Cost-benefit analysis is a method used to evaluate projects by comparing their costs and benefits. It helps planning authorities make optimal investment decisions by maximizing the difference between a project's present value of benefits and costs. A cost is any negative effect of a project, while a benefit is any positive effect. For a business, the goal is for benefits to outweigh costs. There are various criteria used for cost-benefit analysis, including benefit-cost ratio and net present value, with the internal rate of return criterion also commonly applied. Properly conducted cost-benefit analysis can help determine whether a project is economically feasible and provide the best return on investment.

1. COST-BENEFIT ANALYSIS
Dr. Pragati Krishnan
Assistant Professor (Guest)
School of Studies in Economics
Pt. Ravishankar Shukla University
Raipur, Chhattisgarh
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2. INTRODUCTION
• The most popular method of project evaluation is to consider the cost
benefit analysis of different projects and then to select involving
lesser cost and yielding greater benefit.
• It provides superior criteria for project evaluation in planned
economy. It helps the planning authority in making correct
investment decisions to achieve optimum resource allocation by
maximising the difference between present value of benefits and
costs of a project.
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3. COST BENEFIT
Any negative effect on an organization
resulting from the implementation of the
project.
A benefit is any positive effect on the
organization resulting from the
implementation of the project.
Examples:
1. maintenance costs
2. environment
3. research and development
Examples:
1. increase in productivity
2. reduction in costs
The ultimate aim of a business organization is to make profits. Therefore,
any system in the organization must produce more benefits as compared
to its costs for the organization to survive & prosper.
BENEFITS > COSTS
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4. What is Cost Benefit Analysis.. ???
A cost benefit analysis is done to determine how well, or how poorly, a planned
action will turn out.
The analysis relies on the addition of positive factors and the subtraction of
negative ones to determine a net result.
CBA has been established primarily as a tool for use by governments in
making their social and economic decisions.
CBA measures costs and benefits to the community of adopting a
particular course of action e.g. Constructing a dam, by-pass etc.
When investment made commensurate with the benefit derived, it can be said
that operation is positive and viable; but when benefits derived do not
compensate financial investments made, it can be said that it is financially non-
viable and negative.
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5. HISTORY OF C-B ANALYSIS
•19th century by a French engineer &
economist Jules Dupuit.
•In 1936, it is a simple way of weighing up
project costs and benefits, to determine
whether to go ahead with a project
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6. Why Cost Benefit Analysis.???
Cost Benefit Analysis is used to determine:
(1) Whether a solution/project is economically
feasible.
(2) Which of two or more projects provides the
best return on investment.
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7. The General Steps for C-B Analysis
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8. Welfare Foundations of C-B Analysis
•The aim of cost benefit analysis is to channel
resources into projects which will yield the greatest
gain in net benefit to society.
•Maximization of net benefit means the maximization
of social utility.
•Dupuit examined this problem first in 1844.
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10. Criteria for C- B Analysis
There are four benefit cost criteria discussed by the US Sub-
Committee on benefits and costs.
They are:
(i) B—C
(ii) B—C/I
(iii) ∆B/∆C
(iv) B/C
Where B—Benefits, C—Costs, I—Direct Investment, ∆—Increment
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11. • The formula B—C/I is “for determining the total annual returns on a
particular investment to the economy as a whole irrespective of to whom
these accrue”.
• If the private investment happens to be very large, then even high value of
B—C/I may be less beneficial to the economy. Thus, this criterion is not
much useful to achieve satisfactory results.
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12. • The another criterion of ∆B/∆C is meant to determine the size of project.
• The adoption of the B—C criterion favors a large project and makes small
and medium size projects less beneficial. Thus, this criterion helps in
determining the scale of project on the basis of the maximization of the
difference between B and C.
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13. The best and most effective criterion for project evaluation is
B/C.
In this criterion, the evaluation of project is done on the basis of
benefit-cost ratio.
• If B/C=1, then the project is marginal because the benefits
occurring from the project just cover the costs.
• If B/C < 1 , then benefits are less than costs-so the project is
rejected.
• If B/C >1, the benefits are more than costs and the project is
profitable and hence, it is selected.
• The higher the benefit cost ratio, more profitable will be the
project. Dr. Pragati Krishnan 13

14. The Net Present Value (NPV) Criterion
This is an important criterion for project evaluation. NPV=Present value of benefit—
Present value of operating and maintaining costs—Initial outlay. It is also expressed as
the net present value of benefits criterion so that, NPV of benefit = Gross present value of
benefits—Gross present value of costs.
If NPV > O then the project is socially profitable. If there are number of mutually exclusive
projects, then the project with the highest net present value of benefits will be chosen.
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15. The NPV criterion is not accurate method for project evaluation as
it neglects the time horizon. Capital investments give benefits after
a lapse of some time. Therefore, future benefits and costs cannot be
equated with present benefits and costs. So it becomes essential to
discount future benefits and costs because society prefers present to
future.
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16. The discount factor is expressed as
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17. Only those projects should be selected in which present value of benefits
exceeds the present value of costs i.e.
The ratio of present value of benefit to present value of cost should be greater than 1 for the
selection of a project i.e.
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18. The Internal Rate of Return Criterion
This criterion refers to the percentage rate of return implicit in the flows of benefits
and costs of projects. Margin defines the internal rate of return (IRR) as the discount
rate at which present value of return minus cost is zero. The mathematical formula for
the computation IRR is (IRR)
In case of mutually exclusive projects, the project to be selected must have
highest rate of return. Dr. Pragati Krishnan 18

19. Relation between NPV and IRR
The NPV at the social discount rate and the internal rate of return are two criteria which are
frequently used for choosing projects. The relation between NPV and IRR is illustrated with
the help of a diagram
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20. • As NPV falls, the discount rate increases and a situation arises when NPV becomes
negative. The rate at which NPV changes from positive to negative is IRR. For the
selection of project, the IRR must be higher than its discount rate i.e. r > i.
• In the above figure, IRR is taken as 10 per cent be selected for development so long as
NPV > O and r (10 per cent) > i (5 per cent)
• For complex projects, these two criteria can give different results but mostly they are
interchangeable.
• NPV criterion is commonly used for project evaluation in private and public sectors.
But the NPV criterion is technically superior, since IRR can give an incorrect result in
special circumstances.
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