Group Facilities Planning 6

Cost Benefit Analysis

Definition and Purpose

A technique that can be used to evaluate government projects and programs.
It encompasses an appraisal of a policy based on the costs and benefits of the project.
A CBA should be performed for each investment alternative to enable the evaluation
and comparison of alternatives.

Measurement in the Cost Benefit Analysis

1. Net Present Value
The net present value of a project is the sum of the present value of each cost
and other effects of a project. A positive NPV indicates that benefits outweigh
the costs of a project.
2. Benefit Cost Ratio
The ratio obtained by dividing of the sum of the present value of the benefits
by the sum of the present value of the costs. A BCR greater than 1 indicates
that the benefits outweigh the cost of a project.
3. Net Present Value per unit of Investment
the net present value divided by the present value of a project’s capital cost.
This ratio provides an indication of the effectiveness of a given level of
investment.

Process
1. Determine/Define Objectives
The CBA should include a problem definition, pertinent background information
and a list of investment objectives that identify how the system will improve the
work process and support the mission.
2. Document Current Process
The current process should be thoroughly documented and address the areas of
customer satisfaction and system architecture.
3. Estimate Future Requirements
Two items to consider are lifecycle time and lifecycle demands.
4. Collect Cost Data
Data can be collected, from several sources, to estimate the costs of each
investment alternative.
5. Choose at Least Three Alternatives
A CBA should present at least three viable alternatives. “Do nothing” or “Continue
current operations” should not be considered as an alternative. Each viable
technical approach should be included as an alternative.
6. Document CBA Assumptions
It is important to document all assumptions and, if possible, justify them on the
basis of prior experiences or actual data.
7. Estimate Costs
Many factors should be considered during the process of estimating costs for
alternatives. Full lifecycle costs for each competing alternative should be included,
and certain factors should be addressed.
8. Estimate Benefits
The steps to estimate benefits include: defining benefits, identifying benefits,
establishing measurement criteria, classifying benefits, quantifying intangible
benefits, and estimating tangible benefits.
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9. Discount Costs and Benefits

After costs and benefits for each system lifecycle year have been identified, they
are converted into a common measurement unit by discounting future dollar values
and transforming future benefits and costs to their “present value.”
10. Evaluate Alternatives
Many benefits cannot be quantified in dollar terms. As a result, evaluating
alternatives cannot always be done using present values, but valid evaluations can
be made using a combination of dollar values and quantified relative values (values
that are numeric, but do not represent dollar values).
11. Perform Sensitivity Analysis
Sensitivity analysis tests the sensitivity of input parameters and the reliability of the
CBA result. Sensitivity analysis should assure reviewers the CBA provides a sound
basis for decisions.
12. Compare Investments
Even if the CBA shows that benefits will outweigh costs, using Payback Period and
Return on Investment (ROI) analysis help demonstrate an investment is a better
utilization of funds than other proposed investments.

Cost Effectiveness Analysis (CEA)

Introduction
Cost-effectiveness analysis refers to the consideration of decision alternatives in
which both their costs and consequences are taken into account in a systematic way. It
is a decision oriented tool, in that it is designed to ascertain which means of attaining
particular educational goals are most efficient. For example, there are many
alternative approaches for pursuing such goals as raising reading or mathematics
achievements. Developed in the military, CEA was first applied to health care in the
mid-1960s and was introduced with enthusiasm to clinicians by Weinstein and Stason
in 1977.

Basic of Cost Effectiveness Analysis

Cost-effectiveness analysis is an alternative to benefit-cost analysis that relates the
cost of a given alternative to specific measures of program objectives. A cost-
effectiveness analysis helps to compare costs to units of program objectives and may
be the first step in a benefit-cost analysis if the analyst then decides to attempt to place
a dollar value on the benefits. Unlike benefit-cost analysis, cost-effectiveness analysis
does not produce a “net benefit” number, with benefits exceeding costs or costs
exceeding benefits. However, a cost-effectiveness analysis can determine that a
program which costs $1 million produces ten units of outcome x, twelve units of
outcome y, and twenty units of outcome z. Or, if the units are alike, it can determine
the cost per unit of outcome.

An example of this method of analysis using a hypothetical dropout prevention

program is presented in Box1 below.
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Box1: Hypothetical Cost-Effectiveness Results for Dropout Prevention Strategies

The cost-effectiveness of each dropout prevention strategy is determined by dividing

the cost for each strategy by its effectiveness (e.g., the percentage increase in the
number of students graduating). The result is the cost for each percent increase in the
number of students graduating.

