Post on 10-Oct-2015
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COST-BENEFITANALYSIS
PRESENTED BY:P.M.NAYAK
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It is best to think of the cost-benefit approach as a wayof organizing thought rather than as a substitute for it.
Michael Drummond
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Cost-Benefit Analysis
Cost-benefit analysis (CBA) is the implicit orexplicit assessment of the benefits and costs(i.e., pros and cons, advantages and
disadvantages) associated with a particularchoice.
Its simple and widely used technique for
deciding whether to make a change
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Cost-Benefit Analysis
Costbenefit analysis (CBA) is a systematic processfor calculating and comparing benefits and costs of aproject for two purposes:
(1) to determine if it is a sound investment(justification/feasibility)
(2) to see how it compares with alternate projects(ranking/priority assignment).
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History of
Cost-Benefit AnalysisThe concept of CBA dates back to an 1848 article by Jules
Dupuit
The British economist, Alfred Marshall, formulated some of
the formal concepts that are at the foundation of CBA
the Federal Navigation Act of 1936 PROVIDED IMPETUS TOCBA .
CBA has its origins in the water development projects of the
U.S. Army Corps of Engineers
Over the 1960s, CBA was applied in the US for water quality,
recreation travel and land conservation
In the UK, applications of CBA started with transport
projects in the 1960s
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Steps in Cost-Benefit Analysis
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A sales director is deciding whether to implement a new computer-based contactmanagement and sales processing system. His department has only a few computers,and his salespeople are not computer literate. He is aware that computerized salesforces are able to contact more customers and give a higher quality of reliability andservice to those customers. They are more able to meet commitments, and can workmore efficiently with fulfillment and delivery staff.Financial cost/benefit analysis is shown below:
Costs:
New computer equipment:
10 network-ready PCs with supporting software @ $2,450 each1 server @ $3,5003 printers @ $1,200 eachCabling & Installation @ $4,600Sales Support Software @ $15,000
Training costs:
Computer introduction8 people @ $400 eachKeyboard skills8 people @ $400 each
Sales Support System12 people @ $700 each
An Example
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Other costs:
Lost time: 40 man days @ $200 / dayLost sales through disruption: estimate: $20,000Lost sales through inefficiency during first months: estimate: $20,000
Total c os t: $114,000
Benefits:
Tripling of mail shot capacity: estimate: $40,000 / yearAbility to sustain telesales campaigns: estimate: $20,000 / year
Improved efficiency and reliability of follow-up: estimate: $50,000 / yearImproved customer service and retention: estimate: $30,000 / yearImproved accuracy of customer information: estimate: $10,000 / yearMore ability to manage sales effort: $30,000 / year
Total Benefit: $180,000/year
Payback time: $114,000 / $180,000 = 0.63 of a year = app rox. 8 month s
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COMMON UNIT OF MEASUREMENT
CBA SHOULD REPRESENT CONSUMER OR PRODUCER VALUATIONS
BENEFITS ARE ACTUALLY MEASURED BY MARKET CHOICES
INCREASE IN CONSUMPTIONAREA UNDER DEMAND CURVE
BENEFITS REQUIRE VALUATION OF HUMAN LIFE
IMPACT OF PROJECT WITH/WITHOUT COMPARISON
INVOLVES A PARTICULAR STUDY AREA
DOUBLE COUNTING OF BENFITS/COSTS SHOULD BE AVOIDED
DECISION CRITERIA FOR PROJECT
PRINCIPLES OF CBA
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COMMON UNIT OF MEASUREMENT
This means that all benefits and costs of a project should be measuredin terms of their equivalent money value.
In order to reach a conclusion as to the desirability of a project allaspects of the project, positive and negative, must be expressed interms of a common unit; i.e., there must be a "bottom line.
CBA SHOULD REPRESENT CONSUMER OR PRODUCERVALUATIONS
The valuation of benefits and costs should reflect preferences revealedby choices which have been made
The value of time should be that which the public reveals their time isworth through choices involving tradeoffs between time and money.
