Guide to COST-BENEFIT ANALYSIS of investment projects - Ramiri

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or the plant will not reveal excessive spare capacity, personnel skills and management will be available,justification of the project design (scale, location, etc.) against alternative scenarios (‘business as usual’,‘do-minimum’, ‘do-something’ and ‘do-something else’). Financial AnalysisThis should be based on the discounted cash flow approach. The EC suggests a benchmark real financialdiscount rate of 5%. A system of accounting tables should show cash inflows and outflows related to:- total investment costs;- total operating costs and revenues;- financial return on the investment costs: FNPV(C) and FRR(C);- sources of finance;- financial sustainability;- financial return on national capital: FNPV(K) and FRR(K);- the latter takes into account the impact of the EU grant on the national (public and private) investors.The time horizon must be consistent with the economic life of the main assets. The appropriateresidual value must be included in the accounts in the end year. General inflation and relative pricechanges must be treated in a consistent way. In principle, FRR(C) can be very low or negative forpublic sector projects, but FRR(K) for private investors or PPPs should normally be positive. Economic AnalysisCBA requires an investigation of a project’s net impact on economic welfare. This is done in five steps:- observed prices or public tariffs are converted into shadow prices, that better reflect the socialopportunity cost of the good;- externalities are taken into account and given a monetary value;- indirect effects are included if relevant (i.e. not already captured by shadow prices);- costs and benefits are discounted with a real social discount rate (suggested SDR benchmark values:5.5% for Cohesion and IPA countries, and for convergence regions elsewhere with high growthoutlook; 3.5% for Competitiveness regions);- calculation of economic performance indicators: economic net present value (ENPV), economic rateof return (ERR) and the benefit-cost (B/C) ratio.Critical conversion factors are: the standard conversion factor, particularly for IPA assisted countries;sector conversion factors (sometimes leading to border prices for specific tradable goods e.g. agriculturalproducts) and marginal costs or willingness-to-pay for non-tradable goods (e.g. waste disposal); theconversion factor for labour cost (depending upon the nature and magnitude of regional unemployment).Practical methods for the calculation of the economic valuation of environmental impacts, the shadowprice of time in transport, the value of lives and injuries saved and distributional impacts are suggested inthe Guide. Risk AssessmentA project appraisal document must include an assessment of the project risks. Again, five steps aresuggested:- sensitivity analysis (identification of critical variables, elimination of deterministically dependentvariables, elasticity analysis, choice of critical variables, scenario analysis);- assumption of a probability distribution for each critical variable;- calculation of the distribution of the performance indicator (typically FNPV and ENPV);- discussion of results and acceptable levels of risk;- discussion of ways to mitigate risks.14
Other Evaluation ApproachesIn some circumstances a Cost-Effectiveness Analysis can be useful to compare projects with very similaroutputs, but this approach should not be seen as a substitute for CBA. Multi-criteria analysis, i.e. multiobjectiveanalysis, can be helpful when some objectives are intractable in other ways and should be seen asa complement to CBA when, for some reason(s), the project does not show an adequate ERR, but theapplicant still wants to make a case for EU assistance. This is to be regarded as an exceptional step,because CBA is a specific requirement of the Funds’ regulations. In fact, focusing on CBA is consistentwith the overarching goal of Cohesion Policy in terms of sustainable growth; a goal that includescompetitiveness and environmental considerations at the same time. For mega-projects (relative to thecountry, no threshold can be given) economic impact analysis can be considered as a complement toCBA, in order to capture macroeconomic effects which are not well represented by the estimated shadowprices.7. ContentsThe structure of the Guide is as follows:- chapter one provides a reminder of the legal base for the major project and co-financing decisions bythe Commission, highlighting the main developments from the period 2000-2006;- chapter two illustrates the standard methodology for carrying out the six steps for a CBA, especiallythe financial analysis, economic analysis and calculation of performance indicators;- chapter three provides five case studies in the transport, environment and industry sectors;- chapter four includes outlines of project analysis by sector: focusing principally on the transport,environment and industry sectors.There are then the following ten Annexes:- annex A: demand analysis- annex B: discount rates- annex C: project performance indicators- annex D: shadow wage- annex E: affordability- annex F: evaluation of health & environmental impacts- annex G: evaluation of PPP projects- annex H: risk assessment- annex I: determination of EU grant- annex J: table of contents for a feasibility study.The text is completed by a Glossary and a Bibliography.8. DisseminationThis Guide is available in English only. Translation in other languages, reproduction in any form, longcitations of part of the text are all possible provided that the source is duly acknowledged.9. AdviceThe Commission Services and the CBA Guide Team will be pleased to receive comments and to answerquestions. For further information see URL: http://ec.europa.eu/regional_policy/.15
