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PRESENTATION IS ABOUT TO

BEGIN

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WEEKLY INSPIRATION

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Lecture # 8

© 2006  International Training Consortium, Inc.  Office: 301-428-0670  Fax: 301-972-3906 5


Cost Benefit Analysis: A Decision Making Tool

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Inventers of CBA
• A French economist and engineer Jules Dupuit introduced the concept
of CBA in his article in 1848. After this date, a famous economist Alfred
Marshall formalized this approach.

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Introduction to CBA
• Cost Benefit Analysis is a
mathematical approach to compare
the costs and expected benefits of
two or more projects (or options) in
order to arrive at ‘Decision Making’

• These projects may be IT, software


development, construction,
education, healthcare, information
technology, pharmaceutical unit
expansion, store or school
expansion, bringing in HRMS or
FMS to the company to replace the
old system done manually,
expansion of banking branches or
replacing interest based banking
with that of Islamic banking etc.

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What it is?
• The purpose of applying Cost Benefit
analysis is to calculate the ratio of
benefit over costs. It is a simple
technique that can be used when
making financial decisions

• Simply put a Cost Benefit Analysis is


made to identify how well, or how
poorly, a project will be concluded

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Every Business Decision Making Requires CBA

• Nearly every business decision


requires a cost-benefit analysis.
Such an analysis can point out the
risks and rewards of decisions or
actions

• If you don't do a cost-benefit


analysis, you run the risk of taking
on unprofitable tasks and wasting
valuable time and money

• Guessing at the benefits or going


by instinct can be a recipe for
business failure

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CBA Importance for Managers
• Manager
(HR/Sales/Marketing/Finance etc.) is
required to give a presentation on why
they require additional personnel or
machine or need to take a marketing
trip abroad or open up Dubai office of
travel agency before board of directors

• Now If you as a manager don't do a


cost-benefit analysis, you run the risk
of taking on unprofitable tasks and
wasting valuable time and money.
Guessing at the benefits or going by
instinct can be a recipe for business
failure

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CBA Serves Two Purposes for Managers:
• To verify that an investment’s (or a project’s)
benefits are more than it’s costs

• To select an investment (or a project) by


comparing their benefits over costs ratios or
simply put R= B/C
(please remember this formula)

• If a project has a CBR is greater than 1.0, the


project is expected to deliver a positive net
value to a firm and its investors. If you are
analyzing two projects then whichever project
CBR is higher we select that

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What is the common unit in CBA?
• In order to make a comparison
between the positive and
negative aspects of the
alternatives, a common unit is
required. Money is the common
unit used for comparison of
alternatives. In
a CBA calculation, costs and
benefits are represented
as monetary values

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Simple Cost Benefit Example

• Let’s assume that a CEO of a


construction company wants his
team to prepare a comparison
between two potential real estate
development projects to be
constructed. He also reminds
them that the company’s financial
health is getting poor so he has
to select one of them and present
before board chairman for
approval

• The team works and lists below


the potential incomes and costs
of each project

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All the project parameters are summarized in below table:
(Step #1)

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Cost & Benefit Calculations (Step # 2)

Project cost calculations are summarized in Project benefit calculations are summarized in
below table. below table.

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Costs and Benefits Comparison (Step # 3)

• It is obvious that Project 2 is more profitable than Project 1. Although the benefits of Project 1
is more than Project 2, the costs of Project 2 is less than the costs of Project 1.The company
will earn more profit by spending less money

• Now we also do cost benefit ratio R= B/C to find out which project has more positive net
value
*Project 1 63000000/61900000=1.01
*Project 2 54625000/44500000=1.22

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Summary
• This simple example shows how to make a cost benefit analysis for two
projects for managerial decision making

• CBA can also be done for a single project but in order to make it authentic
some sort of comparison with a similar or same project would go a long way
in convincing senior management to release funds

• It is important to bear in mind the intangible factors such as customer


satisfaction, environment, employee satisfaction, or health and safety,
historical importance while making CBA for these factors can either bring
benefits or prove hindrance in analysis

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References
• ProjectCubicle (February 13, 2018). Cost benefit analysis example. Retrieved
from https://www.projectcubicle.com/cost-benefit-analysis-example/

• Mindtools (n.d). Cost-Benefit Analysis: Deciding, quantitatively, whether to go


ahead. Retrieved from https://
www.mindtools.com/pages/article/newTED_08.htm

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Class Activity on CBA
• Group of 3 students without spokesperson

• You are required to make a CBA of an upcoming project for your company
plus give out CBR

• You have 30 minutes. You can assume any monetary value as long as the
CBA is simplified for your audience and teacher

• Use calculators on your cell and internet wherever possible

• The details are given on next slide

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• Your MNC has decided to expand: (In Pak Rupees)
•#1 They have seen a huge new place at Sharah Faisal near Lal masjid costing ______
•#2 They have also seen a huge place in Model Colony costing_____________
•#3 They need to hire 100 resources for each project: Project A______Project B_______
•#4 Hidden costs associated with each project: Project A________ Project B_________
•#5 Time of completion for each project: Project A:__________ Project B: _______________
•#6 The total cost for each project: Project A__________ Project B:_____________
•#7 The total benefit for each project: Project A_________Project B: ________________
•* Mention 3 intangible factor that comes to your mind which may create hurdle in completion
of project
•**At the end determine which project is more feasible by calculating it though the formula of
CBRatio taught in class
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