-driven approach.

Cost-benefit analysis allows an individual or organization to evaluate a decision or potential project free of biases. As such, it offers an agnostic and evidence-based evaluation of your options, which can help your business become more data-driven and logical.

Makes Decisions Simpler

Business decisions are often complex by nature. By reducing a decision to costs versus benefits, the cost-benefit analysis can make this dilemma less complex.

Uncovers Hidden Costs and Benefits

Cost-benefit analysis forces you to outline every potential cost and benefit associated with a project, which can uncover less-than-obvious factors like indirect or intangible costs.

Limitations of Cost-Benefit Analysis

Difficult to predict all variables.

While cost-benefit analysis can help you outline the projected costs and benefits associated with a business decision, it’s challenging to predict all the factors that may impact the outcome. Changes in market demand, material costs, and the global business environment are unpredictable—especially in the long term.

Incorrect Data Can Skew Results

If you’re relying on incomplete or inaccurate data to finish your cost-benefit analysis, the results of the analysis will follow suit.

Better Suited to Short- and Mid-Length Projects

For projects or business decisions that involve longer timeframes, cost-benefit analysis has a greater potential of missing the mark for several reasons. For one, it’s typically more difficult to make accurate predictions the further into the future you go. It’s also possible that long-term forecasts won’t accurately account for variables such as inflation, which can impact the overall accuracy of the analysis.

Removes the Human Element

While a desire to make a profit drives most companies, there are other, non-monetary reasons an organization might decide to pursue a project or decision. In these cases, it can be difficult to reconcile moral or “human” perspectives with the business case.

In the end, cost-benefit analysis shouldn't be the only business analytics tool or strategy you use in determining how to move your organization into the future. Cost-benefit analysis isn’t the only type of economic analysis you can do to assess your business’s economic state, but a single option at your disposal.

Do you want to take your career to the next level? Download our free Guide to Advancing Your Career with Essential Business Skills to learn how enhancing your business knowledge can help you make an impact on your organization and be competitive in the job market.

This post was updated on July 12, 2022. It was originally published on September 5, 2019.

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Cost-Benefit Analysis: A Quick Guide with Examples and Templates

When managing a project, many key decisions are required. Project managers strive to control costs while getting the highest return on investment and other benefits for their business or organization. A cost-benefit analysis (CBA) is just what they need to help them do that. Before we explain how to do a cost-benefit analysis, let’s briefly define what it is.

What Is a Cost-Benefit Analysis?

A cost-benefit analysis (CBA) is a process that’s used to estimate the costs and benefits of projects or investments to determine their profitability for an organization. A CBA is a versatile method that’s often used for business administration, project management and public policy decisions. An effective CBA evaluates the following costs and benefits:

• Direct costs
• Indirect costs
• Intangible costs
• Opportunity costs
• Costs of potential risks
• Total benefits
• Net benefits

These project costs and benefits are then assigned a monetary value and used to determine the cost-benefit ratio. However, a cost-benefit analysis might also involve other calculations such as return on investment (ROI), internal rate of return (IRR), net present value (NPV) and the payback period (PBP).

Cost-Benefit Analysis Template

Use this Excel template to put what you’ve learned into practice. This free cost-benefit analysis template helps you identify quanitative costs and benefits, as well as qualitative costs and benefits, so you can appreciate the full impact of your project. Download yours today.

The Purpose of Cost-Benefit Analysis

The purpose of cost-benefit analysis is to have a systemic approach to figure out the pluses and minuses of various business or project proposals. The cost-benefit analysis gives you options and offers the best project budgeting approach to achieve your goal while saving on investment costs.

When to Do a Cost-Benefit Analysis

Cost-benefit analysis is a technique that helps decision-makers choose the best investment opportunities in different scenarios. Here are some of the most common applications for a cost-benefit analysis in project management.

Cost Benefit Analysis & Feasibility Studies

A feasibility study determines whether a project or business initiative is feasible by determining whether it meets technical, economic, legal and market criteria.

Cost Benefit Analysis & Business Requirements Documents

A cost-benefit analysis should be included in a business requirements document , a document that explains what a project entails and what it requires for its successful completion.

Cost Benefit Analysis & Government Projects

Government projects also require conducting a cost-benefit analysis. However, in these types of projects, decision-makers must not only focus on financial gain, but rather think about the impact projects have on the communities and external stakeholders who might benefit from them.

Keeping track of project costs is easier with project management software. For example, ProjectManager has a sheet view, which is exactly like a Gantt but without a visual timeline. You can switch back and forth from the Gantt to the sheet view when you want to just look at your costs in a spreadsheet. You can add as many columns as you like and filter the sheet to capture only the relevant data. Keeping track of your costs and benefits is what makes a successful project. Get started for free today.

How to Do a Cost-Benefit Analysis

According to the Economist , CBA has been around for a long time. In 1772, Benjamin Franklin wrote of its use. But the concept of CBA as we know it dates to Jules Dupuit, a French engineer, who outlined the process in an article in 1848.

Since then, the CBA process has greatly evolved. Let’s go through this checklist to learn how to do a basic cost-benefit analysis using the cost-benefit ratio and present value formulas:

1. What Are the Project Goals and Objectives?

Create a business case for your project and state its goals and objectives.

2. Review Historical Data

Before you can know if a project proposal might be valuable, you need to compare it to similar past projects to see which is the best path forward. Check their success metrics such as their return on investment, internal rate of return, payback period and benefit-cost ratio.

3. Who Are the Stakeholders?

List all stakeholders in the project. They’re the ones affected by the costs and benefits. Describe which of them are decision-makers.

4. What Are the Project Costs and Benefits?

Estimate the future value of your project costs and benefits and think about all the non-financial benefits that a project proposal might bring

The process can be greatly improved with project management software. ProjectManager has one-click reporting that lets you can create eight different project reports. Get data on project status, variance and more. Reports can be easily shared as PDFs or printed out for stakeholders. Filter any report to display only the data you need at the time.

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Cost Benefit Analysis Template

Use this free Cost Benefit Analysis Template for Excel to manage your projects better.

5. Define a Project Timeframe

Look over the costs and benefits of the project, assign them a monetary value and map them over a relevant time period. It’s important to understand that the cost-benefit ratio formula factors in the number of periods in which the project is expected to generate benefits.

6. What Is the Rate of Return?

As explained above, the rate of return is used to calculate the present values of your project’s costs and benefits, which are needed to find the cost-benefit ratio.

What Is the Cost-Benefit Ratio?

The cost-benefit ratio, or benefit-cost ratio, is the mathematical relation between the costs and financial benefits of a project. The cost-benefit ratio compares the present value of the estimated costs and benefits of a project or investment.

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.

Present Value Formula

The present value of a project’s benefits and costs is calculated with the present value formula (PV).

PV = FV/(1+r)^n

• FV: Future value
• r= Rate of return
• n= Number of periods

We’ll apply these formulas in the cost-benefit analysis example below. Our free cost-benefit analysis template can help you gather the information you need for the cost-benefit ratio analysis.

Cost-Benefit Analysis Example

Now let’s put the formulas reviewed above into practice. For our cost-benefit analysis example, we’ll think about a residential construction project, the renovation of an apartment complex. 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

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.

Capture all the costs and benefits with project management software. But unlike many apps with inferior to-do lists, ProjectManager has a list view that is dynamic. It adds priority and customized tags you can assign team members to own each item. Our online tool automatically tracks the percentage complete for each item in real time. All the data you collect in our list view is visible throughout the tool. Regardless of the view, they all update live and they’re ready for you to utilize.

How Accurate Is Cost-Benefit Analysis?

How accurate is CBA? The short answer is it’s as accurate as the data you put into the process. The more accurate your estimates, the more accurate your results.

Some inaccuracies are caused by the following:

• Relying too heavily on data collected from past projects, especially when those projects differ in function, size, etc., from the one you’re working on
• Using subjective impressions when you’re making your assessment
• Improperly using heuristics (problem-solving employing a practical method that is not guaranteed) to get the cost of intangibles
• Confirmation bias or only using data that backs up what you want to find

Cost-Benefit Analysis Limitations

Cost-benefit analysis is best suited to smaller to mid-sized projects that don’t take too long to complete. In these cases, the analysis can help decision-makers optimize the benefit-cost ratio of their projects.

However, large projects that go on for a long time can be problematic in terms of CBA. There are outside factors, such as inflation, interest rates, etc., that impact the accuracy of the analysis. In those cases, calculating the net present value, time value of money, discount rates and other metrics can be complicated for most project managers .

There are other methods that complement CBA in assessing larger projects, such as NPV and IRR. Overall, though, the use of CBA is a crucial step in determining if any project is worth pursuing.

Templates to Help With Your Cost-Benefit Analysis

As you work to calculate the cost-benefit analysis of your project, you can get help from some of the free project management templates we offer on our site. We have dozens of free templates that assist every phase of the project life cycle. For cost-benefit analysis, use these three.

RACI Matrix Template

One of the steps when executing a cost-benefit analysis includes identifying project stakeholders. You need to list those stakeholders, but our free RACI matrix template takes that one step further by outlining who needs to know what. RACI is an acronym for responsible, accountable, consulted and informed. By filling out this template, you’ll organize your team and stakeholders and keep everyone on the same page.

Project Budget Template

You can’t do a cost-benefit analysis without outlining all your expenses first. That’s where our free project budget template comes in. It helps you capture all the expenses related to your project from labor costs, consultant fees, the price of raw materials, software licenses and travel. There’s even space to capture other line items, such as telephone charges, rental space, office equipment, admin and insurance. A thorough budget makes for a more accurate cost analysis.

Project Risk Register Template

You have your stakeholders identified and your budget outlined, but there’s always the unknown to consider. You can’t leave that up to chance: you must manage risk, which is why our free project risk register is so essential. Use it to outline inherent project risks. There are places to list the description of the risk, its impact, the level of risk and who’s responsible for it. By maintaining a risk register, you can control the project variables and make a better cost-benefit analysis.

Make Any Project Profitable With ProjectManager

No matter how great your return on investment might be on paper, a lot of that value can evaporate with poor execution of your project. ProjectManager is award-winning project management software with the tools you need to realize the potential of your project. First, you need an airtight plan.

Planning on Gantt Charts

Our online Gantt charts have features to plan your projects and organize your tasks, so they lead to a successful final deliverable. If things change, and they will, the Gantt is easy to edit, so you can pivot quickly.

Resource Management Tools

Another snag that can waylay a project is your resources. ProjectManager has resource management tools that track your materials, supplies and your most valuable resource: the project team. If they’re overworked, morale erodes and production suffers.

The workload page on ProjectManager is color-coded to show who is working on what and gives you the tools to reassign to keep the workload balanced and the team productive.

Real-Time Cost Tracking

The surest way to kill any project is for it to bleed money. ProjectManager lets you set a budget for your project from the start. This figure is then reflected in reports and in the charts and graphs of the real-time dashboard , so you’re always aware of how costs are impacting your project. ProjectManager has the features you need to lead your project to profitability.

Cost benefits analysis is a data-driven process and requires project management software robust enough to digest and distribute the information. ProjectManager is online project management software with tools, such as a real-time dashboard, that can collect, filter and share your results in easy-to-understand graphs and charts. Try it today with this free 30-day trial.

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An Expert Guide to Cost Benefit Analysis

By Joe Weller | December 8, 2016

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In business today, it’s essential to get the most out of every idea, option, and investment. To accomplish this, many organizations - from large enterprises to startups and small businesses -  use cost benefit analyses to help make important decisions. Using a cost benefit analysis can help teams identify the highest and best return on an investment based on the cost, resources, and risk involved.   In this article, we’ll walk you through the process of cost benefit analysis, and offer insight and tips from industry experts. They’ll shine a light on the risks and uncertainties you should be aware of as you work, and provide real-world examples to show cost benefit analysis in action.

Cost benefit analysis: What is it?

A cost benefit analysis (also known as a benefit cost analysis) is a process by which organizations can analyze decisions, systems or projects, or determine a value for intangibles. The model is built by identifying the benefits of an action as well as the associated costs, and subtracting the costs from benefits. When completed, a cost benefit analysis will yield concrete results that can be used to develop reasonable conclusions around the feasibility and/or advisability of a decision or situation.   Why Use Cost Benefit Analysis? Organizations rely on cost benefit analysis to support decision making because it provides an agnostic, evidence-based view of the issue being evaluated—without the influences of opinion, politics, or bias. By providing an unclouded view of the consequences of a decision, cost benefit analysis is an invaluable tool in developing business strategy, evaluating a new hire, or making resource allocation or purchase decisions.   Origins of Cost Benefit Analysis The earliest evidence of the use of cost benefit analysis in business is associated with a French engineer, Jules Dupuit, who was also a self-taught economist. In the mid-19th century, Dupuit used basic concepts of what later became known as cost benefit analysis in determining tolls for a bridge project on which he was working. Dupuit outlined the principles of his evaluation process in an article written in 1848, and the process was further refined and popularized in the late 1800s by British economist Alfred Marshall, author of the landmark text, Principles of Economics (1890).

Scenarios Utilizing Cost Benefit Analysis

As mentioned previously, cost benefit analysis is the foundation of the decision-making process across a wide variety of disciplines. In business, government, finance, and even the nonprofit world, cost benefit analysis offers unique and valuable insight when:

• Developing benchmarks for comparing projects
• Deciding whether to pursue a proposed project
• Evaluating new hires
• Weighing investment opportunities
• Measuring social benefits
• Appraising the desirability of suggested policies
• Assessing change initiatives
• Quantifying effects on stakeholders and participants

How to Do a Cost Benefit Analysis

While there is no “standard” format for performing a cost benefit analysis, there are certain core elements that will be present across almost all analyses. Use the structure that works best for your situation or industry, or try one of the resources and tools listed at the end of this article. We’ll go through the five basic steps to performing a cost benefit analysis in the sections below, but first, here’s a high-level of overview:  

• Establish a framework to outline the parameters of the analysis
• Identify costs and benefits so they can be categorized by type, and intent
• Calculate costs and benefits across the assumed life of a project or initiative
• Compare cost and benefits using aggregate information
• Analyze results and make an informed, final recommendation

  As with any process, it’s important to work through all the steps thoroughly and not give in to the temptation to cut corners or base assumptions on opinion or “best guesses.” According to a paper from Dr. Josiah Kaplan, former Research Associate at the University of Oxford, it’s important to ensure that your analysis is as comprehensive as possible:   “The best cost-benefit analyses take a broad view of costs and benefits, including indirect and longer-term effects, reflecting the interests of all stakeholders who will be affected by the program.”

How to Establish a Framework

In establishing the framework of your cost benefit analysis, first outline the proposed program or policy change in detail. Look carefully at how you position what exactly is being evaluated in relationship to the problem being solved. For example, the analysis associated with the question, “should we add a new professor to our staff?” will be much more straightforward than a broader programmatic question, such as, “how should we resolve the gaps in our educational offering?”   Example:

Once your program or policy change is clearly outlined, you’ll need to build out a situational overview to examine the existing state of affairs including background, current performance, any opportunities it has brought to the table, and its projected performance in the future. Also make sure to factor in an objective look at any risks involved in maintaining the status quo moving forward.   Now decide on how you will approach cost benefits. Which cost benefits should be included in your analysis? Include the basics, but also do a bit of thinking outside the box to come up with any unforeseen costs that could impact the initiative in both the short and long term.   In some cases geography could play a role in determining feasibility of a project or initiative. If geographically dispersed stakeholders or groups will be affected by the decision being analyzed, make sure to build that into the framework upfront, to avoid surprises down the road. Conversely, if the scope of the project or initiative may scale beyond the intended geographic parameters, that should be taken into consideration as well.

