Guide to COST-BENEFIT ANALYSIS of investment projects - Ramiri

FOCUS: ENPV VS. FNPVThe difference between ENPV and FNPV is that the former uses accounting prices or the opportunity cost of goods andservices instead of imperfect market prices, and it includes as far as possible any social and environmental externalities. This isbecause the analysis is done from the point of view of society, not just the project owner. Because externalities and shadowprices are considered, most projects with low or negative FNPV(C) will now show positive ENPV.The ENPV is the most important and reliable social CBA indicator and should be used as the mainreference economic performance signal for project appraisal. Although ERR and B/C are meaningfulbecause they are independent of the project size, they may sometimes involve problems. In particularcases, for example, the ERR may be multiple or not defined, while the B/C ratio may be affected byconsidering a given flow as either a benefit or a cost reduction.On the contrary, there might be cases where the use of the benefit-cost ratio is appropriate, for exampleunder the capital budget constraints (see Annex C).In principle, every project with an ERR lower than the social discount rate or a negative ENPV should berejected. A project with a negative economic return, uses too much of socially valuable resources toachieve too modest benefits for all citizens. From the EU perspective, sinking a capital grant in a projectwith low social returns means diverting precious resources from a more valuable development use. Forexample, from the perspective of Cohesion Policy, a low return investment in a Convergence Objectiveregion means that the project will contribute nothing to achieve the objective.In some exceptional cases, however, a project with a negative ENPV could be accepted for EU assistanceif there are important non-monetized benefits (e.g. for biodiversity preservation projects, cultural heritagesites, landscape). This should be seen as a rare occurrence, and the appraisal report should still specify in aconvincing way, through a structured argument, sustained by adequate data, that, in some sense, socialbenefits exceed social costs, even if the applicant is unable to fully quantify the former. There shouldclearly be a strong case for such a request for co-financing of a major project.Table 2.11 Observed ERR of a sample of investment projects sponsored by the EU during theprevious programming periodsN. of projectsERR%AverageERR%Std. Dev.Sector average /total averageEnergy production a 3 14.19 9.36 0.87Energy transport and distribution b 2 12.60 6.22 0.77Roads and highways b 56 15.53 9.58 0.95Railways and underground b 48 11.62 8.21 0.71Ports, airports b 20 26.84 28.99 1.64Water supply and waste water treatment b 116 11.33 6.31 0.69Solid waste treatment b 31 28.27 72.24 1.72Industries and other productive investments a 2 15.17 7.30 0.93Other b 11 11.96 10.53 0.73TOTAL 289 16.39 17.64 1.0a: 1994-1999 programming period; b: 2000-2006 programming periodSource: Authors’ calculations on available DG Regio data. On ISPA projects see Florio and Vignetti (2006).56