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BENEFITS ARE ACTUALLY MEASURED BY MARKET CHOICES
When consumers make purchases at market prices they reveal that thethings they buy are at least as beneficial to them as the money they
relinquish Consumers will increase their consumption of any commodity up to the point
where the benefit of an additional unit (marginal benefit) is equal to themarginal cost to them of that unit, the market price.
INCREASE IN CONSUMPTIONAREA UNDER DEMAND CURVE
The increase in benefits reulting from an increase in consumption is the sumof the marginal benefit times each incremental increase in consumption.
As the incremental increases considered are taken as smaller and smallerthe sum goes to the area under the marginal benefit curve
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BENEFITS REQUIRE VALUATION OF HUMAN LIFE
It is sometimes necessary in CBA to evaluate the benefit of saving humanlivesThere is considerable antipathy in the general public to the idea of placing a
dollar value on human life. Economists recognize that it is impossible to fundevery project which promises to save a human life and that some rationalbasis is needed to select which projects are approved and which are turneddown.The controversy is defused when it is recognized that the benefit of such
projects is in reducing the risk of death.
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IMPACT OF PROJECT WITH/WITHOUT COMPARISON
This that when a project is being evaluated the analysis must estimate notonly what the situation would be with the project but also what it would bewithout the project
In other words, the alternative to the project must be explicitly specified andconsidered in the evaluation of the project.
Note that the with-and-without comparison is not the same as a before-and-after comparison.
INVOLVES A PARTICULAR STUDY AREA
The impacts of a project are defined for a particular study area, be it a city,region, state, nation or the world.
The nature of the study area is usually specified by the organizationsponsoring the analysis.
The specification of the study area may be arbitrary but it may significantlyaffect the conclusions of the analysis.
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DOUBLE COUNTING OF BENFITS/COSTS SHOULD BE AVOIDED
Sometimes an impact of a project can be measured in two or more ways.
. For example, when an improved highway reduces travel time and the riskof injury the value of property in areas served by the highway will beenhanced.
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DECISION CRITERIA FOR PROJECT
If the discounted present value of the benefits exceeds the discountedpresent value of the costs then the project is worthwhile.
This is equivalent to the condition that the net benefit must be positive. . Another equivalent condition is that the ratio of the present value of the
benefits to the present value of the costs must be greater than one.
If there are more than one mutually exclusive project that have positive netpresent value then there has to be further analysis.
From the set of mutually exclusive projects the one that should be selectedis the one with the highest net present value.
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Uses of Cost Benefit Analysis
The Framework
Costs and Benefits
Results & Biases
1. Net Present Value (NPV)
2. Benefit-Cost Ratio
3. Internal Rate of Return
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Applications of CBA
Evaluate or rank the feasibility of projects
Analyze the effect of regulation
Justify equipment and technology investment
Determine the most effect way to cut costs
Determine the relative benefits of outsourcing versus leasing
Quantify hidden costs and intangible benefits
Ensure accountability of decision makers
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Accuracy problems:
The accuracy of the outcome of a costbenefit analysis depends on howaccurately costs and benefits have been estimated.
Studies indicate that the outcomes of costbenefit analyses should be
treated with caution because they may be highly inaccurate. Inaccurate costbenefit analyses likely to lead to inefficient decisions.Theseoutcomes are to be expected because such estimates
Rely heavily on past like projects Rely heavily on the project's members to identify the significant cost drivers Rely on very crude heuristics to estimate the money cost of the intangible
elements Are unable to completely dispel the usually unconscious biases of the team
members and the natural psychological tendency to "think positive
Problems in Cost Benefit Analysis
R f l f ti d l d t i i
http://en.wikipedia.org/wiki/Reference_class_forecastinghttp://en.wikipedia.org/wiki/Reference_class_forecasting5/20/2018 Cost-benefit Analysis Ppt Final
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Reference class forecastingwas developed to increase accuracy inestimates of costs and benefits.