Identify and Categorize Costs and Benefits

Now that your framework is in place, it’s time to sort your costs and benefits into buckets by type. The primary categories that costs and benefits fall into are direct/indirect , tangible/intangible , and real :  

• Direct costs are often associated with production of a cost object (product, service, customer, project, or activity)
• Indirect costs are usually fixed in nature, and may come from overhead of a department or cost center
• Tangible costs are easy to measure and quantify, and are usually related to an identifiable source or asset, like payroll, rent, and purchasing tools
• Intangible cost s are difficult to identify and measure, like shifts in customer satisfaction, and productivity levels
• Real costs are expenses associated with producing an offering, such as labor costs and raw materials

  Now that you’ve developed the categories into which you’ll sort your costs and benefits, it’s time to start crunching numbers.

How to Calculate Costs and Benefits

With the framework and categories in place, you can start outlining overall costs and benefits. As mentioned earlier, it’s important to take both the short and long term into consideration, so ensure that you make your projections based on the life of the program or initiative, and look at how both costs and benefits will evolve over time.

TIP: People often make the mistake of monetizing incorrectly when projecting costs and benefits, and therefore end up with flawed results. When factoring in future costs and benefits, always be sure to adjust the figures and convert them into present value.

Compare Aggregate Costs and Benefits

Here we’ll determine net present values by subtracting costs from benefits, and project the timeframe required for benefits to repay costs, also known as return on investment (ROI).   Example:

The process doesn’t end there. In certain situations, it’s important to address any serious concerns that could impact feasibility from a legal or social justice standpoint. In cases like these, it can be helpful to incorporate a “with/without” comparison to identify areas of potential concern.   With/Without Comparison The impact of an initiative can be brought into sharp focus through a basic “with/without” comparison. In other words, this is where we look at what the impact would be—on organizations, stakeholders, or users—both with, and without, this initiative.   Thayer Watkins, who taught a course on cost benefit analysis during his 30-year career as a professor in the San Jose State University Department of Economics, offers this example of a “with/without” comparison:   “The impact of a project is the difference between what the situation in the study area would be with and without the project. So 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. For example, in determining the impact of a fixed guideway rapid transit system such as the Bay Area Rapid Transit (BART) in the San Francisco Bay Area the number of rides that would have been taken on an expansion of the bus system should be deducted from the rides provided by BART and likewise the additional costs of such an expanded bus system would be deducted from the costs of BART. In other words, the alternative to the project must be explicitly specified and considered in the evaluation of the project.”   TIP: Never confuse with/without with a before-and-after comparison.

3 Steps for Analyzing the Results and Make a Recommendation

In the home stretch of the cost benefit analysis, you’ll be looking at the results of your work and forming the basis to make your decision.   1. Perform Sensitivity Analysis Dr. Kaplan recommends performing a sensitivity analysis (also known as a “what-if”) to predict outcomes and check accuracy in the face of a collection of variables. “Information on costs, benefits, and risks is rarely known with certainty, especially when one looks to the future,” Dr. Kaplan says. “This makes it essential that sensitivity analysis is carried out, testing the robustness of the CBA result to changes in some of the key numbers.”   EXAMPLE of Sensitivity Analysis In trying to understand how customer traffic impacts sales in Bob’s Pie Shop, in which sales are a function of both price and volume of transactions, let’s look at some sales figures:

Bob has determined that a 10% increase in store traffic will boost his pie sales by 5%. This allows Bob to build the following sensitivity analysis, based upon his sales of 400 pies last year, that demonstrates that his pie sales are significantly impacted by fluctuations or growth in store traffic:

2. Consider Discount Rates When evaluating your findings, it’s important to take discount rates into consideration when determining project feasibility.  

• Social discount rates – Used to determine the value to funds spent on government projects (education, transportation, etc.)
• Hurdle rates – The minimum return on investment required by investors or stakeholders
• Annual effective discount rates – Based on a percentage of the end-of-year balance, the amount of interest paid or earned

Here is a template where you can make your Cost Benefit Analysis

Download Simple Cost Benefit Analysis Template

Microsoft Excel | Smartsheet

3. Use Discount Rates to Determine Course of Action After determining the appropriate discount rate, look at the change in results as you both increase and decrease the rate:  

• Positive - If both increasing and decreasing the rate yields a positive result, the policy or initiative is financially viable.
• Negative - If both increasing and decreasing the rate yields a negative result, revisit your calculations based upon adjusting to a zero-balance point, and evaluate using the new findings.

  Based upon these results, you will now be able to make a clear recommendation, grounded in realistic data projections.

The Risks and Uncertainties of Cost Benefit Analysis

Despite its usefulness, cost benefit analysis has several associated risks and uncertainties that are important to note. These risks and uncertainties can result from human agendas, inaccuracies around data utilized, and the use of heuristics to reach conclusions.   Know the Risks Much of the risk involved with cost benefit analysis can be correlated to the human elements involved. Stakeholders or interested parties may try to influence results by over- or understating costs. In some cases, supporters of a project may insert a personal or organizational bias into the analysis.   On the data side, there can be a tendency to rely too much on data compiled from previous projects. This may inadvertently yield results that don’t directly apply to the situation being considered. Since data leveraged from an earlier analysis may not directly apply to the circumstances at hand, this may yield results that are not consistent with the requirements of the situation being considered. Using heuristics to assess the dollar value of intangibles may provide quick, “ballpark-type” information, but it can also result in errors that produce an inaccurate picture of costs that can invalidate findings.   In addressing risk, it’s sometimes helpful to utilize probability theory to identify and examine key patterns that can influence the outcome.   Uncertainties There are several “wild-card” issues that can influence the results of any cost benefit analysis, and while they won’t apply in every situation, it’s important to keep them in mind as you work:  

• Accuracy affects value – Inaccurate cost and benefit information can diminish findings around value.
• Don’t rely on intuition – Always research benefits and costs thoroughly to gather concrete data—regardless of your level of expertise with the subject at hand.
• Cash is unpredictable – Revenue and cash flow are moving targets, experiencing peaks and valleys, and translating them into meaningful data for analysis can be challenging.
• Income influences decisions – Income level can drive a customer’s ability or willingness to make purchases.
• Money isn’t everything – Some benefits cannot be directly reflected in dollar amounts.
• Value is subjective – The value of intangibles can always be subject to interpretation.
• Don’t automatically double up – When measuring a project in multiple ways, be mindful that doubling benefits or costs can results in inconsistent results.

  Controversial Aspects When thinking about the most controversial aspects of cost benefit analysis, all paths seem to lead to intangibles. Concepts and things that are difficult to quantify, such as human life, brand equity, the environment, and customer loyalty can be difficult to map directly to costs or value.    With respect to intangibles, Dr. Kaplan suggests that using the cost benefit analysis process to drive more critical thinking around all aspects of value—perceived and concrete—can be beneficial outcomes. “[Cost benefit analysis] assumes that a monetary value can be placed on all the costs and benefits of a program, including tangible and intangible returns. ...As such, a major advantage of cost-benefit analysis lies in forcing people to explicitly and systematically consider the various factors which should influence strategic choice,” he says.

Cost Benefit Analysis in the Real World

Extending Transport Options in Seattle  

Originally built for the 1962 World’s Fair, the Seattle monorail runs between the Seattle Center and the city’s downtown area. Several times over the past 50+ years, the city has considered extending monorail service to key areas in order to provide more transport options for residents. The following is an excerpt from a cost benefit analysis performed by DJM Consulting and ECONorthwest on behalf of the Elevated Transportation Company to assess an expansion project.   Costs The estimated costs for constructing and operating the monorail are $1.68 billion (in 2002 dollars). This includes a total capital cost of $1.26 billion and a total discounted stream of operating costs of $420 million (at approximately $29 million a year), using the same discount rate (7.95%). Operating costs were discounted over a span of 22 years, from 2008 through 2029.   Benefits

Benefit type                                                     Benefit value (millions, 2002$) Value of travel time savings                           $77.1 Parking savings                                               28.7 Reduced auto operating/ownership costs       11.2 Reliability                                                         7.7 Road capacity for drivers                                 4.6 Reduction in bus-related accidents                 3.7 Reduction in auto-related accidents                2.6 2020 Benefits                                                  $135.6

Benefits accrue for 23 years from 2007 through 2029. A discount rate of 7.95% was used to estimate the total benefits, in 2002 dollars. The net benefits were evaluated to be $2,067,263,000.   Analysis

• Net present value B-C = $390,164,000
• Benefit-cost ratio B/C = 1.23
• Nominal rate of return = 7.95%

  Sensitivity Analysis A team of outside engineers and contractors determined that there is a 60% chance the monorail project would come in at or under budget and a 90% chance the project will come in under 1.15 times the budget. The travel demand forecasters included a 10% range around their estimate of future monorail ridership. For the case where the costs are low and the benefits are high, a 9.9% return is expected. For the case where the costs are higher than expected and the benefits are lower, a 5.2% return is expected.   Read the full analysis here .   Solid Waste Reduction in California California's Department of Resources Recycling and Recovery’s mission is to help state residents achieve the highest waste reduction, recycling and reuse goals in the U.S. The following is an excerpt from a cost benefit analysis performed in 1997 to compare the costs of Cardiovascular Group’s (CVG) solid waste reduction program to its economic benefits.   Costs According to the Environmental Manager, one employee spends eight hours per day on recycling duties. This employee is paid an average of $5.50 per hour. The Environmental Manager spends an estimated 5% of his time ($100,000/per year compensation) directing the solid waste reduction program. Utilizing this cost data, the calculations below demonstrate that CVG spent an estimated $16,440 in 1997 on its solid waste reduction program:   (1 Employee) X ($5.50/hr.) X (8 hrs./day) X (260 work days/year) = $11,440 per year + 5%(100,000) = $16,440 per year   Benefits 1995 Disposal cost reductions (1989 Baseline disposal costs – 1995 disposal costs) = $99,190 - $26,800 = $72,390   1996 Disposal cost reductions (1989 Baseline disposal costs – 1996 disposal costs) = $99,190 - $33,850 = $65,340   Average Annual Disposal Cost Reduction (DCR) (1995 DCR + 1996 DCR)/ 2 = ($72,390 + $65,340)/2 = $68,865   Analysis

• Nominal Rate of Return = 7.95%

  From these data, it is clear that CVG has benefited economically from its solid waste reduction programs. Average annual costs amounted to $16,440 per year, while benefits equaled $1,308,865 per year. Therefore, net savings from CVG’s solid waste reduction program amounted to $1,292,425 per year.

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Cost-benefit analysis: 5 steps to make better choices

A cost-benefit analysis is a process that helps you determine the economic benefit of a decision, so you can decide whether it’s worth pursuing. It’s a useful tool when you want to avoid bias in your decision-making process—especially when you’re faced with a big decision that will impact your team or project success. Cost-benefit analyses can seem daunting at first, but don’t fret—we’ve simplified the process into five concrete steps.

Calculating the social benefit of a bridge sounds like a puzzler, but not for Dupuit. He just measured how much people were willing to pay to use it. Then with some fancy calculations, he was able to recommend a toll amount that took into account the costs and benefits of his bridge.

And so, the cost-benefit analysis was born. The process has been refined since Dupuit’s day, and now it’s used less for calculating bridge tolls and more for figuring out if decisions are economically feasible. But the big picture remains the same—when it comes to decision-making, costs and benefits are key. 

What is a cost-benefit analysis? 

A cost-benefit analysis (CBA)—also called a benefit-cost analysis—is a decision-making tool that helps you choose which actions are worth pursuing. It provides a quantitative view of an issue, so you can make decisions based on evidence rather than opinion or bias.

CBA is particularly useful in project planning; it compares the financial feasibility of new projects against their potential returns.

During your analysis process, you assign monetary values to the costs and benefits of a decision—then subtract costs from benefits to determine net gains. The resulting cost-benefit ratio helps you estimate the full economic benefit (or lack thereof) of your choice so you can decide if it’s a good idea to pursue.

When should you use a cost-benefit analysis? 

A cost-benefit analysis works best when you want to decide whether to pursue a specific course of action. It also helps when your decision has clear economic costs and benefits. For example, it’s easier to create a CBA to determine the feasibility of a new project than to evaluate whether a new hire would be a good fit for your team. That’s because it’s hard to assign concrete financial costs and benefits to someone’s experience and work potential. 

This type of economic analysis also takes some time to complete, so it’s best for when you’re faced with a big decision that will impact your team or project success. For smaller or less complex decisions, try using a simpler process like a decision matrix . 

Here are some examples of when to use a cost-benefit analysis: 

Developing a new business strategy

Making resource allocation or purchase decisions

Deciding whether to pursue a new project

Comparing investment opportunities

Measuring the potential impact or desirability of new company policies

Assessing proposed changes to your company structure or processes

How to do a cost-benefit analysis

Creating a cost-benefit analysis may seem daunting at first, but we’ve simplified the methodology into five concrete steps. After you’ve run through this process once, you can tailor these steps to suit your specific project or team needs. 

1. Build a framework

First, create a framework that lays out the goals of your analysis, your current situation, and the scope of what your analysis will include. 

Your framework should include these components: 

The question your analysis will answer

A successful CBA always starts with a good question. It helps to be as specific as possible—for example, it’s easier to answer “Should we improve our mobile app?” than a broader question like “What products should we improve to drive adoption?” 

An overview of your current situation

An overview provides context for your analysis. It gives you a starting point to work from, so everyone understands where you’re coming from and why you’re considering a change. Here’s what to include in your overview: 

Background: A brief description of your current situation. 

Current performance: Quantitative data to demonstrate how things are going in your current situation.  

Opportunities: Any areas of improvement from your current situation. 

Projected future performance with the status quo: Quantitative data to predict how things will be going in the future if nothing changes. 

Risks of the status quo: What might go wrong if you don’t change anything. 

For example, imagine you’re trying to decide whether to overhaul your mobile app. Here’s what your overview might look like: 

Background: We have a mobile app and web app. 

Current performance: Our mobile app has 100k users and our web app has 400k users.

Opportunities: We have 300k users who use the web app but not mobile. 

Projected future performance with status quo: Adoption of our web app has grown 50% YoY. We project this will continue and there will be 600k users one year from now. Meanwhile, adoption of our mobile app has grown 10% YoY. We project this will continue and there will be 110k users one year from now. 

Risks of status quo: Lack of mobile adoption means users have less flexibility. Competitors with better mobile apps could win the category, while our brand may become known for having a poor mobile experience. Without an effective mobile app, we’re missing out on a large number of potential app users. 

When building a cost-benefit analysis framework, it's important to accurately estimate the expected costs associated with your decision, including both direct and indirect expenses.

The scope of your analysis

Finally, your framework should include the scope of your CBA. Like a project scope , this creates boundaries for your analysis and lays out what type of information you’ll consider in your calculations (plus what you won’t consider). Typically, your scope includes: 

The timeframe over which you’ll estimate potential costs and expected benefits. For example, you may decide to limit projections to one year from now. 

The types of costs and benefits you’ll include (or exclude). For example, you could decide to include labor costs and resources, but not opportunity costs. 

How you’ll measure costs and benefits. For example, you may assign dollar values to measure tangible costs like labor and resources, and assign key performance indicators (KPIs) to measure intangible costs or benefits like brand awareness. 

2. List and categorize costs and benefits

Next, it’s time to list all the costs and benefits of your decision. For this step, it’s helpful to collaborate with stakeholders so you can benefit from their specific expertise (for example, your IT team would be able to estimate how much new software would cost). Think of your decision like a project you’ll complete to achieve your proposed course of action. Ask yourself what resources you need (like materials or labor), and what the results of your decision will be (like additional revenue). 

