A cost-benefit analysis is a process of comparing the projected or estimated costs and benefits (or opportunities) associated with a project decision to determine whether it makes sense from a business perspective.
Generally speaking, cost-benefit analysis involves tallying up all costs of a project or decision and subtracting that amount from the total projected benefits of the project or decision.
The things to consider in the cost-benefit analysis:
- Payback period (PBP)
The payback period (PBP) is the time needed to recover a project investment, usually in months or years. The longer the PBP, the greater the risk.
- Return on Investment (ROI)
The return on investment (ROI) is the percentage return on an initial project investment. ROI is calculated by taking the projected average of all net benefits and dividing them by the initial project cost.
- Internal Rate of Return (IRR)
The internal rate of return (IRR) is the projected annual yield of project investment, incorporating both initial and ongoing costs. IRR is the estimated growth rate percentage that a given project is expected to attain.
- Net Present Value (NPV)
The net present value (NPV) is the future value of expected project benefits expressed in the value those benefits have at the time of investment. NPV takes into account current and future benefits, inflation, and factors in the yield that could be obtained through investing in financial instruments as opposed to a project.