PPA 502 – Program
Evaluation
Lecture 7 – Benefit-cost Analysis in
Program Evaluation
Benefit-cost and Costeffectiveness Analysis
 Benefit-cost analysis is an applied branch of
economics that attempts to assess service
programs by determining whether the total societal
welfare has increased (in aggregate more people
have been made better off) because of the project
or program.
 Steps.
– Determine the benefits of a proposed or existing
program and place a dollar value on those benefits.
– Calculate the total costs of the program.
– Compare the benefits and costs.
Benefit-cost and Costeffectiveness Analysis
 Simple steps pose real challenge, especially
estimating intangible benefits.
 Procedure still useful in uncovering
assumptions and estimating value of
intangibles.
Benefit-cost and Costeffectiveness Analysis
 Cost-effectiveness analysis.
– The major costing alternative to benefit-cost analysis.
• Relates the cost of a given alternative to specific measures of
program objectives.
– For example, dollar per life saved on various highway
safety programs.
– Often the first step in a benefit-cost analysis.
– Especially useful if analyst cannot quantify benefits,
but has fairly specific program objectives.
– Key problem: situation where there are multiple
benefits. Results often very subjective.
– 2nd key problem: does not produce a bottom line
number.
Benefit-cost and Costeffectiveness Analysis
 A private sector analogy.
– Benefit-cost analysis similar to financial analysis in
private sector.
• Should the firm have done the project at all, i.e., Is the project
producing a satisfactory rate of return?
• Public version: is the program a success, i.e., Has it improved
social welfare?
• What other options are there for the use of the firm’s
resources?
• Public version: should the program be continued when
weighed against alternative uses for the government’s funds.
Benefit-cost and Costeffectiveness Analysis
 A private sector analogy.
– Benefits and costs do not occur simultaneously
in either private or public sector.
• R&D costs, marketing, capital investment, training.
• Government not priced, thus benefits are more
broadly defined.
– Alternative uses of resources (opportunity
costs).
Benefit-cost and Costeffectiveness Analysis
 Benefit-cost illustration.
Costs
Year
R&D
Capital
O&M
Total
Benefits
1
$1500
$2000
$0
$3500
$0
2
500
2000
2000
4500
3500
3
2000
2500
4500
5500
4
2000
3000
5000
6500
5
2000
3500
5500
8500
$10000
$11000
$23000
$24000
Totals
Year
$2000
Benefit-Costs
Present Value, Benefits-Costs (10%)
1
($3500)
($3500)
2
(1000)
(909)
3
1000
826
4
1500
1127
5
3000
2049
$1000
($407)
Totals
Net Present Value @ 10% ($407)
Net Present Value @ 5%
219
Benefit-cost and Costeffectiveness Analysis
 Formula for net present value.
y2
y2
y3
y3
yx
yx
B

