CAPM Practice Exam Question

Question:

During the initiation phase, how can a business analyst best quantify the economic feasibility of a new project for the organization?

A) Pareto Analysis

B) Cost-Benefit Analysis

C) Fishbone Diagram

D) Monte Carlo Simulation

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The Best Answer is B.

Here's a detailed explanation of why Cost-Benefit Analysis is the best choice:

Cost-Benefit Analysis (CBA) is a systematic approach to evaluate the potential economic gains and losses of a project. It involves comparing the total costs of the project against the total benefits it is expected to generate over its entire lifecycle. Here's how CBA works during the initiation phase:

1. Identifying Costs: Business analysts start by identifying all the costs associated with the project. These costs can include initial investment costs, operational costs, maintenance costs, and any other expenses related to the project.
2. Identifying Benefits: Similarly, they identify all potential benefits the project could bring. These benefits could be in the form of increased revenue, cost savings, improved efficiency, or other positive impacts on the organization.
3. Quantifying Costs and Benefits: Each cost and benefit is quantified in monetary terms. This step requires careful estimation and forecasting, often involving financial experts or relevant stakeholders.
4. Time Value of Money: CBA takes into account the time value of money by discounting future costs and benefits to present value. This is essential because money received or spent in the future is worth less than money today.
5. Net Present Value (NPV): The key outcome of CBA is the calculation of the Net Present Value. If the NPV is positive, it indicates that the expected benefits outweigh the costs, making the project economically feasible. If the NPV is negative, it suggests that the project may not be financially viable.
6. Sensitivity Analysis: In some cases, business analysts may also use sensitivity analysis to assess how variations in project parameters (such as cost estimates or benefit projections) can impact the overall economic feasibility.

Now, let's briefly discuss the other options:

A) Pareto Analysis: Pareto Analysis is a tool used to prioritize issues or problems based on their impact. While it's valuable for decision-making, it doesn't directly quantify economic feasibility.

C) Fishbone Diagram: Fishbone Diagram (Ishikawa or Cause-and-Effect Diagram) is a visual tool for identifying the root causes of a problem. It's not designed for economic feasibility analysis.

D) Monte Carlo Simulation: Monte Carlo Simulation is a statistical technique used to model the probability of different outcomes in a project. While it's valuable for risk analysis, it doesn't directly address economic feasibility.

In summary, during the initiation phase of a project, the most appropriate method to quantitatively assess the economic feasibility is Cost-Benefit Analysis (Option B). It provides a comprehensive evaluation of project costs and benefits, accounting for the time value of money, and helps in making informed decisions about whether to proceed with the project.