Cost-Benefit Analysis

1.1

USAGE

1.1.1 PURPOSE
Cost benefit analysis identifies, assesses, and weighs cost vs
benefits to evaluate the financial and economic merits of
development projects.

1.1.2 USES
Cost benefit analysis is used to:
1. Provide a comprehensive analysis of costs and benefits including
secondary, indirect, intangible, and societal benefits and costs of a
proposed project or program.
2. Provide measures for deciding whether a project is financially viable
and, in the process of analysis, to raise questions for consideration in
redesign or implementation.
3. Rank projects for funding priority.
4. Decide among alternative policies, strategies, or components of a
single program, e.g., for Planning, Programming, and Budgeting

1.1.3 SHORT DESCIPTION

Cost benefit analysis is a generic term covering a range of
theoretical issues and practical techniques. Because cost
benefit analysis has practitioners in many discipline, a universal
approach has not evolved. This description present the system
engineering approach which views cost benefit analysis as a
multi stage process leading to a comprehensive picture of
project

1)
2)
3)
4)

Measurement of contribution and counterfactual

Quantification of impact (net outcomes)
Monetization of impacts
Cash flow analysis and discounting

Cost-Effectiveness

Risk Analysis

Net Present Worth

Internal Rate of Return

The Internal Rate of Return is the discount rate r* at which the net
present worth is zero. It is given by solving the following equation for
r*:
n

i=1

( Bi Ci )

[ ( )]
r
1+
100

=0

Where:
n = number of years of the project
Bi

= gross incremental benefits for year i

Ci

= gross incremental costs for year i

r* = internal Rate of Return (%)

The formula cannot be solved analytically unless the pattern of

benefits and costs are uniform. Otherwise, a trial and error approach
(as described in the procedure) is necessary.
Considerable debate has addressed the practicality of the IRR as a
criterion for project evaluation. Certain patterns of benefits and costs
(in particular, a large cost near the end of a project) many result in
more than one solution to equation. Gittinger (1972) answers the
critics by claiming that the multiple solution problem is not likely to
occur for cash flows typical of development projects.
IRR is a widely used criterion for analyzing the financial and economic
soundness of development projects. It has been adopted as the
principal measure for project appraisal by the US Agency for
International Development (USAID, Handbook 3). The distinction
between internal financial return and internal economic return
underlines the importance of both financial and economic analysis for
project evaluation (Gittinger, 1972)