Costs and benefits, the government’s way

A cost-benefit analysis lists the costs and benefits of each option over its life, puts dollar values on them where it can, and discounts later amounts to today’s dollars so they can be weighed against each other. The Office of Impact Analysis (OIA) asks for net present values at a real discount rate of 7% a year, tested at 3% and 10%.

A guide published by Dotto. The OIA’s guidance note is written for Australian Government regulatory proposals, not for businesses. This page explains its method and marks where it reads that logic across to a business’s own spending. The note is dated August 2023; the OIA says a new Australian Government Impact Analysis Framework took effect on 1 July 2026, and that the note’s references to the earlier framework are no longer current.

The load: Present value of the costs
The counterweight: Present value of the benefits
The reading: Net present value

Notch 5 of 6 on the steelyard.

The nine steps

The guidance note sets out the major steps of a cost-benefit analysis in this order. The step names are the OIA’s own words; the notes under them are this guide’s summary.

“Specify the set of options”
Weigh real alternatives; for a regulatory proposal the note asks for at least three, one of them non-regulatory. A “do nothing” or business-as-usual option usually serves as the base case, and only costs and benefits that would not have happened in the base case are counted.
“Decide whose costs and benefits count”
For most proposals, the costs and benefits to everyone living in Australia.
“Identify the impacts and select measurement indicators”
Find the full range of each option’s effects compared with the base case, and let the base case look forward rather than assume nothing will change.
“Predict the impacts over the life of the proposed regulation”
Put numbers on the impacts in each period, take care with evaluation periods longer than about 20 years, and set out the main uncertainties.
“Monetise (place dollar values on) impacts”
Value gains and losses in dollars where possible. Where an impact cannot sensibly be priced, give a detailed qualitative account backed by evidence.
“Discount future costs and benefits to obtain present values”
Bring every year’s amounts back to today’s dollars, as set out below.
“Compute the net present value of each option”
The present value of benefits less the present value of costs. A positive answer means the proposal improves efficiency.
“Perform sensitivity analysis”
Test how the answer moves when uncertain figures change: worst and best cases, one variable at a time, or Monte Carlo simulation.
“Reach a conclusion”
The option with the highest net benefit is normally the one recommended, although the testing may favour an option with a smaller chance of a large net cost.

Why later dollars count for less

The note gives two reasons for discounting. People prefer a dollar today to a dollar in the future, which is why banks pay interest to persuade depositors to wait. And money tied up in one use has an opportunity cost: the return it could have earned in the best alternative use.

The discount rate turns future values into present ones. The note’s rule: at a constant rate of r per cent a year, a benefit of B_t dollars received in t years is worth B_t ÷ (1 + r)^t today.

Inflation is a separate reason a future dollar buys less. The note says it is usually simplest to state every cash flow in today’s dollars, called real values, rather than in the dollars of the future date, called nominal values.

The note’s worked example

The OIA’s example is equipment that industry must install to limit air pollution. It costs $5 million to install and then runs for four years, with maintenance of $1 million a year and benefits estimated at $3 million a year, all in constant prices.

The OIA’s example at its central 7% rate, in $ million: this guide’s recalculation

Present value of costs: 5 now, then 1 a year for four years: 8.39
Present value of benefits: 3 a year for four years: 10.16
Net present value: 1.77

The OIA reports the same net present value, 1.77, at 7%. Splitting it into the two pans is this guide’s arithmetic.

The OIA puts the same project’s net present value at 2.43 at a 3% rate and 1.34 at 10%. The higher the rate, the less the later years’ benefits are worth today, so the same project looks thinner.

Which rate

The OIA requires net present values at an annual real discount rate of 7%, and asks for the same figures at 3% and 10% as a sensitivity test. If the answer switches between a net benefit and a net cost across those rates, the note says the choice of rate is important and should be flagged in the summary.

Four pitfalls the note names

Letting the easy numbers win Effects that are simple to value in dollars should not overshadow important ones that are hard to value.
Counting a benefit twice The note’s example: time saved on travel by a group of homeowners should not be counted again as the rise in their house prices, which only capitalises the same benefit.
Before and after, instead of with and without Compare the world with the change against the world without it, rather than simply the situation before against the situation after.
A riskless rate for risky benefits A riskless interest rate should be used only to discount net benefits that do not move with market returns.

Read across to a business’s own spending

What follows is this guide’s reading, not the OIA’s. The method is written for regulation, and its second step counts costs and benefits to the whole community; a business weighing its own outlay would count its own instead. The other habits carry across. Name the do-nothing option. Put the outlay and its running costs in the years they fall. Bring later savings back to today’s dollars. Then test whether the answer survives a less hopeful forecast.

For a quick reading, return on investment and payback are simpler. The NSW lighting report’s business case template shows the two kinds of measure used side by side, asking for the payback period together with the internal rate of return and net present value.