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Cost-benefit analysis (CBA), sometimes called benefit costs analysis (BCA), is a systematic approach to calculating and comparing the benefits and costs of a course of action in a given situation. The goal of CBA is to determine which option returns the optimal ratio of benefits to savings. It may be used to compare potential courses of action or simply to evaluate the desirability of a single decision, project, or policy. Common areas of application include commercial transactions, functional business decisions, policy decisions (especially government policy), or project investments.
Broadly, CBA has two main applications:
CBA is related to cost-effectiveness analysis. In CBA, benefits and costs are expressed in monetary terms, and are adjusted for the time value of money, so that all flows of benefits and flows of project costs over time are expressed on a common basis in terms of their net present value, regardless of whether they are incurred at different points in time.
Other closely related formal techniques include: cost-effectiveness analysis, cost-utility analysis, risk-benefit analysis, economic impact analysis, fiscal impact analysis, and social return on investment (SROI) analysis.
Cost-benefit analysis is often used by organizations to appraise the desirability of a given policy. It is an analysis of the expected balance of benefits and costs, including an account of any alternatives and of the status quo. CBA helps predict whether the benefits of a policy outweigh its costs, and by how much, relative to other alternatives. This allows for ranking of alternate policies in terms of cost-benefit ratio. Generally, accurate cost-benefit analysis identifies choices that increase welfare from a utilitarian perspective. Assuming an accurate CBA, changing the status quo by implementing the alternative with the lowest cost-benefit ratio can improve Pareto efficiency. While CBA can offer an informed estimate of the best alternative, perfect appraisal of all present and future costs and benefits is difficult, and perfection in terms of economic efficiency and social welfare is not guaranteed.
The following is a list of steps that compose a generic cost-benefit analysis.
A similar breakdown is employed in the environmental analysis of total economic value. Both costs and benefits can be diverse. Financial costs tend to be most thoroughly represented in cost-benefit analyses due to relatively abundant market data. The net benefits of a project may incorporate cost savings or public willingness to pay compensation (implying the public has no legal right to the benefits of the policy) or willingness to accept compensation (implying the public has a right to the benefits of the policy) for the welfare change resulting from the policy. The guiding principle of evaluating benefits is to list all (categories of) parties affected by an intervention and add the (positive or negative) value, usually monetary, that they ascribe to its effect on their welfare.
The actual compensation an individual would require to have their welfare unchanged by a policy is inexact at best. Surveys (stated preference techniques) or market behavior (revealed preference techniques) are often used to estimate the compensation associated with a policy. Stated preference technique is a direct way of assessing willingness to pay. Because it involves asking people directly to indicate their willingness to pay for some environmental feature, or some outcome that is closely connected to the state of the environment. However, survey respondents often have strong incentives to misreport their true preferences, and market behavior does not provide any information about important non-market welfare impacts. Revealed preference technique is an indirect approach to individual willingness to pay. People make market choices among certain items that have different characteristics related to the environment, revealing the value they place on these environmental factors. 
One controversy is valuing a human life, e.g. when assessing road safety measures or life-saving medicines. However, this can sometimes be avoided by using the related technique of cost-utility analysis, in which benefits are expressed in non-monetary units such as quality-adjusted life years. For example, road safety can be measured in terms of cost per life saved, without formally placing a financial value on the life. However, such non-monetary metrics have limited usefulness for evaluating policies with substantially different outcomes. Additionally, many other benefits may accrue from the policy, and metrics such as 'cost per life saved' may lead to a substantially different ranking of alternatives than traditional cost-benefit analysis. See also: Statistical murder
Another controversy is valuing the environment, which in the 21st century is typically assessed by valuing ecosystem services to humans, such as air and water quality and pollution. Monetary values may also be assigned to other intangible effects such as business reputation, market penetration, or long-term enterprise strategy alignment.
CBA generally attempts to put all relevant costs and benefits on a common temporal footing using time value of money calculations. This is often done by converting the future expected streams of costs and benefits into a present value amount using a discount rate.
The selection of a discount rate for this calculation is subjective. A smaller rate values future generations equally with the current generation. Larger rates (e.g. a market rate of return) reflects humans' present-bias or hyperbolic discounting--valuing money that they will receive in the near future much more than money they will get in a distant period of time. Empirical studies suggest that people discount future benefits in a way similar to that described in these calculations. The choice makes a large difference in assessing interventions with long-term effects. One example of this issue is the equity premium puzzle, which suggests that long-term returns on equities may be higher than they should be, after controlling for risk and uncertainty. If so, market rates of return should not be used to determine the discount rate, as this would have the effect of undervaluing the distant future (e.g. climate change).
Risk associated with project outcomes is usually handled using probability theory. This can be factored into the discount rate (to have uncertainty increasing over time), but is usually considered separately. Particular consideration is often given to agents' risk aversion -- preferring a situation with less uncertainty to one with higher uncertainty, even if the latter has a higher expected return. In such a context, expected return calculations provide biased estimates of cost-benefits for a project, as they fail to account for differences in the degree of uncertainty.
Uncertainty in CBA parameters can be evaluated using a sensitivity analysis, which shows how results respond to parameter changes. Alternatively a more formal risk analysis can be undertaken using Monte Carlo simulations. However, even a low parameter uncertainty does not guarantee the success of a project.