Strategy Costs Effectiveness C/E Ratio

Mentoring $80,000 10 $8,000
After-School
$65,000 5 $13,000
Sports

Deciding Between Cost-Effectiveness Analysis and Benefit-Cost Analysis

Those faced with deciding between the two types of analysis may find it helpful to
keep three basic questions in mind:

1. How will you use the results? Benefit-cost analysis enables you to compare
strategies that do not have the same outcomes, or to compare strategies across
different areas of public expenditure (e.g., health, welfare, justice). Cost-effectiveness
analysis is useful for comparing strategies that are trying to achieve the same
objective (e.g., increased graduation rates).

2. What resources do you have? Benefit-cost analyses typically require more

resources, because they take more time for analysis and involve significant
methodological expertise (often in economics), such as the capacity for determining
the discounted present value of a stream of benefits and costs.

3. How difficult are costs and benefits to value? While you may want to have as much
information as possible on both benefits and costs, you must weigh the value of the
increased accuracy gained from the accumulation of new data against the costs
associated with the data collection. Thus, any analysis should begin by assimilating
existing data to determine whether it is sufficient.

Conclusions
The more intangible the benefit (for example saved wilderness), the more likely it is
that a cost-effectiveness analysis will be of greater use to decision makers. This type
of analysis can help them assess whether a cost is justifiable, when compared with
other uses of the same funds.

UTILITY ANALYSIS

UTILITY:

The satisfaction of wants and needs obtained from the use or consumption of
goods and services. The terms utility and satisfaction are, for the most part, used
interchangeably in economics. The concept of utility is integral to utility analysis,
consumer demand theory, and the microeconomic analysis of consumer behavior and
market demand.
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Utility is another term for the satisfaction of wants and needs obtained from
the consumption of goods. Two other economic terms that are also frequently used to
capture this notion are welfare and well-being. Whichever term is used, the
underlying concept is the same: Utility is the extent to which unlimited wants and
needs are fulfilled using the goods and services produced from society's limited
resources. The utility concept is an integral part of consumer demand theory and the
in-depth study of market demand, the demand curve, and the law of demand.

UTILITY ANALYSIS:

A subset of consumer demand theory that analysis consumer behavior and

market demand using total utility and marginal utility. The key principle of utility
analysis is the law of diminishing marginal utility, which offers an explanation for the
law of demand and the negative slope of the demand curve.
Utility analysis, a subset of consumer demand theory, provides insight into an
understanding of market demand and forms a cornerstone of modern microeconomics.
In particular, this analysis investigates consumer behavior, especially market
purchases, is based on the satisfaction of wants and needs (that is, utility) generated
from the consumption of a good.
Utility analysis is primarily taught in introductory courses. A more
sophisticated version of consumer demand theory relies on the analysis of indifference
curves and is more commonly found at the intermediate course level and above.

Balanced Scorecard

Balanced Scorecard is a new approach to strategic management was developed by

Drs. Robert Kaplan and David Norton. It recognizes some of the weaknesses and
vagueness of previous management approaches. Balanced scorecard approach
provides a clear prescription as to what companies should measure in order to balance
the financial perspective.

Kaplan and Norton found that companies are using the scorecard to:
• Clarify and update strategy
• Communicate strategy throughout the company
• Align unit and individual goals with strategy
• Link strategic objectives to long term targets and annual budgets
• Identify and align strategic initiatives
• Conduct periodic performance reviews to learn about and improve strategy
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Four fundamental perspectives

Financial perspective

How do we perform
according to our
shareholders?

Customer perspective Vision Business proses

and perspective
How do our customer Strategy
see us? What must we excell at?

Learning and growth

perspective

Can we continue to
improve & create value?

Advantages of applying balanced scorecard:

• Helps align key performance measures
• Provides management with a comprehensive picture of business goals and
strategies
• Transforms the strategic plan from an attractive but passive document into the
marching orders for the organization on a daily basis
• Enables executives to truly execute their strategies

Disadvantages and problems of using balanced scorecard :

• Lack of time for the decision makers to focus on strategy
• Difficult in creating well defined metrics and connecting them to deliverables
• Difficult and time consuming to implement a comprehensive balanced scorecard
system in a large organization
• Require sustained top level support and commitment to ramp up and put the
system in place

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