Conducting A Cost Benefit Analysis

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A cost benefit analysis depends and requires the calculation of the costs of operations, the investment, the total return and building a considered project over its functional life-time as well as the suggested time-stream of profits expected to accrue from the project. These timelines of costs and benefits of the project are needed to be converted to a mutual time base due to the time-merit of money. (couture et al.,2016)

Cost benefit analysis is used as a financial decision tool. Analysis differ for the most part in which cost and benefits are taken into account, how they are quantified, the time period considered and the discount factors applied. While the details of cost benefit analysis often vary significantly from place to place and project to project, the basic principles of cost benefit analysis remain the same. Cost benefit analysis allows for comparison of often quite different projects (e.g. Rail vs. Highway) using standardized procedures. The ‘do nothing’ scenario must also be considered as an option, and evaluated. The time frame a project is evaluated over is a key choice in the of cost benefit analysis process. (Olsson et al., 2012).

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In theory a cost benefit analysis captures all the costs and benefits of the project it is assessing. In practice, what can be practically predicted and/or assessed and the approach taken to choosing the time line of the analysis limit the scope of cost benefit analysis s. A cost–benefit analysis calculates both the positive and negative parts of the project. Cost benefit analysis processes consistently value savings and increases in safety. However, beyond these, the inclusion of different kinds of benefits, especially civil and environmental benefits such as greenhouse gas savings, air quality and noise effects are incorporated in cost benefit analysis s are inconsistent. (Quinet, 2004).

The impacts included in the cost benefit analysis, the time period chosen and the factors used are critical to the results of a cost benefit analysis. Research has shown that the same projects evaluated using cost benefit analysis guidelines from different countries can lead to divergent result that would change the evaluation decision from build to no build and vice versa (Fenwick et al., 2001).

The gradation of costs related with a transport project is more straightforward to calculate than the benefits. They consist, in the first instance, of the fixed costs and costs related with operation and maintenance. Inputs to costs general come from easily available data or outputs of standard models (Levinson, 2013).

In general, a cost-benefit analysis aims at answering whether a project or activity or program should be executed and if funds are limited, which elements should be selected. In doing this, the specific project is compared to its next-best alternative (Mishan et al., 2007).

While the use of cost benefit analysis is widespread, the literature identifies a number of problems with its use. These include:

  • Difficulty in assessing environmental and social impacts.
  • Difficulty is assessing meso and macro-economic impacts.
  • Timing of cost benefit analysis in the planning process

With approaches to cost benefit analysis there are concerns that the impacts on different users or non-user group are poorly understood and that some impacts are not well quantified (Iacono, 2013). Early cost benefit analysis largely avoided assessing environmental, civil and social impacts and focused on the direct costs (construction) and savings (travel time) related with transportation projects (Pearce, 1998). In dealing with environmental impacts, cost benefit analysis often monetizes the value of nature using people’s willingness to pay to protect it. This ignores the intrinsic value of nature and the impact of nature on society rather than on an individual. Many also criticize the monetization process saying that it debases the environment (Pearce, 1998).

Many proposals have been made to improve the cost benefit analysis process. It is recommended to use changing in land value to assess local user benefits on the micro-economic scale rather than evaluating times savings multiplied by the value of time (Iacono & levinson, 2013).

While doing a cost benefit analysis it might be necessary to do a quantitative risk analysis (QRA). This type of cost benefit analysis is called CBA-DK.

First, the analyst needs to specify the set of alternative projects. This is especially helpful if there are a number of ways to proceed to a given result.

Second, and very importantly, one must look at whose benefits and costs matter. The costs and benefits to the firm are all that matters. If, however, there are a number of stakeholders located in various counties or states, the impact on them must be considered as well.

Third, the literature suggests that the person conducting the CBA should identify impact categories, catalogue them, and set measurement indicators. The term “impact categories” refers to the costs and benefits themselves. Costs are generally thought of as the expense of a project and benefits are generally thought of here as the return and the profit of a project. While cataloguing this list may be tedious and time consuming, it is necessary that it be as complete

Fourth, the analyst must attempt to predict the impacts quantitatively over the life of a project. Most projects are designed to last more than a single year. Furthermore, the benefits of a project may not be accruing until several years into the project. Nevertheless, the analyst should attempt to make the best predictions as to what those benefits may be in order to see if the future benefits are worth the present costs.

Fifth, all of the required costs and profits of a project should be authentic. In a very real sense this is the most crucial step in the whole analysis since the ultimate goal of the analysis is to compare the dollar value of the benefits and cost of the project. Nonetheless, this may be very difficult for a number of reasons. Prices and costs may occur at future dates and may not be known with certainty.

Furthermore, certain costs (i.e. the cost of someone being injured on the job) may be hard to quantify. It may thus be helpful to look at past analyses of similar projects or to borrow estimates from other researchers on these costs to include in the analysis. Indeed, even, if no explicit data on these things can be obtained, they need to be mentioned in the analysis to aid in making the final go/no go decision (Metrolinx, 2015).

Before a recommendation can be made by the Cost Benefit analyst two other important considerations must be made. Inputs and outputs must be discounted over time and sensitivity analysis must be performed. As we have already noted, both profits and expense occur over time and those expenses and profits that occur in different years must be summed together if we are to have a single cost and a single benefit number. (Williamson, 1992).

After evaluating and comparing the results of these analyses, a decision is made based on the gain, profit and business of the project and if the project costs such as the preliminary investment and maintenance cost outweighs these benefits than a project might be dropped overall.

References

  1. Fenwick, Elisabeth, Claxton, Karl and Mark Sculpher, “Representing Uncertainty: The Role of Cost-Effectiveness Acceptability Curves,” Health Economics 10(8) 2001, 779 – 787.
  2. Gunn, H. (2001). Spatial and temporal transferability of relationships between travel demand, trip cost and travel time. Transportation Research Part E: Logistics and Transportation Review, 37(2-3), 163–189. doi:10.1016/S1366-5545(00)00023- 5
  3. Metrolinx. (2015). Business Case Development Handbook, Tier 3 Guidance: Technical notes and methods. Toronto, Ontario, Canada.
  4. Salling, K., & Banister, D. (2010). Feasibility risk assessment of transport infrastructure projects: the CBA-DK decision support model. European Journal of Transport and Infrastructure Research, 10(1), 103–120. Retrieved from http://www.ejtir.tbm.tudelft.nl/issues/2010_01/pdf/2010_01_08.pdf

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