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Cost Benefit Analysis

Cost Benefit Analysis Assignment / Homework Help
Cost Benefit Analysis can be defined as a decision making process or a process that aids in taking decisions and involves assessing the costs and benefits of one or more actions in order to choose the best and the most profitable option. The benefits must outweigh the costs for a project or idea to materialize. The analysis requires that the costs and benefits associated with the project be expressed in monetary terms for the purpose of assessing the suitability of the project. Monetary values are also assigned to less tangible items also such as loss of reputation, risks involved, etc before arriving at a decision. Generally, this technique is used when the company has two or more options to choose from. It does a cost benefit analysis of various options to conclude on the best possible option. Note that cost benefit analysis is and can be done for single project also.

The benefits and costs expressed in monetary terms are adjusted for time value of money for the purpose of analysis. The present value of costs and benefits are taken to assess the viability of the project or decision.

One of the most important considerations in performing the cost benefit analysis is to ensure that all costs and benefits are identified and quantified in monetary values. Often, intangible aspects of a decision making process are ignored as it becomes difficult to assign any monetary value to such costs. The process of assigning costs to such intangibles also makes this exercise a subjective one. This is one of the major dis-advantage of this. In order to avoid the subjective nature, companies only take the financial costs and benefits that are readily measurable for carrying out cost benefit analysis. Missing the costs and benefits that may affect the decision making process may defeat the purpose of this exercise. Another area of caution is to ensure that double counting of costs and benefits are avoided.

Example:
Typical examples of situations where cost benefit analysis is used are:
  • Whether to make a product or part in-house or procure it from outside vendors?
  • Whether to invest in a project or bid for a project or not?
  • Whether to hire an additional labor or pay overtime wages?
  • Whether to buy an automatic or a semi-automatic machine?


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