Using iSIKHNAS for Budget Advocacy

3.5 Cost-benefit analysis

Objectives for this session

• At the end of this session you should be able to:– Describe the meaning of net present value,

benefit-cost ratio and internal rate of return– Interpret the results of a cost-benefit analysis– Implement a simple cost-benefit analysis

Role of economic analysis

• Economic value (benefit) is only one factor in making decision about a proposed program

• May be other reasons to go ahead with uneconomic program – For example public health concerns such as for Rabies

• Or to not go ahead with program with a high NPV or benefit-cost ratio– For example political reasons, financial reasons (lack of

funds), other priorities more important• Decision maker will consider all of these factors to make

a decision

What is a cost-benefit analysis?

• Compares costs and benefits of a program over multiple years

• Takes account of fact that money spent or received in the future is worth less than money spent/received today – why?

• All costs and benefits discounted (depreciated) to current year value for comparison = Present value

• Discount (depreciation) rate similar to interest that would be earned if money was invested

• Usually for:– larger and more complicated programs– Programs that run over multiple years (5 or 10, up

to 20 years)– Programs where costs are higher at the start and

benefits higher at the end

Inputs

• Costs of the program– Fixed costs

• capital equipment, • staff, • Vehicles• Office rent. electricity

– Variable costs • Surveillance costs, • control costs, • per diems, travel

• Need to be calculated separately for each year of the program

• Benefits– Savings due to reduced level of disease• Lower mortality• Lower morbidity• Reduced treatment costs

– Losses from disease without program – losses with program

• Need to be calculated separately for each year of the program

Outputs

• Net Present Value (NPV): = Overall value of all of the program in today’s $= Present value of benefits – present value of costs– Benefits and costs discounted by the “discount rate”

to provide values in today’s $– NPV >0 program has an overall benefit– NPV <0 program not economic – Costs greater than

benefits– The larger the difference the greater the value of

the program

• Benefit-cost ratio:= Present value of benefits / present value of costs– > 1 means a program is worth doing (benefits

greater than costs)– < 1means not economically worthwhile (costs

exceed benefits)

• Internal rate of return– The discount rate required for Net Present Value =

0 (or Benefit-Cost Ratio = 1) – This is the interest rate (return) you would need to

get to be worth investing elsewhere

Discussion and questions?

NPV example• Open spreadsheet Net present value calculations.xlsx worksheet

NPV calculations• Work through calculations to see how the NPV function

calculates the discounted value of future benefits.• Variable benefit received for each of next 10 years• Each annual benefit is discounted back to a current value

according to the discount rate• Sum of discounted values for all amounts = value from NPV

function• The more years until the benefit is received the less it is worth

today• Works the same for costs

IRR example

• Open spreadsheet Net present value calculations.xlsx worksheet IRR calculations

• Work through calculations to see how the IRR function calculates the discount rate required to make NPV = 0.

• Variable net return (benefits-costs) received for each of next 10 years

• Some years return is negative (spend more than the benefit gained)

• Each annual value is discounted back to a current value according to the discount rate and rate is calculated so that NPV = 0

Exercise

• Open and work through spreadsheet – cost-benefit analysis.xlsx

• This is:– Brucellosis in dairy cattle– Losing calves every year due to abortions– Proposing a vaccination program to control the

disease– Is the program going to be economic (profitable)

Proposed program

• Vaccinate all cows in first year then only replacement heifers

• Initial cost (first year only) for – cold-chain, – whole herd vaccination and– staff training

• Ongoing cost (every year after first year) for – annual vaccination of replacements– Extra feed and treatments for additional calves– Other costs– Additional staff costs (salary and operational expenses)

Benefits

• Extra calves born and sold• Other benefits – extra milk sold• Benefits delayed because: – extra calves born in second year – sold in third and later years

Calculation

• Calculate:– Costs and benefits calculated over 20 years– Discounted (present) value of all costs– Discounted (present) value of all benefits– Calculate

• Net present value• Benefit-cost ratio• Internal rate of return

• The spreadsheet will do this for you once you enter the values

Exercise

• Work through spreadsheet together (on screen) or individually– Enter values in the orange cells– Try alternative values and see what effect they

have, for example:• Lower calf value?• Double the cost of vaccination?• Increased initial costs

– Look at formulae to see how the calculations work

Discussion and questions?

• Show completed model on-screen– Do the results make sense?– How do you interpret the results?– Is the program profitable with the values used?– What impact do changes to input values make:• Calf value?• Cost of vaccination?• Staff costs?

Example (if required)

• There is a worked example in 3.5 cost-benefit analysis example.xlsx

• If required, open this and look at input values and results

• Note: input values may not all be realistic• See results on next slide and discuss

Project costs Total discountedTotal (no discount) Year 1 Year 2 Year 3

Investments in cold chain and training (year 1 only) 70 70 70 Initial vaccination (all cows) (year 1 only) 5,000 5,000 5,000 Annual Vaccination 11,273 12,000 1,500 1,500 1,500Ongoing variable costs (salaries, operating) 5,636 6,000 750 750 750Feed for additional survival of calves? 5,805 6,237 891 891Total costs 27,784 29,307 7,320 3,141 3,141

Project benefitsCash from additional calves sold 61,326 65,934 0 10,989Other benefits such as cash from extra milk 19,546 21,000 3,000 3,000Total benefits 80,871 86,934 3,000 13,989

• Year 1 expenses high and no return• Year 2 expenses only slightly higher than benefits• From year 3 on Benefits exceed costs

Report back and discuss• Project is economically worthwhile• Results below for example analysis• Net Present Value (benefit) = IDR 53 billion• Discounted benefits 2.9 times the discounted costs• IRR = 0.8 means need 80% return to be better off investing

elsewhere

Net Present Value (Benefits – Costs in millions) 53,087

Benefit Cost Ratio (Return on Investment) 2.911

Internal Rate of Return 0.805

Final discussion

• Any final questions or comments?

Session summary

• Cost-benefit analysis used for larger projects extending over multiple years

• Costs and benefits estimated for each year of the project

• Values then discounted back to calculate a present value for total costs and present value for total benefits

• Result summarised as:– Net Present Value– Benefit-cost ratio– Internal rate of return