Cost Benefit Analysis

# Decision Making Techniques

- Break Even Analysis
- Differential Cost Analysis
- Cost Estimation
- With probabilities and sensitivity analysis
- With learning curve

# Break Even Analysis

- this technique uses projections of costs, revenues, contributions, and appropriations to determine the level of operation where total costs are equal to total revenues.
- It is called break even because the point of intersection between total cost and total revenue is the break even point because there is neither a loss nor a profit.
- Formula for break even point:
- break even point = fixed cost dollars/selling price (per unit)-variable cost
- or break even point = fixed cost dollars/contribution margin per unit
- Example of selling book bags to patrons
- Cost from supplier is $12
- Library will purchase 300 bags, nonreturnable
- Library will sell them for $15 each.
- How many to sell to break even
- =$12 x 300/$15 = 240 bags
- Limitations:
- distinguishing between fixed and variable costs
- fixed costs and time period under analysis; fixed costs may not remain constant over the long term

# Differential Cost Analysis

- Like Break Even, uses projected cost information to make decisions
- Unlike Break Even, manager is only concerned with costs that change when faced with making a choice between two alternatives
- Usually with short term projects, so present value calculations not relevant
- Only cash costs between alternatives considered
- Both fixed and variable costs can change between alternatives
- Data are not “hard” data but projections developed by managers and vendors
- Examples

- whether to develop a new asset within the library or purchase it from an outside vendor
- replacement of equipment

# Cost Estimation

- With Probabilities and Sensitivity Analysis
- Subjective probability – estimated by individual manager
- Empirical probability – calculated through sampling or count of activities; probability then calculated based on the frequency of past occurrence of these counted activities
- Example is selling library T shirts in different sizes and estimating how many of each size would be needed.

- With Learning Curve – based on pilot of how long it takes an employee to carry out a task
- Assumes that first time you carry out a task you are inefficient
- As you continue to perform it you discover efficiencies and short cuts
- Several iterations are measured and calculation is made to determine how long it will take to reach an expected standard rate of performing a task.
- The learning curve shows the relationship between the amount of time required to complete a task and the cumulative amount of items that are produced. It is a measure of efficiency.
- Most directly applicable to technical type activities such as cataloging, maintaining the catalog, processing digital files.
- The learning curve allows a manager to determine how many hours it should take to complete a repetitive activity.
- Caveat: Always clarify whether you are dealing with an estimate or “hard data.” If an estimate, always find out how it was determined.

page revision: 2, last edited: 17 Dec 2010 05:26