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Cost bnefit analysis has to be done at the beginning of the project or activity in conjunction with the draft plans.It is basically Weighing future values in today's scenarios.The farther into the future you look when performing your analysis, the more important it is to convert your estimates of benefits over costs into today’s dollars. Unfortunately, the farther you look, the less confident you can be of your estimates. For example, you may expect to reap benefits for years from a new computer system, but changing technology may make your new system obsolete after only one year.Thus, the following two key factors influence the results of a cost-benefit analysis: How far into the future you look to identify benefits On which assumptions you base your analysisAlthough you may not want to go out and design a cost-benefit analysis by yourself, you definitely want to see whether your project already has one and, if it does, what the specific results of that analysis were.The net present value (NPV) is based on the following two premises: Inflation: The purchasing power of a dollar will be less one year from now than it is today. If the rate of inflation is 3 percent for the next 12 months, $1 today will be worth 97 cents just 12 months from today. In other words, 12 months from now, you’ll pay $1 to buy what you paid 97 cents for today. Lost return on investment: If you spend money to perform the project being considered, you’ll forego the future income you could earn by investing it conservatively today. For example, if you put $1 in a bank and receive simple interest at the rate of 3 percent compounded annually, 12 months from today you’ll have $1.03 (assuming zero-percent inflation).To address these considerations when determining the NPV, you specify the following numbers: Discount rate: The factor that reflects the future value of $1 in today’s dollars, considering the effects of both inflation and lost return on investment Allowable payback period: The length of time for anticipated benefits and estimated costsIn addition to determining the NPV for different discount rates and payback periods, figure the project’s internal rate of return for each payback period.
