What is Cost–Benefit Analysis and how does it help evaluate infrastructure projects?
Understanding cost-benefit analysis
Last updated 26 July 2019
With recent AHURI research examining whether social housing should be considered as infrastructure, it is important to understand the decision making process that applies to ‘standard’ infrastructure projects. When resources are allocated to developing or building new infrastructure, or maintaining existing infrastructure, governments have to know which projects are the most effective and efficient use of their monies.
Cost–Benefit Analysis and infrastructure projects
For many infrastructure projects, policy makers rely on business case appraisals that incorporate Cost-benefit analysis (CBA). A business case ‘articulates the impetus and business need for the project’, together with an assessment of the project’s strategic fit; economic, environmental and social benefits; feasibility; costs and affordability; and a plan for delivery, all with regard to potential risks. A CBA seeks to estimate the economic costs and benefits of a proposal over its life.
For a project or policy to qualify as positive on cost-benefit grounds, its total social benefits must exceed its total social costs, typically measured by net present value (NPV)—‘the difference between the present value of cash inflows and the present value of cash outflows over a period of time’ and the benefit-cost ratio (BCR) which is calculated by dividing the proposed total benefits of a project by the proposed total costs of the project.
A positive NPV and a BCR of greater than 1 indicates that a project is of net benefit to society.
The Handbook of Cost-benefit analysis used within the Australian Government distinguishes financial evaluation (‘What is the net benefit to the individual organisation?’) from Cost-benefit analysis (‘What is the net benefit to the community as a whole?’).
In essence, CBA can reduce the uncertainty in decision-making by clarifying the quantifiable costs and benefits, and it can form the basis for considering the qualitative benefits of alternatives.
However, CBA is not standardised and procedural in nature, with process and outcome determined to some extent by the professional judgement of individual analysts and also by decisions about which development options are to be considered (which may not focus on making ‘better use of existing infrastructure through technology and data’). CBA is often just one of many inputs into infrastructure decisions, as indicated by examples of decisions to proceed with projects that have a benefit-cost ratio of less than one (such that their costs exceed their benefits) or projects that are committed to before a business case or appraisal is undertaken.