Page 3: ACRONYMS AND ABBREVIATIONSBAUB/CCBA
Page 7 and 8: TABLESTable 2.1 Financial analysis
Page 9: FIGURESFigure 1.1 Project cost spre
Page 12 and 13: Cohesion Fund, and through the leve
Page 17 and 18: CHAPTER ONEPROJECT APPRAISAL IN THE
Page 19 and 20: Some specifications for financial t
Page 21 and 22: FOCUS: INFORMATION REQUIREDGeneral
Page 23 and 24: In particular, CBA results should p
Page 25 and 26: CHAPTER TWOAN AGENDA FOR THE PROJEC
Page 27 and 28: objectives, are, as far as possible
Page 29 and 30: considered the appropriate shadow p
Page 31 and 32: 2.3.2 Feasibility analysisFeasibili
Page 34 and 35: This approach will be presented in
Page 36 and 37: Current assets include:- receivable
Page 38 and 39: The following items are usually not
Page 40 and 41: Mainly, the examiner uses the FRR(C
Page 42 and 43: The dynamics of the incoming flows
Page 44 and 45: eturn on their own capital (Kp). Th
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Page 48 and 49: 2.5.1 Conversion of market to accou
Page 50 and 51: Table 2.9 Electricity price dispers
Page 52 and 53: 2.5.1.2 Fiscal correctionsSome item
Page 54 and 55: previously estimated in projects wi
Page 56 and 57: FOCUS: ENPV VS. FNPVThe difference
Page 58 and 59: 2.6 Risk assessmentProject appraisa
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eneficiary. The project proposer sh
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There are many ways to design an MC
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PROJECT APPRAISAL CHECK-LISTCONTEXT
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- reduction of congestion by elimin
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- the methods applied to estimate e
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- the marginal external costs: cong
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- the benefits for the existing tra
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The following tables show some refe
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3.1.1.6 Risk assessmentDue to their
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As shown in Figure 3.1, only under
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3.1.3.7 Other project evaluation ap
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- Waste Management Hierarchy rules
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The time horizon for a project anal
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every user support the total costs
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Territorial reference frameworkIf t
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Cycle and phases of the projectGrea
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One of the most important aims of t
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projects, as in other sectors in wh
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3.2.3.2 Project identificationBasic
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In order to evaluate the overall im
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for regassification plants, number
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Examples of objectives are:- change
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decontamination if any;- the techni
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3.3.3.6 Risk AnalysisCritical facto
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3.3.4.6 Risk assessmentCritical fac
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3.4.1.5 Economic analysisThe follow
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Financial inflows• Admission fees
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expectancy suitably adjusted by the
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The time horizon for project analys
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A Cost-Benefit Analysis should cons
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CHAPTER FOURCASE STUDIESOverviewThi
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- finally, there is the traffic tha
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c) Road users producer’s surplus:
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4.1.5 Scenario analysisTwo scenario
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The financial performance indicator
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Table 4.10 Economic analysis (Milli
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Table 4.12 Financial return on capi
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4.2 Case Study: investment in a rai
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4.2.4 Economic analysisThe benefits
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Financial investment costs have bee
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Figure 4.6 Results of the risk anal
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Table 4.22 Economic analysis (Milli
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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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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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