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Group 2 Assignment II

Definition of cost benefit analysis

Costbenefit analysis (CBA), sometimes called benefitcost analysis (BCA), is a systematic

process for calculating and comparing benefits and costs of a project for two purposes: (1) todetermine if it is a sound investment (justification/feasibility), (2) to see how it compares withalternate projects (ranking/priority assignment). It involves comparing the total expected cost ofeach option against the total expected benefits, to see whether the benefits outweigh the costs,and by how much.

CBA is related to, but distinct from cost-effectiveness analysis. In CBA, benefits and costs areexpressed in money terms, and are adjusted for the time value of money, so that all flows ofbenefits and flows of project costs over time (which tend to occur at different points in time) areexpressed on a common basis in terms of their "present value."

Use of cost-benefit analysis in relation to Human Life

Cost-benefit analysis is a prescriptive technique. It has an explicit normative basis and isperformed for the purpose of informing policy makers about what they ought to do. It is based onwelfare economics and requires all policy impacts to be stated in monetary terms.

Some people find the very idea of assigning a monetary value to lifesaving or to quality of life,which is an essential element of cost-benefit analysis, meaningless and ethically wrong. Humanlife, it is argued, is not a commodity that can be traded against other goods. It should therefore

not carry a price tag. However, the purpose of assigning a monetary value to human life is not toengage in trading in the usual sense of that term. It is simply to provide a guideline with respectto the amount of resources we would like to spend on the prevention of accidents or injuries,given the fact that not all of our resources can be spent for this purpose. Some form of economicreasoning that is some form of thinking that recognizes the fact that resources are limited andcan be put to very many alternative uses is simply inevitable, given the following basic facts:

A limited amount of resources is at our disposal for the prevention of accidents orinjuries, or indeed for catering to any human need.

Human needs and value systems are complex and multi-dimensional. While safety iscertainly one of the more basic human needs, it is not the only one and no society wouldever be able to spend more than a fraction of disposable resources on the prevention ofaccidents or injuries.

How much to spend on the prevention of accidents or injuries will depend, and ought todepend, on how important people think this good is, seen in relation to all other goodsthey would like to see produced.

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It is, in principle, possible both to provide too little safety and to provide too much of it.The objective of cost-benefit analysis is to help us find the right balance between safetyand other goods.

If these basic observations are accepted as a fair description of the choices we are facing, then

some kind of cost-benefit reasoning, although not necessarily formalized, is simply inevitable:We engage in this sort of thinking whether we are conscious of it or not.

An Illustration:

A sales director is deciding whether to implement a new computer-based contact managementand sales processing system. His department has only a few computers, and his salespeople arenot computer literate. He is aware that computerized sales forces are able to contact morecustomers and give a higher quality of reliability and service to those customers. They are moreable to meet commitments, and can work more efficiently with fulfillment and delivery staff.

His financial cost/benefit analysis is shown below:

Costs:New computer equipment:

10 network-ready PCs with supporting software @ $2,450 each 1 server @ $3,500 3 printers @ $1,200 each Cabling & Installation @ $4,600 Sales Support Software @ $15,000

Training costs:

Computer introduction 8 people @ $400 each Keyboard skills 8 people @ $400 each Sales Support System 12 people @ $700 each

Other costs:

Lost time: 40 man days @ $200 / day Lost sales through disruption: estimate: $20,000 Lost sales through inefficiency during first months: estimate: $20,000

Total cost: $114,000

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Benefits:

Tripling of mail shot capacity: estimate: $40,000 / year Ability to sustain telesales campaigns: estimate: $20,000 / year Improved efficiency and reliability of follow-up: estimate: $50,000 / year

Improved customer service and retention: estimate: $30,000 / year Improved accuracy of customer information: estimate: $10,000 / year More ability to manage sales effort: $30,000 / year

Total Benefit: $180,000/year

Payback time: $114,000 / $180,000 = 0.63 of a year = approx. 8 months

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