As you list out costs and benefits, sort them into the following categories. Then in the next step, you’ll estimate dollar amounts of each of these items.  

Types of costs

Direct costs: Costs associated with the production of your product, service, or project. This is typically the materials, equipment, or labor you need to follow through on your proposed course of action. For example, these could be the direct cost of revamping your mobile app: product team hours, a contract with a user testing firm, and new development software. 

Indirect costs: Fixed costs that aren’t directly associated with production. These are typically ongoing overhead costs that you need to operate your business—like rent, utilities, or transportation fees. For example, these might be the indirect costs to create a new mobile app: internet for your remote development team, plus subscriptions to new development and collaboration software .

Intangible costs: Costs that you can’t assign a dollar amount to, like impacts to brand perception or customer satisfaction. This might also include opportunity costs, which are lost opportunities when you make one decision instead of another. For example, you could include this intangible cost for your app creation project: decreased satisfaction for prospective desktop users. This is an opportunity cost, since you’re choosing to upgrade your mobile app instead of creating a desktop app. 

Costs of potential risks: Costs associated with unexpected roadblocks. In other words, what you’ll need to spend money on if an unforeseen event knocks your project off track. Think of setbacks you would include in a project risk register —like data security breaches, scheduling delays, or unplanned work. For example, you might list these potential costs for your mobile app project: overtime pay for unplanned work, data security team hours to resolve unforeseen app privacy issues, and rush rates to accommodate for scheduling delays. 

When listing out tangible costs (like direct and indirect costs), follow the same process you would when creating a project budget . Think of all the tasks you need to complete to follow through on your decision, then list out the resources required for each deliverable. For intangible costs, you’ll have to use a bit more creativity. If you’re stuck, try looking at similar projects that have been completed in the past to see what type of impact they had. 

Types of benefits

Direct benefits: Benefits you can measure with a currency value, like the revenue you’ll gain from a project. For example, this could include revenue from new mobile app subscriptions. 

Indirect benefits: Benefits you can perceive but can’t measure with currency values. For example, this could include increased customer satisfaction and improved brand awareness.

3. Estimate values

Now it’s time to estimate the value of each cost and benefit you’ve listed. This is most straightforward for tangible categories you can assign a specific dollar amount to—like direct costs, indirect costs, and direct benefits. For intangible categories like intangible costs and indirect benefits, assign KPIs in lieu of monetary units. For example, you could measure customer satisfaction by tracking customer churn rate (the rate at which customers stop using your service). If you can, use the same KPIs for both costs and benefits so you can easily compare them later. 

We can’t predict the future, so these are ultimately just estimates. To make your calculations as accurate as possible, try comparing costs and benefits from similar projects you’ve completed in the past. Old projects are a gold mine of historical data and lessons learned . They can help you see the real-life economic value of past costs and benefits—plus any items or circumstances you might have overlooked. Using a project management tool can make this step easy—since all of your project information and communications are housed in one place, you can easily look back at past initiatives. 

4. Analyze costs vs. benefits

Now comes the fun part—the actual analysis of your costs and benefits. Before you get started, here are some key terms to keep in mind: 

Total costs: The sum of all costs.

Total benefits: The sum of all benefits.

Net cost-benefit: Total benefits minus total costs. This is also called net benefits. 

Net present value (NPV): The difference between the present value of cash inflows and the present value of cash outflows over a period of time. In simpler terms, net present value is a more dynamic way to measure net cost-benefit, because it includes how your net cost-benefit will change over a period of time. 

Internal rate of return (IRR): Calculates the profitability of an investment by determining the annualized return rate that makes the total value of all cash flows (positive and negative) from the investment balance out to zero. 

Benefit-cost ratio : Represents the overall relationship between costs and benefits over a period of time. It’s essentially the proposed total cash benefit divided by the proposed total cash costs—but to make the calculation more dynamic, you calculate the net present value of your costs and benefits over the proposed lifetime of your project. If your benefit-cost ratio is greater than one, that means benefits outweigh costs. 

Discount rates : Used to estimate how the values of your costs and benefits will change over a long period of time—for example, how they might be influenced by inflation. In other words, discount rates are essentially an interest rate you apply to costs and benefits that will occur in the future, so you can convert them into their present value. That way, you can more accurately estimate what the time values of future  costs and benefits would be worth today. 

Sensitivity analysis : Determines how uncertainty affects your decisions, costs, and profits. For example, you could use a sensitivity analysis to compare the worst- and best-case scenarios for your decision. If the worst-case scenario has more costs than benefits, you can look into strategies to mitigate some of those risks. 

These are a lot of fancy terms, but don’t let that scare you. If you don’t want to include more complex calculations like net present value, benefit-cost ratio, discount rates, and sensitivity analysis, you don’t have to. To keep things simple, you can just calculate your net cost-benefit and leave it at that. 

If you used KPIs to measure intangible costs and benefits, you can compare those separately. To analyze KPIs, there are a couple different approaches: 

If you have the same KPIs for costs and benefits, you can subtract costs from benefits to calculate net gains. For example, if you estimate a 5% increase in churn rate due to your decision not to pursue a desktop app and a 20% decrease in churn rate due to your new mobile app, you would have a net 15% decrease in churn rate. 

If you have different KPIs for costs and benefits, you can compare each one to the status quo. For example, you could compare predicted churn rate to your current churn rate, and predicted adoption rates to current adoption rates. This gives you a better idea of the magnitude of these costs and benefits—but at the end of the day, you’ll need to make a subjective decision about how much you value each different KPI. As such, it’s better to use the same metrics for costs and benefits so you can more accurately compare them. 

5. Make recommendations

Now that you’ve completed your cost-benefit analysis (huzzah!), you can make a recommendation. Here are some factors to consider for your decision: 

If your net cost-benefit is positive, that means the benefits of the project outweigh the costs. However, it’s important to consider the size of your net cost-benefit—if it’s too small, you might not be getting much benefit from all the effort you put in. In that case, you may want to consider an alternative decision. 

If your net cost-benefit is negative, that means your project costs outweigh the benefits. In this case, it’s helpful to consider what the biggest cost inputs are. Is there a different approach you could take that would mitigate some of those extra costs? 

If you used KPIs to measure intangible costs and benefits, you need to consider those in addition to your net cost-benefit. For example, if your net cost-benefit was relatively small but you calculated a large decrease in churn rate, your mobile app project may be worth pursuing after all. 

Cost-benefit analysis examples

Cost-benefit analysis offers valuable insights by quantifying and comparing the pros and cons of different choices. Here are three practical examples demonstrating how cost-benefit analysis can be applied in three different scenarios.

Cost-benefit analysis example 1: Implementing new software in a small business

The decision to upgrade software systems in a small business presents a classic case for cost-benefit analysis.

On one side, there's the initial financial outlay and the training costs for employees.

On the other hand, the benefits include improved efficiency, faster customer service, and long-term savings.

By quantifying these factors, a business can determine whether an investment in new technology will yield a favorable return on investment.

Cost-benefit analysis example 2: Assessing the impact of new environmental regulations

A manufacturing company faces new environmental regulations requiring significant changes in its processes.

The cost-benefit analysis here involves comparing the upfront costs of altering equipment and workflows with the long-term benefits, such as:

Reduced environmental impact

Compliance with legal requirements

Potential improvements in public image

This analysis helps decision-makers understand whether the benefits of adhering to these new regulations outweigh the associated costs.

Cost-benefit analysis example 3: Evaluating an urban public transportation expansion

A thorough cost-benefit analysis is essential when a city is thinking about growing its public transportation system. 

This involves calculating the direct costs of construction and operation expenses against the benefits, including:

Reduced traffic congestion

Lower pollution levels

Improved accessibility for residents

By assessing these factors, the city can decide if the project's long-term benefits justify the significant initial investment.

Pros and cons of cost benefit analysis

Understanding both the advantages of cost analysis and its limitations is important for decision-makers. Let's look at what makes cost-benefit analysis a powerful, but not always simple, tool.

Advantages of cost analysis

Streamlining decision-making processes: Cost-benefit analysis aids in simplifying complex decisions by translating them into quantifiable terms. This approach is particularly useful in scenarios where return on investment and cost effectiveness are key considerations.

Revealing overlooked costs and advantages: Some benefits or expenses are not immediately apparent, but a thorough cost-benefit analysis makes them clear and guarantees a thorough evaluation.

Emphasizing a data-centric method: By focusing on quantifiable data, such as estimated costs and forecasted benefits, cost-benefit analysis promotes objectivity, reducing the influence of subjective biases.

Limitations of cost-benefit analysis

Cost-benefit analysis is a handy tool for data-driven decision making . But like any estimation technique, it isn’t perfect. When deciding whether to use a cost-benefit analysis or another decision-making process, keep in mind these limitations: 

Revenue and cash flow can be unpredictable due to changing market conditions.

In some cases, the costs or benefits of a project or decision can’t be directly reflected by dollar amounts. 

Value is subjective when you use KPIs to measure intangible costs and benefits. 

It can be hard to accurately predict all potential risks. 

A cost-benefit analysis requires a significant time commitment to complete. 

Forecasting accuracy diminishes for projects extending over a long period, affecting the reliability of the analysis.

The complexity of accurately predicting every variable, such as future costs and intangible benefits, poses a challenge.

The effectiveness of cost-benefit analysis depends on the accuracy of the data used. Misleading or incorrect data can result in flawed conclusions.

If you decide that a cost-benefit analysis isn’t the right fit for your particular situation, you may want to consider creating a decision matrix or decision tree analysis instead. 

Make decisions count

A cost-benefit analysis helps you use data to make the best possible decision. That means you can say goodbye to coin flips and choose your options with confidence. 

Creating a cost-benefit analysis can seem like a project in its own right, especially if you’re working with multiple stakeholders to get the job done. Before you dive in, consider using a project management tool to coordinate work. Asana lets you create and assign tasks, organize work, and communicate with stakeholders directly where work happens. You can also map out your entire cost-benefit analysis project and save it as a template for future use.

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Cost Benefit Analysis Example and Steps (CBA Example)

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In today’s economic environment, it is fundamental to use financial tools and techniques to support organizational decision making before you decide to start a new business or make a sweeping change in your current workstream. Organizations across all industries – from construction to the chemical, use various decision-making tools to become successful in their field. Basically, Cost Benefit Analysis Methodology (also known as Benefit Cost Analysis) is a mathematical approach that allows organizations to compare the costs and expected benefits of two or more projects by employing some basic steps. In this article, we will analyze simple but real-world Cost Benefit Analysis Examples and Calculation steps by discussing how net present value is related to it.

Table of Contents

What is Cost Benefit Analysis Methodology?

Most probably you have been using the Cost Benefit Analysis Methodology in your life while purchasing a new car or deciding to move to a new apartment. Because calculating the costs and returns of a decision is an integral part of anybody’s life.

Obviously, every project has a list of expenses and incomes. You need to calculate the net present value (NPV) and payback period to evaluate each of them. Basically, cost benefit analysis is a decision-making tool widely used in finance and economics. It is applicable to many industry projects such as IT, software development, construction, education, healthcare, and information technology.

Generally speaking, the main purpose of tracking the Cost Benefit analysis steps is to calculate the ratio of benefits over costs. Simply put, a Cost Benefit Analysis is conducted to identify how well, or how poorly, a project will be concluded.

A Brief History

A French economist and engineer Jules Dupit, who used this tool before in a bridge project, introduced the concept of CBA in his article in 1848. After this date, a famous economist Alfred Marshall structured this approach in his book” Principles of Economics” in 1890. The U.S. Army Corps of Engineers has been using Cost Benefit Analysis since the 1930s for many projects such as federal waterway infrastructure.

What Makes Cost Benefit Analysis Important?

As mentioned above, Cost Benefit Analysis is a systematic approach widely used in economics that takes into consideration the net present value of costs and expected benefits. It helps to minimize risks and maximize incomes both for your project and your company.

For example, you can use it while deciding to purchase a real estate property or undertake a new project.

But, what is the purpose of making a CBA for an investment?

Basically, Cost Benefit Analysis Methodology serves two purposes ;

• To verify that an investment’s (or a project’s) expected benefits are more than its costs.
• To select an investment (or a project) by comparing their benefits over cost ratios.

In order to make a comparison between the positive and negative aspects of the alternatives, a common unit is required. Money is the common unit used for comparison of alternatives.

In financial analysis, the time value of money is an important factor to consider. While performing a CBA calculation future costs and expected benefits of an investment are converted into the present value by using a discount rate.

Conducting a cost benefit analysis provides a methodology to decision-makers for weighing up a decision such as purchasing a new home or expanding sales in a new region.

It can be conducted by big companies as well as individuals while selecting the most effective alternative.

Cost Benefit Analysis Steps

Whether you are working in the private sector or in the public sector, it is essential to write down all the parameters while you are making a decision such as establishing a new program or expanding a current system. Below are essential steps that you can use while performing a cost benefit analysis.

• Build the structure: Analyze the current status of the change and determine all the requirements clearly.
• Determine the stakeholders: Determine who will be impacted by the change, who will bear the costs, and who will obtain the benefits.
• Categorize the costs and benefits: Categorize and classify costs and benefits as direct, indirect, tangible, and intangible in order to determine their effects clearly.
• Project both costs and benefits: Project and evaluate how costs and benefits change over the lifespan of the program/change. Because all the calculations will be affected by duration.
• List the costs as a monetary value
• List the benefits as a monetary value
• Use Net Present Value to adjust the future cash flows and costs to the present day.
• Calculate payback period
• Perform sensitivity analysis
• Evaluate the results

Cost Benefit Analysis and Net Present Value (NPV)

Before to analyze a cost benefit analysis example and calculation steps, let’s discuss how net present value is related to cost benefit analysis. Whether you are planning to undertake a large project or buying a desktop computer for office works, you need to weigh the expected costs against benefits to take the right decision. Therefore, you must compare both costs and benefits on equal terms. That’s why you need the net present value calculations.

In finance, the time value of money concept holds that 1 USD today has a greater value than 1 USD in the future. Therefore, while making a CBA, you need to bear in mind the time value of money. Using a discount rate adjusts the future cash flows to the present day. However, to provide simplicity, we will use the discount rate as “1” in our example.

Example for CBA and NPV

Net Present Value (NPV) relies on the following decision;

• The value of money today is greater than the value of money later on.

Because money is a tool to make more money! You can buy and sell goods or start a new business, so that earn more money with your current capital.

In our cost benefit analysis example, your company is deciding to undertake a project which longs for three years. The expected total project cost is $ 15,000 today and the expected income after three years will be $25,000. The discount rate is 10%.

Now we will analyze if that is a good investment or not by using Cost Benefit Analysis and Net Present Value.

The Value of Money Today: $ 15,000.

The Present Value (PV) of $ 25,000 is;

PV= $ 25,000 / (1,10 × 1,10 × 1,10) = $ 18,783 now (to nearest cent)

So, if the discount rate is %10, that investment is worth $ 3783.  Your company can undertake the project because $ 3783 is a positive value.

A Simple Cost Benefit Analysis Example and Calculation Steps

Let’s assume that a board chairman of a construction company claims his team to make a comparison between two potential real estate development projects. He also reminds them that the company’s financial health is getting poor so he has to select one of them.

The team works and lists below the potential incomes and costs of each project.

Assumptions

Note: In order to simplify the cost benefit analysis example , we will not use a discount rate for each cost and income.

