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Cost Benefit Analysis

Comparison of costs and benefits of a project.

It's a systematic approach to estimating strengths and weaknesses of alternatives used to determine options which provide the best approach with the lowest costs.
5 minutes 5 Questions

Concepts covered: Cost Effectiveness Analysis, Payback Period, Life Cycle Cost Analysis, Net Present Value, Opportunity Cost, Discounted Cash Flow, Sensitivity Analysis, Internal Rate of Return, Risk Analysis, Cost Utility Analysis, Benefit Analysis, Break-Even Analysis, Cost-Benefit Ratio

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CAPM - Cost Benefit Analysis Example Questions

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Question 1

Why would a project with a higher net present value (NPV) not always be the best choice for your organization?

Correct Answer: The project might have higher risks or longer payback period

A project with higher net present value (NPV) may not always be the best choice for your organization due to circumstances like higher associated risks or a longer payback period. These factors can make a project less desirable despite its high NPV. Answer '147323' is incorrect because there will be instances where higher NPV projects are not the best choice, depending on a variety of factors such as risk and payback period. Answer '147324' may be valid in a scenario where calculation error has occurred, but it doesn't necessarily make it the main reason why a higher NPV project might not be the best choice. Also, there are protocols in place to avoid such errors in most cases. Answer '147325' is incorrect because the first answer given is a valid reason why a project with a higher NPV may not be the preferred choice for an organization.

Question 2

If a project has a cost of $300,000 and a utility measure of 0.8, what is the utility per dollar of this project multiplied by 1000?

Correct Answer: 0.00267

To find the utility per dollar multiplied by 1000, first calculate the utility per dollar: divide the utility measure by the cost. So, utility per dollar = 0.8 / 300,000 = 0.000002667. Then, multiply this result by 1000 to get 0.000002667 × 1000 = 0.00267. Therefore, the correct answer is 0.00267.

Question 3

Two potential projects for Company EFG have been proposed. Project X costs $90,000 and projects an annual return of $20,000, while Project Y costs $120,000 and projects an annual return of $30,000. Which project has a shorter payback period?

Correct Answer: Project Y

The payback period is a measure of how quickly an investment can be recovered through its cash inflows or returns. To find the payback period for each project, we divide the initial cost by the projected annual return. For Project X: - Initial cost: $90,000 - Annual return: $20,000 - Payback period for Project X = Initial cost of Project X / Annual return of Project X - Payback period for Project X = $90,000 / $20,000 For Project Y: - Initial cost: $120,000 - Annual return: $30,000 - Payback period for Project Y = Initial cost of Project Y / Annual return of Project Y - Payback period for Project Y = $120,000 / $30,000 The payback period for Project X is 4.5 years, and for Project Y, it is 4.0 years. Therefore, Project Y has a shorter payback period compared to Project X. This means that, despite Project Y's higher initial cost, its higher annual return allows the initial investment to be recovered more quickly than Project X. - Project Y has a shorter payback period.

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