Lecture 10 Cost Benefit Analysis & Quiz By Ziafat Ali

Cost Benefit Analysis, Ejaz Gul, FUIEMS, 2009

Engineering EconomicsEngineering Economics

Cost Benefit AnalysisCost Benefit Analysis


Methods of AnalysisMethods of Analysis• Present worthPresent worth

• Future worthFuture worth

• Annual Worth - Finding the annual equivalent Annual Worth - Finding the annual equivalent cost cost for each alternativefor each alternative

• Capitalized costCapitalized cost

• Study periodStudy period

• Pay back PeriodPay back Period

• Internal rate of return (IRR)Internal rate of return (IRR)

• Project balance (PB)Project balance (PB)

• Cost – benefit analysisCost – benefit analysis


Cost – Benefit Analysis Cost – Benefit Analysis (CBA) (CBA)

• A cost benefit analysis is done to determine how well, or A cost benefit analysis is done to determine how well, or

how poorly, a planned action will turn outhow poorly, a planned action will turn out

• Although a cost benefit analysis can be used for almost Although a cost benefit analysis can be used for almost

anything, it is most commonly done on financial aspectsanything, it is most commonly done on financial aspects

• Cost benefit analysis relies on the addition of positive Cost benefit analysis relies on the addition of positive

factors and the subtraction of negative ones to determine a factors and the subtraction of negative ones to determine a

net resultnet result

• A cost benefit analysis A cost benefit analysis

– finds, quantifies, and adds all the positive factors. These finds, quantifies, and adds all the positive factors. These

are the benefitsare the benefits

– Then it identifies, quantifies, and subtracts all the Then it identifies, quantifies, and subtracts all the

negatives, the costsnegatives, the costs

– The difference between the two indicates whether the The difference between the two indicates whether the

planned action is advisableplanned action is advisable


• Weighing the total expected costs against the total Weighing the total expected costs against the total

expected benefits in order to choose the best or most expected benefits in order to choose the best or most

profitable option. The formal process is often referred profitable option. The formal process is often referred

to as CBA (Cost-Benefit Analysis)to as CBA (Cost-Benefit Analysis)

• It is an analysis of the cost effectiveness of different It is an analysis of the cost effectiveness of different

alternatives in order to see whether the benefits alternatives in order to see whether the benefits

outweigh the costs outweigh the costs

• The process involves monetary value of initial and The process involves monetary value of initial and

ongoing expenses vs. expected return ongoing expenses vs. expected return

• A technique designed to determine the feasibility of a A technique designed to determine the feasibility of a

project or plan by quantifying its costs and benefitsproject or plan by quantifying its costs and benefits

Cost – Benefit Analysis Cost – Benefit Analysis (CBA)(CBA)


Application and History Application and History • The concept of CBA dates back to an 1848 article by The concept of CBA dates back to an 1848 article by

Dupuit and was formalized in subsequent works by Alfred Dupuit and was formalized in subsequent works by Alfred

Marshall Marshall

• The practical application of CBA was initiated in the US – The practical application of CBA was initiated in the US –

cost benefit analysis for proposed federal waterway cost benefit analysis for proposed federal waterway

infrastructure in 1936 infrastructure in 1936

• Subsequently, cost–benefit techniques were applied to the Subsequently, cost–benefit techniques were applied to the

development of highway and motorway investments in the development of highway and motorway investments in the

US and UK in the 1950s and 1960s US and UK in the 1950s and 1960s

• An early and often-quoted, more developed application of An early and often-quoted, more developed application of

the technique was made to the technique was made to London Underground Victoria Line

• Over the last 50 years, cost–benefit techniques have Over the last 50 years, cost–benefit techniques have

gradually developed gradually developed

http://en.wikipedia.org/wiki/London_Underground

http://en.wikipedia.org/wiki/Victoria_Line


Benefit Analysis - FormulaBenefit Analysis - Formula

• BCR (BCR (benefit cost ratio = PVB / PVC) this should this should

be equal to 1 for the project to be be equal to 1 for the project to be

economically feasibleeconomically feasible

• Net benefit = PVB – PVC = 0Net benefit = PVB – PVC = 0

http://en.wikipedia.org/wiki/Benefit-cost_ratio


PrinciplesPrinciples

1.1. There must be a common unit of measurementThere must be a common unit of measurement

2.2. CBA represents values by actual behavior CBA represents values by actual behavior

3.3. Benefits are usually measured by market choicesBenefits are usually measured by market choices

4.4. Measurements of intangibles & tangibles Measurements of intangibles & tangibles

5.5. Analysis involves comparison Analysis involves comparison

6.6. CBA involves a particular study area and time CBA involves a particular study area and time


Numerical Numerical A telecom system is expected to cost $43,250,000 to complete. The A telecom system is expected to cost $43,250,000 to complete. The

revenues generated by the new plant are expected to be $3,875,000 per revenues generated by the new plant are expected to be $3,875,000 per

year while operational expenses are estimated to $2,000,000 per year. If year while operational expenses are estimated to $2,000,000 per year. If

the system is expected to last forty years and the authority uses 3% as the system is expected to last forty years and the authority uses 3% as

interest, determine if the system should be built? (Use B/C ratio analysis)interest, determine if the system should be built? (Use B/C ratio analysis)

• We can find the present worth or the annual worth

• PW benefits = 3875000 = 89489051.1

• PW Costs = 43250000 + 2000000 =89437897.34

• B/C = 89489051.1 / 89437897.34 = 1 Build the plantBuild the plant



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Lecture 10 Cost Benefit Analysis & Quiz By Ziafat Ali