Understanding Costs and Benefits Analysis

Business EconomicsFall Semester 2011

Standard A5

Standard

• After this lesson you will be able to …– Demonstrate an understanding of costs and

benefits analysis by giving real-world examples which properly evaluate alternatives.

• Cost-benefit analysis (CBA), sometimes called benefit-cost analysis (BCA), is an economic decision-making approach

• CBA is used in the assessment of whether a proposed project policy is worth doing, or to choose between several alternative ones.

• It involves comparing the total expected costs of each option against the total expected benefits, to see whether the benefits outweigh the costs, and by how much.

Valuation

• The costs of an intervention are usually financial. The overall benefits of a government intervention are often evaluated in terms of the public's willingness to pay for them, minus their willingness to pay to avoid any adverse effects.

• A cost benefit analysis is done to determine how well, or how poorly, a planned action will turn out. Although a cost benefit analysis can be used for almost anything, it is most commonly done on financial questions.

• A cost benefit analysis finds, quantifies, and adds all the positive factors. These are the benefits. Then it identifies, quantifies, and subtracts all the negatives, the costs. The difference between the two indicates whether the planned action is advisable.

Cost Benefit Analysis – Purchase of New Stamping Machine (costs per

month) Purchase of Machine .................... -$20,000Installation of Machine ..................... -3,125Increased Revenue .......................... 27,520Quality Increase Revenue ..................... 358Reduced material costs ...................... 1,128Reduced Labor Costs ....................... 18,585New Operator ................................. -8,321Utilities ............................................ -250

Insurance ......................................... -180 Square footage ...................................... 0 Net Savings per Month ........................... $15,715

It Doesn’t Have To Be Monetary

• For example, road safety can be measured in terms of 'cost per life saved', without placing a financial value on the life itself.