Cost-Benefit Analysis
| Author | Mary Michel, Mary Oliverio |
| Pages | 167-168 |
Page 167
Cost-benefit analysis is used for determining which alternative is likely to provide the greatest return for a proposed investment. Sometimes referred to as cost-effectiveness analysis, it is relevant to businesses as well as to not-for-profit entities and governmental units.
A business might find it helpful to use cost-benefit analysis to determine if additional funds should be invested in a facility in the home country or in another country. A community not-for-profit organization that provides a variety of programs for children might use cost-benefit analysis to assist management in determining which activities will provide the most services for the costs specified. A federal governmental agency might use cost-benefit analysis to determine which of several projects planned for the national parks is likely to be most used by interested citizens, given the costs.
Because resources such as money and time are limited, an organization usually cannot undertake every project proposed. To decide whether to undertake a project, decision makers weigh the benefits from the project against the cost of the resources it requires, normally approving a project when its benefits exceed its costs. Cost-benefit analysis provides the structure and support for making such decisions.
Benefits increase the welfare of the organization. Some benefits are monetary benefits, such as the dollar amount of cash inflows from additional sales of a product or the saving in cash outflows that a project enables. Other benefits are important but harder to quantify. For example, a project may increase customer satisfaction; increased customer satisfaction may increase future sales, but the exact relationship between sales and satisfaction is often hard to specify.
Costs are the outlays or expenditures made in order to obtain a benefit. Many costs are measured monetarily, such as the cost of buying a new machine or of hiring an additional employee.
A cost-benefit analysis is straightforward when all costs and benefits are measurable in monetary terms. Assume that Company A must decide whether to rent an ice cream machine for the summer for $900. The ice cream machine will produce additional cash inflows of $1,000 during the summer. The benefit of additional cash...
To continue reading
Request your trial