Cost-Benefit Analysis · B/C Ratio
Cost-Benefit Analysis (B/C Ratio)
What is cost-benefit analysis?
- Convert benefits and costs into money and compare them
- A B/C above 1 meets the minimum feasibility threshold
- Results shift with the discount rate and assumptions
What cost-benefit analysis really changes is not the conclusion but the language in the meeting room. Discussions that used to run on lines like “the field keeps asking for it” or “our competitors already do it” become a debate over assumptions the moment a benefit table and discount rate land on one page. Even opponents have to ask not “let’s not do it,” but “what is your basis for assuming the savings hold after year 3?” It makes people argue over the evidence, not the conclusion, and that is the method’s real value. So even after the calculation is done, keep the benefit table and the list of assumptions.
In practice, B/C is never read alone. Because it is a ratio, it hides project scale. A small project with KRW 200 million (≈ US$149,600) invested and KRW 300 million (≈ US$224,500) in benefits scores higher than a large one with KRW 20 billion (≈ US$14,963,300) invested and KRW 26 billion (≈ US$19,452,300) in benefits, so the standard practice is to read it alongside net present value (NPV). B/C is useful for ranking several projects under a fixed budget, and NPV when scale matters. The discount rate also depends on context. Public projects use a social discount rate set by regulation, while private companies use their cost of equity or WACC, and the debate usually lands in the 8–12% range. You also need to screen out double counting of benefits. Listing labor savings and productivity gains separately counts the same effect twice.
The most common failure is using B/C as an approval document instead of a decision tool. When an order comes down to “just get it above 1.0” for an investment that has already been decided, the analyst lowers the discount rate and stretches the benefit period from 7 to 10 years to make the numbers work. A 1.2 built by working backward will inevitably fall apart at execution. Labor-cost savings are especially risky. If the books say the cost of 3 people disappears but those people were actually reassigned to another line, not a single won has left the company’s bank account, yet the benefit has been booked. Verify benefits against cash flow, not the ledger, and don’t force items that can’t be converted into money. Leave them as “not quantifiable” so the decision-maker can judge them directly.
John KimInstructor John Kim, author of “B2B Marketing Design” and CEO of Nanum Consulting
Jinho DanAccounting instructor who makes financial statements, costing, and tax easy to understandIt became a formal method for evaluating public projects when the 1936 U.S. Flood Control Act required a project’s benefits to exceed its costs. It has since become a standard tool in feasibility studies and policy evaluation worldwide.
Company A, an auto parts maker with 320 employees and KRW 84 billion (≈ US$62,846,000) in annual revenue, spent six weeks deciding whether to invest KRW 2.4 billion (≈ US$1,795,600) in automating its packaging and inspection line. The production division argued, 'We can’t find workers, so we have to do it.' The finance team countered that a company with KRW 4.1 billion (≈ US$3,067,500) in operating profit the previous year can’t approve a single KRW 2.4 billion (≈ US$1,795,600) investment on instinct. (Hypothetical example)
- When Kim in finance re-sorted the benefit items into those that 'show up in the bank account' and those that don’t, three of the production division’s eight lines turned out to be the same effect counted twice.
- For the defect-reduction benefit, they used the actual prior-year claims and returns figure of KRW 420 million (≈ US$314,200) instead of an estimate. They left out the delivery-time benefit altogether because they had no solid basis for it, and noted it in a footnote as 'not quantifiable'.
- Using a 9% WACC as the discount rate and converting 7 years of cash flows to present value gave benefits of KRW 3.1 billion (≈ US$2,319,300) and costs of KRW 2.4 (≈ US$1) billion, for a B/C of 1.29.
- In the sensitivity analysis, removing the labor savings of three workers flipped B/C to 0.94. Then the plant manager said, 'We were going to move those three to the assembly line anyway,' and the premise collapsed.
- Instead of cutting headcount, the team redesigned the plan to eliminate the night shift, which actually cut outsourced packaging costs by KRW 240 million (≈ US$179,600) a year. They recalculated B/C at 1.18 and passed the investment review on the first try. The following year, outsourced packaging costs fell by KRW 210 million (≈ US$157,100) from the prior year.