– 500 housing units will be constructed. – 400 of them will be sold and 100 of them will be rented for 20 years. – Rental Price of each unit is 4,000 USD per year – Rented 100 units will be sold 70,000 USD after 20 years. – Construction Cost of each unit is 100,000 USD. – The sale price of each unit is 120,000 USD. – The project needs a luxury sales office with a price of 2,000,000 USD. – The sales personnel cost is 300,000 USD per year. – The project duration is 3 years. – Project financing cost is 3,000,000 USD per year

– 400 housing units will be constructed. – 350 of them will be sold and 50 of them will be rented for 15 years. – Rented 50 units will be sold 80,000 USD after 15 years. – Rental Price of each unit is 4,500 USD per year – Construction Cost of each unit is 90,000 USD. – The sale price of each unit is 135,000 USD. – The project needs a luxury sales office with a price of 3,000,000 USD. – The sales personnel cost is 250,000 USD per year. – The project duration is 2 years. – Project financing cost is 2,500,000 USD per year

Comparing the Project Parameters

In this cost benefit analysis example , we will calculate the amount of money to be spent and the amount of money to be earned from each project to address economic efficiency.

Below table summarizes all the given project parameters.

Cost Calculations

Below table summarizes the project costs.

Benefit Calculations

Below table summarizes the project benefits.

Costs and Benefits Comparison

In this simple cost benefit analysis example , there are too many parameters affecting the board’s decision. Financing costs per year, units for sale, units for rent, total units to be constructed are some of them that make decision making difficult.

The above table summarizes the benefits, costs, and profits of each project. Although the income of Project 1 is more than Project 2, the costs of Project 2 are less than the costs of Project 1.

It is obvious that Project 2 is more profitable than Project 1. If the board chairman selects Project 2, the company will earn more profit by spending less money.

This simple example shows that Cost Benefit Analysis is a useful calculation tool in economics. Decision makers often use it while comparing multiple projects.

Another Real-World Cost Benefit Analysis Example

In the following cost benefit analysis example, three basic steps;

• Conducting a brainstorming session to determine all the costs and benefits related to the decision.
• Assigning a monetary value to all the costs.
• Assigning a monetary value to all the benefits.
• Comparing costs and benefits to calculate the payback period.

Assume that you have a software company operating for three years and you are planning to speed up the delivery dates in order to meet the market demand. You have five coders working full time but you need three more coders to facilitate the testing process. Hiring three more coders requires additional investments such as buying additional furniture, computers, and leasing additional workspace.

• Yearly revenue is $100,000 but it will increase by %30 as the capacity increases.
• Every month you are outsourcing an average of 200 hours of work with a cost of $80 per hour to another software company for testing.
• The productivity of team members will increase by %5 with a more comfortable office environment.

In this cost benefit analysis example, payback period can be calculated as;

$175,000 / $213,008 = 0.821 of a year, or approximately 10 months.

It is often difficult to estimate the benefits rather than estimating costs. Because benefits are subjective and can be affected by the estimator’s bias. On the other hand, as a decision-making tool in economics, the cost benefit analysis often guides decision-makers to select the most effective alternative.

Cost Benefit Analysis Excel Examples

ABC Chemical Ltd. is deciding which investment alternative is feasible considering costs and benefits of each of them.

Alternative 1

• Total Costs of Alternative  1 = $ 88.000.000.
• Expected Benefits s of Alternative  1 = $ 108.000.000

Alternative 2

• Total Costs of Alternative  2 = $ 11.000.000.
• Expected Benefits s of Alternative  2 = $ 23.000.000

Let’s decide which alternative ABC Chemical Ltd . should choose?

In order to decide which alternative is profitable, we will calculate the benefit-cost ratio for each one through a spreadsheet.

Excel Calculation for Alternative 1

= $ 108.000.000 / $ 88.000.000

Benefit-Cost Ratio = 1,23

Excel Calculation for Alternative 2

= $ 23.000.000 / $ 11.000.000

Benefit-Cost Ratio = 2,09

According to Benefit-Cost Ratio calculations of Alternative 1 and Alternative 2, both investment opportunities have positive outcomes. In other words, both alternatives are beneficial for ABC Chemical Ltd. So the company will be in a good position it selects any of the alternatives. However, in that example, benefit-cost ratio of Alternative 2 is higher than benefit-cost ratio of Alternative 1. So, according to the Cost Benefit Analysis, ABC Chemical Ltd. should select Alternative 2, in the light of the information given above.

Fox Car Maintenance Company is thinking to expand its current repair shop, and for that purpose, it will require additional vehicle mechanics and equipment. The owner of the company decides to make a cost benefit analysis to understand if that investment is beneficial or not. Here below you can find all the parameters related to costs and benefits.

• Hiring 5 more vehicle mechanics will provide a revenue increase by 45 % within one year. This expansion is planning to bring a revenue of $ 220.000.000.
• This expansion will increase the brand awareness of Fox Car Maintenance Company. Thus, this will bring additional revenue of $ 40.000.000.
• The salary of the new vehicle mechanics is around  $ 110,000.
• The purchase cost of new equipment is $ 20,000.
• The cost of additional electrical and mechanical infrastructure will be around $ 15,000

Let’s perform a Cost Benefit Analysis for the given example.

Total Benefits (TB)

• Total benefits of the expansion: Increase in revenue of hiring 5 more vehicle mechanics + Increase in revenue of brand awareness
• TB: $ 220.000.000 + $ 40.000.000 = $ 260.000.00

Total Costs (TC)

• Total costs of the expansion: Salary of additional employees + purchase cost of new equipment + cost of additional electrical and mechanical infrastructure.
• TC: $ 110,000 + $ 20,000 + $ 15,000
• TC: $ 145,000

Now we will make the calculations by using Excel.

According to the Benefit-Cost Ratio calculations, the expansion of the current repair shop has positive outcomes. The Fox Car Maintenance Company should expand its business and employ new vehicle mechanics as well as purchasing new equipment and build new infrastructures.

Where to Use Cost Benefit Analysis? Example Scenarios

As discussed above, cost benefit analysis facilitates the course of the decision-making process across a wide variety of areas. It is applied to many disciplines from business to finance. You can take advantage of using cost benefit analysis when;

• Comparing two or more projects
• Deciding whether to start a new business
• Making the right hiring decisions
• Comparing investment opportunities
• Evaluating social benefits
• Evaluating policies
• Making decisions regarding changes

These simple but real-world cost benefit analysis examples show how to conduct cost benefit analysis in different situations. It is important to bear in mind the intangible benefits such as customer satisfaction, environment, employee satisfaction, or health and safety, historical importance while making cost benefit or benefit cost analysis in economics.

Because benefits do not only consist of revenues obtained from business actions but also consist of intangible factors. In order to make a correct cost benefit analysis, you need to calculate the current worth of future earnings with the help of financial techniques such as net present value.

Sometimes it may be difficult to compare the options that have very close values. At this stage, intangible factors affect the final decision.

Generally, these kinds of analyses are evaluated by high-level stakeholders, top management, and board members. After the selection of the project, they start the process of developing the project charter .

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8 thoughts on “Cost Benefit Analysis Example and Steps (CBA Example)”

I am the student of environmental science department and progress my education

It’s very good

i am a student of Computer system Engineering and it is very helpful for me

ensoft, a software house, is considering developing a payroll application for use in academicinstitutions and is currently engaged in a cost-benefit analysis. Study of the market has shownthat, if they target it efficiently and no competing products become available, they will obtain ahigh level of sales generating an annual income of £800,000. They estimated that there is a 1 in10 chance of this happening. However, a competitor might launch a competing applicationbefore their own laun

NEED SOLUTION

The Board of Quest plc is due to meet to consider investing in a new project which will allow the company to diversify its existing product range. Before the meeting the Finance Director, has asked you, to evaluate the project using the following information.

Market research has been undertaken at a cost of HK$500,000 which shows that the project will result in the following cash flows:

Sales volume (units)

Selling price (HK$/unit)

Variable cost (HK$/unit)

Fixed costs (HK$)

These forecasts are after taking account of selling price inflation of 3·0% per year, variable cost inflation of 6·0% per year and fixed cost inflation of 3·5% per year.

In addition included in the fixed costs is a figure of HK$1,000,000 which represents an apportionment of general overheads. The balance of the fixed costs are incremental fixed costs which are associated with the new project.

The total machinery costs of the project in year 0 are estimated to be HK$40,000,000 and the machinery from the project will be sold for scrap with a value of HK$4,000,000 at the end of year 4.The company will also have to spend HK$ 3,000,000 refurbishing the building before the new machinery can be installed.

Quest plc pays corporation tax of 25% per year. This is paid in the following year (i.e. one year in arrears) Capital allowances on an 18% reducing balance basis are available on the machinery only. A balancing charge or allowance is available at the end of the fourth year of operation.

Quest plc has a real cost of capital of 9% and the general rate of inflation is 3.7%

Recommend to the Board whether the project should be undertaken by: Calculating the nominal after-tax Net Present Value of the new project using the money cost of capital.(Round to the nearest whole number)

Calculating the Internal Rate of Return of the new project.

After the Board meeting, you were asked to consider the risk of the project and you have reported back to the board that the Expected Net Present Value and the Standard Deviation of the project are HK$1,290,000 and HK$1,640,000 respectively.

Calculate the percentage probability that the project will be value destroying (you can assume a normal distribution of outcomes.) and briefly discuss the difficulties of using probability analysis in incorporating risk into investment appraisal.

One of the directors thinks that incorporating inflation into the calculation in the way outlined above is too time consuming and just adds more costs to the business without giving a significant benefit.

Explain one other way that inflation can be incorporated in the NPV calculation and discuss which method you think the company should adopt.(use the figures above to support your answer)

can I have an example of cost-benefit analysis of a road construction project in excel form. please.

Very helpful. Thank you very much. May I have a a social cost benefit analysis = one that does not have financial or tangible benefits. For example, introducing social workers in schools to eliminate cases of child suicides.

1. A government is considering building a tunnel across a sea channel which can currently only be crossed by ship. The following Information is available. (i) The tunnel will consist of a tow- truck railway and cars and passengers will be carried by train. It will cut crossing time by two hours for car and passengers. (ii) The relevant categories of traffic are: (a) Cars (and their passengers) (b) Passengers not in cars (c) Freight (iii) The authorities who would operate the tunnel have decided to charge a toll which would maximize revenue. The toll that they have decided to charge is 160 per car which compares favorably with the charge by ship which is 200. (iv) Because of the quicker and chipper journeys available, it is forecast that the following traffic per year for the foreseeable future will be diverted from the existing method of travel: 75,000 cars (with the average of two passengers) 50,000 passengers not in cars 350,000 tonnes of fright In addition 50,000 extra car journeys (with two passengers each) will be made. (v) The average value of passenger’s time is 6 per hours. (vi) The diverted traffic will reduce the cost of operation of the existing ship by 40 million a year, while at the forecast levels of traffic, the maintenance and operating cost of the tunnel will be 3 million. Its capital cost will be 400 million. The life of the tunnel will be 50 years. (vii) Assuming that the monetary figures given the above reflect social value, calculate the IRR of the streams of social costs and benefits. 2. A government is considering whether it should close down the branch line passengers services from station A to station B. no good are currently carried by rail. The chief accountant of the government estimate the annual cost of the train movement, track maintenance, signaling, and other expense to be 1, 520,000, including 120,000 toward depreciation and interest charges. If the line were closed at any time, the diesel train operating on it could be sold to another country for 240,000. Noting else has any re-sale value the line is used for 1000 single Journeys each day (250 days per year). The single fare is 4.00. So the line is losing money, a deficit met by taxation. If the line is closed, It is estimated that of the former journeys 800 will be made by bus (at the same fare) and 200 will not be made. The bus fare is the same as the rail fare and the extra bus fares exactly offset the bus operations extra cost. Bus journey takes an average of 40 minute longer than the rail journey. The average value of passenger’s time is 2 per hour. Enumerate the social costs and benefits associated with the proposal.

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What Is a Cost-Benefit Analysis?

• Understanding CBA
• The Process
• Limitations

The Bottom Line

• Business Essentials

Cost-Benefit Analysis: How It's Used, Pros and Cons

Adam Hayes, Ph.D., CFA, is a financial writer with 15+ years Wall Street experience as a derivatives trader. Besides his extensive derivative trading expertise, Adam is an expert in economics and behavioral finance. Adam received his master's in economics from The New School for Social Research and his Ph.D. from the University of Wisconsin-Madison in sociology. He is a CFA charterholder as well as holding FINRA Series 7, 55 & 63 licenses. He currently researches and teaches economic sociology and the social studies of finance at the Hebrew University in Jerusalem.

Pete Rathburn is a copy editor and fact-checker with expertise in economics and personal finance and over twenty years of experience in the classroom.

A cost-benefit analysis (CBA) is a process of comparing the projected costs and benefits of a decision to determine its feasibility. Businesses can determine whether a decision is worthwhile by summing up the potential rewards expected from an action and subtracting the associated costs. If the benefits outweigh the costs, the decision is likely worthwhile for the business.

A cost-benefit analysis doesn't always involve concrete numbers or measurements. Consultants or analysts , for example, could create models to assign a dollar value to intangible factors, such as the benefits and costs of living in a particular town.

Key Takeaways

• A cost-benefit analysis measures the benefits of a decision or action by subtracting the associated costs.
• It involves measurable financial metrics such as revenue earned or costs saved from pursuing a project.
• The analysis can also consider intangible benefits and costs, like employee morale and customer satisfaction.
• More complex analyses may include sensitivity analysis, discounting cash flows, and what-if scenarios for various options.
• Generally, if the benefits outweigh the costs, the project is favorable for a company.

Michela Buttignol / Investopedia

Understanding Cost-Benefit Analysis

Cost-benefit analysis (CBA) estimates and assesses the value of a project's benefits and costs to determine whether or not it's worth pursuing. Originating from the work of Jules Dupuit and Alfred Marshall and developed further by the U.S. Corps of Engineers in the 1930s, CBA involves comparing all current and projected costs and benefits of a project, both monetary and intangible.

Before taking on a new project, prudent managers perform a CBA to evaluate all the potential costs and revenues it might generate. The analysis's outcome determines whether the project is financially viable or whether a company should consider other alternatives.

Many CBA models also factor opportunity cost into the decision-making process. Opportunity cost represents the potential benefits a business misses out on when choosing one alternative over another. It accounts for the value of the next best option that isn't selected, highlighting the trade-offs involved in any decision. Evaluating opportunity cost can make the decision-making process more comprehensive and effective.

Finally, a manager will compare the total costs and benefits to determine if the benefits outweigh the costs. If they do, the rational decision is to proceed with the project. If not, the business reviews the project to see if adjustments can be made to increase benefits or decrease costs to make it viable. Otherwise, the project should likely be avoided.

With cost-benefit analysis, a degree of forecasting is built into the process. If any of the forecasts are inaccurate, the results may not be reliable.

The Cost-Benefit Analysis Process

There is no single, universally accepted method of performing a cost-benefit analysis. However, the process usually has some variation of the following five steps.

Define the Project's Scope

The first step in a cost-benefit analysis is understanding the current situation, identifying goals, and establishing a framework to define the project scope. Begin by determining the purpose of the cost-benefit analysis. For example, the purpose might be "to decide whether to expand to increase market share " or "to evaluate the benefits of overhauling the company website."

In this initial stage, the project planning takes place. This includes:

• Setting a timeline
• Identifying necessary resources
• Understanding constraints
• Determining required personnel
• Selecting evaluation techniques

A company must assess whether it's equipped to perform an accurate cost-benefit analysis. If the business doesn't have the technical staff needed for an adequate assessment, it may need to hire outside professionals.

