Term Paper: Cost Benefit Analysis

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¶ … benefit Analysis

Cost benefit analysis is a systematic process of comparing and calculating costs and benefits of a project. The benefit of cost-benefit analysis is to determine the justification of a project in order to enhance a sound investment decision. The cost-benefit analysis also assists in comparing projects based on their expected costs and benefits and determines whether the benefits of a project outweigh the costs. Discounting is a technique to compare the present value of a project against the benefits received in different periods in a project lifecycle. (Richard, Zerbe, & Joseph 2010).

Objective of this report is to use a cost-benefit analysis to evaluate the proposed project of National Guard Armory of the State of Massachusetts.

Project Overview

The State of Massachusetts attempts to replace the National Guard armory that is rapidly reaching its service life. According to the Department of Military Affairs, the special maintenance will be $275,000 annually while the rehabilitation of facility would cost $4,000,000, which would extend the armory's service life by 15 years. Based on the information provided, the report calculates the Discount Factor for each year using 4% discount rate for 15 years.

Calculation of Discount Factor of the Project

A discount factor calculates the value that a future sum of money will worth presently. The discount factor of each year of the project is as follows:

Year

Interest Rates

Discount Factor

0

4%

1

1

4%

0.9615

2

4%

0.9246

3

4%

0.8890

4

4%

0.8548

5

4%

0.8219

6

4%

0.7903

7

4%

0.7599

8

4%

0.7307

9

4%

0.7026

10

4%

0.6756

11

4%

0.6496

12

4%

0.6246

13

4%

0.6006

14

4%

0.5775

15

4%

0.5553

Calculation of the Annual Present Value Cost of Special Maintenance (15 years)

The paper calculates the annual present value costs of special maintenance of the project for 15 years to enhance greater understanding of the overall costs associated to the project. The total costs of special maintenance of the project for 15 years are $4,125,000 and the breakdown is as follows:

Year

Costs of Special Maintenance of Armory ($)

1

275,000

2

275,000

3

275,000

4

275,000

5

275,000

6

275,000

7

275,000

8

275,000

9

275,000

10

275,000

11

275,000

12

275,000

13

275,000

14

275,000

15

275,000

Total Costs of Special Maintenance for 15 years

=275,000x 15,

=$4,125,000

The costs of rehabilitation of the facility costs $4,000,000. Thus, the overall costs of the rehabilitation and maintenance of the project are as follows:

Total Costs to extend the life of the project for 15 years

Total Costs of Special Maintenance for 15 years

$4,125,000

Costs of the Rehabilitation

$4,000,000

Total Costs Invested

$8,125,000

However, the report estimates the potential delays that might occurs before completing the project. Perincherry and Wu (2012) develop a schedule delay cost model and reveal that one year of delay in a new construction project is equivalent of losing an average of 37 cents on every dollar invested in a project. Perincherry and Wu (2012) reveals that the six government constructions are estimated to costs approximately $6.0 Billion in 2011, which is an average of $1 billion per project. Due to the project delay, the estimated costs of the project are $7.5 Billion. The major factors leading to the increase in the costs of a project because of the delay is that there will be an increase in the costs of materials to be used for the project with the effect of inflation. (Richard, Zerbe, & Joseph 2010). Since the National Guard Armory project is a new project, the report will estimate that the Massachusetts will lose 37 cents on every dollar invested in the project in case the project is delayed for one year. Thus, this report assumes that the proposed project will be delayed for one year. The report will integrate the costs of delay in the final report of the costs-benefit analysis.

Calculating Discounted Benefits of Rehabilitating Armory

The report uses the discounting to calculate the benefits that the State Government is going to derive from the project. Discounting is a technique used to translate the costs and benefits of the present-day project values into the time value of money. The time value of money… [END OF PREVIEW]

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