Another challenge to costbenefit analysis comes from determining whichcosts should be included in an analysis (the significant cost drivers).
This is often controversial because organizations or interest groups maythink that some costs should be included or excluded from a study.
Failure to address and incorporate other issues
Execution of Government policies and regulations on:oEnvironmental issuesoHealth hazardsoPollution
One of the problems of CBA is that the computation of manycomponents of benefits and costs is intuitively obvious butthat there are others for which intuition fails to suggestmethods of measurement.
Therefore some basic principles are needed as a guide.
S i l C t B fit A l i D lhi
http://en.wikipedia.org/wiki/Reference_class_forecastinghttp://en.wikipedia.org/wiki/Reference_class_forecasting5/20/2018 Cost-benefit Analysis Ppt Final
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Social- Cost Benefit Analysis: Delhi
Metro Delhi Metro is a rapid transit system
serving Delhi, Gurgaon,Noida and Ghaziabad in the National Capital
Region of India. It is one of the largest metro networks in the world.
The network consists of six lines with a total length of 189.63 kilometres(117.83 mi) with 142 stations of which 35 are underground.
Delhis metro rail system, to be constructed in four phases covering 245
kilometers, is scheduled to be finished in 2021. Today three functioning linesconnect central Delhi to east, north, and southwest Delhi
Phase I (1995 - 2005) Phase II (2005 -2011)
Distance 65.10 km 53.02 km
Corridors
1) Shahdara - Barwala (22) 1) Vishwa Vidhyalaya- Jahangirpuri (6.36)
2) Vishwa Vidhyalaya- Central Secretariat (11) 2) Central Secretariat- Qutab Minar (10.87)
3) Barakhamba Road - Dwarka (22.8) 3) Shahdra- Dilshad Garden (3.09)
4) Barakhamba Road - Indraprastha (2.8) 4) Indraprastha- New Ashok Nagar (8.07)5) Extension into Dwarka Sub city (6.5) 5) Yamuna Bank- Anand Vihar ISBT (6.16)
6) Kirti Nagar- Mundka (18.47)
Investment Rs 6406 crores (2004 prices) Rs 8026 crores (2004 prices)
Phase III Phase IV
Distance 62.2 km
Corridors
1) Rangpuri to Shahabad Mohammadpur 1) Jahangirpuri to Sagarpur West
2) Barwala to Bawana 2) Narela to Najafgarh
3) Jahangirpuri to Okhla Industrial Area Phase I 3) Andheria Mod to Gurgaon4) Shahbad Mohammadpur to Najafgarh
C t B fit C i
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Benefits
DM contributes to the diversion of a very high proportion of current passenger trafficfrom road to Metro.
Reduction in traffic
Saving travel time of passengers on Delhi roads
Reduction in air pollution in Delhi because of the substitution of electricity for petroland diesel and reduced congestion on the roads
Reductions in motor vehicles operation and maintenance charges to both the
government and the private sector
Employment benefits to the unskilled labour
Savings in Foreign Exchange due to reduced Fuel Consumption
Cost-Benefit Comparison:
Delhi Metro
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Cost-Benefit Comparison: Delhi Metro
Items Foreign Exchange(Rs. Million)
Local Cost Total
Civil works - 31,327 31,327
Electrical works - 6,970 6,970
Signaling andtelecommunication
2,574 1,930 4,504
Rolling stock 4,596 6,403 10,999
Land - 3,339 3,339
General establishment andconsultancy charges
322 4,779 5,101
Contingencies 230 1,593 1,823
The total project cost of Rs. 64,060 million at 2004 prices for Phase Iconsists of the foreign exchange cost of Rs. 7720 million and the domesticmaterial and labour cost of Rs. 56,340 million.
