Guide to COST-BENEFIT ANALYSIS of investment projects - Ramiri

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Furthermore, travel demand depends on the locations of activities and families, and therefore trends in thedistribution of economic activities by sector and population should also be considered. Location patterns affect notonly the distance travelled, but also the frequency of trips and thus the total demand. Accessibility is one factoraffecting the choices of firms and families about where to locate, and as a consequence of these choices the ‘withproject’ and ‘without project’ demand may not be the same.The price of the service provided is not the only determinant of travel demand. The choice of how much travel toconsume or how far to ship a good depends on the travel cost and the time spent in travelling. Elasticity to traveltime is a further determinant to be introduced in travel demand predictions. As for price elasticity, also in the case oftravel time, direct and cross-elasticity are relevant. Demand for a specific mode of transport can be influenced by anincrease in the speed of that mode, but also by an increase/decrease in the speed of the competing mode(s).Demand characteristics, price, income and cross elasticity, value of time, value attributable to comfort for passengersand damage for freight will vary with the different segments of the market, as will the transport costs, type of servicedemanded etc. It is therefore extremely useful to disaggregate travel demand into homogeneous segments. Thecharacteristics of the different type of commodities, the income group to which the individuals belong as well as thepurpose of the trip are important determinants in predicting travel demand 106 .106 Despite the considerable experience and the wide range of techniques available, forecasting transport demand remains a challenging task.Recent studies (Flyvberg et al., 2006) found considerable deviations between forecast and actual traffic volumes in more than 200 large-scaletransport projects. Forecast inaccuracy is often higher in rail than in road projects. This is not to say that road forecasts are always accurate; in fact,the rate of inaccuracy in road projects is significant, but it is more balanced between over- and underestimation. For rail travel the inaccuracies aresystematically higher and overestimates are the rule. Many factors contribute to making rail travel forecasts less accurate than road travel forecasts:railway projects are, in general, bigger in size (but a study on aviation showed no correlation between size and demand forecast inaccuracy), andhave a longer implementation phase. However, overestimation of rail traffic seems to be linked to an overoptimistic expectation of modal shift.204
ANNEX BTHE CHOICE OF THE DISCOUNT RATEThe financial discount rateAs a general, and quite uncontroversial, definition, the financial discount rate (FDR) is the opportunity cost ofcapital. Opportunity cost means that when we use capital in one project we sacrifice a return on another project.Thus, we have an implicit cost when we sink capital into an investment project: the loss of income from analternative project.In academic literature and in practice we can find, however, differing views regarding the discount rate that shouldbe used in the financial analysis of investment projects.There are at least three approaches:- the first one estimates the actual (weighted average) cost of capital. The benchmark for a public projectmay be the real return on Government bonds (the marginal direct cost of public funds), or the longtermreal interest rate on commercial loans (if the project needs private finance), or a weighted averageof the two rates. This approach is very simple, but it may be misleading: the best alternative projectcould earn much more than the actual interest rate on public or private loans;- the second approach establishes a maximum limit value for the discount rate as it considers the returnlost from the best investment alternative. In other words, the alternative to the project income is notthe buying back of public or private debt, but it is the return on an appropriate financial portfolio;- the third approach is to determine a cut-off rate as a planning parameter. This implies using a simplerule-of-thumb approach, i.e. a specific interest rate or a rate of return from a well-established issuer ofsecurities in a widely traded currency, and then to apply a multiplier to this minimum benchmark.Table B.1 shows some estimates for real rates of return on financial assets as a starting point for the choice of thefinancial discount rate. We can then think that non-marginal investors and experienced professionals are able toobtain higher than average returns. Supposing project proposers are experienced investors, then a rate of returnmarginally higher than the mean of the values in the table will better fit our requirements.Table B.1Indicative estimates for the long-term annual financial rate of return on securitiesAsset Class Nominal Annual Return Estimates% Real Annual Return Estimates*%Large Stocks 9,0 6,4Mid/Small Stocks 10,7 8,1International Stocks 9,1 6,5Bonds 4,8 2,2Cash Equivalent 3,2 0,6Inflation 2,6 -Simple average 107 4,76A 20-year horizon is used and asset classes correspond to indexes. ‘Large stocks’ to S&P 500, ‘Mid/Small’ to Russell 2000 index, ‘Internationalstocks’ to MSCI AEFE, ‘Bonds’ to Lehman Aggregate Bond Index and ‘Cash equivalent’ to the 3 month T-Bill Index.* The Fisher formula was used because of low inflation; r = i −πwhere r is the real rate i the nominal rate and inflation is π. The more general rule is1+ir = −11 +πTable B.1 suggests that a 5% financial discount rate is marginally higher than the average value of a portfolio ofdifferent securities.107A weighted average of these rates, according to the relative significance of the various assets in a ‘typical portfolio’, might be moreappropriate than a simple un-weighted average. This should be estimated country by country.205
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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
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FOCUS: ENPV VS. FNPVThe difference
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2.6 Risk assessmentProject appraisa
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Table 2.14 Impact analysis of criti
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Figure 2.6 Probability distribution
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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
Page 154 and 155: Table 4.24 Financial return on capi
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Page 158 and 159: ate of 0.6% per year is assumed for
Page 160 and 161: The shadow price of the CO 2 avoide
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Page 164 and 165: Table 4.36 Financial return on capi
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Page 168 and 169: 4.4 Case Study: investment in a was
Page 170 and 171: 4.4.2 Financial analysisAlthough in
Page 172 and 173: THE CALCULATION OF REVENUESReferrin
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Page 176 and 177: As result, the probability distribu
Page 178 and 179: Figure 4.13 Probability distributio
Page 180 and 181: Table 4.48 Financial return on nati
Page 182 and 183: Table 4.50 Financial return on priv
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Page 186 and 187: 4.5 Case Study: industrial investme
Page 188 and 189: 4.5.4.1 Investment costsThe total i
Page 190 and 191: Finally, a residual value was estim
Page 192 and 193: This analysis shows the need to pay
Page 194 and 195: Table 4.62 Financial return on inve
Page 196 and 197: Table 4.64 Return on private equity
Page 198 and 199: Table 4.66 Economic analysis (thous
Page 200 and 201: ANNEX ADEMAND ANALYSISDemand foreca
Page 202 and 203: The method applied for the forecast
Page 206 and 207: This Guide supports a unique refere
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Page 210 and 211: Figure C.1 Project ranking by NPV v
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Page 216 and 217: Another exhaustive way to include d
Page 218 and 219: Figure E.2 Percentage of low income
Page 220 and 221: ANNEX FEVALUATION OF HEALTH &ENVIRO
Page 222 and 223: Figure F.1 Main evaluation methodsS
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Page 228 and 229: BENEFIT TRANSFER - SELECTED REFEREN
Page 230 and 231: ANNEX GEVALUATION OF PPP PROJECTSIt
Page 232 and 233: adjustments for Competitive Neutral
Page 234 and 235: ANNEX HRISK ASSESSMENTIn ex-ante pr
Page 236 and 237: Reference ForecastingThe question o
Page 238 and 239: Figure H.5 Levels of risks in diffe
Page 240 and 241: ANNEX IDETERMINATION OF THE EU GRAN
Page 242 and 243: A.4. Technological Alternatives and
Page 244 and 245: GLOSSARYAccounting period: the inte
Page 246 and 247: Market price: the price at which a
Page 248 and 249: BIBLIOGRAPHY1. ReferencesBelli, P.,
Page 250 and 251: Ray, A. 1984, Cost-benefit analysis
Page 252 and 253: 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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