Cost-benefit analysis

Definition

Cost-benefit analysis is a systematic approach used to evaluate the strengths and weaknesses of alternatives in order to determine the best course of action. This technique compares the total expected costs of a project against its total expected benefits, helping stakeholders make informed decisions about whether to proceed with a project or initiative. By quantifying and comparing these factors, it plays a crucial role in project selection, assessing project closure outcomes, and prioritizing projects within a portfolio.

5 Must Know Facts For Your Next Test

1. Cost-benefit analysis helps identify which projects will yield the highest net benefits, guiding decision-makers towards more effective resource allocation.
2. It can be used not only for selecting projects but also for assessing the success of projects after their completion by comparing actual outcomes to projected benefits.
3. In portfolio selection, cost-benefit analysis aids in prioritizing projects based on their expected return compared to their associated costs, ensuring that limited resources are allocated efficiently.
4. This analysis can also incorporate qualitative factors, such as social or environmental impacts, which may not be easily quantifiable but are important for comprehensive decision-making.
5. Sensitivity analysis is often performed alongside cost-benefit analysis to understand how changes in assumptions can impact the outcomes, providing insight into potential risks.

Review Questions

• How does cost-benefit analysis influence project selection methods and criteria?
  • Cost-benefit analysis significantly influences project selection by providing a clear framework for evaluating and comparing potential projects. It allows decision-makers to assess the expected costs versus benefits quantitatively, ensuring that only projects with favorable outcomes are pursued. This method not only highlights financial implications but also considers broader impacts, guiding stakeholders toward making choices that align with strategic objectives.
• Discuss the role of cost-benefit analysis in evaluating project closure activities and documentation.
  • In project closure activities, cost-benefit analysis plays a critical role by evaluating whether the project achieved its intended outcomes compared to its costs. This evaluation helps document the success or shortcomings of the project, providing valuable lessons for future initiatives. By assessing actual benefits against projected ones, stakeholders can better understand project performance and inform decisions about similar future projects.
• Evaluate how incorporating cost-benefit analysis into portfolio selection and prioritization can enhance decision-making.
  • Incorporating cost-benefit analysis into portfolio selection and prioritization enhances decision-making by ensuring that projects are evaluated based on their potential value relative to their costs. This systematic evaluation helps organizations prioritize initiatives that offer the highest returns on investment while aligning with strategic goals. Additionally, by analyzing trade-offs between different projects, organizations can create balanced portfolios that maximize overall benefits while managing risks effectively.

Related terms

Return on Investment (ROI):

A financial metric used to evaluate the profitability of an investment relative to its cost, expressed as a percentage.

Net Present Value (NPV):

The difference between the present value of cash inflows and outflows over a period of time, used to assess the profitability of an investment.

Feasibility Study:

An assessment of the practicality and potential success of a proposed project, including an analysis of its economic viability.