Guide to COST-BENEFIT ANALYSIS of investment projects - Ramiri

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REGULATORY FRAMEWORK: STATE AIDEven if the European Union declares the principle of incompatibility between State Aid and the common market, some derogations have beenestablished (Art. 87.3a and 87.3c of the Treaty which establishes the European Community).From such derogations it follows that Member States may grant aid for investment in disadvantaged regions (the so-called ‘Regional AidSchemes’) or rather targeted at particular sectors (the so-called ‘horizontal aid’ to small and medium sized enterprises, R&D, professionaltraining, protection of the environment etc.) respecting the Guidelines on State Aid, through a prior authorization scheme from the Commissionof the aid proposed by the Member State.Implementing Article 87 (3a,c) of the Treaty, the Commission may consider state aid as compatible with the common market when granted toimprove the economic development of certain disadvantaged areas within the European Union. These kind of aid are commonly referred to asRegional State Aid. This is considered indeed financial support for investments favouring large enterprises, or rather, in certain circumstances,operating aid destined to specific regions, in order to re-balance regional disparity. Such aid, by addressing the handicaps of the disadvantagedregions promotes the economic, social and territorial cohesion of Member States and the Community as a whole. Local specificity is indeed adifferentiator between the regional State aid and the other forms of horizontal aids, such as aid for research, development and innovation,employment, which pursue different objectives of common interest. In line with the relevant provisions of the EC Treaty, the EuropeanCommission adopted new Community Guidelines for Regional State aid (2006/C 54/08), to be applied between 2007-2013. The Guidelinesspecify rules for the selection or regions, that are eligible for regional aid, and define the maximum permitted levels of this aid.With the Regulation (EC) 1628/2006 the Commission expressly established that ‘transparent’ regional aid shall be exempt from the notificationrequirement to the European Union; to this end, regional aid schemes will be ‘transparent’ when it is possible to calculate precisely the GrossGrant Equivalent as a percentage of eligible expenditure ex ante, without need to undertake a risk assessment.State Aid may be declared compatible when pursuing Community interests, or when the Commission establishes, in absence of it, that themarket forces would not allow beneficiary businesses to adopt some target desirable behaviours.The Commission’s assessment is based on the following principles: a compensatory justification and the real need for the aid; following thesedirections, various categories of ‘horizontal aid’ have been identified. This is, indeed, a State aid applicable without geographical constraints,whose aim is to support business modernization and development and to address certain problems of general scope.Horizontal classifications, providing the criteria establishing when a certain aid may benefit of a presumption of compatibility, are related atpresent to aid for small and medium-sized enterprises, employment, training, research, development and innovation, aid for the environment,and for risk capital.3.3.1.3 Feasibility and option analysisThe feasibility of the project should be verified evaluating both the technological features (e.g. theproduction technologies employed) and the economic/financial ones (the financial solidity and theeconomic efficiency of the company and the possible dynamics of the product market). Moreover, it couldbe important to make a more in-depth analysis with regard to the:- management skills and capabilities;- organisational activities described in the business plan supplied by the companies, like logistics, supplychain and commercial policies.The options analysis should consider:- location;- alternative methods of financing (e.g. financing the interest account instead of the capital account,financing a leasing contract, or other methods of financing);- technical or technological alternatives to the proposed project and the global alternatives (e.g.supplying low-cost real services).3.3.1.4 Demand analysisThe forecast for the future market demand for the products to be produced is a key issue in order toevaluate the profitability and sustainability of an industrial investment project.The first step should be a general overview of the estimated Gross Domestic Product over the next tenyears.After this, it would be essential to assess growth dynamics or the specific productive segment. The keyquestions are: ‘is this an innovative (fast growing but potentially high-risk) industrial sector?’ and ‘how isthe future demand likely to depend on the economic cycle and eventual global economic weakness?’It would be useful to try to make some assumptions about the yearly percentage growth of the sector.Starting from this point, analysts should try to deduce the relative performance of the company ascompared to the sector as a whole.106
In order to evaluate the overall impact of demand, analysts should also estimate the product pricedynamics in the international market. These dynamics should be adjusted in accordance with the specificpricing policy the company intends to adopt.3.3.1.5 Financial analysisGiven the short economic lives of some assets, the time horizon for project analysis is often around 10years. The financial inflows and outflows attributable to the investment project are:Financial inflowsFinancial outflows• Sales of the new products • Investment costs• Increased sales of existing products - works• Other incremental revenues - general expenses- expenses for new equipment• Operating costs- raw materials for production- maintenance- technical and administrative personnel costs- fuel and electricity- sales expenses3.3.1.6 Economic analysisInvestments in the industrial sector usually exhibit a better financial and economic performance thaninvestments in other sectors. The economic analysis requires attention to be focussed on the shadowprices, particularly the shadow wage, and the conversion factors required to adjust financial values.The main external costs and benefits are related to the environmental impact of the investment. A newplant will increase air pollution because of polluting emissions; on the contrary, for example, a projectinvolving the renovation or conversion of an old plant, could reduce emissions.Other non-financial costs and benefits can come from the improvement or deterioration in the safetyconditions faced by the workers.3.3.1.7 Risk assessmentCritical factors- Economic growth- Market demand for the products- Product price dynamics- Investments costs- Operating costsMainvariablesto consider- GDP growth- Specific sector growth foreseen- Relative weight of the company on the total sector- The price of the products the company is expected to produce- The cost of the new plant- The cost of machinery- The cost of labour- The cost of raw materials- The cost of energy107
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ACRONYMS AND ABBREVIATIONSBAUB/CCBA
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TABLESTable 2.1 Financial analysis
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FIGURESFigure 1.1 Project cost spre
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Cohesion Fund, and through the leve
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or the plant will not reveal excess
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CHAPTER ONEPROJECT APPRAISAL IN THE
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Some specifications for financial t
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FOCUS: INFORMATION REQUIREDGeneral
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In particular, CBA results should p
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CHAPTER TWOAN AGENDA FOR THE PROJEC
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objectives, are, as far as possible