During this phase, the business should identify key stakeholders who will be impacted by the analysis and give them a chance to provide input on the process. For example, if the outcome would be to renovate a company's website, the IT department may be required to hire multiple additional staff or take on extra work. They should be consulted about the impact this will have on their department, workflow, and other projects.

Determine the Costs

With the framework behind you, it's time to start looking at numbers. The second step of a cost-benefit analysis is to determine the project costs.

"Costs" can be financial, such as expenses recorded on an income statement, or non-financial, such as negative repercussions on the community. These costs can be categorized as follows:

• Direct costs : Created by the project, such as labor, inventory, raw materials , and manufacturing expenses
• Indirect costs : Associated or partially associated with the project, such as electricity, overhead costs from management, rent, and utilities
• Intangible costs : Impact that can't be measured directly, such as the impact on customers, employees, or delivery times
• Opportunity costs : Potential benefits lost from choosing this alternative instead of another
• Cost of potential risks : Regulatory risks, competition, and environmental impacts

When determining costs, consider if they're recurring or one-time expenses. Additionally, evaluate whether costs are variable or fixed. For fixed costs, consider step costs and relevant ranges that could impact those expenses.

Using net present value (NPV) in project decisions offers the benefit of considering an alternative rate of return that could be earned if the project weren't undertaken. A positive NPV indicates that the projected earnings exceed the anticipated costs, making the project a worthwhile investment, while a negative NPV suggests the opposite.

Determine the Benefits

Every project will have different underlying principles, and the benefits might be tangible or intangible. These could include:

• Higher revenue and sales from increased production or new products
• Improved employee safety and morale
• Greater customer satisfaction
• Increased customer retention
• Competitive advantage
• Expanded market share

In this stage, the project manager or analyst performing the cost-benefit analysis will need to determine both explicit and implicit benefits. Explicit benefits require future assumptions about market conditions, sales volumes, customer demand, and product expectations. Implicit benefits, such as the impact of increased employee satisfaction, may be difficult to quantify as there's no straightforward formula to calculate the financial effect of happier workers.

For the analysis to work, each type of benefit will need a monetary value assigned to it.

Be careful not to underestimate costs or overestimate benefits. A conservative approach that avoids subjective tendencies when calculating estimates is best for assigning value to both costs and benefits.

Compute Analysis Calculations

With the cost and benefit figures in hand, it's time to perform the analysis. This involves concisely summarizing the costs, benefits, net impact, and how the findings support the original purpose of the analysis.

However, some cost-benefit analyses require more detailed examination. This may include:

• Applying discount rates to determine the net present value of cash flows
• Running the analysis with different discount rates
• Conducting cost-benefit analysis for multiple options, each with different costs and benefits
• Comparing different options by calculating a cost-benefit ratio
• Performing sensitivity analysis to understand how slight changes in estimates may impact outcomes

Make Recommendation and Implement

If a cost-benefit analysis is positive, the project offers more benefits than costs. However, a company must consider its limited resources, which may force it to make mutually exclusive decisions. For example, a company with limited capital might find positive cost-benefit analyses for upgrading its warehouse, website, and equipment, but it may not have enough funds to pursue all three projects at the same time.

Not all cost-benefit analyses that result in net benefit should be accepted. For example, a company must consider the project's risk, alignment with its company image, and capital limitations.

Advantages of Cost-Benefit Analysis

There are many reasons to perform a cost-benefit analysis. The technique relies on data-driven decision-making with recommendations based on quantifiable information. It also keeps that information specific to a single problem, rather than over-complicating the decision that needs to be made by considering too many factors at once.

A cost-benefit analysis requires substantial research across all costs, including unpredictable ones, and a thorough understanding of expense types and characteristics. This extensive research strengthens the findings and supports strategic planning efforts.

A cost-benefit analysis also requires quantifying non-financial metrics, such as the financial benefit of increased employee satisfaction. Although challenging to assess, this process forces the analyst to consider aspects of the project that are harder to measure. The ultimate goal is to deliver a straightforward report that simplifies decision-making.

Limitations of Cost-Benefit Analysis

Accurately performing a detailed cost-benefit analysis requires capital and resources, such as personnel and dedicated time. For smaller decisions, this may be more expensive than is worthwhile for the project.

A cost-benefit analysis relies heavily on estimates and forecasts. It may be possible to make accurate forecasts for mid-level capital expenditures over short or intermediate periods of time. However, for large projects with a long-term time horizon, a cost-benefit analysis might overlook critical factors, such as inflation, interest rates, varying cash flows, and the present value of money.

If these factors are either over- or underestimated, the entire cost-benefit analysis becomes unreliable.

Cost-Benefit Analysis

Data-driven analysis

Avoids considering too many options at once

Deeper, potentially more reliable findings

Insights to financial and non-financial outcomes

May be unnecessary for smaller projects

Requires capital and resources

Relies heavily on forecasted figures

Over or underestimating can make findings inaccurate

What Are the Five Steps of Cost-Benefit Analysis?

The broad process of a cost-benefit analysis is to set the analysis plan, determine your costs, determine your benefits, perform an analysis of both costs and benefits, and make a final recommendation. These steps may vary from one project to another.

What Is the Main Goal of Using a Cost-Benefit Analysis?

The main goal of cost-benefit analysis is to determine whether it is worth undertaking a project or task. This decision is made by gathering information on the costs and benefits of that project. Management leverages the findings of a cost-benefit analysis to decide whether it is in the best interest of a company to pursue a new project or to find an alternative.

How Do You Weigh Costs vs. Benefits?

Cost-benefit analysis is a systematic method for quantifying and then comparing the total costs to the total expected rewards of undertaking a project or making an investment. Each cost and benefit, whether tangible or intangible, is assigned a numerical cost. This can require estimating and forecasting, which should be done as accurately as possible. If the benefits greatly outweigh the costs, the decision should go ahead; otherwise, it should probably not. A cost-benefit analysis should also include the opportunity costs of missed or skipped projects.

What Are Some Tools or Methods Used in Cost-Benefit Analysis?

Depending on the specific investment or project being evaluated, a cost-benefit analysis may require discounting the time value of cash flows using net present value calculations. A benefit-cost ratio (BCR) may also be computed to summarize the overall relationship between the relative costs and benefits of a proposed project. Other tools may include regression modeling, valuation, and forecasting techniques.

What Are the Costs and Benefits of Doing a Cost-Benefit Analysis?

The process of doing a cost-benefit analysis itself has its own inherent costs and benefits. The costs involve the time needed to carefully understand and estimate all of the potential rewards and costs. This may also involve money paid to an analyst or consultant to carry out the work. One other potential downside is that various estimates and forecasts are required to build the cost-benefit analysis, and these assumptions may prove to be wrong or even biased.

The benefits of a cost-benefit analysis, if done correctly and with accurate assumptions, are to provide a good guide for decision-making that can be standardized and quantified.

Some complex problems require deeper analysis, and a company can use cost-benefit analysis when it isn't immediately clear whether or not to pursue a new project, expansion, or other undertaking. By determining the expenses and identifying what will be favorable, a company can simplify decision-making by synthesizing a cost-benefit analysis.

However, it's crucial to be aware of the limitations and challenges of CBA. Although it provides a structured method for decision-making, its accuracy relies heavily on the precision of forecasts and assumptions. Incorrect estimates of future costs or benefits can result in faulty conclusions. Despite these challenges, when performed with careful consideration and accurate data, CBA is a valuable tool for strategic planning and resource allocation.

Harvard Business School. " How to Do a Cost-Benefit Analysis and Why It's Important ."

San Jose State University. " An Introduction to Cost Benefit Analysis ."

Mercatus Center at George Mason University. " Accounting for the Opportunity Cost of Capital in Cost-Benefit Analysis: Public Interest Comment on the Marginal Excess Tax Burden as a Potential Cost under Executive Order 13771. "

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Doing Cost Benefit Analysis in Excel – a case study

• Last updated: September 2016

Imagine you are the in-charge of finance department at Hogwarts. So one fine day, while you are practicing the spells, Dumbledore walks in to your office and says, “Our electricity bills are way too high. As the muggles don’t accept wizard money, we have to find a way to reduce our power consumption.”

So you summoned the previous 12 month utility bills to examine energy consumption patterns, and pretty soon you realized that most of the electricity consumption is due to the light bulbs. You suddenly have a brilliant idea. Why not replace the light bulbs with a variety that consumes low power?   A light bulb moment indeed.

Your next step is to figure out what varieties of light bulbs are out there. Fortunately this is easier than catching a snitch in a game of quidditch. A quick search revealed that there are 3 types of light bulbs:

• Regular incandescent bulbs (the kind Hogwarts currently uses)
• Compact Fluorescent Light bulbs (CFL)
• Light Emitting Diode bulbs (LED)

Now your job is to do a  cost benefit analysis  of these options and pick one.

What is cost benefit analysis & how to do it?

Cost benefit analysis, as the name suggests is a process of identifying all the costs & benefits of different decision choices and finding which choice offers maximum benefit for minimum cost.

It is a generic technique and the implementation varies depending on situation, industry and available data.

A typical cost benefit analysis involves these steps:

• Gather all the necessary data
• Fixed or one time costs
• Variable costs
• Calculate the benefits
• Compare costs & benefits over a period of time
• Decide which option is best for chosen time period
• Optional: Provide what-if analysis

Let’s conduct cost benefit analysis for our light bulb problem and figure out which option is best.

But first, download the cost benefit analysis workbook

Click here to download the cost benefit analysis workbook . Refer to it as you read this article for best results.

1. Input Data & Assumptions

For each type of bulb we need to find out below information:

• Electricity consumption (watts/hr)
• Life time in hours
• Amount of light (lumens) generated by the bulb

Assumptions:

We also need to assume a few things to keep our cost benefit analysis model realistic & simple.

Some of the assumptions we can go with are,

Global assumptions:

• We need only 1 bulb (doing analysis for n bulbs is just a matter of multiplying 1 bulb results with  n )
• Analysis will be conducted in Indian Rupees
• Let’s compare bulbs that give same amount of light (lumens). This means we can ignore the benefit part and focus on costs alone
• This analysis ignores any impact / costs / benefits associated with environmental impact (CO2 emissions, harmful metals like mercury, heat generation etc.)
• Analysis time frame is 5 years.

Other assumptions:

• Average usage of bulb per day is 8 hours .
• Cost of electricity is Rs. 5 per unit (KWH)
• Inflation for electricity cost is 1%

Once we have all the data, tabulate it in Excel like this:

2. Calculate Total Cost of Ownership

Once we have all the necessary data, let’s calculate the total cost of each option (Regular, CFL & LED) over a period of 5 years.

This step involves calculating both fixed & variable costs.

Fixed or one time costs:

The fixed cost for each light bulb type is nothing but the price .

But wait… what about the life time of bulb?

Since each type of bulb has certain life time, we will have to pay for replacement of bulbs too.

This means, apart from fixed cost at the start of time period, we will also have a variable cost that depends on the life time of bulb type.

Variable costs:

There are 2 variable costs in our analysis.

• Electricity consumption cost
• Bulb replacement cost

Electricity consumption cost:

This is calculated by below formula:

Wattage per month / 1000 * Inflated unit cost

The actual Excel formula looks like this:

FV($C$13/12,$B20,-$C$14*30*C$8*$C$12/1000)

How this formula works?

To understand this formula, first imagine what the total unit cost should be at the end of Month x .

For first month, the cost is = total monthly usage in hours * watts per hour / 1000 * unit cost * (1 + inflation/12)^ 1

For second month, the cost is same as above, but the exponent in the end becomes 2 .

Let’s say, the blue part of the formula is denoted by  something .

Then, the cost at the end of Month X will be,

= something * ( (1+inflation/12)^1 + (1+inflation/12)^2 + … + (1+inflation/12)^X )

Oh, all this math is confusing… Isn’t there a simple spell to answer this?

I am glad you asked. There is a spell to get this answer in one shot. It is called as FV()

The FV formula calculates sum of above series.

We simply write

= -FV(inflation/12, month number,  total monthly usage in hours * watts per hour / 1000 * unit cost )

to get the answer we want.

Why the minus sign in front of FV?

This is because, by default FV returns values in negative. It has got something to do with how banks always take money from us, but are very reluctant to give back or like that .

Bulb replacement cost:

The unit cost formula felt like trying to catch a snitch while riding a broomstick upside down. Thankfully, the bulb replacement cost formula feels like sitting in the crowd, cheering match while eating chocolate frogs.

The calculation for bulb replacement goes like this:

Cumulative usage in hours / life time of the bulb * unit price of bulb

Here is the formula for this:

(INT(cumulative usage/ life time of the bulb)+1)*unit price of bulb

Why use INT(…) + 1

Let’s say the life time is 1,000 hrs, cost is Rs 20 and we use 240 hrs in first month. Our cost is still Rs. 20, not 24% of 20.

Likewise, at the end of 5th month, our total usage would be 1200 hrs (240 x 5 = 1200) and we must buy a new bulb as the life time is only 1000 hrs.

The replacement cost is not uniformly spread across months (or hours). It happens once at beginning and then recurs once per lifetime of the bulb.

Hence we use INT to round the  cumulative usage / life time  to the integer portion (ex: INT(240/1000) will be  0 ) and add 1 to it as there is initial cost.

Explanation of these formulas in our spreadsheet

Look at below illustration to understand how these formulas look in the cost benefit analysis worksheet.

3. Calculate benefits

This part is not required for our problem as the benefits are same for all 3 types of bulbs. You can use logic similar to cost calculation when the benefits vary. For example if you want to do cost benefit analysis of 3 types of investment choices – mutual funds, stocks, bank deposits, then you can use below framework:

• Brokerage costs
• Entry costs
• Operating expenses
• Volatility / risk factors
• Return of the investment
• Liquidity benefit

4. Compare costs & benefits over a period of time

Once we have these cost & benefit calculations ready, we need to calculate them for 60 months (5 years) for all 3 types of bulbs.

The resultant table looks something like this:

5. Decide the winner

Once we have all the numbers, it is just a matter of picking the winner. If you are comparing costs, pick the lowest cost item . If you are comparing benefits, pick the item that offers most benefit / cost ratio .

How to convince your boss about the decision?

While it is easy to decide which option is the winner by just looking at numbers, when you take this proposal back to Dumbledore, he may want a little more explanation. This is where a  visualization of cost benefit analysis  can help.

Example – Visualization of Cost benefit analysis

Here is a completed visualization of our light bulb cost benefit analysis.

How to create this chart?

Simple, just follow below steps.

• Select the total cost of ownership table that you calculated
• Insert a new line chart
• Format the chart as per your (or your boss’) taste

Things to keep in mind:

• Go with line charts if your analysis is against a time period or similar
• Go with column / bar charts if you are comparing various options with one time costs only
• Format the chart so that it is easy to identify winning choice at each point of time.

Adding what-if analysis

What if analysis is a great way give power to your decision makers. When you prepare a cost benefit analysis model like above, you will always hear questions like:

• So what would be the total cost for using 12 CFL bulbs 16 hours per day for next 25 years?
• In above case, how much would we save if we switch to LED bulbs?
• What would be the cost for 30 years? 10 hours a day? 20 bulbs?

Thanks to powerful Excel form control feature , you can easily add a comprehensive what-if analysis tool to your model.

Process for adding what-if analysis

Follow below process for including what-if analysis in your spreadsheet models.

