Cost Benefit Analysis

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As per 11th Jan 2016 PMP changes, a new task – Task 7 added under Initiating Process Group. Conduct benefit analysis with relevant stakeholders to validate project alignment with organizational strategy and expected business value. This task aims at involvement of project manager earlier in the project in project selection decisions.

Cost-benefit analysis (CBA) or sometimes also called benefit-cost analysis (BCA) is an analytical tool for assessing the pros and cons of moving forward with a business proposal. As a technique, it is used most often at the start of a programme or project when different options or courses of action are being appraised and compared, as an option for choosing the best approach. It can also be used, however, to evaluate the overall impact of a programme in quantifiable and monetized terms.

Purpose and Approach

Broadly, CBA has two purposes:

1.To determine if it is a sound investment/decision (justification/feasibility for a process, project program, policy) which can be expressed in terms of Payback or Rate of Return.

2.To provide a basis for comparing projects. It involves comparing the total expected cost of each option against the total expected benefits, to see whether the benefits outweigh the costs, and by how much.

To account for this, it is necessary to ‘discount’ or reduce the value of future costs or benefits to place them on a par with costs and benefits incurred today. The ‘discount rate’ will vary depending on the sector or industry,

If the discounted present value of the benefits exceeds the discounted present value of the costs then the project is worthwhile. This is equivalent to the condition that the net benefit must be positive. Another equivalent condition is that the ratio of the present value of the benefits to the present value of the costs must be greater than one.

In CBA, benefits and costs are expressed in monetary terms, and are adjusted for the time value of money, so that all flows of benefits and flows of project costs over time (which tend to occur at different points in time) are expressed on a common basis in terms of their “net present value.”

Both tangible and intangible factors need to be addressed and taken into account. Components may include: cost of labor, equipment, and support services. Intangible factors, such as cultural impacts, customer satisfaction, or control savings factors, such as current expenditures vs. future expenditures. Although often treated as unquantifiable, intangibles also can and should be quantified.

Tangible benefits can be measured in terms of their direct monetary value, such as increase in revenue; intangible benefits are the favorable results that may not be measurable in dollar terms, such as improved morale of the employees, but can be estimated using a qualitative approach

Careful consideration should be given to quantifying intangible factors, such as cultural impacts (e.g., quality of work life, empowerment vs. control, incentive system, etc.) For this reason, a method for quantification which is a standard practice within the organization should be used, if possible.

The process for quantifying costs and benefits should be confirmed by the project sponsors or reference groups, early in the task, and any assumptions should be clearly delineated. If organizational standards are not available, work with project stakeholders to compute intangible benefits and costs in this manner.

Recommended steps/Procedures:

1.Determine all direct and indirect cost estimates.

2.Define and calculate all tangible and intangible benefits .

3.Choose an appropriate Cost Benefit Analysis (CBA) algorithm to analyze the cost and benefit streams.

4.Compute estimated costs and benefits schedule over time to determine the payback period.

5.Make recommendations, and set next steps as required.

Principles to be followed:

1) There must be a Common Unit of Measurement.

2) Transparency in CBA enhances its value.

3) CBA should disclose areas of uncertainty and clearly describe how uncertainty has been addressed.

4) The effort required for a CBA should not outweigh the expected value of the resulting information.

5) If there are more than one mutually exclusive project that have positive net present value then there has to be further analysis.

6) Do not over exaggerate potential funding sources or potential benefits.

To conclude , the purpose of cost-benefit analysis is to provide a consistent procedure for evaluating decisions in terms of their consequences. This might appear as an obvious and sensible way to proceed, but it is by no means the only one.

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