IRJET- Project Economic Appraisal Techniques in Construction Industry - A Com...
The Importance of Benefit Cost Analysis in decisionmaking
1. The Importance of Benefit Cost Analysis
in decisionmaking
Kristina Gogić, mag.iur./LLM
2. BCA is simply rational decision-making
• BCA is yet controversial regulatory tool (people use it every day – projects, programmes,
policy proposals, any kind of economic decision, etc.)
• BCA is relatively simple and widely technique for deciding whether to make a
change (2*)
• BCA is very important in political, Governmental decisions, European Commission
decisions
• An individual might be satisfied with an emotional or ad hoc response;
Governmental body must be very careful and cannot rely on such reactions
• Governments are using BCA very often
- successful decision – when total expected costs are less than total expected benefits (5*)
- results with the most profitable option
• BCA might be the most efficient decision framework; in efficiency terms (6*)
3. BCA is simply rational decision-making
• Each analysis is different and demands careful and innovative thought
• If there is a single decision – maker than an analysis from one point of view
is often adequate (individual aproach in decisionmaking)
• If the interests of more than one person or group are affected, the several
analysis might be necessary (dual or group aproach in decision making) (3*)
4. BCA in the framework of EU Funds:
European Commission decision – a basis for decisionmaking on the
co-financing of major projects included in operational programs (Ops)
of the ERDF and CF
• Since 2007. the level of investments in EU dropped off by about 15% as a
consequence of the economic and financial crisis (debt crisis, unemployment)
(1*)
• EC made Strategy for Europe 2020. through guide to BCA of Investments
projects (2014.-2020.) (2*)
• EC made EU Investment Plan for the period 2015.-2017.
• BCA is an analytical tool for judging the economic advantages od
disadvantages of an investment decision by assessing it’s costs and
benefits in order to assess the welfare change attributable to it
• The purpose of BCA - to facilitate a more efficient allocation of resources
demonstrating the convenience to society of a particular intervention rather
than possible alternatives
• The legal basis for major projects appraisal is Regulation 1303/2013 of
European Parliament and Council (EUR-Lex web site) (6*)
5. BCA in the framework of EU funds
• BCA (including an economic and an financial analysis including risk
assessment) is one of the very important information required for the
approval of a major project (1*)
• The analytical framework of BCA refers to a list of underlying concepts:
- oportunity costs
- long term perspective (min. 10 years – max. 30 years or more – depending of
the sector of intervention):
a) set a proper time horizon
b) forecast future costs and benefits (looking forward)
c) adopt appropriate discount rates to calculate the present value
of future costs and benefits
d) take into account uncertainty to assessing the project risks
- calculation of eceonomic performance indicators expressed in monetary terms
(2*III)
- macroeconomic approach; BCA is typically a macroeconomic approach
enabling the assessment of the projects impact on society as a whole via the
calculation of economic performance indicators, thereby providing an
assessment of expected welfare changes (2*IV)
6. Standard BCA
Project appraisal steps
1. Description of the context; presentation of the socio-economic, institutional
and political context;
- the socio-econimc conditions of the county/region that are relevant for the
project, including e.g. demographic dynamics, expected GDP growth, labour
market conditions, unemployment trend etc.
- the policy and institutional aspects, including existing economic policies and
development plans, organisation and management of services to be
provided/developed by the project as well as capacity and quality of the
institutions involved
- the current infrastructure endowment and service provision, including
indications/data on coverage and qualities of service provides, current
operating costs and tariffs/fees/charges paid by users, if any
- other information and statistics that are relevant to better quality the context,
for instance, existence of environmental authorities likely to be involved, etc.