• Identify all possible scenarios for which what-if analysis may be required.
• Determine the variables (in our case, the variables are number of bulbs, bulb type, usage in hours & years)
• Figure out what output should be displayed (in our case, the output is total cost and a comparison with other bulb types)
• Set up an input area where user can select any combination of variables
• Use form controls , slicers , data validation , VBA  or simple input cells for gathering this data Tip: click on those linked words to understand how to set them up
• Write formulas that link to the user input cells / form controls
• Display the output (text, charts etc.)

Please examine the download workbook for actual implementation of this.

Guidelines for creating better analysis models

Whenever you are analyzing something like this, please follow below guiding principles for awesome results.

• Do your research first:  Identify all factors, inputs, assumptions & facts that impact the decisions. Spend sometime researching before jumping in to Excel.
• Set up separate areas of input, analysis & output:  Create separate areas in your workbook to handle inputs, calculations & outputs (such as charts, text). Clearly demarcate them by using different styles or headers for each section.
• Avoid analysis paralysis:  Keep your analysis workbooks simple & realistic. Don’t over complicate them with too many inputs or too much calculation. If a certain factor is irrelevant or too complicated to consider for your analysis, ignore it. Example: in our analysis we ignored benefits as they are same for all 3 options. We also ignore environmental impact as it is tricky to calculate.
• Use consistent formulas:  Write your formulas in such a way that same pattern is repeated many times. This way you can write once and use the power of relative & absolute references in Excel to fill the formulas everywhere.
• Let users play with your model:  Include what-if analysis or form control based interaction in your workbooks so that your users can play with the model and get answers for their questions.
• Visual explanations: Visual explanations like charts, dashboards are very powerful & memorable. So depict your results visually as much as possible. Remember the old adage,  a picture is worth thousand words. 

Related: Spreadsheet modeling best practices for analysts

Download Cost Benefit Analysis workbook

Please click here to download cost benefit analysis workbook . Examine the calculations & form controls to learn more.

Cost benefit analysis – your experiences please…

Cost benefit analysis was a big part of my work when I worked as an analyst. Now I am in the role of a CEO and it is even more relevant for me. For most situations I create a simple Excel model to examine the costs & benefits to decide the winner.

What about you?  How do you analyze costs vs benefits? What techniques do you use? Please share your stories, examples & tips in the comments section.

Want more? Introducing 50 ways to analyze data course

If you like to learn how to analyze data, gather insights, prepare outputs & interpret results, then you will love my new course –  50 ways to analyze data.

The above example is lesson number 24 in our course. Each of the 50 lessons deal with common business analysis situations, case studies & techniques so that you can become the analytical wizard you always wanted to .

This course is now open.

If you want to know more about it, please click here .

Welcome to Chandoo.org

Thank you so much for visiting. My aim is to make you awesome in Excel & Power BI. I do this by sharing videos, tips, examples and downloads on this website. There are more than 1,000 pages with all things Excel, Power BI, Dashboards & VBA here. Go ahead and spend few minutes to be AWESOME. Read my story • FREE Excel tips book

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20 Responses to “Doing Cost Benefit Analysis in Excel – a case study”

It shows my address is already subscribed. Am I listed in the mail list?

Truly magnificent.

Hello Chandoo,

Great post to become awesome.

Just a minor matter. Please check the units of Power, it is "Watt" not "Watts per hour". If a 60 Watt bulb is used for an hour it uses 60 Watthour(= 60 Wh) of energy, divided by 1000 this gives 0.06 kWh.

I know this is not a site for physics, and is has no impact for the end results, but it may confuse some of your readers and blur a for the rest good example.

I love your site!

Regards, Hardy

Very good model Chandoo, simple and to the point. Just to help improve the input process in an evaluation. Be doubly careful if your decision depends too much on assets / articles lifetime. As an example: advertised bulb CFL lifetime is 8000 hr. But this only happens at the Lab and only if you turn on the bulb once per day. Reality is that in many locations, electricity voltage & power is variable, and bulbs are turned on more often increasing the probability of burning. So the real lifetime of bulbs are not too different between the options. Regards Carlos

Good post but missing very important issue. LEDs deteriorate with time, so just after 5k hrs usually the LED is capable of 50-60% of initial Lumens. Quite a drastic drop. As for the lifetime both CFL and LED lights (the mainstrem ones) lifecycle is around 6-8k hrs. And in places where lights is often switched on/off the lifetime of CFL/LED drops to 3-4k hrs.

Hi Chandoo. Interesting analysis as always. I especially liked your what-if tool. Another way to think about multi-year cost/benefit is from a discounted cash flow perspective. Using your example I would use the Incandescent bulb as the base line and calculate the differential cash flows for the two alternatives. Period zero would be an incremental investment (cash out) of 100 for the CFL and 380 for the LED. Benefits (cash in) would be each period's cost savings for each alternative comparing their costs to the Incandescent's (including any additional bulb purchases). You could then use these cash flow estimates to calculate simple Payback but I would discount the cash flow streams (excluding initial cash outlay) using the business's Weighted Average Cost of Capital (WACC) or Hurdle Rate and Excel's NPV or IRR functions. Subtract out that initial cash outlay and the result would suggest that, all other factors being equal, the highest NPV (or IRR) is the best alternative. A negative NPV, or an IRR less than the discount rate, would suggest the Incandescent is the better alternative. The benefit of this approach is that it considers the always important time value of money.

One final thought, I would do this type analysis with annual data. The monthly nuances aren't worth the trouble - especially when you are forecasting the future.

Hi Bob. I like your approach. Do you think you could adjust Chandoo's spreadsheet to match your idea?

Sure. But I am not sure how to post a sample workbook here.

@Bob You can't attach a file here

Ask the question in the Chandoo.org Forums http://chandoo.org/forum/

Where you can attach a file

Hi Chandoo. I am always geeking out on this website. I agree with Bob. I think an important aspect of time value of money is being lost here. the expensive upfront cost of the LED typically outweighs the low cost of energy. I think long run though this model indicates that LED's reign supreme in a childless home that is. As always keep up the good work. 🙂

Two other points I neglected to include in my earlier post.

First, NPV and/or IRR calculations should use risk adjusted cash flows. With any cost/benefit forecast there is some degree of risk. (As someone once said, forecasting is difficult, especially about the future.) For example, if because of the CFL lifetime risk noted by Carlos, and the LED lumen output risk pointed out by ChrisAd, you estimate the probability of achieving the incremental cash flow benefits of these alternatives is only 60%. For the NPV calculation you would then use only 60% of the originally calculated benefits -- a 100 Rupee cash benefit becomes 60 for NPV purposes.

Secondly, somehow I forgot the always present tax authorities. NPV/IRR costs (if expense, not capex) and benefits should be after tax. Depending on your country and your tax situation your 60 Rupees may become 40.

So if you adjust your cash flow stream for risk and taxes you are good to go. Sorry I forgot these two important factors in my initial comment.

[…] Chandoo has a light bulb moment, while setting up a cost benefit analysis. […]

Hi Chandoo. There is a unique flaw in your model specifically related the cost effectiveness of light bulb technologies. The flaw has nothing to do with the challenges indicated by the other commenters. It also comes with a fun story.

It was spring break for my two young children. We visited a local science and technology museum where we live. I first identified the flaw watching my children play with one of the hands-on exhibits. The exhibit was a small bicycle connected to a generator. The generator is connected to three light bulbs, regular, CFL, and LED. As you pedal the bike the lightbulbs illuminate. Light pedaling illuminates only the LED. Very aggressive pedaling illuminates all three bulbs. The purpose of the exhibit is to show children how much extra energy is required to power regular lightbulbs. Simple enough in a very linear world.

The flaw I identified, then validated with the museum staff, is the math is completely linear. Meaning the math favors LED technology assuming 100% of the light is required 100% of the time, in the same room, and assumes the light is either on or off.

1) Buildings tend to have multiple rooms, which have different lighting requirements. Think about your house.

The lights over the vanity mirror in your bathroom may only require 1 x LED in terms of total lumens however may require multiple bulbs to eliminate shadows while applying makeup. Which takes a short amount of time, then the lights are turned off for much of the day. The cost of LED may be too high based on the short amount to time the lights are in use.

Lamps in your living room may have a 3-way switch that progressively increases the lumens, requiring a special bulb.

Your back porch may require a high power bulb that shines brightly over a large area.

In these cases you need to identify the bulb technology that meets the "art" side of the equation before applying the "science" part. When done correctly you will identify a mix a build technologies that meet your overall requirements.

2) CFL and other specialized bulb technologies cannot be used with a dimmer switch. Only a traditional on-off switch. The ceiling light in my kids bedrooms are connected to a dimmer switch, allowing me to progressively change the lumens up or down depending on need and time-of-day. That barrier eliminates some bulb technologies from the equation for those rooms.

Net/net, in a linear world we would always choose LED technology. However, the more accurate analysis is to treat each room as it's own cost analysis based on your lighting requirements and use case.

[…] http://chandoo.org/wp/2015/01/28/cost-benefit-analysis-in-excel/ […]

The crux of the matter in this lesson is to learn how to use some Excel tools and techniques for analysis. The choice of light bulbs is only an example, which appears to be subject of many controversies. However, the numeric data associated with this example are pretty good for the learning purpose of Excel techniques.

Excellent work Chandoo.

Hi Chandoo, I’m shy about asking, but if I buy 20 LED bulbs at 400 rupee each, then wouldn’t the first year cost for an LED bulb be at least 8,000 for cost of bulbs (not including the energy cost)? The Quick Compare says the total cost would be 6,088 (16hrs/day). If I’m buying bulbs, I would like to know the upfront cost. Maybe I’m missing something in this cost-benefit. I enjoy your blog very much.

Hi Chandoo, would like to know if the course would include supply chain analysis and modeling etc. If not, will you consider adding them or conduct a separate course on this?

am particular interested to know more on this aspect.

Rgds, Jason

Hi Chandoo,

Thank you very much for sharing your experience and knowledge here! It became very useful discussion. Thanks to all guys who shared their opinions and different solutions as well. The article is EXCELENT and full of professionalism! A real example how excel can help you doing real solutions.

For this, I had been using this and it's great. It has instructions which can help you. They also have live support and forum to help you anytime.

Hi Chandoo, I am a big fan of your dashboards and reports, i take lot of ideas from it to build my project management dashboards. Regarding Benefits Analysis, could you please help provide information in details on how to calculate benefits realization for 5 years for a IT Software development project? it can be both tangible and intangible benefits

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• The Workstream
• Strategic planning
• Cost benefit analysis

What is a cost-benefit analysis (CBA)?

Browse topics.

Cost-benefit analysis, or CBA, is a data-driven approach to evaluating a project or decision's financial benefits and costs from a business perspective. By forecasting profitability through a CBA, teams can work to avoid financial loss. 

A CBA involves defining the project scope, identifying costs and benefits, assigning monetary values, calculating the net present value (NPV), analyzing results, and making informed decisions. It compares the total expected costs against the expected benefits to determine the project's overall value and feasibility (often in the form of a ratio). 

This guide will discuss the advantages and disadvantages of CBA, identify critical components of a CBA, and explain how to conduct a cost-benefit analysis correctly.

Understanding cost-benefit analysis

Cost-benefit analysis compares a project or decision's estimated or projected costs and benefits. It’s a vital component of project management because it measures a project’s financial feasibility and helps companies avoid losses. If the analysis shows that the benefits outweigh the costs, you can assume that the project will be profitable for your company and that it’s viable to proceed.

In contrast, if the costs exceed the expected benefits, the project is not viable and should be rejected.

You can use cost-benefit analysis in the following scenarios:

• Project initiation : CBA allows you to forecast the viability of your project by comparing the potential benefits and costs. You can decide whether to proceed or decline based on the expected value.
• Budgeting : You can manage multiple projects more efficiently with a limited budget. By evaluating the anticipated benefits, CBA will tell you whether to approve your allocated budget. 
• Resource allocation : You can effortlessly calculate the ROI (Return on investment) and thus identify which projects will be more lucrative. CBA can optimize your resource allocation and distribute them more efficiently, especially when integrated with project scheduling software . 
• Risk management : Using CBA, you can assess risks and apply mitigation strategies, leveraging Scrum to address risks iteratively and adaptively. It also enables you to allocate a budget for potential risks based on the cost-benefit trade-offs of different contingency measures.
• Improving communication : Evaluating CBA, especially when visualized through a Kanban Board , can help justify your project decisions and enhance transparency with a quantitative approach, improving stakeholder communication.

Policy development : CBA can guide you in evaluating new policies or regulations within the project framework to apply implementation strategies. You can ensure regulatory compliance by assessing the costs and benefits of different compliance approaches. 

Using cost-benefit analysis, you can make informed decisions that evaluate your project discovery , align with your organizational goals, optimize resource use, and maximize project value.

Due to its data-driven nature, CBA can also be applied to product analytics , product development strategy , and other economic decisions. Whether using Agile or Waterfall methodology to manage your projects, CBA is crucial.

Key components of a cost-benefit analysis

The key components of cost-benefit analysis are costs , benefits , timeframes , and discount rates . These components help project managers efficiently calculate a business's costs and benefits.

You can assess the following costs throughout the CBA process:

• Direct costs : You can trace direct costs to producing a specific product or service, including labor, materials, supplies, and wages.
• Indirect costs : You can't link indirect costs to producing goods or services. These costs include office rent, administrative salaries, utilities, and overheads.
• Intangible costs : You can identify intangible costs, but measuring them in monetary value is difficult. Examples of intangible costs include decreases in productivity, loss of goodwill, and customer dissatisfaction.
• Opportunity costs : Opportunity costs refer to choosing one project or strategy over another. For instance, allocating resources to develop a new feature for a software project rather than improving existing features represents an opportunity cost of potentially enhanced user satisfaction and retention.

After identifying the costs, it’s crucial to recognize the benefits of projects that CBA measures:

• Tangible benefits : Tangible benefits are easily quantified and measured in terms of monetary value. Examples include revenue growth, cost savings, and increased efficiency.
• Intangible benefits : Similar to intangible costs, intangible benefits are difficult to measure in monetary value. These benefits include enhanced reputation, employee satisfaction, and customer loyalty.

When conducting a cost-benefit analysis, you must consider both short-term and long-term costs and benefits:

• Short-term : Short-term cost-benefit analysis gives you an idea of the immediate results you can expect from your project. For example, hiring temporary staff for a project increases immediate payroll expenses.
• Long-term : Long-term analysis provides a broader picture of the project's feasibility. For instance, investing in new equipment involves maintenance and replacement costs.

The discount rate is the rate of return a company must earn from a project to be profitable. It’s essential to find the discount rate to accurately calculate the present value of all the future cash flows.

If not calculated correctly, it will give a false NPV, leading to wrong decision-making that can cause project losses.

There are different approaches to calculating the discount rate , such as:

• The capital asset pricing model (CAPM) : The CAPM method considers an investment's systematic or market risk compared to the overall market.
• The build-up method : This method focuses on the company's capital structure. It calculates the weighted average cost of capital (WACC) by considering the cost of debt and equity financing, proportional to their usage.
• The Fama-French three-factor model : It’s a more comprehensive approach than CAPM. It considers factors beyond market risk, incorporating size and value factors to refine the discount rate estimate.

The CAPM model is the perfect choice for publicly traded companies as it leverages publicly available data. The build-up method is suitable if you have detailed information regarding the company's capital structure, including debt and equity proportions and their respective costs.

Moreover, if you have access to the necessary data on market risk, size, and value factors, the Fama-French factor model can offer more accurate results than the other two.

