cost-benefit analysis

Cost-Benefit Analysis

The formal or informal process of comparing the expected costs of a project against its expected revenue. When a company conducts a cost-benefit analysis, it assigns dollar amounts to costs and benefits in order to determine whether a particular project is likely to be profitable. Cost-benefit analysis is important when making investment decisions.

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cost-benefit analysis

The comparison of benefits and costs in decision making. Dollar values are assigned to benefits and costs in most cost-benefit analyses.

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cost-benefit analysis

A decision-making tool that evaluates all the hard-dollar and economic consequence costs associated with pursuing a course of conduct against all the hard-dollar and economic consequence benefits reasonably to be expected from that decision,and comparing the two to see if they make economic sense.

Example: Riverdale Apartments is experiencing increased competition because of the abundance of new apartment projects being built nearby. In order to compete more effectively, it is considering adding a sophisticated security system with Web cameras allowing residents to monitor gate access; areas around the buildings; and common areas such as the laundry room, swimming pool, and playground. The hard costs of $270,000 can be partially defrayed by charging rental rates $15 per month higher than other properties. Spread across 200 apartments, this results in an additional income of $36,000 per year. In addition, the system is anticipated to result in the ability to retain occupancies at 95 percent rather than an expected short-term drop
to 75 percent until the new apartment buildings fill up and begin charging market rents in about 2 years. Calculations may attach a value of $36,000 per year to this consideration. Finally, the security system will result in significant insurance premium reductions amounting to $20,000 per year. The total short-term economic benefit is $92,000 per year for 2 years and $56,000 per year each year afterward (without adjusting for inflation or the cost of money). As a result, the initial $270,000 investment can be recouped in about 31/2 years and will show a profit afterward. After completing this cost-benefit approach, management will probably decide to spend the money for the improvements.