C
B

C
B

C
NPV  B y1  C y1 

 ... 
2
1 r
(1  r )
(1  r ) x1
 Formula sensitive to choice of rate of return.
 Could also use return on investment.
– Discount rate that would make the present value zero.
Benefit-cost and Costeffectiveness Analysis
 Continuing or not continuing the project.
Costs
Year
R&D
6
Capital
$500
O&M
Total
Benefits
$400
$4500
$5400
$9000
7
400
5000
5400
8500
8
400
6000
6400
8500
9
400
7500
7900
8000
10
400
8000
8400
7500
$2000
$31000
$33500
$41500
Totals
Year
$500
Benefit-Costs
Present Value, Benefits-Costs (10%)
6
$3600
3600
7
3100
2818
8
2100
1736
9
100
75
(900)
(615)
$8000
$7614
10
Totals
Net Present Value @ 10% $7614
Net Present Value @ 5%
$7803
Benefit-cost and Costeffectiveness Analysis
 Total versus marginal benefits and costs.
– When considering the overall profitability of a project,
an agency will consider the total costs involved in
getting the project started through its operation’s cycle.
– But at any point in time, when an agency is continuing
or discontinuing a project or program, it only considers
the marginal costs or benefits.
– Definitions.
• Marginal cost: incremental cost of producing one more unit of
output.
• Marginal benefit: incremental benefit of that one unit of output.
– Public sector usually does not do it on the basis of a
single unit, but what are the benefits being generated
now versus the costs now?
Benefit-cost and Costeffectiveness Analysis
 Public-private sector differences and
similarities.
– Similarities – alternative uses for funds, onetime costs, recurring costs, land, labor, capital.
– Differences.
• Distributional considerations.
• Spillovers.
Framework for Analysis
Benefit
Indicator
Measure
Dollar value
Assumptions
Indicator
Measure
Dollar value
Assumptions
Real
Direct
Tangible
Intangible
Indirect
Tangible
Intangible
Cost
Real
Direct
Tangible
Intangible
Indirect
Tangible
Intangible
Transfers
Framework for Analysis
 Real benefits and costs versus transfers.
– Real: net gains and losses to society.
– Transfers: merely alter the distribution of
resources in society.
Framework for Analysis
 Direct and indirect benefits and costs.
– Direct costs and benefits are closely related to
the primary objectives of the project.
• Direct costs – personnel, facilities, equipment,
material, project administration.
– Indirect costs and benefits are byproducts,
multipliers, spillovers, or investment effects.
• Indirect costs are unintended costs that result from
government action.
• Indirect benefits might include benefits of space
exploration.
Framework for Analysis
 Tangible and intangible benefits and costs.
– Tangible benefits and costs can be converted
readily into dollar figures.
– Intangible benefits and costs are those things
that cannot be directly assigned an explicit
price.
 Determining the geographic scope of
analysis.
– Spillover effects may determine true
geographic jurisdiction.
Framework for Analysis
(Agricultural Dam Example)
Real Benefits
Nature of Benefit/Cost
Direct
Tangible
Increased farm output
New supply of water
Intangible
Maintaining family farms
Indirect
Tangible
Reduced soil erosion
Intangible
Preservation of rural society
Real Costs
Direct
Tangible
Construction material, labor, operations and maintenance, direct program supervision by agency
Intangible
Loss of recreational value of land or river
Indirect
Tangible
Administrative overhead of government
Diversion of water and its effects
Increased salinity
Intangible
Loss of wilderness area
Transfers
Relative improvement of profit for farm implement industry
General taxpayers may be subsidizing farmers.
Measuring Benefits
 Evaluation problem difficult for government
because of multiple benefits and
intangibles.
Measuring Benefits
 Sources of data.
– Existing records and statistics kept by agency.
– Feedback from clients.
– Ratings by trained observers.
– Experience of other governments or private or
nonprofit corporations.
– Special data gathering.
 Whenever possible analyst should use
market value or willingness to pay.
Measuring Benefits
 Valuing benefits.
– Cost savings.
– Time saved.
– Lives saved.
– Increased productivity or wages.
– Recreational benefits.
– Land values.
– Alternatives to market prices.
Measuring Costs
 Cost categories.
– One-time, fixed, or up-front costs.
– Ongoing investment costs.
– Recurring costs.
– Compliance costs.
– Mitigation measures.
Measuring Costs
 Valuing indirect costs.
– Flat overhead figure.
• Does the project actually costs increased administrative
burden?
–
–
–
–
Costs to the private sector.
Valuing the use of capital.
Valuing the damage effects of government programs.
Other cost issues.
• Sunk costs.
• Interest costs.
Analysis of Benefits and Costs
 Framework.
– Retrospective.
– Snapshot.
– Prospective.
Analysis of Benefits and Costs
 Importance of using present value.
– Choice of an appropriate discount rate.
• Private sector rate.
• Low social discount rate.
• Long-term treasury bill rates.
– Adjustment for inflation.
Analysis of Benefits and Costs
 Presenting the results.
– Net present value (B-C).
– Benefit cost ratio (B/C).
– Return on investment (discount rate to reduce
present value to zero).
 Appropriate perspective.
– Costs and benefits vary across stakeholders.
– May conduct analyses from several
perspectives.
Analysis of Benefits and Costs
 Sensitivity analysis.
– Use spreadsheet analysis to vary the assumptions.
 Intangibles.
– Relate intangibles to dollar results: if there are net
costs, do the intangible benefits overcome the deficit?
 Particular problems.
– Equity concerns (weighting of values).
– Multiple causation and co-production problems.