1. EVAL 6970: Cost Analysis for Evaluation Dr. Chris L. S. Coryn Nick Saxton Fall 2014

2. Agenda Cost-benefit analysis Activity

3. Cost-benefit analysis

4. “What is the value of a graduate education?”

5. The concept of benefits Many, but not all, benefits can be expressed in monetary units (e.g., lifetime earnings) Maximum ‘willingness-to-pay’ (WTP) is one means for expressing benefits in monetary units—though subject to many validity concerns When monetizing benefits, benefits for all relevant constituencies should be considered

6. Methods of valuing benefits 1.Estimate benefits from experimental, quasi-experimental, or correlational designs (relative to alternatives/controls) 2.Estimate benefits using ‘contingent valuation’ (surveys designed to elicit WTP) 3.‘Observed behavior’ (based on actual economic decisions rather than reported WTP)

7. Benefits (+) and Costs (-) From the Perspective of Program ParticipantsOther Members of Society Total Benefits Earnings gained +0+ Reduced costs of nonexperimental services 0++ Transfers Reduced welfare benefits -+0 Wage subsidies +-0 Costs Operational program costs 0-- Forgone leisure and home production -0- Net benefits +/-

8. Discounting benefits Premised on the same rationale as that used for cost-effectiveness analysis Essentially, early investments accrue greater financial benefits than later investments – Money invested earlier is of greater ‘value’ than money invested later

9. Analyzing the distribution of benefits As with cost-effectiveness analysis, benefits should be (if appropriate) disaggregated over relevant subgroups If necessary and appropriate, benefit-cost ratios should be estimated (1) overall and (2) for each subgroup

10. Combining costs and benefits Compare the benefits of each alternative to its associated costs – Nearly always requires ‘discounting’ as benefits and costs occur over time (the sum of discounted benefits and discounted costs) I prefer using the benefit-cost ratio (BCR) and net benefits (NB) methods to the internal rate of return (IRR), which has many practical limitations

11. The formula for ‘discounting’ benefits (B) and costs (C) are presented on page 176

12. BenefitsCosts Year 1 $0$300 Year 2 $150$0 Year 3 $150$0 Year 4 $150$0 Year 5 $150$0 Here, assuming a discount rate of 5%, the discounted sum of benefits = $531.89 (see formula, calculations, and example on page 176) Costs, however, are not discounted as they occur only in the first year and = $300

13. Note that ‘discounting’ is not necessary in the first year, or instance, of estimating either costs or benefits as one part of the term in the denominator is always = 0 (therefore, use the actual costs and actual benefits) This will be important in the ‘Exercise’ later

14. From these data, the benefit-cost ratio (BCR) is: BCR = B/C or BCR = $531.89/$300.00 = $1.77

15. Expressed as net benefits (NB), the sum of benefits are: NB = B - C or NB = $531.89 - $300.00 = $251.89

16. Activity

17. Download the Excel file “Cost-Benefit Data Set” from the course website – Estimate the benefit (B), cost (C), benefit-cost ratio (BCR), and net benefit (NB), for each alternative using discount rates of 3%, 5%, and 10% – Interpret the results