Cost–benefit analysis

CBA has two purposes:

1. To determine if it is a sound investment/decision (justification/feasibility),
2. To provide a basis for comparing projects. It involves comparing the total expected cost of each option against the total expected benefits, to see whether the benefits outweigh the costs, and by how much.

Theory

Cost–benefit analysis is often used by governments and other organizations, such as private sector businesses, to evaluate the desirability of a given policy. It is an analysis of the expected balance of benefits and costs, including an account of foregone alternatives and the status quo. CBA helps predict whether the benefits of a policy outweigh its costs, and by how much relative to other alternatives (i.e. one can rank alternate policies in terms of the cost-benefit ratio). Generally, accurate cost-benefit analysis identifies choices that increase welfare from a utilitarianperspective. Assuming an accurate CBA, changing the status quo by implementing the alternative with the lowest cost-benefit ratio can improve Pareto efficiency. An analyst using CBA should recognize that perfect evaluation of all present and future costs and benefits is difficult, and while CBA can offer a well-educated estimate of the best alternative, perfection in terms of economic efficiency and social welfare are not guaranteed.


Process

1. List alternative projects/programs.
2. List stakeholders.
3. Select measurement(s) and measure all cost/benefit elements.
4. Predict outcome of cost and benefits over relevant time period.
5. Convert all costs and benefits into a common currency.
6. Apply discount rate.
7. Calculate net present value of project options.
8. Perform sensitivity analysis.
9. Adopt recommended choice.

Valuation

1. Effects on users or participants
2. Effects on non-users or non-participants
3. Externality effects
4. Option value or other social benefits.

Reference

http://en.wikipedia.org/wiki/Cost%E2%80%93benefit_analysis