- the perception of the expectation of the population with relation to the service
to be provided including, when relevant, the positions adopted by civil society
organisations
7. Standard BCA
Project appraisal steps
2. Definition of the objectives; needs assessment, project relevance
- identify of the effects of the project to be further evaluated to BCA; the
identification of the effects should be linked to the project objectives in order to
measure the impact of welfare; the clearer the definition of objectives, the
easier identification of the project and it’s effects; objectives are highly relevant
for the BCA which should reveal to what extent they are met (1*I)
- verify the project relevance; evidence should be provided that the project’s
rational responds to a priority for the territory; this is achieved by checking that
the project contributes to reaching the EU policy goals and national/regional
long term development plans in the specific sector of assistance (1*II)
3. Identification of the project; project activities; body responsible for project
implementation; who was standing
- a project is defined as a series of works, activities or services intended in
itself accomplished and invisible task of a precise economic and technical
nature which has clearly identify goals (Art. 100 of the Regulation 1303/2013)
- the project owner is the body responsible for project implementation should
be identified and described in terms of it’s technical, financial and institutional
capacity
- „who was standing” should account for all stakeholders who are significantly
affected by the costs and benefits of the project
8. Standard BCA
Project appraisal steps
4. Technical flexibility & Environmental sustainability; Demand analysis; Option
analysis; Environmental considerations, including Environmental Impact
Assessment and climate change; Technical design, Cost estimates and
implementation schedule (1*)
- demand analysis identifies the need for an investment by assessing:
a) current demand (based on statistics provided by service
suppliers/regulators/national and regional statistical offices
for the various types of users)
b) future demand (based on reliable forecasting models that
take into consideration macro – and – socio-economic
forecasts, alternative sources of supply, elasticity of demand
to relevant prices and income)
- strategic option analysis; once the strategic option is identified, a
comparison of the specific technological solutions is typically carried out
(1*I)
9. Standard BCA
Project appraisal steps
- environmental and climate change considerations; important regulations,
agreement;
a) scope of Strategic environmental assessment (SEA) 2001/42/EC
b) Council Directive 2014/52/EU on Environmental Impact
Assessment (EIA) must be carried out to identify, describe and
assess the direct and indirect of the project on human beigns and the
environmental
c) Paris Agreement; December 2015., 195 countries adopted first-
ever universal, legally binding global climate deal (1*II)
d) while the EIA is formally distinct and self-standing procedure, its
outcomes need to be integrated in the BCA and be in the balance
when choosing the final project option (1*III) (1*IV) (1*IV/1)
- technical design, cost estimates and implementation schedule; a summary of
the proposed project shall be presented with the following headings (1*V)
10. Standard BCA
Project appraisal steps
5. Financial analysis; (financial discount rate recommended by EC is 4% in real terms),
cash flows for project costs and revenues, including residental value; tariff and
affordability analysis (where relevant); sources of financing; financial profitability
& sustainability
- fiscal corrections; taxes and subsides are transfer payments (have to be in
prices) that do not represent real economic costs or benefits for society as they
involve merely a transfer of control over certain resources from one group in
society to another (1*I)
- conversion from market to shadow prices
- evaluation of non-market impacts
Sources of financing:
- union assistance (EU grant)
- national public contribution
- project promoter’s contribution
- private contribution under PPP (public private partnership)
11. Standard BCA
Project appraisal steps
Financial sustainability; the project is financial sustainalbe when the risk of running out of
cash in the future, both during the investment and the operational stages, is expected to
be nil.
Risk assessment is included in BCA as one of the important information necessary for the
approval of the major project; this is required to deal with the uncertainty that always
permeates investment projects, including the risk that the adverse impacts of climate
change may have on the project. (1*I)
Project risks – recommended steps:
- sensitivity analysis enables the identification of the „critical” variables of the
project (1*II); before proceeding to the sensitivity analysis, the BCA model should
be reviewed with the aim of isolating the independent variables eliminating the
deterministic interdependencies (e.g. splitting a variable in its independent
components) (1*II/I)
12. Standard BCA
Project appraisal steps
- the quantitative risk analysis aims shell include the following elements;
a) a list of adverts events to which the project is exposed
b) a risk matrix for each adverse event indicating:
- the possible causes of occurrence
- the link with the sensitivity analysis, where applicable
- the negative effects generated on the project
- the (ranked) levels of probability of occurrence and of the severity
of impact
- the risk level
c) an interpretation of the risk matrix including the assessment of
acceptable levels of risk
d) a description of mitigation and/or prevention neasures for the main
risks, indicating who is responsible for the applicable measures to
reduce risk exposure, when they are considered necessary
13. Standard BCA
Project appraisal steps
- probabilistic risk analysis;
according to the BCA methodology, the probabilistic risk analysis is required
where the residual risk exposure is still significant; in other cases it may be
carried out where appropriate, depending on project size and data availability
- risk prevention and mitigation;
the implementation of the steps described above defines the risk prevention
and mitigation strategy of the project
14. Thank you on your attention
E-mail:
gogic.kristina@hotmail.com
Editor's Notes
2* As it’s name suggests, to use technique simply add up the value of the benefits of course of the action, and substract the costs associated with it. BCA is carried out using only financial costs and financial benefits
5* It is an analysis of the cost effectiveness of different alternatives in order to see whether the benefits outweigh the costs
6* Is BCA the most efficient decision framework? Might be
3* If you’ll use dual or group approach you’ll try to explain your reasoning to a colleague or friend. That will help you check that how your argument is sound. If you’re challenging someone else’s conclusions, it is especially important to be able to explain your reasoning so that you can explain it to that person or group of persons in a way that helps you reach a shared conclusion and avoid conflict.
