Guide to COST-BENEFIT ANALYSIS of investment projects - Ramiri

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This approach will be presented in detail in the rest of the section. The following related topics will behighlighted along the way:- the time horizon for different types of project (par. 2.4.1)- social affordability (par. 2.4.2)- the polluter-pays principle (par. 2.4.2)- the treatment of taxation (par. 2.4.2)- the investment profitability - FRR(C) - normally expected (par. 2.4.3)- the adjustment for inflation (par. 2.4.3)- the public-private partnership (par. 2.4.4)- the return on capital – FRR(K) – to private investors (par. 2.4.6).Table 2.1 Financial analysis at a glanceFNPV(C) SUSTAINABILITY FNPV(K)Total investment costsLand - -Buildings - -Equipment - -Extraordinary Maintenance* - -Licences - -Patents - -Other pre-production expenses - -Changes in working capital -(+) -(+)Residual value* + +Total operating costsRaw materials - - -Labour - - -Electric power - - -Maintenance - - -Administrative costs - - -Other outflowsInterest - -Loans reimbursement - -Taxes -Total operating revenuesOutput X + + +Output Y + + +Sources of financingCommunity assistance +National public contribution + -National private capital + -Loans +Other resources (e.g. operating subsidies) +* In the calculation of the funding-gap rate these item are included in the discounted net revenue (DNR) and not in the discounted investment cost(DIC) because not occurring during the investment phase (see Annex I). The same applies to the capital expenditures incurred during the operationalphase (e.g. replacement of short-life equipment).Note: The ‘-’ and ‘+’ signs indicate the nature of the cash-flow. For instance, national public contributions are considered as inflows when checking theproject sustainability and as outflows when estimating the return on the national capital (K).2.4.1 Total investment costsThe first logical step in the financial analysis is the estimation of how large the total investment cost willbe. The investment outlays can be planned for several initial years and some non-routine maintenance orreplacement costs in more distant years. Thus we need to define a time horizon.By time horizon, we mean the maximum number of years for which forecasts are provided. Forecastsregarding the future of the project should be formulated for a period appropriate to its economicallyuseful life and long enough to encompass its likely mid-to-long term impact.34
Although the investment horizon is often indefinite, in project analysis it is convenient to assume reachinga point in the future when all the assets and all the liabilities are virtually liquidated simultaneously.Conceptually, it is at that point that one can cost up the accounts and verify whether the investment was asuccess. This procedure entails choosing a particular time horizon. The choice of time horizon may havean extremely important effect on the results of the appraisal process and may also affect the determinationof the EU co-financing rate.For the majority of infrastructures the time horizon is at least 20 years; for productive investments, andagain indicatively, it is about 10 years. Nevertheless, the time horizon should not be so long as to exceedthe economically useful life of the project.In practice, it is helpful to refer to a standardbenchmark, differentiated by sector and basedon some internationally accepted practices. Anexample is shown in Table 2.2. Each projectproposer, however, can justify the adoption of aspecific time horizon based on project-specificfeatures.Having set the horizon, the investment costs areclassified by (see Table 2.3):- fixed investments,- start-up costs, and- the changes in working capital over the entiretime horizon.Table 2.2 Reference time horizon (years)recommended for the 2007-2013periodProjects by sectorYearsEnergy 25Water and environment 30Railways 30Roads 25Ports and airports 25Telecommunications 15Industry 10Other services 15Source: OECD (1993)2.4.1.1 Fixed investmentsFixed investments are often, but not always, the largest component of total investment costs.The information relating to fixed investments will be taken from the feasibility study data on localisationand technology. The data to consider are the incremental cash disbursements encountered in the singleaccounting periods to acquire the various types of fixed assets: land, buildings, machinery, etc.The residual value of the fixed investment must be included within the fixed investment costs account forthe end-year with opposite sign (negative if the others are positive), because it is considered as an inflow.2.4.1.2 Start-up costsAccording to a standard definition, all those costs that are incurred in view of the effects that will accruebeyond the financial period in which the relative disbursements were made are of an investment nature.Although the tax rules do not always allow for the capitalization of these costs, they should be included inthe total investment costs. These include several start-up costs, such as: preparatory studies (including thefeasibility study itself), costs incurred in the implementation phase, contracts for the use of someconsulting services, training expenses, research and development, issue of shares and so on.2.4.1.3 Changes in working capitalIn some types of projects, particularly in the productive sector, the initial investment in working capital issizeable. Net working capital is defined as the difference between current assets and current liabilities. Itsincrease over one period of time corresponds to an investment outlay. The estimation depends on theanalysis of demand for credit from customers or other users of the service, on technological and businessinformation on average stocks needed, on information on the credit usually offered by suppliers and onthe assumption about the cash needed over time.35
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 14 and 15: or the plant will not reveal excess
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 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
Page 46 and 47: While the approach presented in thi
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
Page 60 and 61: Table 2.14 Impact analysis of criti
Page 62 and 63: Figure 2.6 Probability distribution
Page 64 and 65: eneficiary. The project proposer sh
Page 66 and 67: There are many ways to design an MC
Page 68 and 69: PROJECT APPRAISAL CHECK-LISTCONTEXT
Page 70 and 71: - reduction of congestion by elimin
Page 72 and 73: - the methods applied to estimate e
Page 74 and 75: - the marginal external costs: cong
Page 76 and 77: - the benefits for the existing tra
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
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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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