Cost-Benefit Evaluation:-The primary objective of cost-benefit analysis is to find out whether it is economically worthwhile to invest in the proposed project. If the return on investment is high, the project is considered economically worthwhile.
The common methods for Cost-Benefit Evaluation are:-
- Payback Method
- Present Value Method
- Net Present Method
- Net Benefit Method
- Break Even Method
- Cash Flow Analysis
Payback analysis defines the time required to recover the money spent on a project.
Payback Time=Overall cost outlay/ Annual cash return+ installation period.
Present Value Method
The payback method has certain drawbacks. The value of today’s money& tomorrow’s money is not the same. In the payback method, today’s cost is compared with tomorrow’s benefits & thus the time value of money is not considered.
The present value method compared the present value to future values by considering the time value of invested money. The present value analysis determines how much money it is worthwhile investing now, in order to receive a given return in some year’s time.
Where P is the present value
F is the future value
r is the rate of interest
n is the number of years
Net Present Value Method
This method takes into consideration the time value of money & attempts to calculate the return on investment by introducing the factor of the time element.
The net present values of all inflows& outflows of cash occurring during the entire life of the project are determined separately for each year by discounting these flows by the firm’s cost of capital.
Net Benefit Method
In this method, the net benefit is calculated by subtracting the total estimated cost from the total estimated benefit.
Break Even Method
In the Break-Even Method, the costs of current & new systems are compared to find the time when both are equal. This point is called a break-even point. The breakeven point is the time at which the cost of the new system equals the cost of the current one.
Cash Flow Analysis
Cash flow is a procedure designed to keep track of accumulated saving and expenditure on a regular basis. In cash flow analysis method, projected expenditure& costs are identified & totaled. The difference between the incoming savings& outgoing expenses is the cash flow.