How useful do you believe Cost-Benefit Analysis is as a tool to assist in making decisions about major capital projects
Cost-Benefit analysis (CBA or BCA) is a technique used to assess the viability of implementing a certain project or proposal quantitatively. The history of cost-benefit analysis may be traced in an 1848 article by Dupuit which featured the application of this tool in a proposed federal waterway infrastructure which was found successful and was subsequently applied in other infrastructure projects. This tool provides quantitative results of each of the investment options being considered, which in turn will allow the analyst to rank each of those options from the most beneficial to the least. It entails computation of a Benefit Cost Ratio (BCR) by dividing the quantified expected benefits of each of the investment options by the expected costs or expenses for each of the options.
This decision-making tool is widely used by the government to assess the feasibility in terms of cost-effectiveness of implementing different alternatives. The initial aim of this tool was to compare the expected output of each of the alternatives as compared to the current scenario, or the status quo. Over the years, experts in the use of this tool had discovered and devised methods to expand the use of this tool and apply in various scenarios. Furthermore, the theory behind this tool had been developed. It no longer limits its variables with the outright and expected costs and benefits. It evolved its theory to consider other variables such as inflation rates and cost of money.
In using this tool, it is important that the foundation or the principle behind the tool is properly established, that is, an accurate list of assumptions must be established. This means that the expected costs such as purchase price, training expenses, interruption costs and the benefits relative to it which includes but are not limited to revenue, sales and increased efficiency are properly computed for or quantified. The accuracy of the said assumptions minimizes the risk of erroneous decision-making.
The cost-benefit analysis is a useful tool in making decisions about major capital projects because of the following benefits it can provide to decision-makers
Cost-Benefit Analysis is an unbiased method to decide which investment option to pursue.
Since this tool is highly quantitative, the results are accurate and are impartial. Furthermore, since this is backed-up by quantitative data, there is no need for extreme scrutiny in defending the selected investment option to pursue. The tools end result is a numerical value which can be interpretation or explained outright.
Cost-benefit analysis immediately eliminates infeasible options.
In any decision-making scenario, it is important to brainstorm all possible options which can be considered in order to address a certain concern. It is also important that all possible angles of the problem be studied and be devised with a possible solution. The cost-benefit analysis serves as a mesh that screens viable options from those that are not.
In computing for the Benefit Cost ratio, all investment options with ratio less than one (1) are immediately removed from the list as these are foreseen as unprofitable venture options. All the options with Benefit Cost Ratio greater than one (1) are furthermore scrutinized.
The cost-benefit analysis allows comparison and ranking of the different investment options quickly and accurately.
From the short-listed options, the options are arranged based on increasing Benefit Cost ratio. The investment option with the highest Benefit Cost ratio is expected to be the most profitable and viable option.
The cost-benefit method does not only apply to the evaluation of capital projects.
The cost-benefit analysis was initially used in infrastructure projects. The concept emerged and was applied in acquisition issues such as purchase or a new machine or addition of a new production line. This tool is versatile as it can also be applied in various evaluation scenarios, not related to investment projects. Management may also apply this tool in decision-making scenarios which involve retrenchment concerns, business expansions, and implementation of a new process.
This can also be applied in any business scale, may it be on a small-scale business or a large-scale business.
The cost-benefit method provided basis for post-analysis.
Cost-benefit analysis does not stop once the decision-makers had chosen their investment option. Upon implementation of such, the cost-benefit can also serve as a tool to review or look back and assess the performance of the chosen option. From it, a decision-maker may understand which of the variables vary, which of the benefits and costs are highly sensitive to dependent variables.
Furthermore, the cost-benefit tool may also be used when studying and expansion of a certain investment.
The cost-benefit analysis is easy to apply and understand.
This tool is highly theoretical in nature. Furthermore, the results are self-explanatory.
I firmly believe that the cost-benefit method is an extremely useful tool to use when making decisions on capital projects. It provides confidence in the results because it requires accurate date and is highly quantitative in nature. Furthermore, it is quick and easy to use and more importantly, easy to understand.
Several companies, as well as government institutions, had used and had enjoyed the results of the cost-benefit analysis. Take the case of Blackwell Publishing Limited, one of the worlds leading society publishers. It had partnered with at least six hundred (600) academic and professional societies and has production facilities in the United States, United Kingdom, Australia and Japan. As it envisions itself to expand its production and distribution in the East, it used Cost-Benefit Analysis to examine the feasibility of such, as well as, the area where it can build its facility. It chose three different Oriental countries China, Malaysia and Singapore. These countries were short-listed from the other Eastern countries as these are where they can not only penetrate more suppliers and customers but also operate at the least cost. After careful study, the company decided to establish a new production and distribution facility in Singapore. This is because the area offers an optimistic opportunity for a new venture because of its strategic location.
While Cost-Benefit Analysis is a highly beneficial tool used by the management in decision-making, it is but advised that management does not fully rely on the results of the said decision-making tool. It is also suggested that other decision-making methods such as the net present value analysis (NPV) or the breakeven analysis and other similar tools be used to sensibly picture out the implementation of a certain option. The cost-benefit analysis only looks at the viability in terms of the benefit to be extracted from the implementation of a certain option. Other management tools will illustrate not only the performance but also the cash flow needed for the implementation of such.