The benefit-cost analysis

The benefit-cost analysis refers to the precise quantitative technique used in determining the appropriateness of policies or projects, particularly when future effects and potential negative effects are taken into account. The technique assesses the benefits and costs of various initiatives to society members in monetary terms. One of the most common applications of the benefit-cost analysis technique is in grant and funding proposal writing. In this context, the technique focuses on potential programs from the standpoint of society, accounting for their net benefits and costs using established criteria.

Advantages of Benefit-Cost Analysis

Galati (2013) observed that the benefit-cost analysis revealed a variety of advantages. First, it monetizes the overall benefits of an intended program before its commencement. Second, it facilitates the short-term and long-term views of a project regarding its benefits and impacts to the society members. Third, it supports a deep understanding and rationale for the allocation of funds to the proposed project. Fourth, the agencies and parties can be forward-looking through long-term planning for cash outflows and inflows. Fifth, in its analysis it focuses on the benefits to the public along the avenues of economic growth. This report aims at presenting the benefit-cost analysis to support the understanding of an application for the hazard mitigation grant.

In estimating the program’s benefits and costs, a time horizon, which denoted the number of years that the projections have been made, is set. After this period, the project is fictitiously deemed to stop or sold out if it has a residual value. However, the time horizon may be virtually indefinite, making the forecast of the final year a matter of convenience.

Estimation of Parameters

Cost Estimation

The costs of a program are arrived at by summing both the investment and operating costs. The costs may vary depending on the nature of the project, but basically, they the implementation, maintenance and other costs. The implementation costs are those needed to develop and execute the intervention and tools acquisition. The maintenance costs are those used in maintaining the operation of the intervention in working. Other costs are the significant expenses needed to implement the program. Fort the purpose of this FEMA hazard mitigation grant proposal, the costs considered are those involved in the acquisition of some privately-held properties in a flood-prone region of Somewhere City. These are the property acquisition costs, building removal and landscaping. Other costs are those necessary in converting these areas into an integrated green space with some amenities for public recreational use such as the several benches, trash receptacles and small parking area among others.

Benefits Estimation

In most cases, the benefits of a proposed project are ascertained by measuring its expected impact. Since the grant proposal is aimed at mitigating hazards in Somewhere City in Anywhere County, the benefits will positively be assessed based on the program’s ability to reduce the emergency response costs, reduce disaster recovery assistance costs, minimize public health as well as the general safety risks to residential area, reduce flood insurance costs, and provide extra recreational and aesthetic benefits.

Results

Preliminary Benefit-Cost Analysis

The intended project is of the capital budgeting in nature as the initial stage involves the huge commitment of funds. Therefore, the acquisition costs of a number of privately-held properties relate to: project and construction coordination; demolition of structures and disconnection of utilities; land and building acquisition; evaluation, title search and closing; seeding, grading and landscaping; and asbestos abatement for $4,700, $68,000, $510,000, $12,800, $32,000, and $4,500 respectively. Annual maintenance costs will be $15,000. In total, the anticipated project cost in year 1 comprising the initial and maintenance expenses is $647,000. The other nine years each has a cash outflow of $15,000 as shown below.

The benefits are projected to be $94,500 annually, and the break-down is as follows. The reduction in s response costs $10,000, removal of local cost share and reduction in public assistance recovery costs $30,000, the decline in local flood insurance costs $40,000, projected public health benefits following the reduction in risks $10,000, and recreational benefits $4,500.

In performing the benefit-cost analysis, the future financial values of the project are discounted to their present values. In the first benefit-cost analysis, the fiscal discount rate used is 7% as shown below. The discounting factor values obtained were used to discount both the benefit and cost values. The computed present values of benefits and costs are $575,410.70 and $696,007.93 respectively. The benefit-cost ratio is 0.8267. Following Watkins and Alley suggested benefit-cost analysis decision criterion for projects that a program is worthwhile if the computed ratio of the present value of benefits and costs is greater than 1, then, the proposal at hand should not be implemented.