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considered the appropriate shadow p
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2.3.2 Feasibility analysisFeasibili
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This approach will be presented in
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Current assets include:- receivable
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The following items are usually not
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Mainly, the examiner uses the FRR(C
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The dynamics of the incoming flows
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eturn on their own capital (Kp). Th
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While the approach presented in thi
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2.5.1 Conversion of market to accou
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Table 2.9 Electricity price dispers
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2.5.1.2 Fiscal correctionsSome item
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previously estimated in projects wi
Page 56 and 57: FOCUS: ENPV VS. FNPVThe difference
Page 58 and 59: 2.6 Risk assessmentProject appraisa
Page 60 and 61: Table 2.14 Impact analysis of criti
Page 62 and 63: Figure 2.6 Probability distribution
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Page 68 and 69: PROJECT APPRAISAL CHECK-LISTCONTEXT
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Page 78 and 79: The following tables show some refe
Page 80 and 81: 3.1.1.6 Risk assessmentDue to their
Page 82 and 83: As shown in Figure 3.1, only under
Page 84 and 85: 3.1.3.7 Other project evaluation ap
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Page 89 and 90: The time horizon for a project anal
Page 91 and 92: 3.2.1.7 Other project evaluation ap
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Page 95 and 96: Territorial reference frameworkIf t
Page 97 and 98: Cycle and phases of the projectGrea
Page 99 and 100: One of the most important aims of t
Page 101 and 102: projects, as in other sectors in wh
Page 103 and 104: 3.2.3.2 Project identificationBasic
Page 105: 3.2.3.7 Other project evaluation ap
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Page 111 and 112: Examples of objectives are:- change
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Page 115 and 116: 3.3.3.6 Risk AnalysisCritical facto
Page 117 and 118: 3.3.4.6 Risk assessmentCritical fac
Page 119 and 120: 3.4.1.5 Economic analysisThe follow
Page 121 and 122: Financial inflows• Admission fees
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Page 125 and 126: The time horizon for project analys
Page 127 and 128: A Cost-Benefit Analysis should cons
Page 129 and 130: CHAPTER FOURCASE STUDIESOverviewThi
Page 131 and 132: - finally, there is the traffic tha
Page 134 and 135: c) Road users producer’s surplus:
Page 136 and 137: 4.1.5 Scenario analysisTwo scenario
Page 138 and 139: The financial performance indicator
Page 140 and 141: Table 4.10 Economic analysis (Milli
Page 142 and 143: Table 4.12 Financial return on capi
Page 144 and 145: 4.2 Case Study: investment in a rai
Page 146 and 147: 4.2.4 Economic analysisThe benefits
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Page 150 and 151: Figure 4.6 Results of the risk anal
Page 152 and 153: Table 4.22 Economic analysis (Milli
Page 154 and 155: Table 4.24 Financial return on capi
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4.3 Case Study: investment in an in
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ate of 0.6% per year is assumed for
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The shadow price of the CO 2 avoide
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As a result, the probability distri
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Table 4.36 Financial return on capi
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16 17 18 19 20 21 22 23 24 25 26 27
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4.4 Case Study: investment in a was
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4.4.2 Financial analysisAlthough in
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THE CALCULATION OF REVENUESReferrin
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0.15 m 3 /m 2 a depreciation of 20%
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As result, the probability distribu
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Figure 4.13 Probability distributio
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Table 4.48 Financial return on nati
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Table 4.50 Financial return on priv
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16 17 18 19 20 21 22 23 24 25 26 27
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4.5 Case Study: industrial investme
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4.5.4.1 Investment costsThe total i
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Finally, a residual value was estim
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This analysis shows the need to pay
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Table 4.62 Financial return on inve
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Table 4.64 Return on private equity
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Table 4.66 Economic analysis (thous
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ANNEX ADEMAND ANALYSISDemand foreca
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The method applied for the forecast
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Furthermore, travel demand depends
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This Guide supports a unique refere
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A higher discount rate for countrie
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Figure C.1 Project ranking by NPV v
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The main problems with this indicat
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EXAMPLE OF SHADOW WAGE IN DUAL MARK
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Another exhaustive way to include d
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Figure E.2 Percentage of low income
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ANNEX FEVALUATION OF HEALTH &ENVIRO
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Figure F.1 Main evaluation methodsS
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- expenditure on capital equipment
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due to air pollution or water conta
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BENEFIT TRANSFER - SELECTED REFEREN
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ANNEX GEVALUATION OF PPP PROJECTSIt
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adjustments for Competitive Neutral
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ANNEX HRISK ASSESSMENTIn ex-ante pr
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Reference ForecastingThe question o
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Figure H.5 Levels of risks in diffe
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ANNEX IDETERMINATION OF THE EU GRAN
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A.4. Technological Alternatives and
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GLOSSARYAccounting period: the inte
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Market price: the price at which a
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BIBLIOGRAPHY1. ReferencesBelli, P.,
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Ray, A. 1984, Cost-benefit analysis
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EnvironmentGeneralAtkinson, G., 200
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European Commission, DG Tren, 2003,
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Guide to COST-BENEFIT ANALYSIS of investment projects - Ramiri

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