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Cost-Benefit Analysis

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Cost-Benefit Analysis (CBA) is a systematic approach used in financial analysis to evaluate the economic worthiness of a project or investment by comparing its expected costs with its anticipated benefits. In the context of business analysis, CBA helps decision-makers determine whether a project is financially feasible and worth pursuing. The process involves identifying all the costs associated with a project, including initial capital expenditures, operational costs, maintenance costs, and any other relevant expenses. Simultaneously, all the tangible and intangible benefits are quantified, such as increased revenues, cost savings, improved efficiency, or enhanced customer satisfaction. Once both costs and benefits are quantified, they are typically discounted to their present values to account for the time value of money, enabling a fair comparison when costs and benefits occur over different time periods. The net benefit is then calculated by subtracting the total present value of costs from the total present value of benefits. A positive net benefit indicates that the project's benefits outweigh the costs, suggesting it is financially viable. Conversely, a negative net benefit suggests that the costs exceed the benefits, and the project may not be a sound investment. CBA aids in prioritizing projects by comparing their net benefits, allowing organizations to allocate resources effectively. Moreover, sensitivity analysis can be incorporated into CBA to assess how changes in key assumptions affect the outcome, thereby providing insights into the project's risks and uncertainties. This comprehensive evaluation ensures that decision-makers consider all financial implications before committing to a project. In summary, Cost-Benefit Analysis is a fundamental concept in financial analysis and feasibility studies, serving as a crucial tool for determining the economic viability of projects and guiding strategic decision-making in business environments.

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PMI-PBA - Financial Analysis and Feasibility Studies Example Questions

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Question 1

During a Cost-Benefit Analysis workshop, what is the primary purpose of conducting sensitivity analysis?

Correct Answer: To assess how changes in key variables affect the analysis outcome

Sensitivity analysis in Cost-Benefit Analysis (CBA) serves a crucial purpose: it helps understand how the overall results might change when key variables fluctuate. The correct answer is that sensitivity analysis assesses how changes in key variables affect the analysis outcome. This is essential because: - It helps identify which variables have the most significant impact on results - It accounts for uncertainty in estimates and assumptions - It provides stakeholders with a range of possible outcomes - It strengthens decision-making by showing the robustness of the analysis Why other options are incorrect: Establishing minimum benefit-cost ratios is a separate process that happens during project planning and requirement setting, not during sensitivity analysis. Determining mathematical accuracy is part of quality control, not sensitivity analysis. This would be done during model validation. Validating historical data is a preliminary step that occurs before conducting the CBA, not a function of sensitivity analysis. Historical data validation is part of the data gathering and verification process.

Question 2

A human resources manager is evaluating two training programs for employee development. Program X costs $50,000 and is expected to improve employee productivity by 10%, leading to an estimated annual benefit of $70,000. Program Y costs $80,000 and is anticipated to enhance productivity by 15%, resulting in an estimated annual benefit of $90,000. Considering a 3-year timeframe, which program should the HR manager select based on a Cost-Benefit Analysis?

Correct Answer: Select Program Y as it offers a higher net benefit over the 3-year period.

Based on the cost-benefit analysis over a 3-year period, Program Y offers a higher net benefit by providing greater annual benefits compared to its initial cost.

Question 3

A Human Resources manager is considering launching a new mentorship program. The initial cost is $15,000, and ongoing annual costs are $3,000. The program is projected to generate annual benefits valued at $20,000 through improved employee retention and performance. Using cost-benefit analysis, what should the HR manager conclude?

Correct Answer: Proceed with the mentorship program, as the present value of benefits outweighs the present value of costs.

Proceed with the mentorship program, as the present value of benefits outweighs the present value of costs. The program's annual benefits of $20,000 exceed the ongoing annual costs of $3,000, resulting in a net benefit of $17,000 each year. Additionally, when considering the initial investment of $15,000, the benefits will surpass the costs over time, demonstrating that the program is a financially sound investment for the organization.

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