Advantages of using CBA in project management

Decision-makers need information to make crucial decisions, making CBA a helpful tool for project management. For example, if you constantly want to evaluate your project and make decisions to ensure a smooth and dynamic analysis, use lean methodology to avoid chaos.

Cost-benefit analysis can help you with the following aspects of project planning :

• Objective decision-making . Objective decision-making is a data-driven approach in which analysts collect and analyze data to help make decisions. This approach is fully evidence-based and free from biases, allowing for more informed decisions. Remember, CBA is a useful tool for collecting relevant data.
• Risk mitigation . CBA helps the project management team identify potential issues such as budget overruns, scope creep , resource allocation problems, risk management challenges, stakeholder conflicts, regulatory compliance issues, technological difficulties, quality assurance problems, market changes, environmental and social impacts, and communication breakdowns. Alternatively, if the project seems unprofitable, the company can drop it to avoid the risk of losses.
• Resource optimization . CBA helps you identify hidden costs associated with a project. This information provides the tools you need to generate alternate options for resource allocation and optimize resources to minimize costs and maximize benefits. 
• Stakeholder confidence . CBA increases the chance of project success because the team will only select profitable projects. Successful projects help companies gain stakeholder confidence.

Challenges and limitations of CBA

Although CBA is crucial for the decision-making process in project management, it’s not free from limitations. 

Determining the monetary value of intangible costs and benefits can be challenging as they rely heavily on assumptions. As a result, you may not get a clear picture of the effect of these components. Initially, a project may seem profitable, but intangible losses underestimated during the CBA process can lead to unexpected future losses.

Moreover, if you’re working with limited cost and benefit data, the result will not be accurate. These factors can influence the analysis's results and lead to false predictions.

How to conduct a cost-benefit analysis for project management

Follow these steps to conduct an accurate cost-benefit analysis for your next project:

Define the project scope

The first step in cost-benefit analysis is defining the project scope and creating a framework. A simple project plan template makes this easy. You can start by stating the purpose of the analysis. Similarly, you should define your goals and objectives.

Determine the required resources, equipment, timeline, evaluation technique, personnel requirements, and relevant data. At this stage, you should also identify and notify key stakeholders so they can provide their input.

To simplify the process, use a common currency for all monetary values. Remember, this is teamwork, and you should apply proper team management strategies to achieve the best outcome.

Identify costs and benefits

The second step is to identify all the related costs and benefits. Sit down with your project management team and hold a brainstorming session to ensure you cover all the bases -- a brainstorming template can help keep the conversation productive. This is where you may find hidden costs that were not apparent at first glance. 

Once you identify the project’s costs and benefits, you should start categorizing them as direct, indirect, tangible, intangible, and others. Note that you only identify the items in this step, not their monetary values.

Assign monetary values

When you finish categorizing all the cost and benefit items, it’s time to assign them a monetary value. 

Quantifying tangible costs and benefits using market prices, historical data, and estimation techniques should be easy, but quantifying intangible items can be difficult.

However, you can try the contingent valuation method (CVM), hedonic pricing method, cost-effectiveness Analysis (CEA), or software to get closer to an accurate estimation and assign dollar value more efficiently.

Calculate net present value (NPV)

The cost-benefit analysis includes many future cash inflows and outflows. Calculating their current worth is essential to understanding their current worth. 

Then, you can find the difference between the costs and benefits to calculate the NPV, which indicates whether the project will be profitable.

The calculations include four factors: benefits (B), costs (C), interest rate or discount rate (i), and the number of years since starting the project (t).

Below is the formula for calculating net present value:

NPV = B 0 -C 0 (1+i) 0 +B 1 -C 1 (1+i) 1 +......+B t -C t (1+i) t ,

Or, NPV = \[\sum_{t=0}^T\Bigg\{{(B_t- C_t) \over (1+i)^t}\Bigg\}\Bigg\{(B_t- C_t) / (1+i)^t\]  

• NPV is the present value. 
• t is the time period (starting from 0 up to T).
• Bt is the cash inflow at time t. 
• C t is the cash outflow at time t. 
• i is the discount rate or the interest rate.  

The formula uses a chosen discount rate to find the present value of all the future costs and benefits. As discussed earlier, different methods can be used to select a discount rate for the analysis. Finding the present value of all the future cash flows sums up the differences between the costs and benefits to find the NPV.

Here is the simpler formula:

Net present value (NPV) = Present value of future benefits - Present value of future costs

Analyze your results

The NPV tells you whether the project will be profitable. You’ll likely get one of the three results: 

• Positive : A positive value means the project will be profitable, and you can accept it. 
• Negative : A negative value means it will be unprofitable, and you should ditch the project. 

Zero : A zero value means you’ll neither profit nor lose money from it.

Make informed decisions

Depending on the results of the analysis, you will need to make a decision. Meet with your project management team and decide whether to proceed or halt the project.

Make smarter decisions with cost-benefit analysis in Confluence

Cost-benefit analysis is imperative to make informed decisions and manage risks. Despite a few limitations, it’s an excellent method to determine if a project or economic activity is profitable. Following this guide, you can properly conduct your cost-benefit analysis to manage projects more efficiently.

It’s crucial to share the cost-benefit analysis report, project updates, and business decisions with your team members to ensure everyone is on the same page. Again, performing the analysis manually can be difficult and time-consuming. To address these issues, we recommend using project collaboration software like Confluence . 

Confluence allows you to conduct a cost-and-benefit analysis and communicate all project updates in real-time with your teammates. It enables you to do the job your way: take notes, brainstorm on a whiteboard or record videos . You can invite your peers to collaborate through real-time editing and inline comments. When you’re ready, you can easily share with your broader company. 

Its intuitive navigation and powerful search ensure your work stays organized and connected to the right teams, projects, and goals, even as your business scales and grows. Key company-wide and project-related knowledge is centralized in one place, making it instantly accessible and ready to move your business forward.

Try Confluence for free

Frequently asked questions

What is a cost-benefit analysis.

A cost-benefit analysis is a company's systematic approach to evaluating the strengths and weaknesses of a project, business, or any economic activity related to decision-making.

What are the five steps of cost-benefit analysis?

The five steps of cost-benefit analysis are: 1) Identifying costs and benefits, 2) Quantifying costs and benefits, 3) Calculating net present value, 4) Assessing risk and uncertainty, and 5) Making a decision.

What is a cost-benefit analysis example?

Examples of cost-benefit analysis include assessing the expenses of manufacturing a product, conducting a project budget review, and comparing the costs of different healthcare treatments.

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Cost-Benefit Analysis

Investments or single business cases need to be evaluated based on a certain set of criteria. Since financial performance is the key criterion in a case interview , you need to have an idea about future financial impacts. A key tool to assess this impact is the cost-benefit analysis, which is used to determine the net effect of potential revenues and costs . In the case of multiple options, this net effect can be considered as opportunity costs of an option.

A thorough cost-benefit analysis of all available alternatives is the foundation of every decision

Solving a case is a lot about coming up with hypotheses and then testing your ideas. If you have several ideas, you have to base your decision on analysis . Cost-benefit analysis helps you evaluate your ideas with respect to 1) feasibility and 2) relative attractiveness (comparisons, benchmarking ).

*article-lock-trigger*

• The  quantitative aspect : Check the consequences of your decision quantitatively. E.g., determining  the  number of customers or prices, leading to the calculation of revenues and costs, and the corresponding  profitability  of the idea.
• Qualitative aspect:  This might be more important in the final decision-making. E.g., the culture of the firm. Remember that even though it is more critical to quantify the business idea/decision in terms of profitability, you must not ignore the qualitative aspects, which often give insights about the implementation of decisions/ideas.
• Relative attractiveness  is extremely crucial. Evaluate various options using a cost-benefit analysis, compare them all and pick the most attractive one  in terms of financial benefits and risks (qualitative aspects).

From a financial aspect, although it is usually neglected as it mathematically complicates the case solution, you can make your analysis more precise  by applying the discounting concept to future income or cost streams. This is especially appropriate in the case of highly volatile streams that occur in the distant future. In such cases, the net present value as the output of your cost-benefit analysis is the best metric on to base your decision on.

Apply the cost-benefit concept in every case, in which you need to make decisions

The cost-benefit framework is the  basic tool  for valuation and M&A  cases and you probably already apply it intuitively here. In addition, it works well for questions with a broad array of possible solutions. For example, “how can we achieve more revenue/growth”-questions,  market entry  cases, new product cases, among others. This way, you transform the question into a profitability case.

Example: You have an ice-cream parlor and now you are looking for further revenue options.

Among other options, one is to use an ice cream truck. Assume the truck is used during the summer season of about 5 months or 150 days.

Key takeaways

• Use a cost-benefit analysis  as a   framework  to check  feasibility and compare  options.
• Use quantitative and qualitative cost-benefit analysis to show competency in both aspects.
• If you have time left, try to  quantify qualitative data .

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How to Write a Cost/Benefit Analysis for a Business Case

Business analysis for dummies.

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Cost/benefit analysis is an estimation and evaluation of net benefits associated with alternatives for achieving defined goals of the business and is the primary method used to justify expenditures. It’s also a critical piece of the business case.

You may or may not need to include a detailed cost/benefit analysis for each alternative in the business case. Some opportunities may warrant having just the final recommendation fully documented in this section. The audience and the opportunity drive the level and complexity of the details required.

A good rule of thumb is that, if the recommendation is obvious to and will mostly be accepted easily by all individuals responsible for approval, you can simply include the details for only the final recommendation. However, if two or more options are viable solutions, providing more detail in this section gives the audience members the additional information they require to make an informed decision.

If the opportunity is outside the expertise of readers, you should include more details to allow them to become comfortable with your recommendation. Companies are looking for a positive return on their investment, and most organizations have minimal financial measurements for the opportunity to achieve before it can be considered cost justified. Therefore, additional details can help companies predict financial impact even when the recommendation isn’t easily measurable.

Where most analysts stumble in writing a business case is in knowing how much analysis is enough but not too much. (You don’t have to fully analyze each recommended option to the point of absolute certainty.) A business case is a vehicle to gain approval to move forward, which means more analysis occurs after approval but before the project is actually developed or software is purchased.

Committing the resources to fully analyze a solution before approval doesn’t make sense. However, not doing enough analysis can result in approval for significantly less funding than is ultimately necessary. Through experience, you’ll become better at aligning the appropriate analysis effort and the amount of the funding request with the final estimates for the actual results.

Financial terminology and metrics for a cost/benefit analysis

Here are a few of the terms and financial metrics you should be familiar with as you develop a business case:

Tangible/intangible : You can quantify t angible costs and benefits in financial terms, market share, employee satisfaction measures, or by any measurable scale. Intangible costs and benefits must be documented subjectively. Examples of tangible and intangible costs and benefits include the following:

Tangible costs: Labor and material costs, overhead, and decreased quality and production

Intangible costs: Customer, employee, or vendor dissatisfaction and loss of potential customers

Tangible benefits: Increased revenue or income, increased production or quality, and reduced cost

Intangible benefits: Goodwill and customer, employee, or vendor satisfaction

Goodwill: An accounting term describing an intangible benefit received by an organization when its customers and investors have a positive feeling or impression of it. Although goodwill isn’t included in the net cost/benefit calculation, you should include it in the description as supporting text to justify or support why an alternative wasn’t selected. You may also refer to it in the risk section.

Sunk costs: An accounting phrase describing expenditures that are in the past and shouldn’t have any bearing on future decisions. An opportunity may be a continuation of another project, but any sunk costs associated with the prior project shouldn’t be included in the calculation for the current business case.

Cash flow: The availability of assets at any given time in an organization. The cost of developing a project and the resulting ongoing or operating cost should be offset by the positive revenue or cost savings over time. The cash flow analysis shows the initial cash required to develop and implement and the expected returns over time.

Payback period: The length of time required to recover the cost of making the change or developing a new product. Most organizations have a minimum requirement for a project to be paid back in order to be approved based on the amount funded.

Return on investment (ROI): A financial performance measure used to evaluate the efficiency of a number of different investments. ROI is calculated by dividing the profit or savings of an investment by the cost of the investment over time.

Estimation techniques or a cost/benefit analysis

If multiple alternatives are being considered, each alternative must be analyzed and documented using the same approach. This step is extremely important for options where a financial comparison is being shown.

Determining the costs and benefits means estimating two main categories — one-time cost of change and net impact to ongoing operations. The source of cost that is usually most obvious is the one-time cost of change.

The less-obvious (but equally important) cost is the difference between the cost of the current business process and the cost of the recommendation after it’s in place at some future time: the net impact to ongoing operations. These two categories make up the overall cost/benefit of the proposal, which may reflect a positive or negative cost/savings after calculated.

The current process is considered your as-is process, and the future recommendation is your to-be scenario. For a brand new initiative, you have only a to-be cost or savings. These costs are composed of the ongoing or operating costs of the new recommendation plus the costs to get it built, implemented, and working in place.

How to quantify a business’s ongoing/operating costs and benefits

Initiatives can impact people, processes, or systems and should be analyzed individually to ensure that all aspects have been included. After you’ve identified and quantified all costs and benefits for each impact group, the total of these items makes up your current and future ongoing/operating costs/benefit cost or savings. The difference between these items is your cost justification or comparison for each option.

About This Article

This article is from the book:.

• Business Analysis For Dummies ,

About the book authors:

Paul Mulvey, CBAP , Director, Client Solutions, B2T Training, has been involved in business analysis since 1995. Kate McGoey, Director, Client Solutions, B2T Training, has more than 20 years' experience in application development and life cycle processes business. Kupe Kupersmith, CBAP, President of B2T Training, possesses more than 14 years of experience in software systems development. He serves as a mentor for business analysis professionals.

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Cost Benefit Analysis

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It is a company’s goal to keep itself up and running. Aside from their priorities in keeping the operations in good condition, from time to time, they have to execute financial simple analysis to make sure that the company is earning and not shut down in the near future.

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HR Cost Benefit Analysis Example

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With so many approaches applicable to help you decide which actions or activities to take, particularly with the cost and benefits in mind. One easy writing analysis example you can follow is the cost-benefit analysis technique. On this page, you will be able to see samples on how to make your own.

Simple HR Cost Benefit Analysis Example

Social Cost Benefit

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Economic Analysis

Financial Cost Benefit

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Military Cost Benefit

Project Analysis

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Cost Benefit Analysis Defined

Cost-benefit analysis is a process in which decision analysis makers measure the feasibility of alternatives in order to select the best option and to decide whether pursuing that course of action is good or not.

• If process analysis shows a sequential order in the process of a project, cost-benefit analysis is a process wherein two or more alternatives are analyzed by comparing their advantages and disadvantages.
• Aside from cost-benefit analysis widely used for comparing potential revenues and risk analysis that may be incurred in a project, this technique can also be applied to social and environmental costs and benefits.

Significance of Cost Benefit Analysis

A big factor in keeping a business analysis up and running is to make sure that the decisions made are the best and most effective one there is. When you decide, there are always more than one or two choices. The challenge is to choose which one you can profit from the most. Therefore, cost-benefit analysis helps you,

• select a better educated guess on which investment analysis to prioritise.
• evaluate the risks associated with the projects as well as its rewards.
• prepare budgets, as well as project the quantity of sale for that investment.
• foretell the increase of project revenues.

Risk Analysis

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Recycling Cost Benefit

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Utility Analysis

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Environmental Analysis

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Cost- Benefit Analysis Aims To…

In a world where businesses have rapidly grown, decisions should be made with thorough analysis. Financial analysis helps in telling us whether the organisation is earning or not, while a cost-benefit analysis has a different objective. A cost-benefit analysis aims to reveal the difference of alternatives to help decision makers chose the most effective option. It shows what advantage and disadvantage the business might face when one decision is made. The main objective of cost-benefit analysis is to make sure that the benefits gained from a decision will over weigh the costs incurred in that activity.

