L13-ECONOM

• Cost-benefit analysis


  The process of comparing the projected or estimated costs and benefits (or opportunities) associated with a project decision to determine whether it makes sense from a business perspective
• Cost-benefit analysis


  1. Tallying up all costs of a project or decision

  2. Subtracting that amount from the total projected benefits of the project or decision
• Benefit cost ratio


  The ratio of the present value/worth of Benefits to the present value/worth of Costs
• If the projected benefits outweigh the costs, the decision is a good one to make
• If the costs outweigh the benefits, a company may want to rethink the decision or project
• Benefit cost ratio formula


  Benefit cost ratio = Present value/worth of Benefits / Present value/worth of Costs
• Importance of Benefit Cost Ratio (BCR)

  • A higher BCR indicates a better investment where benefits exceed costs
  • In the absence of funding constraints, projects with the highest Net Present Value (NPV) are the best value for money
• Cost-benefit ratio formula


  A tool professionals use to measure the total cost of a potential project against its expected profit
• How to calculate the cost-benefit ratio

  1. Find the present value factor

  2. Find the present value of expected benefits

  3. Find the present value of expected costs

  4. Find the discounting rate

  5. Input the numbers into the formula
• A BCR greater than 1 suggests the present value of benefits exceeds the present value of costs, indicating potential economic viability or profitability
• A BCR of exactly 1 implies that the benefits equal the costs
• A BCR of less than 1 signifies that the benefits do not outweigh the costs, indicating potential losses or inefficiency in the project or investment
• BCR calculations should be considered alongside other factors like risk, uncertainty, strategic alignment, and qualitative considerations to make well-informed investment decisions
• A benefit-cost ratio (BCR) serves as a critical tool in evaluating the economic viability of projects or investments, with a BCR greater than 1 indicating potential profitability and a BCR less than 1 suggesting potential economic inefficiency or losses
• Example


  • PV of expected benefits = P1,000

  PV of expected costs = P500

  Discounting rate = 2% or 0.02

  Number of periods = 3

  Cost Benefit Ratio = 5.77