NATIONAL UNIVERSITY OF SCIENCE AND TECHNOLOGY

FACULTY OF THE BUILT ENVIRONMENT

BACHELOR OF QUANTITY SURVEYING (HONOURS)DEGREE

CONSTRUCTION FINANCE (AQS4203)

COST-BENEFIT ANALYSIS (CBA

COST-BENEFIT
Cost-Benefit Analysis (CBA) estimates and totals ANALYSIS (CBA money value of the
up the equivalent
benefits and costs to the community of projects to establish whether they are worthwhile.
These projects may be dams and highways or can be training programs and health care
systems.

Principles of Cost Benefit Analysis

One of the problems of CBA is that the computation of many components of benefits and
costs is intuitively obvious but that there are others for which intuition fails to suggest
methods of measurement. Therefore some basic principles are needed as a guide.

There Must Be a Common Unit of Measurement

In order to reach a conclusion as to the desirability of a project all aspects of the project,
positive and negative, must be expressed in terms of a common unit. The most convenient
common unit is money. This means that all benefits and costs of a project should be
measured in terms of their equivalent money value. A program may provide benefits which
are not directly expressed in terms of dollars but there is some amount of money the
recipients of the benefits would consider just as good as the project's benefits. For example, a
project may provide for the elderly in an area a free monthly visit to a doctor. The value of
that benefit to an elderly recipient is the minimum amount of money that that recipient would
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take instead of the medical care. This could be less than the market value of the medical care
provided. Not only do the benefits and costs of a project have to be expressed in terms of
equivalent money value, but they have to be expressed in terms of dollars of a particular
time. This is due to the concept of time value of money.

CBA Valuations Should Represent Consumers or Producers

The valuation of benefits and costs should reflect preferences revealed by choices which
have been made. For example, improvements in transportation frequently involve saving
time. The question is how to measure the money value of that time saved. The value should
not be merely what transportation planners think time should be worth or even what people
say their time is worth. The value of time should be that which the public reveals their time is
worth through choices involving tradeoffs between time and money. If people have a choice
of parking close to their destination for a fee of 50 cents or parking farther away and
spending 5 minutes more walking and they always choose to spend the money and save the
time and effort then they have revealed that their time is more valuable to them than 10 cents
per minute. If they were indifferent between the two choices they would have revealed that
the value of their time to them was exactly 10 cents per minute.

The most challenging part of CBA is finding past choices which reveal the tradeoffs and
equivalencies in preferences. For example, the valuation of the benefit of cleaner air could be
established by finding how much less people paid for housing in more polluted areas which
otherwise was identical in characteristics and location to housing in less polluted areas.
Generally the value of cleaner air to people as revealed by the hard market choices seems to
be less than their rhetorical valuation of clean air.

Some Measurements of Benefits Require the Valuation of Human Life

It is sometimes necessary in CBA to evaluate the benefit of saving human lives. There is
considerable antipathy in the general public to the idea of placing a dollar value on human
life. Economists recognize that it is impossible to fund every project which promises to save
a human life and that some rational basis is needed to select which projects are approved and
which are turned down. The controversy is defused when it is recognized that the benefit of
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such projects is in reducing the risk of death. There are many cases in which people
voluntarily accept increased risks in return for higher pay, such as in the oil fields or mining,
or for time savings in higher speed in automobile travel. These choices can be used to
estimate the personal cost people place on increased risk and thus the value to them of
reduced risk. This computation is equivalent to placing an economic value on the expected
number of lives saved.

The Analysis of a Project Should Involve a With Versus Without Comparison

The impact of a project is the difference between what the situation in the study area would
be with and without the project. This that when a project is being evaluated the analysis must
estimate not only what the situation would be with the project but also what it would be
without the project. For example, in determining the impact of a fixed guideway rapid transit
system such as the Bay Area Rapid Transit (BART) in the San Francisco Bay Area the
number of rides that would have been taken on an expansion of the bus system should be
deducted from the rides provided by BART and likewise the additional costs of such an
expanded bus system would be deducted from the costs of BART. In other words, the
alternative to the project must be explicitly specified and considered in the evaluation of the
project. Note that the with-and-without comparison is not the same as a before-and-after
comparison.

Another example shows the importance of considering the impacts of a project and a with-
and-without comparison. Suppose an irrigation project proposes to increase cotton
production in Matebeleland. If Department of Agriculture limits the cotton production in the
Zimbabwe by a system of quotas then expanded cotton production in Matebeleland might be
offset by a reduction in the cotton production quota for Mashonaland. Thus the impact of the
project on cotton production in the Zimbabwe might be zero rather than being the amount of
cotton produced by the project.

Cost Benefit Analysis Involves a Particular Study Area

The impacts of a project are defined for a particular study area, be it a city, region, state,
nation or the world. In the above example concerning cotton the impact of the project might
be zero for the nation but still be a positive amount for Matebeleland.
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The nature of the study area is usually specified by the organization sponsoring the analysis.
Many effects of a project may "net out" over one study area but not over a smaller one. The
specification of the study area may be arbitrary but it may significantly affect the conclusions
of the analysis.

Double Counting of Benefits or Costs Must be Avoided

Sometimes an impact of a project can be measured in two or more ways. For example, when
an improved highway reduces travel time and the risk of injury the value of property in areas
served by the highway will be enhanced. The increase in property values due to the project is
a very good way, at least in principle, to measure the benefits of a project. But if the
increased property values are included then it is unnecessary to include the value of the time
and lives saved by the improvement in the highway. The property value went up because of
the benefits of the time saving and the reduced risks. To include both the increase in property
values and the time saving and risk reduction would involve double counting.

Decision Criteria for Projects

If the discounted present value of the benefits exceeds the discounted present value of the
costs then the project is worthwhile. This is equivalent to the condition that the net benefit
must be positive. Another equivalent condition is that the ratio of the present value of the
benefits to the present value of the costs must be greater than one.

If there are more than one mutually exclusive projects that have positive net present value
then there has to be further analysis. From the set of mutually exclusive projects the one that
should be selected is the one with the highest net present value.

An Example

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