Short note: Cost-benefit analysis

Cost-benefit analysis (CBA) compares the total expected benefits of a project with its total costs, both expressed in money and discounted to present value, to judge whether the project is worthwhile.

Steps: identify all costs and benefits; assign money values (using shadow prices if market prices are distorted); choose a discount rate and project life; discount; calculate indicators.

Indicators:

$$B/C = \frac{PV\ \text{of benefits}}{PV\ \text{of costs}},\quad NPV = \sum \frac{B_t - C_t}{(1+r)^t}$$

A project is accepted if $B/C > 1$, $NPV > 0$ and $IRR >$ required rate.

Ordinary (private/financial) CBA counts only the cash costs and benefits to the owner at market prices. Social CBA (SCBA) counts all costs and benefits to society, including externalities and non-market effects, using shadow prices and a social discount rate.

Drawbacks: hard to give money value to intangible items (environment, human life, time); choice of discount rate affects results; forecasts are uncertain; ignores distribution of benefits among groups; externalities can be missed; costs may be underestimated and benefits overstated; not suitable alone for decisions with large social or ecological effects.