ANALYSIS OF COSTS AND BENEFITS AS A METHOD OF ECONOMIC VALUATION AND DECISION-MAKING IN PROJECT MANAGEMENT

Abstract

The process of analyzing costs and results in order to make a decision whetheror not to accept a certain investment project includes: defining the project, determining and quantifying costs and expected results, choosing a discount rate, discounting costs and results, and comparing the present value of costs and results. The basis of the approach is the assessment of investment alternatives based on the consideration of all costs and results and giving priority to investment alternatives that would have no chance of being realized assuming that they are evaluated exclusively through the prism of the purely economic interests of individual economic entities. Determining and quantifying the costs of the considered investment project is a relatively simple procedure. Total costs consist of operating and investment costs. The first are the costs arising from its exploitation, while the second relate to the costs of planning and creating the project, procurement of basic assets, construction of machines, including labor costs. The result of the implementation of the investment project are the economic effects that are realized through its exploitation. However, the realized investment project can bring significant indirect effects both for the investor and for other economic entities (individuals and companies), as well as for society as a whole.
The validity of an investment decision in a cost-benefit analysis largely depends on the discount rate used in the analysis. The amount of the discount rate is influenced by a large number of factors, and there is still no established mathematical procedure for choosing its optimal size, which is understandable due to the fact that its choice is influenced by subjectivism and different preferences of analysts. A large or small discount rate depends on the overestimation or underestimation of the value of the project. The discount rate is equated with the interest rate only in conditions of a perfect capital market, or, when the amount of available capital is unlimited, and therefore the interest rate is unchanged. Due to the fact that the capital market is not perfect even in highly developed countries, it is logical to expect that the interest rate will change with the amount of loans given or received on the capital market.
The financial analysis considers the financial effects of the project, which are valued in the market through the monetary amounts of estimated costs and expected revenues of the company from the point of view of investors. The economic analysis determines the social value of the project. In other words, it gives an answer to the question of how the implementation of the project affects the entire society. Due to this fact, when evaluating and making decisions in capital budgeting, it is necessary to look at the overall effects that will be given by the specific project. A frequently used tool for identifying, measuring and comparing the costs and benefits of an investment project, program or government activity is the cost benefit analysis methodology. Looking at the total costs and benefits of an investment project, this concept goes a step further and quantifies all the consequences of the project - taking into account both tangible and intangible impacts.