Benefit-cost analysis:-

The benefit-cost analysis method is mainly used for economic evaluation of public projects which are mostly funded by government organizations. In addition this method can also used for economic evaluation of alternatives for private projects. The main objective of this method is used to find out desirability of public projects as far as the expected benefits on the capital investment are concerned. As the name indicates, this method involves the calculation of ratio of benefits to the costs involved in a project.     

In benefit-cost analysis method, a project is considered to be desirable, when the net benefit (total benefit less disbenefits) associated with it exceeds its cost. Thus it becomes imperative to list out separately the costs, benefits and disbenefits associated with a public project. Costs are the expenditures namely initial capital investment, annual operating cost, annual maintenance cost etc. to be incurred by the owner of the project and salvage value if any is subtracted from the costs. Benefits are the gains or advantages whereas disbenefits are the losses, both of which are experienced by the owner in the project. In case of public projects which are funded by the government organizations, owner is the government. However this fund is generally taxpayers’ money i.e. tax collected by government from general public, thereby the actual owners of public projects are the general public. Thus in case of public projects, the cost is incurred by the government whereas the benefits and disbenefits are mostly experienced by the general public.

In order to know the costs, benefits and disbenefits associated with a public project, consider that a public sector organization is planning to set up a thermal power plant at a particular location. The costs to be incurred by the public sector organization are cost of purchasing the land required for the thermal power plant, cost of construction of various facilities, cost of purchase and installation of various equipments, annual operating and maintenance cost, and other recurring costs etc. The benefits associated with the project are generation of electric power that will cater to the need of the public, generation of revenue by supplying the electricity to the customers, job opportunity for local residents, development other infrastructure in the nearby areas etc. The disbenefits associated with project are loss of land of the local residents on which the thermal power plant will come up. If it is agricultural land, then the framers will lose their valuable land along with the annual revenue generated from farming, even though they get money for their land from the public sector organization at the beginning. The other disbenefits to the local residents are greater likelihood of air pollution in the region because of the thermal power plant, chances of contamination of water in the nearby water-bodies etc.

In benefit-cost analysis method, the time value of money is taken in to account for calculating the equivalent worth of the costs and benefits associated with a project. The benefit-cost ratio of a project is calculated by taking the ratio of the equivalent worth of benefits to that of the costs associated with that project. Either of present worth, annual worth or future worth methods can be used to find out the equivalent worth of costs and benefits associated with the project.

The benefit-cost ratio of projects is determined in different forms namely conventional benefit-cost ratio and modified benefit-cost ratio. The benefit-cost ratio is generally designated as B/C ratio.