The concept of CBA dates back to an 1848 article by Jules Dupuit and was formalized in subsequent works by Alfred Marshall. The Corps of Engineers initiated the use of CBA in the US, after the Federal Navigation Act of 1936 effectively required cost-benefit analysis for proposed federal waterway infrastructure. The Flood Control Act of 1939 was instrumental in establishing CBA as federal policy; it demanded that "the benefits to whomever they accrue [be] in excess of the estimated costs."
The application for broader public policy started from the work of Otto Eckstein, who in 1958 laid out a welfare economics foundation for CBA and its application for water resource development. Over the 1960s, CBA was applied in the US for water quality, recreation travel, and land conservation. During this period, the concept of option value was developed to represent the non-tangible value of preserving resources such as national parks.
CBA was later expanded to address both intangible and tangible benefits of public policies relating to mental illness, substance abuse, college education, and chemical waste policies. In the US, the National Environmental Policy Act of 1969 first required the application of CBA for regulatory programs, and since then, other governments have enacted similar rules. Government guidebooks for the application of CBA to public policies include the Canadian guide for regulatory analysis, Australian guide for regulation and finance, US guide for health care programs, and US guide for emergency management programs.
CBA application for transport investment started in the UK with the M1 motorway project, and was later applied on many projects including London Underground's Victoria line. Later, the New Approach to Appraisal (NATA) was introduced by the then Department for Transport, Environment and the Regions. This presented cost-benefit results and detailed environmental impact assessments in a balanced way. NATA was first applied to national road schemes in the 1998 Roads Review but subsequently rolled out to all transport modes. As of 2011, it was a cornerstone of transport appraisal in the UK, and it is maintained and developed by the Department for Transport.
The EU's 'Developing Harmonised European Approaches for Transport Costing and Project Assessment' (HEATCO) project, part of its Sixth Framework Programme, reviewed transport appraisal guidance across EU member states and found that significant differences exist between countries. HEATCO's aim was to develop guidelines to harmonise transport appraisal practice across the EU.
In the US, both federal and state transport departments commonly apply CBA, using a variety of available software tools including HERS, BCA.Net, StatBenCost, Cal-BC, and TREDIS. Guides are available from the Federal Highway Administration,Federal Aviation Administration,Minnesota Department of Transportation,California Department of Transportation (Caltrans), and the Transportation Research Board Transportation Economics Committee.
The increased usage of CBA in the US regulatory process is often associated with President Ronald Reagan's administration. Though the use of CBA in US policy making dates back many decades, Reagan's Executive Order 12291 mandated the use of CBA in the regulatory process. Reagan campaigned on a deregulation platform, and once he took office in 1981 quickly issued this EO, which vested the Office of Information and Regulatory Affairs (OIRA) with the authority to review agency regulations and required federal agencies to produce regulatory impact analyses when the annual impact could be estimated over $100M. Shortly thereafter, in the 1980s, academic and institutional critiques of CBA started to emerge. The three main criticisms were:
These criticisms continued through the 1990s under the Clinton administration. Clinton furthered the anti-regulatory environment through his Executive Order 12866. EO 12866 changed some of Reagan's language, requiring benefits to justify, rather than exceed costs, and added "reduction of discrimination or bias" as one of the benefits to be analyzed. Criticisms of aspects of CBA, including uncertainty valuations, discounting future values, and the calculation of risk, were used to argue that CBA should play no part in the regulatory process. The use of CBA in the regulatory process continues today under the Obama administration, though the debate over its practical and objective value continues. Some analysts oppose the use of CBA in policy making, while those in favor of its use favor improvements to the analysis and calculations.
The value of a cost-benefit analysis depends on the accuracy of the individual cost and benefit estimates. Comparative studies indicate that such estimates are often flawed, preventing improvements in Pareto and Kaldor-Hicks efficiency.  Causes of these inaccuracies include:
Interest groups may attempt to include or exclude significant costs from an analysis to influence the outcome.
In the case of the Ford Pinto (where, because of design flaws, the Pinto was liable to burst into flames in a rear-impact collision), the company's decision was not to issue a recall. Ford's cost-benefit analysis had estimated that based on the number of cars in use and the probable accident rate, deaths due to the design flaw would cost it about $49.5 million to settle wrongful death lawsuits versus recall costs of $137.5 million. However, Ford failed to consider the costs of the negative publicity that would result, which eventually forced a recall and damaged Ford's sales.
In health economics, some analysts think cost-benefit analysis can be an inadequate measure because willingness-to-pay methods of determining the value of human life can be influenced by income level. They support use of variants such as cost-utility analysis, QALY and DALY to analyze the effects of health policies.
For some environmental effects, cost-benefit analysis can be substituted with cost-effectiveness analysis. This is especially true when there is only one type of physical outcome that is sought, such as the reduction of energy use by increasing energy efficiency. Using cost-effectiveness analysis is less laborious and time-consuming as it does not involve the monetization of outcomes, which can be difficult in some cases.
In environmental and occupational health regulation, it has been argued that if modern cost-benefit analyses had been applied prospectively to decisions such as whether to mandate the removal of lead from gasoline, block the construction of two proposed dams just above and below the Grand Canyon on the Colorado River, and regulate workers' exposure to vinyl chloride, these measures would not have been implemented even though they are considered to be highly successful in retrospect. The Clean Air Act has been cited in retrospective studies as a case where benefits exceeded costs, but the knowledge of the benefits (attributable largely to the benefits of reducing particulate pollution) was not available until many years later.
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