Year Benefits Costs Discounting Factor PV for Benefits PV for Costs

1 - 647,000.00 1.07 - 604,672.90

2 94,500.00 15,000.00 1.14 82,539.96 13,101.58

3 94,500.00 15,000.00 1.23 77,140.15 12,244.47

4 94,500.00 15,000.00 1.31 72,093.60 11,443.43

5 94,500.00 15,000.00 1.40 67,377.19 10,694.79

6 94,500.00 15,000.00 1.50 62,969.34 9,995.13

7 94,500.00 15,000.00 1.61 58,849.85 9,341.25

8 94,500.00 15,000.00 1.72 54,999.86 8,730.14

9 94,500.00 15,000.00 1.84 51,401.74 8,159.01

10 94,500.00 15,000.00 1.97 48,039.01 7,625.24

Sum of PV Benefits & Present Value Costs: 575,410.70 696,007.93

Benefit-Cost Ratio:

0.8267

Besides the benefit-cost analysis criterion, the proposed program has been evaluated using the net present value technique. The handy rule for making a capital investment states that: if the computed NPV of a program using the determined cost of capital is greater than zero, then such an investment is viable and should be executed. On the other hand, the investment should not be undertaken if the NPV is negative. Then, a matter of indifference arises when the NPV=0. Having this background in mind, the computed NPV for the proposed program is ($120,597.23) implying that the green space project is not feasible and should therefore not be undertaken.

Year Benefits Costs B - C Discounting Factor Annual Returns

1 - 647,000.00 (647,000.00) 1.07 (604,672.90)

2 94,500.00 15,000.00 79,500.00 1.14 69,438.38

3 94,500.00 15,000.00 79,500.00 1.23 64,895.68

4 94,500.00 15,000.00 79,500.00 1.31 60,650.17

5 94,500.00 15,000.00 79,500.00 1.40 56,682.40

6 94,500.00 15,000.00 79,500.00 1.50 52,974.21

7 94,500.00 15,000.00 79,500.00 1.61 49,508.60

8 94,500.00 15,000.00 79,500.00 1.72 46,269.72

9 94,500.00 15,000.00 79,500.00 1.84 43,242.73

10 94,500.00 15,000.00 79,500.00 1.97 40,413.77

NPV Criterion Result: (120,597.23)

Initial Sensitivity Analysis Using 5%

Besides the preliminary evaluation, this report represents the initial sensitivity analysis using a discount rate of 5%. As shown below, the present values of the future benefit is $639,703.95 while that of the project cost is $717,730.79. The ratio of benefits to costs is 0.8913. Though slightly above the 0.8267 value computed using a discount rate of 7%, the ratio is also not desirable as it is not greater than 1. As a result, this project seems infeasible.

As further indicated below, the analysis using the net present value criterion proves that the green space project is not viable as it has a negative NPV value of $78,026.84.

Year Benefits Costs Discounting Factor PV for B PV for C

1 - 647,000.00 1.05 - 616,190.48

2 94,500.00 15,000.00 1.10 85,714.29 13,605.44

3 94,500.00 15,000.00 1.16 81,632.65 12,957.56

4 94,500.00 15,000.00 1.22 77,745.38 12,340.54

5 94,500.00 15,000.00 1.28 74,043.22 11,752.89

6 94,500.00 15,000.00 1.34 70,517.35 11,193.23

7 94,500.00 15,000.00 1.41 67,159.39 10,660.22

8 94,500.00 15,000.00 1.48 63,961.32 10,152.59

9 94,500.00 15,000.00 1.55 60,915.54 9,669.13

10 94,500.00 15,000.00 1.63 58,014.80 9,208.70

Sum of PV Benefits & Present Value Costs: 639,703.95 717,730.79

Benefit-Cost Ratio:

0.8913

Year Benefits Costs B - C Discounting Factor Annual Returns

1 - 647,000.00 (647,000.00) 1.05 (616,190.48)

2 94,500.00 15,000.00 79,500.00 1.10 72,108.84

3 94,500.00 15,000.00 79,500.00 1.16 68,675.09

4 94,500.00 15,000.00 79,500.00 1.22 65,404.85

5 94,500.00 15,000.00 79,500.00 1.28 62,290.33

6 94,500.00 15,000.00 79,500.00 1.34 59,324.12

7 94,500.00 15,000.00 79,500.00 1.41 56,499.17

8 94,500.00 15,000.00 79,500.00 1.48 53,808.73

9 94,500.00 15,000.00 79,500.00 1.55 51,246.41

10 94,500.00 15,000.00 79,500.00 1.63 48,806.10

NPV Criterion Result: (78,026.84)

Conclusion

A benefit-cost analysis for grant funding for a standard proposed program has been presented. The project is selected for funding based on the set evaluation criteria. In this practical case, the benefit-cost ratio and the NPV criteria have been used. It has proved that the purchase of the privately-owned property in the flood-prone city for a green space project to mitigate the experienced hazards is not viable for funding.

References

Galati, S. R. (2013). Developing a convincing benefit-cost analysis for grants. AGWA Annual Conference, (pp. 1-36).

Watkins, T., & Alley, T. (n.d.). An introduction to cost-benefit analysis. Retrieved October 20, 2017, from San José State University: http://www.sjsu.edu/faculty/watkins/cba.htm