2. Cost/benefit analysis gives a picture of the
various costs,benefits and rules associated
with each alternative system.
Costs and benefits are classified as:
1. Tangible & Intangible costs and benefits
2. Direct & Indirect costs and benefits
3. Fixed & variable costs and benefits
3. Cost/benefit analysis is done with the
following procedure:
1. Identifying the costs and benefits related to
the project.
2. Categorising the various costs and benefits
for the analysis.
3. Selecting a method of evaluation.
4. Interpreting the result of an analysis.
5. Taking action.
4. When all the financial data have been
identified, the analyst has to select a method
of evaluation.
Based on that evaluation,the result has been
interpreted. On the basis of the interpreted
result, an action has been taken for the
alternative system of an organisation.
5. 1. Net Benefit Analysis
2. Present Value Analysis
3. Net Present Value
4. Payback Analysis
5. Break-even Analysis
6. Cash-flow Analysis
6. It involves subtracting total cost from total
benefits i.e.
Net Benefit=Total Benefit – Total Cost.
8. Advantages:
It is easy to calculate.
It is easy to interpret.
It is easy to present.
Disadvantage:
It does not account for the time value of
money.
9. Present Value analysis is used for long-term
projects where it is difficult to compare
today’s cost with the benefits of tomorrow.
In this method cost and benefits are
calculated in terms of today’s value of
investment.
The present value analysis determines how
much money is invested now in order to
receive a given return in some year’s time.
10. The present value can be computed through the
formula:
F=P(1+i)^n
So, P=F/(1+i)^n
E.g. The present value of Rs1500(which is
estimated future value) invested at 10% interest
at the end of fourth year is:
P=1500/(1+.10)^4
=1500/1.61=Rs 1027.39
i.e. if we invest Rs1027.39 today at 10% interest,
we can expect to have Rs1500 in four years.
11. Year Estimated Present Cumulative
future vale value present
value of
benefits
1 Rs 1500 Rs 1363.63 Rs 1363.63
2 Rs 1500 Rs 1239.67 Rs 2603.30
3 Rs 1500 Rs 1127.82 Rs 3731.12
4 Rs 1500 Rs 1027.39 Rs 4758.51
It shows that present value of a stream of estimated
future values of Rs. 1500 each for the next 4 years
after discounting for 10% is Rs. 4758.51
12. Advantages:
It is easy to calculate.
It equates different investment opportunities
with various costs and benefits and discount
rates.
It accounts for time value of money.
Disadvantage:
It is only a relative(not absolute) measure of a
project’s return on investment.
13. The present value analysis when carried out
for the net benefits is called NET PRESENT
VALUE(NPV).
Its equal to benefits minus costs. It is
expressed as percentage of the investment.
NET PRESENT VALUE(%)=BENEFITS-COSTS
14. Example:
Suppose a company invested Rs 3000 for a
microcomputer that yields a cumulative
benefit of Rs 4758.51. So, net present
value(gain) of Rs 1758.51.
The net present value is expressed as a
percentage of the investment. Therefore,
1758.51/3000=0.55=55%
15. Advantages:
It is relatively easy to calculate.
It accounts for time value of money.
Disadvantage:
It is only a relative(not absolute) measure of a
project’s return on investment.
16. When a project is started, costs are incurred
while the benefits take time to start.
Payback analysis is to determine how long it
will take for a project when the accumulated
benefits equal the benefits used.
Payback analysis defines the period required
to recover the money spent on a project. This
period is called the payback period. The
shorter the period ,the faster the benefits.
18. Advantage:
It is easy to calculate.
It has straightforward interpretation for
choice between two or more alternatives for
candidate system.
Disadvantages:
It is conservative economic measure applied
to one opportunity at a time.
It does not compare profitability of multiple
investment alternatives.
It does not allow for time value of money.
19. Break-even analysis is a technique which
compares the costs of using present and
candidate systems.
It is based on categorizing production costs
between those which are "variable" (costs that
change when the production output changes)
and those that are "fixed" (costs not directly
related to the volume of production).
20. Total variable and fixed costs are compared
with sales revenue in order to determine the
level of sales volume.
Sales value or production at which the
business makes neither a profit nor a loss is
known as the "break- even point".
21. It is a graphical representation of costs at
various levels of activity shown on the same
chart as the variation of income with the
same variation in activity.
The point at which neither profit nor loss is
made is known as the "break-even point" and
is represented on the chart below by the
intersection of the two lines.
22.
23. Advantage:
It is easy to understand.
Disadvantage:
It does not allow for time factor and
depreciation value of money.
24. Cash flow analysis deals with the timing and
amount of cash inflows/outflows from a firm
or an investment.
Cash flow analysis keeps tracks of
accumulated cost and revenues on regular
basis.
25. It is simply calculated by deducting the
operating cost from revenues created from
investment on a period-by-period basis and
then calculates the accumulated cost.
Cash flow =Revenue – operating Expenses
Accumulated Cash Flow=Cash Flow (month 1)
+ Cash Flow(month 2) +…+Cash Flow(month
n).
27. Advantage:
It combines benefits of both break-even and
payback method.
Disadvantages:
Ignores time value of money for limited time
period.
It does not take into account the probability
of the project.
Ignores behavioral implications of numbers in
the financial statement.
28. Once the evaluation of the project is
complete, actual results are compared against
standards or alternative investments.
The decision to adopt an alternative system
can be highly subjective, depending on the
analyst’s or user’s confidence in the
estimated cost and benefit values and the
magnitude of the investment.
29. 1. Net Benefit Analysis is calculated through
(a) Total cost –Total benefit
(b) Total benefit – Total cost
(c) Total cost + Total benefit
2. What is “break-even” point?
(a) Profit with loss.
(b) No profit but loss
(c) Profit but no loss
(d) Neither profit nor loss
30. 3. What is the formula for calculating future
value of a project?
(a) F=P(1+i)^n
(b) F=P/(1+i)^n
(c) F=P^n/(1+i)
(d) None of the above.
4. Tangible cost can be
(a) Measured
(b) Identified
(c) All of above
31. 5. “Cost of breakdown of an online system
during banking hours will cost the bank to
lose deposit” is an example of
(a) Tangible cost
(b) Indirect cost
(c) Variable cost
(d) Intangible cost