Cost Estimate of DM (Phase I)
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Savings in fuel consumption
- Due to diversion of a part of the Delhi road traffic to Metro and reduced congestion to vehicles
- inter-fuel substitution of petrol and CNG to electricity and saving of forex
- Fuel saved due to traffic diverted to the Metro (assuming the annual run and fuel consumption)
Identification of Financial Benefits
Annual Run and Fuel Consumption Norms
Traffic ModeDiverted
Traffic
Fuel
Consumption
Norm
Daily Run Fuel Savings
Value of
Fuel savings
(million)
Cars 164,252 13 30 138,350,586 5,257
Two-wheelers 985,789 35 25 257,009,274 9,766
Buses 9,450 18 209 39,651,154 714
For cars and two-wheelers using petrol, price is Rs. 38/ltr
For buses using CNG, price is Rs. 18/kg
Current Statistics:
The residual traffic on Delhi roads for the year 2011-12 are 200,752 and 28,351 respectively. The fuel savings during the year 2011-12 due to the decongestion effect for cars and buses are
20,714,391 ltr and 38,510,952 ltr, respectively.
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Cost Benefit Analysis is a useful technique
Do you Agree?
Yes No1. It helps to measure the benefits It may ignore the distributional impact For
example non-motorists are overlooked.
2. It offers an aid to decision making A CBA may be ignored for political
reasons3. A decision has to be made. The costbenefits of any decision have to beweighed up. This technique helps toconfront the need to make such adecision
It is difficult to put a value on safety(Facts are based on estimation)
By reducing the positive and negative impacts of a project to their
equivalent money value Cost-Benefit Analysis determines whether on
balance the project is worthwhile.
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References
www. wikipedia.orgwww.sjsu.edu/faculty/watkins/cba.htmwww.mindtools.com Decision Makingwww.management.about.com/cs/money/a/CostBenefit.htm
http://www.sjsu.edu/faculty/watkins/cba.htmhttp://www.google.co.in/url?url=http://www.mindtools.com/pages/main/newMN_TED.htm&rct=j&sa=X&ei=4MP6Tqi8GuaOiAew-8GpDA&sqi=2&ved=0CEcQ6QUoADAC&q=cost+benefit+analysis&usg=AFQjCNGXFPMZFsUulmirfLD_2ws3jlQG5whttp://www.google.co.in/url?url=http://www.mindtools.com/pages/main/newMN_TED.htm&rct=j&sa=X&ei=4MP6Tqi8GuaOiAew-8GpDA&sqi=2&ved=0CEcQ6QUoADAC&q=cost+benefit+analysis&usg=AFQjCNGXFPMZFsUulmirfLD_2ws3jlQG5whttp://www.google.co.in/url?url=http://www.mindtools.com/pages/main/newMN_TED.htm&rct=j&sa=X&ei=4MP6Tqi8GuaOiAew-8GpDA&sqi=2&ved=0CEcQ6QUoADAC&q=cost+benefit+analysis&usg=AFQjCNGXFPMZFsUulmirfLD_2ws3jlQG5whttp://www.google.co.in/url?url=http://www.mindtools.com/pages/main/newMN_TED.htm&rct=j&sa=X&ei=4MP6Tqi8GuaOiAew-8GpDA&sqi=2&ved=0CEcQ6QUoADAC&q=cost+benefit+analysis&usg=AFQjCNGXFPMZFsUulmirfLD_2ws3jlQG5whttp://www.sjsu.edu/faculty/watkins/cba.htmhttp://www.sjsu.edu/faculty/watkins/cba.htmhttp://www.sjsu.edu/faculty/watkins/cba.htmhttp://www.sjsu.edu/faculty/watkins/cba.htmhttp://www.sjsu.edu/faculty/watkins/cba.htmhttp://www.sjsu.edu/faculty/watkins/cba.htmhttp://www.sjsu.edu/faculty/watkins/cba.htmhttp://www.sjsu.edu/faculty/watkins/cba.htm5/20/2018 Cost-benefit Analysis Ppt Final
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