Cost benefit analysis is a method of assessing the relationship from an economic point of view between the costs incurred and benefits accrued from making a certain investment. The costs and benefits may also include social and environmental costs and benefits, but must be able to be expressed as a monetary value. These metrics are then assessed and a result concluded using either the actual present value of the impact or the future value of the impact.
Simply put, CBA seeks to ascertain whether the benefits of an action will outweigh the costs.
The main disadvantage of CBA in monetizing social and environmental costs and benefits is the fact that these values are subjective and open to manipulation based on required outcomes. However if all values are fully substantiated and a uniform system of monetizing costs and benefits is followed, this disadvantage is greatly reduced if not diminished. The most efficient and effective cost-benefit analyses considers all costs and benefits including direct and indirect costs while also taking into account direct revenues and saved costs. It considers the interests of all stakeholders who will be affected by the project. The analysis must therefore be as thorough as possible to make sure all costs and benefits relating to all stakeholders are considered comprehensively enough.
To illustrate CBA, let’s take the example of an industrial company setting up an effluent treatment facility in their area.
What are the monetary costs:
1) Cost of building plant including cost of the land on which it will be built. If it is being built on land already owned by the company, we may include the money the company may lose as they change the use of the land. For example if it was being rented out to another company before this decision is made. However, for purposes of simplicity of this example, we will only include direct costs of building the plant
2) Costs of the labour that will be used to run the new effluent plant.
The above two costs are easily monetized and for financial modelling purposes can be easily ascertained.
What are the social and environmental costs:
3) Cost of by reducing municipal revenue when the company uses recycled water. Reduced municipal revenues may lead to reduced social expenditure by the municipality.
4) Environmental costs of the use of the land for effluent cleaning. In this case there will be negative effects on the local environment of putting up the plant here. These environmental effects must be monetised
The above costs are not easily monetized but by adopting a set of standards for monetizing costs that is the same for monetizing benefits, the benefits of the CBA model can be maximized
What are the monetary benefits:
1) Income from processing other industrial companies industrial waste
2) Costs reduced by not having to outsource effluent cleaning
3) Reduced cost of water bill as firm can now use recycled water for production and other purposes.
The above two benefits can be easily monetized and ascertained.
What are the social and environmental benefits that need to be monetized:
4) Reduced company sick leave days due to cleaner community water
5) Reduced poverty due to increased employment in community
6) Increased industrial activity due to effluent plant being created in the area. More companies are bound to invest in the area as they will not have to build their own effluent cleaning plants.
By using the above simplified example, we create a cost benefit analysis. We must make sure that the costs and benefits are all calculated at the same time. Therefore costs must be calculated to the present value at time zero being the beginning of the project, as well as benefits being calculated at time zero. The above example has however been simplified and does not include a comprehensive analysis of costs and benefits that will flow from the said project. It is merely used to illustrate the treatment of costs and benefits and their uniform measurement especially from an overall impact aspect in terms of financial, environmental and social perspective.
