Cost-Benefit Analysis
A systematic method of comparing the total expected costs and benefits of a decision to determine whether it creates net positive value.
What is Cost-Benefit Analysis?
Cost-benefit analysis (CBA) is a decision-making framework that quantifies and compares the total costs and total benefits of a project, policy, or investment to determine whether it should be pursued. When benefits exceed costs (positive net benefit), the decision creates value; when costs exceed benefits, it destroys value. In public policy, CBA converts all effects — including intangible social benefits like time savings, reduced pollution, and improved safety — into monetary terms using techniques like willingness-to-pay and social cost of carbon. In corporate settings, CBA is often formalized as Net Present Value (NPV) analysis, which discounts future cash flows to present value. A key challenge is estimating intangible or uncertain benefits and deciding on the appropriate discount rate. CBA is required by U.S. federal agencies for significant regulations under Executive Order 12866, which mandates that benefits must justify costs before new rules can be issued.
Example
A city evaluates building a new subway line costing $2 billion. Benefits include reduced traffic congestion ($400M/year), lower commuter time costs ($200M/year), reduced pollution ($100M/year), and economic development ($150M/year) = $850M/year total. Over a 30-year useful life discounted at 5%, the present value of benefits is approximately $13 billion — far exceeding the $2 billion cost. The positive cost-benefit ratio justifies the project.
Source: U.S. Office of Management and Budget — Circular A-4 Regulatory Analysis