Guide to COST-BENEFIT ANALYSIS of investment projects - Ramiri

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GLOSSARYAccounting period: the interval between successive entries in an account. In project analysis, the accounting periodis generally one year, but it could be any other convenient time period.Accounting prices: the opportunity cost of goods, sometimes different from actual market prices and fromregulated tariffs. They are used in the economic analysis to better reflect the real costs of inputs to society, and thereal benefits of the outputs. Often used as a synonym for shadow prices.Accounting unit: the unit of account that makes it possible to add and subtract unlike items. Euro is the unit ofaccount for the appraisal of EU financed projects.Appraisal: the ex-ante analysis of a proposed investment project to determine its merit and acceptability inaccordance with established decision-making criteria.Benefit-cost ratio: the net present value of project benefits divided by the net present value of project costs. Aproject is accepted if the benefit-cost ratio is equal to or greater than one. It is used to accept independent projects,but it may give incorrect rankings and often cannot be used for choosing among mutually exclusive alternatives.Benefits transfer: the benefits transfer method can be defined as the use of a good value estimate in one site, the‘study site’, as a proxy for values of the same good in another site, the ‘policy site’.Border price: the unit price of a traded good at the country's economic border. For exports, it is the f.o.b. (free onboard) price, and for imports, it is the c.i.f. (cost, insurance, and freight) price. The economic border for a MemberState of the EU can be with non-EU members or wherever there are substantial differences in observed pricesbecause of market distortions.Business as usual scenario: a reference scenario which assumes that future evolution is an extension of the currenttrends. See also ‘do nothing scenario’.Constant prices: Prices that have been deflated by an appropriate price index based on prices prevailing in a givenbase year. They should be distinguished from current or nominal prices.Consumer’s surplus: the value consumers receive over and above what they actually have to pay.Conversion factor: the factor that converts the domestic market price or value of a good or production factor to anaccounting price.Cost-Benefit analysis: conceptual framework applied to any systematic, quantitative appraisal of a public or privateproject to determine whether, or to what extent, that project is worthwhile from a social perspective. Cost-benefitanalysis differs from a straightforward financial appraisal in that it considers all gains (benefits) and losses (costs) tosocial agents. CBA usually implies the use of accounting prices.Cost/effectiveness analysis: CEA is an appraisal and monitoring technique used when benefits cannot bereasonably measured in money terms. It is usually carried out by calculating the cost per unit of ‘non monetised’benefit and is required to quantify benefits but not to attach a monetary price or economic value to the benefits.Current prices: (Nominal prices) prices as actually observed at a given time. They refer to prices that include theeffects of general inflation and should be contrasted with constant prices.Cut-off rate: the rate below which a project is considered unacceptable. It is often taken to be the opportunity costof capital. The cut-off rate would be the minimum acceptable internal rate of return for a project or the discount rateused to calculate the net present value, the net-benefit investment ratio, or the benefit-cost ratio.Discount rate: the rate at which future values are discounted to the present. The financial discount rate andeconomic discount rate may differ, in the same way that market prices may differ from accounting prices.Discounting: the process of adjusting the future values of project inflows and outflows to present values using adiscount rate, i.e. by multiplying the future value by a coefficient that decreases with time.Do-minimum: the project option that includes all the necessary realistic level of maintenance costs and a minimumamount of investment costs or necessary improvements, in order to avoid or delay serious deterioration or to complywith safety standards.Do nothing: the baseline scenario, ‘business as usual’, against which the additional benefits and costs of the ‘withproject scenario’ can be measured (often a synonym for the ‘without project’ scenario).244
Do-something: the scenario(s) in which investment projects are considered, different from ‘do nothing’ and ‘dominimum’,see above.Economic analysis: analysis that is undertaken using economic values, reflecting the values that society would bewilling to pay for a good or service. In general, economic analysis values all items at their value in use or theiropportunity cost to society (often a border price for tradable items). It has the same meaning as social cost-benefitanalysis.Economic impact analysis: the analysis of the total effects on the level of economic activity (output, income,employment) associated with the intervention. This kind of analysis focuses on macroeconomic indicators andforecasts the influence of the project on these indicators. It goes beyond CBA when very large projects areconsidered in relatively small economies.Economic rate of return: ERR, the internal rate of return (see definition below) calculated using the economicvalues and expressing the socio-economic profitability of a project.Environmental impact analysis: the statement of the environmental impact of a project that identifies its physicalor biological effects on the environment in a broad sense. This would include the forecasting of potential pollutionemissions, loss of visual amenity, and so on.Externality: an externality is said to exist when the production or consumption of a good in one market affects thewelfare of a third party without any payment or compensation being made. In project analysis, an externality is aneffect of a project not reflected in its financial accounts and consequently not included in the valuation. Externalitiesmay be positive or negative.Ex-ante evaluation: the evaluation carried out in order to take the investment decision. It serves to select the bestoption from the socio economic and financial point of view. It provides the necessary base for the monitoring andsubsequent evaluations ensuring that, wherever possible, the objectives are quantified.Ex-post evaluation: an evaluation carried out a certain length of time after the conclusion of the initiative. Itconsists of describing the impact achieved by the initiative compared to the overall objectives and project purpose(ex-ante).Feasibility study: a study of a proposed project to indicate whether the proposal is attractive enough to justify moredetailed preparation. It contains the detailed technical information necessary for the financial and economicevaluation.Financial analysis: the analysis carried out from the point of view of the project operator. It allows one to 1) verifyand guarantee cash balance (verify the financial sustainability), 2) calculate the indices of financial return on theinvestment project based on the net time-discounted cash flows, related exclusively to the economic entity thatactivates the project (firm, managing agency).Financial rate of return: the FRR measures the financial profitability of a project with a pure number. In somecases it cannot be calculated in a meaningful way and can be misleading.Financial sustainability analysis: analysis carried out in order to verify that financial resources are sufficient tocover all financial outflows, year after year, for the whole time horizon of the project. Financial sustainability isverified if the cumulated net cash flow is never negative during all the years considered.Impact: a generic term for describing the changes or the long term effects on society that can be attributed to theproject. Impacts should be expressed in the units of measurement adopted to deal with the objectives to beaddressed by the project.Internal rate of return: the discount rate at which a stream of costs and benefits has a net present value of zero.The internal rate of return is compared with a benchmark in order to evaluate the performance of the proposedproject. Financial Rate of Return is calculated using financial values, Economic rate of Return is calculated usingeconomic values.Independent projects: projects that in principle can all be undertaken at the same time. These should bedistinguished from mutually exclusive projects.In itinere evaluation (on-going evaluation): an evaluation carried out at a certain point during the projectimplementation in order to allow a re-orientation of the activity in case the first results suggest the need of a readjustmentof the project.Long run: the time period in the production process during which all factors of production can be varied, except thebasic technological processes being used.245
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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
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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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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 204 and 205: Furthermore, travel demand depends
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
Page 212 and 213: The main problems with this indicat
Page 214 and 215: EXAMPLE OF SHADOW WAGE IN DUAL MARK
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 226 and 227: due to air pollution or water conta
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 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
Page 254 and 255: European Commission, DG Tren, 2003,
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Guide to COST-BENEFIT ANALYSIS of investment projects - Ramiri

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