Benefit-cost ratio

Benefit-Cost Ratio is a financial metric that is widely used in the fields of economics, business, and project management. It is a numerical expression of the cost-effectiveness of a project or proposal, calculated by dividing the projected benefits of a project by its anticipated costs.

Definition

The Benefit-Cost Ratio (BCR) is a ratio used in cost-benefit analysis to summarize the overall relationship between the relative costs and benefits of a proposed project. BCR can be calculated in terms of the present value of costs to the present value of benefits. The higher the BCR, the better the investment.

Calculation

The formula for calculating the Benefit-Cost Ratio is:

BCR = Total Expected Benefits / Total Expected Costs

Both the benefits and costs should be expressed in present value terms to account for the time value of money. This involves discounting future benefits and costs using an appropriate discount rate.

Interpretation

A BCR greater than 1.0 indicates that the project's benefits outweigh its costs, suggesting that the investment is a sound financial decision. Conversely, a BCR less than 1.0 suggests that the project's costs outweigh its benefits, indicating that the project may not be a wise investment. A BCR of exactly 1.0 indicates that the project's benefits are equal to its costs.

Limitations

While the Benefit-Cost Ratio is a useful tool, it has its limitations. It does not take into account the affordability of a project, the distribution of costs and benefits over time, or the project's risks and uncertainties. Furthermore, it assumes that all costs and benefits can be quantified and expressed in monetary terms, which is not always the case.

See also

• Cost-effectiveness analysis
• Net present value
• Internal rate of return
• Payback period