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Cost-Benefit Analysis Critique

902 Words4 Pages

Question 1
Criticisms of cost benefits analysis
Accuracy
This concept relies heavily on the accuracy of costs and benefits estimates. The estimates are arrived at after inferring from past projects data which are more often different in size and duration. The analysis is also subject to confirmation bias and subjective impressions in a bid to influence the supporters of certain projects. The process of cost-benefit analysis have loopholes that allow for people to either exclude or include fundamental costs that may influence the overall decision on the projects.
Time
The cost-benefit analysis process is lengthy and may result in significant delays in making important decisions. The process involves assessing many projects with regards to their …show more content…

The project has the highest benefit cost ratio of 1.7 meaning that the project will have a benefit of 1.7 million for every 1 million of costs.
Limited funds
In a situation of limited funds, the projects are first ranked in descending order with regards to the benefits cost ratio.
B and C should first be undertaken. 60M-50M= 10 M
The remaining 10 M should be invested in A but only a fraction of it. I.e. 10M/50M=1/5
B and C and a 1/5 of project A.
Unlimited funds
Projects A, B, C, B and C should be undertaken when there are unlimited funds. Project E should be ignored as it has a negative benefit-cost ratio.
Question 3
A rental control law is used to set a rental ceiling above which renters cannot charge their tenants. Such laws have an impact in the market by shifting the demand and supply of rental houses. The law will limit the market from being a free market where prices are set by market …show more content…

Question 5
a. NPV
NPV= PV- initial cost
PV= annual amount [(1 - (1 / (1 + r) n)) / r]
PV= $0.1M [(1 - (1 / (1 + 0.07) 5)) / 0.07]
PV= $ 0.1M * 4.100= $ 0.41M
NPV=$410000-$407004= $ 2,996
b. The project should be undertaken because it has a positive NPV value
c. An increase in the inflation rate will result into a higher discount rate to compensate for the impact of the inflation.
i.e.
(1+money rate)= (1+real rate) + (1+ inflation rate)
1+n= (1+i) + (1+r)
Therefore the resultant discount rate, n= r + i + ri
d. Sensitivity analysis is appropriate in situations where there are additional information that affect the amount of variables significant to analysis of a project. This example has the issue of the inflation rate which automatically affects the discount rate and resultant NPV which is a deciding variable when choosing a

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