Up’s & Downs of Cost Benefit Analysis

A coin will always have two sides: this goes for cost-benefit analysis and all other analysis examples in excel as well. But what are those advantages and disadvantages in using a cost-benefit analysis?

• The simplicity of cost-benefit analysis makes it easy to understand. It is basically looking into costs not exceeding the benefits.
• Although it is simple, these might also lead to complexity in determining whether to pursue a project or not.
• Inaccuracy of calculations may incur a loss of opportunity.
• Cost-benefit analysis gives objectivity in comparing alternatives of the actual financial analysis  alternatives, overcoming biases.

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This resource pack, curated by the Center for Health Decision Science, introduces the theory and practice of benefit-cost analysis. It is targeted towards advanced students as well as practitioners and those interested in teaching benefit-cost analysis. Benefit-cost analysis (also referred to as cost-benefit analysis) is a well-established and widely-used form of economic evaluation. It is designed to inform policy and other decisions by providing evidence on the consequences of alternative interventions. In benefit-cost analysis, all…

Resource Pack

This resource pack, curated by the Center for Health Decision Science, introduces the theory and practice of benefit-cost analysis. It is targeted towards advanced students as well as practitioners and those interested in teaching benefit-cost analysis.

The US Environmental Protection Agency (EPA) Guidelines for Preparing Economic Analyses provide a framework for …

The US Environmental Protection Agency (EPA) Guidelines for Preparing Economic Analyses provide a framework for assessing the impacts of environmental regulations and policies that has been extensively peer-reviewed and is widely-applied both within and outside of the agency. The Guidelines discuss: (1) statutory and executive order requirements for conducting economic analyses; (2) identifying the need for policy action; (3) regulatory and non-regulatory approaches to pollution control; (4) baseline definition; (5) discounting future benefits and costs;…

This document provides detailed guidance for conducting cost-benefit analysis of government programs in Norway. It …

This document provides detailed guidance for conducting cost-benefit analysis of government programs in Norway. It includes an overview of the main features of such analysis. It then describes several analytic components: distributional effects; real prices; social discount rates; lifespan, analysis period, and residual value; wider impacts of transportation projects; disasters and irreversible effects; carbon pricing; longevity and health valuation; and financial and administrative implications.  

The Green Book is guidance issued by HM Treasury in the United Kingdom on how …

The Green Book is guidance issued by HM Treasury in the United Kingdom on how to appraise government policies, programs, and projects. It also provides guidance on monitoring and evaluating impacts after implementation. The Green Book introduces the analytic approaches and the policy framework, describes the generation of policy options, discusses the valuation of costs and benefits, and describes the presentation of the results. It also includes technical appendices that discuss nonmarket valuation, distributional analysis,…

This paper provides a brief introduction to the use of benefit-cost analysis in global health. …

This paper provides a brief introduction to the use of benefit-cost analysis in global health. It discusses the general framework and analytic components, then considers the valuation of changes in health and longevity in more detail. It concludes with a case study example.  

This paper provides a short introduction to the use of benefit-cost analysis to assess interventions …

This paper provides a short introduction to the use of benefit-cost analysis to assess interventions undertaken at the city or municipal level. It introduces the concepts that underlie the conduct of benefit-cost analysis, describes the major analytic components, and discusses how to tailor the analysis to the characteristics of the policy and the resources available. It concludes with a list of references for those interested in learning more.  

Before promulgating a major environmental, health, or safety regulation, U.S. government agencies are expected to …

Before promulgating a major environmental, health, or safety regulation, U.S. government agencies are expected to analyze the distribution of its impacts as well as its total costs and benefits. This article reviews several analyses to explore whether this expectation is being met. The authors find that agencies provide little information on distributional impacts. To the extent that these impacts are assessed, agencies often focus on the distribution of health effects and do not address the…

Benefit-cost analysis is rooted in neoclassical welfare economics, which in its most simplified form assumes …

Benefit-cost analysis is rooted in neoclassical welfare economics, which in its most simplified form assumes that individuals act rationally and are primarily motivated by self-interest, making decisions that maximize their welfare. Behavioral economics explores the psychological aspects of decision-making and challenges some of these assumptions. This paper considers the implications of this behavioral research for predicting how individuals will respond to policy options and for valuing outcomes. The authors argue that benefit-cost analysis should focus…

This book presents a series of a self-contained modules designed to be used in teaching …

This book presents a series of a self-contained modules designed to be used in teaching benefit-cost analysis, authored by a group of leading practitioners. It is intended to appeal to both undergraduate and graduate students as well as professionals interested in expanding their understanding of these issues. Each module consists of a short, accessible discussion of the topic; many include a list of additional resources as well as class exercises. Specific topics include overarching concepts…

The Society for Benefit-Cost Analysis (SBCA), founded in 2007, works to improve the theory and …

The Society for Benefit-Cost Analysis (SBCA), founded in 2007, works to improve the theory and practice of benefit-cost analysis and support evidence-based policy decisions. It addresses policy areas including public health, transportation, criminal justice, education, energy, environmental quality, homeland security, and poverty. Members include scholars and practitioners from around the world, who work in government, academia, nonprofits and private industry. Its members represent numerous disciplines such as economics, law, engineering, public policy, decision science, and…

Economic evaluation is a powerful tool, encouraging the systematic collection and assessment of the evidence …

Economic evaluation is a powerful tool, encouraging the systematic collection and assessment of the evidence needed to support sound policy decisions. In low- and middle-income countries, where resources are especially scarce and needs are very great, such decisions are exceptionally difficult. In these settings, economic evaluation can be particularly useful in determining how to best improve health and welfare. Typically, cost-effectiveness analysis (CEA) is used to prioritize interventions within the health care sector. This approach…

How to Perform a Cost Benefit Analysis

May 9, 2019 by Bernie Roseke, P.Eng., PMP Leave a Comment

A cost benefit analysis is a project selection method in which a common metric is used to compare a project’s costs and the benefits it provides.  It is used in public projects (like road building) or projects where the end product is not purely monetary.

The cost benefit analysis is performed by computing the net present value of the project with the net present value of the project’s benefits.

Intangible Benefits

In a traditional investment analysis, an investment is made with an expectation of a return, like this:

What happens when the return is of an intangible form or doesn’t generate a revenue stream (partial or complete)?

In this case, the return must be quantified in other terms to compare it with the money used to pay for it, in order to get an apples to apples comparison and justify the feasibility of the project.  That’s where cost-benefit analysis comes in.

For example, projects like building a road, enhancing/restoring the environment, developing a safety program, or performing research do not generate a revenue stream, hence they cannot be analyzed via investment return metrics.

Projects with intangible returns tend to be concentrated within government, hence governments tend to have strong policies and procedures for performing cost benefit analyses.  For that reason, if your project is by or for a government the first place to look is a manual or procedure guide for that jurisdication.

The Willing To Pay (WTP) Principle

Cost Benefit Analysis is built upon the idea that even though a benefit is not monetary, someone is willing to pay for it.  This is the foundational justification for the expenditure.  It is the overarching theme of the cost benefit report (if one is produced) and focuses the analysis on the monetary value of the benefit.

It is called the Willing to Pay (WTP) Principle.

Obviously, the people who are experiencing the benefits are not paying for them (at least full price) or traditional capital budgeting methods would be more appropriate.  The Willing to Pay Principle asks,  if the end users had to pay, how much would they be willing to pay?

Hence, the cost benefit analysis focuses on defining the intangible benefit in monetary terms.

There are very often market based value indicators which provide a rough guide for the value of an intangible benefit.  For example,

• What similar products or services are being paid for in a free market.  What price are they being sold for?
• What are the costs (direct and indirect) for the stakeholder to experience the benefit?
• What are the underlying features of the benefit that have an established market value?
• If the product is part of a larger network, what is the market value of the network that can be subdivided into its smaller parts.

Conversely, the size of the investment can be analyzed.  When others have spent money on the same benefits, a rough guide for value has been created, for example:

• What are the viable upper and lower bounds of the investment?  That is, how big of an investment is too high?  Too low?
• What other similar projects have been completed, and how much was their investment?  What was the level of stakeholder acceptance ?

Cost Benefit Analysis and Risk

For example, a new environmental enhancement project might be a success in its construction, but there is a risk that the public does not spend their time to enjoy it.

Risk has two underlying factors:

• Probability The risk level of an event is proportional the odds of it occurring.
• Severity The risk level of an event is proportional to the size of the impact it makes.

For example, your office might be hit by an airplane (a “risk event”).  The probability is very low, but the severity is very high.  One variable is positive and the other negative, and they actually cancel each other out.  However, for most people the low probability outweighs the high severity, allowing you to conclude that this risk event is not worth the creation of a risk response plan .

There are four steps to carrying out a cost benefit analysis:

• Identify Stakeholders and Benefits
• Develop Alternatives
• Assess Costs and Benefits

Step 1: Identify Stakeholders and Benefits

The first step is to identify the people or groups who are receiving the benefits, called stakeholders.  Usually there is one major stakeholder, however it should not be underestimated that there are usually minor stakeholders which fly under the radar, and enough effort should be made to identify all of them.

Secondly, the benefits to that stakeholder group should be defined.  At this stage, the monetary aspect is not important, rather the exact definition of the benefit – who, what, when, where, why, and how.

Step 2:  Develop Alternatives

Cost benefit analysis is used to compare projects to each other, but also to compare alternatives within projects.  For example, the type of environmental solution, or the size of the safety program, or the width and length of the road.  All the alternatives must be considered in tandem with the benefits of each option.  The stakeholders usually expect an analysis of the alternatives.

Step 3:  Estimate the Cost

There are two sides to the financial coin of a cost-benefit analysis:  The Cost (investment) and benefits.  In this step, we address the costs.  In the next step, we will tackle the benefits.

Costs are usually estimated using traditional project estimating techniques such as bottom up estimating in conjunction with analogous and parametric estimating.  This works by dividing the project into tasks.  Each task is estimated using either:

• Analogous:   The task is estimated from the actual cost from a previous project, for example, The concrete for our previous project cost X, therefore the concrete for this project should cost Y.
• Parametric:  The task is estimated using a unit rate, for example, The local Construction Association estimates that concrete costs X per square foot.

The estimates for each task are then conglomerated into an overall project estimate using bottom up estimating .  Conversely, the analogous and parametric technique can be applied in a top down fashion, like this:

• Analogous: The City down the road built their runway for a cost of X, therefore ours should cost Y.
• Parametric:  The federal government database lists a runway cost of X per square foot.

Step 4: Determine the Benefits

The benefits are generally the part that requires the most work because they are difficult to define.  And the general pattern in life holds, that the most difficult part is the one that makes or breaks the analysis.  Since the cost benefit analysis is only as strong as the benefits definition, I will start by outlining the 3 most common situations and then branch into general valuation methods for intangible assets.

• Value of human life (safety) This topic is always controversial, but fortunately in most jurisdictions a workers compensation board (WCB) is tasked with wrestling with this question so that individual market participants don’t have to.  Compensation rates for loss of life or limb are set by the WCB and all corporations pay premiums (like an insurance policy) which are increased or reduced based on its safety record and externally audited safety programs or initiatives. A company is considering spending $100,000 to produce a safety program which will reduce its WCB premiums by $10,000 per year.  The WCB has determined the value of the benefit.

Environmental remediation projects, on the other hand, can usually be valued more directly, whereby a new development can proceed because the previous environment has been cleaned up.  The value of the remediation is the value of the new development that can occur.

• Value of social impact People want to have relationships and interact with each other.  Projects that influence social structures, whether positive or negative, have a benefit that must be defined.  Disruption of people’s lives usually carries a monetary value which is easy to define, such as the construction of a new house or additional travel to a job.  These must be meticulously estimated, but it’s the non-monetary disruption which requires the most analysis.  The key to valuing these social impacts is to find the precedents.  Generally, established precedents are available even if they are in another location or slightly different, and research needs to be conducted to determine the precedent for this type of disruption. A city government wishes to build a new runway at the local airport.  It requires the demolition of some residences in the path of the new runway.  The benefit is a negative social benefit.  The government officials consult the average compensation for expropriation for other projects within that city as the starting point for negotiations.

The benefits are quantified to allow decision makers to take the best course of action.

Methods of Valuing Intangible Assets

Although the specific methods of dealing with the three main situations are defined above, we present the following as a checklist to define the value of any intangible asset.

• Hedonic value This refers to valuation of an asset through known values of characteristics or attributes of that asset.  For example, the value of a park is based on the size of the park and the number of visitors.
• Travel cost method This method values an intangible asset based on the cost stakeholders pay to experience it.  Its name refers to the travel cost to visit an environmental attraction, but can include any cost to experience the intangible asset.
• Averting behavior method This method seeks to determine what behaviors are being modified due to the intangible asset.  For example, the people of a community no longer drive to a more distant park after a park is built in their community, saving them on the cost of fuel.  Hence, this cost puts a floor under the asset’s value.
• Cost of illness method This method seeks to quantify the medical costs associated with an intangible asset.  For example, the new park decreases the incidents of heart attack because the local people are more active.  The cost of treating a heart attack can then be defined from local medical data.
• Stated preference method This method seeks to value an intangible asset by directly asking stakeholders how much they would be willing to pay for something.  This is accomplished using surveys, interviews, and questionnaires.  These results can be skewed based on participants not having the full amount of data available.
• Benefit transfer method This method uses a previous cost benefit analysis to determine the benefits for a new cost benefit analysis.  Of course, this does not introduce any new information, but it is widely used in the health and environment fields.

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About Bernie Roseke, P.Eng., PMP

Bernie Roseke, P.Eng., PMP, is the president of Roseke Engineering . As a bridge engineer and project manager, he manages projects ranging from small, local bridges to multi-million dollar projects. He is also the technical brains behind ProjectEngineer , the online project management system for engineers. He is a licensed professional engineer, certified project manager, and six sigma black belt. He lives in Lethbridge, Alberta, Canada, with his wife and two kids.

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Case studies tagged with Cost-benefit analysis

Giz values - cost-benefit-analysis of the bala dam proposal, bolivia.

There were plans for a huge dam for hydro-electric energy production, mainly for export. The study was designed as a standard Cost-Benefit Analysis (CBA), including environmental costs and distributional impacts. Cost-benefit-analysis was used to assess the value of the project because it is a widely accepted framework and can combine diverse secondary data about the expected consequences. Despite time pressure and relatively poor data availability, conservative estimates about investment costs, likely returns and environmental damage (along with associated loss of natural assets and...

GIZ ValuES - Rewarding farmers for reducing sedimentation, Indonesia

Removing sediment from reservoirs is an important part of the costs of hydro-power generation. Under the “Rewarding Upland Poor for Environmental Services” project (RUPES), an initiative by ICRAF, upstream farmers changed land-use practices for reducing soil erosion and sedimentation load in streams. The sedimentation rate was used as an indicator to measure the effectiveness of the agreed activities. Monitoring sedimentation rate as an indicator for the positive impact of improving land-use practices made the success of the changes in land-use practices transparent and motivated all...

GIZ ValuES - Combining flood protection and habitat restoration, USA

The area surrounding the confluence of the north and south branches of Thornton Creek (Seattle) experiences storm water-related flooding more often than other areas. A cost-benefit analysis, which incorporated ecosystem services values, aimed at identifying the best cost-benefit ratio among three possible options. The assessment results were intended to inform the decision of the choice of a project option.