Cost-Benefit Analysis

Note: Scenario two is a separate calculation. Scenario two is not influenced by the results of Scenario 1.

In doing the following exercise, please refer to the discussionin pages 319-333 of Chapter 7 from Mikesell's FiscalAdministration on cost-benefit and cost-effectivenessanalysis. Cost-benefit analysis is a technique that assumes allcosts and benefits can have a dollar value attached to them. It isa tool and should not be used as the sole basis for decisionmaking. The result of a calculation is a ratio between costs andbenefits. After all other calculations have been made, the analysisneeds to conclude with the calculation of the ratio between costsand benefits. If the ratio costs exceed benefits, the projectadvice is to not accept the project and to consider accepting theproject if benefits exceed costs. Consider the following examplefrom the fictitious Swobodaville's efforts to build a CommunityWindmill Renewable Energy Project.

The following has been agreedupon:

Land is already owned. The price of a new is windmill is$150,000.

A minimum of 50 windmills are needed to achieve desiredefficiency compared to the current coal-burning method.

Staff training costs over three years when considering directcosts, including loss of productive hours while in training, willbe $55,000 for each of the 10 specialists to be hired.

The annual operating and maintenance costs of the machine in thethree-year period will be $35,000 per windmill.

The cost of shutting down a portion of the coal plant to achievethe same energy production as the windmills is $1,000,000.

Three full-time coal workers will lose their jobs as a result ofthe transition. Their hourly wage is $35 per hour and they work2,080 hours annually.

As a widely supported community project with an investment inevery aspect of the community's well being, quality of lifeexpected from reductions in pollution is considered in the costcalculation. The medical center that conducted an analysis hasconcluded that the value of increased life expectancy should beincluded as a benefit to the community. The quality of life of5,000 residents is expected to be increased by an average ofdollars over three years. The average benefit of a resident(including all men, women, and children) over a three-year periodis estimated to be $1,500.

The three-year savings on other pollution damage to buildingsand grounds, calculated by the Sierra Club, is$7,000,000.

Scenario 2 tasks:

Calculate the cost-benefit ratio.

Explain whether the ratio is positive ornegative.

If positive, explain if you would replace a portion ofthe coal-burning operation or the whole operation? Why or whynot?