Cost-benefit analysis (CBA) is a method for judging whether a project, policy or investment is worthwhile by listing its expected costs and benefits, expressing them in money terms and comparing their present values. Governments use it to appraise roads, health programs and regulations; businesses use similar tools to rank investments; and development banks use it to decide which loans to make.
The method rests on opportunity cost: resources used for one project cannot be used elsewhere, so a project should go ahead only if society gains more than it gives up. It differs from a company's purely financial appraisal because it tries to count effects that markets do not price, such as pollution, travel time saved or lives protected. Related tools include cost-effectiveness analysis, which finds the cheapest way to reach a fixed goal, and multi-criteria analysis, which scores options without converting everything into money.
Cost-benefit analysis in plain terms
Think about whether to fit insulation in your loft. It costs money now, but it cuts heating bills every winter for years. You would add up the savings, remember that money saved far in the future is worth less than money today, and see if the total beats the price. If it does, the insulation pays.
A government does the same for a new bridge, only with more items on the list: building costs, maintenance, time saved by drivers, fewer accidents, extra noise for neighbors. The hard part is not the adding up but agreeing what each item is worth.
How the calculation works
The core test is the net present value of benefits minus costs over the project's life:
- and are the benefits and costs in year .
- is the discount rate, written as a decimal.
- is the final year of the appraisal period.
A positive net present value means the project adds value. Analysts often also report the benefit-cost ratio, the present value of benefits divided by the present value of costs. Suppose a town can build a cycle path for $100,000 today that yields $30,000 a year in health and travel-time benefits for four years. At a 5% discount rate the benefits are worth about $106,400 today, so the NPV is about $6,400 and the benefit-cost ratio about 1.06. At 10% the benefits fall to about $95,100 and the project fails the test. The result can turn on the discount rate, which is why the time value of money sits at the heart of every appraisal.
Valuing what has no price
Many benefits are not bought and sold. Analysts estimate them through market evidence, such as higher house prices near parks, or through surveys asking what people would pay. Typical items include travel time, injuries avoided, clean air and the "value of a statistical life", the amount people collectively pay for small reductions in the risk of death. Damage from an externality such as carbon emissions is often valued with a social cost of carbon, which links CBA to the design of a carbon tax or a Pigouvian tax. Public goods such as flood defenses, which benefit everyone at once, are a common subject because markets undersupply them.
History and official use
French engineer Jules Dupuit set out the logic in 1844 when he asked how to measure the usefulness of public works such as bridges. The US Flood Control Act of 1936 required that the benefits of federal flood projects, "to whomsoever they may accrue", exceed their costs. President Reagan's Executive Order 12291 (1981) and President Clinton's Executive Order 12866 (1993) required analysis of major federal regulations, guided by the Office of Management and Budget's Circular A-4. The 2003 version of A-4 asked agencies to use discount rates of 3% and 7%; a 2023 revision lowered the default to 2%, but it was rescinded in early 2025 and the 2003 version reinstated.
In the UK, HM Treasury's Green Book guides appraisal of all central government spending. Its standard social discount rate was 3.5% for the first 30 years from 2003; in September 2026 the government accepted a review recommendation to cut it to 3.0% (with 2.5% for years 31 to 75 and 2.25% for years 76 to 125), confirmed in HM Treasury's October 2026 response. The European Commission publishes a guide for projects funded by EU cohesion money, and the World Bank applies economic analysis to its lending. Large infrastructure and public spending decisions in most OECD countries now go through some form of formal appraisal.
Criticism and limitations
- Distribution. Standard CBA adds up gains and losses regardless of who receives them. Under the Kaldor–Hicks test a project passes if winners could in principle compensate losers, even if they never do, which can worsen economic inequality. Some guidance applies distributional weights to correct for this.
- Discounting the far future. A high discount rate makes damage decades away look small. The 2006 Stern Review on climate change used a low rate and found strong action worthwhile; critics such as William Nordhaus argued for higher, market-based rates.
- Pricing the priceless. Putting money values on life, health or nature is contested on ethical grounds.
- Uncertainty and bias. Benefits of big projects are often overstated and costs understated. Deep uncertainty makes single-number answers misleading, and public choice theory warns that appraisals can be shaped to support decisions already taken.
- Sunk costs. A correct appraisal counts only future costs; money already spent is a sunk cost and should be left out.