Cost Benefit Analysis Examples

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Examples of Cost-Benefit Analysis

An example of Cost-Benefit Analysis includes Cost-Benefit Ratio where suppose there are two projects where project one is incurring a total cost of $8,000 and earning total benefits of $ 12,000 whereas on the other hand project two is incurring costs of Rs. $11,000 and earning benefits of $ 20,000, therefore, by applying cost-benefit analysis the Cost-Benefit ratio of the first project is 1.5 ($8,000/ $12,000) and the ratio of the second project is 1.81 ($11,000/$20,000) which means project two is feasible being having high cost-benefit ratio.

The following examples of Cost-Benefit analysis provide an understanding of the various types of areas where an organization can conduct a Cost-Benefit study. The managers of the company conduct the cost-benefit study before selecting any new plant project to evaluate all potential benefits (revenue) and costs that the company may generate if it undertakes and complete the project as the outcome of the analysis will help in determining whether it is financially feasible for the company to start the analyzed project or not.

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Cost Benefit Analysis Examples

Example #1

Financial analysis International Ltd is planning to undertake one project. It has two alternatives, with the following benefits and costs.

Given,

Alternative 1

  • The total value of the Costs from project 1 = $ 60 million.
  • Benefits available from project 1 = $ 100 million

Alternative 2

  • The total value of the Costs from project 2 = $ 10 million.
  • Benefits available from project 2 = $ 21 million

I am using the Cost-benefit analysis; which Project the company should choose?

Solution

For deciding which project the company should opt using the cost-benefit analysis, the benefit-cost ratio will be calculated for both of the projects.

Benefit-Cost ratio = Benefits available from the project / Total value of the Costs

Alternative 1

The benefit-cost ratio can be calculated as,

Cost Benefit Analysis Example 1

= $ 100 million / $ 60 million

Benefit-Cost Ratio = 1.667

Alternative 2

The benefit-cost ratio can be calculated as,

Cost Benefit Analysis Example 1.1jpg

= $ 21 million / $ 10 million

Benefit-Cost Ratio = 2.1

Analysis: Being both the projects have positive outcomes; both of the projects are beneficial for the company, i.e., the company will be in profit if it undertakes any of the projects. However, as the company has to choose one out of two, the project with a higher benefit-cost ratio will be selected. In the present case, project 2 has a higher benefit-cost ratio, so as per Cost-benefit analysis, project two will be selected by financial analysis International Ltd

Example #2

Sports International limited is planning to expand its business, and for that, it will require four new employees in the organization. For analyzing whether the expansion is beneficial or not, the management of the company decides to use the cost-benefit analysis. The following are the information available related to benefits and costs related to expansion:

  • Within the time frame of one year, it is expected that if the company hires four employees for the expansion, then the revenue of the company will increase by 50 %, i.e., the revenue benefit will be around $ 250,000.
  • Also, due to the new hiring, the company value of the business will increase, which would result in additional revenue of $ 30,000.
  • The salary of the new employees is estimated to be $ 160,000.
  • The additional cost of hiring is estimated to be $ 15,000.
  • The cost of additional hardware and software required will come at around $ 25,000

Analyze the expansion using Cost-benefit analysis.

Solution

  • Total benefit from the project = Increase in revenue from expansion
  • Total benefit from the project = $ 250,000 + $ 30,000 = $ 280,000
  • Total Cost from expansion = Salary of new employees + Cost of hiring + Cost of additional hardware and software
  • Total Cost from expansion = $ 160,000 + $15,000 + $25,000
  • Total Cost from expansion = $ 200,000

Now the benefit-cost ratio will be calculated for the expansion.

Cost Benefit Analysis Example 2

= $280,000 / $ 200,000

Benefit-Cost Ratio = 1.40

As the expansion has a positive benefit-cost ratio (the total benefits due to expansion is greater than total cost), the company should go ahead with the expansion of the project and hire new employees as that will be beneficial for the company.

Example #3

Constru Ltd is a real estate developer. It is planning to make the investment for which it came across different investment options. The following are the information available related to benefits and costs related to various investment options:

Option 1

Build 200 flats out of which 100 flats will be given on the rent for 10 years at the rent of $ 2,000 per year. After 10 years, the rented 100 flats would be sold out at the price of $ 100,000

On the cost side, the cost of construction would come to $ 110,000 per flat, which can be sold at $150,000 each. Apart from the construction cost, the cost of sales and staff would come to $ 700,000 per year. The financing cost of the project would be $1,500,000, and the project would last for two years.

Option 2

Build 100 flats out of which 20 flats will be given on the rent for 5 years at the rent of $ 3,000 per year. After 5 years, the rented 20 flats would be sold out at the price of $ 120,000

On the cost side, the cost of construction would come to $ 150,000 per flat, which can be sold at $200,000 each. Apart from the construction cost, the cost of sales and staff would come to $ 450,000 per year. The financing cost of the project would be $4,000,000, and the project would last for one year.

Analyze the investment options using Cost-benefit analysis.

Solution

Option 1

The benefit-cost ratio can be calculated as,

Cost Benefit Analysis Example3.1jpg

= 27000000 / 26400000

Benefit-Cost Ratio = 1.02

Option 2

The benefit-cost ratio can be calculated as,

Cost Benefit Analysis Example3jpg

= 18700000 / 17900000

Benefit-Cost Ratio = 1.04

We can see that the Benefit-cost ratio of option 1 is 1.02, and option 2 is 1.04. When we compare both options, option 2 has a higher benefit to cost ratio, and therefore the company should choose it over option 1.