Guide to COST-BENEFIT ANALYSIS of investment projects - Ramiri

A simplified CBA usually implies focusing only on the key financial and economic tables (see below), withrough estimates of the data, because in a differential approach the absolute values of the variablesinvolved are less important than in a fully developed comparison of alternatives.The calculation of the financial and economic performance indicators must be made with the incrementalnet benefits technique, which considers the differences in the costs and benefits between the dosomethingalternative(s) and a single counterfactual without the project, that is, in principle, the BAUscenario.Under some exceptional circumstances, the BAU option should be disregarded and the do-minimumscenario used as the reference solution. In fact, in some cases, the BAU (do-nothing) scenario cannot beconsidered acceptable because it produces ‘catastrophic’ effects (see example below).EXAMPLE: CATASTROPHIC DO-NOTHING SCENARIOIt is customary in project appraisal practice to consider at least three options: do-nothing (BAU), do-minimum and dosomething.In some cases the first option may produce ‘catastrophic’ effects so that it has to be neglected and the do-minimumbe considered as the baseline scenario.In the case of an outdated healthcare infrastructure, for example a hospital, which can no longer operate without renovation,BAU would mean the interruption of the service, which may be not acceptable to the Government. The baseline scenarioshould be that of renovating the infrastructure at least in a way to guarantee a minimum service. In practice, the catastrophic donothingoption leads us to consider the partial reinvestments of the do-minimum option as the technically minimum capitalexpenditure to maintain the existing service. Again, there may be better do-something solutions, e.g. a new large infrastructureelsewhere, or a network of smaller clinics.One issue that sometimes arises when considering the expansion or restructuring of existing projects ishow to ‘apportion’ incremental flows between the old and the new capacity. Unfortunately, simpleaccounting apportionment rules (e.g. the share of ‘old’ and ‘new’ revenues are attributed in proportion to‘old’ and ‘new’ capital expenditures) are often misleading. The right approach is always to compare the‘with’ and ‘without’ project scenarios, albeit in a sketchy way. Thus, the incremental revenues or timesaving benefits of the third lane in an existing tolled two-lane highway must be related to a forecast ofincremental traffic and cannot be assumed to be one third of the future traffic.In other cases, again for projects consisting of upgrading or extension of a previous infrastructure, anincremental benefit cannot always be quantified in terms of output, because the output does not change atall. In such cases, the incremental benefit should often be appraised as an improvement, for example, inservice quality, or as avoided cost, because of service interruptions (e.g. based on willingness-to-pay forquality or continuity of supply of electricity).EXAMPLE: OPTION ANALYSIS OF THE WATERWAY CROSSING MAGDEBURG PROJECT (GERMANY)The Waterway Crossing Magdeburg is part of the German midland canal which crosses the centre of Germany from West toEast, namely from the Ruhr area to Berlin. It consists of a 918 m. channel bridge above the Elbe river and it is owned andmanaged by the Federal German Waterway and Navy Agency.During the ex-ante project appraisal, three different do-something alternatives were considered in the options analysis:- one-way bridge (no parallel usage possible – alternative 1),- two-way bridge (bridge can be used in both directions at the same time – alternative 2),- dam alternative (independence of the water level of the river Elbe – alternative 3).The alternatives were analysed with the CBA methodology and were compared with a ‘do-minimum’ scenario, because somereinvestments on the existing infrastructure would have been necessary even without the implementation of any additionalproject.All analysed alternatives achieved very good economic results, but the ‘one-way bridge’ across the river Elbe showed the bestBenefit/Cost ratio and was therefore the option implemented.Source: EVA-TREN2.4 Financial analysisThe main purpose of the financial analysis is to use the project cash flow forecasts to calculate suitable netreturn indicators. In this Guide a particular emphasis is placed on two financial indicators: the FinancialNet Present Value (FNPV) and the Financial Internal Rate of Return (FRR), respectively in terms ofreturn on the investment cost, FNPV(C) and FRR(C), and return on national capital, FNPV(K) andFRR(K).32