1* Italy 25%, Portugal 36%, Spain 38%, Ireland 39% and Greece 64%
2* The EU cohesion policy aims to deliver growth and jobs together with the targets and objectives contained within the Europe 2020 strategy
6* This Regulations contains common provisions of the European Regional Development Fund, the Social Fund, the Cohesion Fund, the European Agricultural Fund for Rural Development and the Maritime and Fisheries Fund
1* In order to get approval for the co-financing of the major project the managing authority (MA) of the programme (s) which submits is asked to make available the information necessary for the approval of the major project (article 101 of the Regulation 1303/2013)
2*III – BCA is based on a set of predetermined project objectives giving a monetary value to all the positive (benefits) and negative (costs) welfare effects of the intervention
2*IV While direct employment or external environmental effects realised by the project are reflected in the Economic net Present Value (ENPV), indirect (i.e. on secondary markets) and wider effects (i.e. on public funds, employment, regional growth etc.) should be excluded. This is for two main reasons: most indirect and/or wider effects are usually transformed, redistributed and capitalised forms of direct effects; thus, the need to limit the potential for benefits double counting; other reson: there remains little practice on how to translate them into robust technique for project appraisal, thus the need to avoid the analysis relies on assumptions whose reliability is difficult to check.
It’s recommended to provide a qualitative description of these impacts to better explain the contribution of the project to the EU regional policy goals.
1*I – Article 111. of the Regulation 1303/2013; implementation reports for the investment of growth and jobs goals; by the 31.5.2016. and the same date of each subsequent year until and including 2023. the MS shell submit in the Commission an annual implementation report in accordance with Art. 50.; programme for the ERDF, ESF and Cohesion Fund and EARDF and EMFF (financial data, common and program specific indicators and quantified target valuea etc.)
1*II reference to these strategic plans should demonstrate that the problems are recognized and that there is a plan in place to resolve them
1* Information necessary for the approval of the major project; Art. 101. of the Regulation: details concerning the body to be responsible for implementation of the major project and its capacity; a description of the investment and its location, te total costs and total eligible cost; feasibility studies carried out including the options analysis and the results; a BCA including an economic and a financial analysis and risk assessment; an analysis of environmental impact taking into account climate change adoption and mitigation needs, and disaster resilience; an explanation as to how a major project is consistent with the relevant priority axes of the operational programme or operational programmes concerned and its expected contribution to achieving of the specific objectives of those priority axes and the expected contribution on socio-economic development; the financial plan showing the total planned financial resources (the planned support from teh Funds, EIB and all other sources of financing together with physical and financial indicators for monitoring progress taking account of the identified risks); the timetable of implementing of the major project and where the implementation period is expected to be longer than the programming period, the phases for which support from the Funds is requested during the programming period
1*I Strategic option; examples: - different routes or construction in transport projects (roads/rails); centralized or decentralized systems for water supply or wastewater treatment projects; construction of underground gas storage vs. new LNG terminal; large hospital structures rather than a more widespread offer or health services through local clinics, etc.
1*II The Paris Agreement is a bridge between today’s policies and climate-neutrality before the end of the century. It sets out a global action plan to put the world on track to avoid dangerous climate change by limiting global warming to well below 2 degrees C; the agreement is due to enter into force in 2020.; it will be deposited at the UN in New York and opened for signature for one year on 22 April 2016; it will enter into force after 55 countries that account for at least 55% of global emissions have deposited their instruments of ratification;
1*III uncertainties; the phenomena; weather disasters: heat waves (forest fires, damage crops and impact on human health), extreme rainfalls, riverine flooding; storms and high winds (including damage to buildings, infrastructure, crops and forests); landslides; rising sea levels; cold spells; freeze-thaw damage;
To support reselience to climate change in infrastructure investments, the Commission encourage project promoters to assess the project’s risk-exposure and vulnerability to climate change impacts. EC-Directorate General-Climate action made „The guidelines for project managers; making vulnerable investment climate resilient”. (EC web-site)
1*IV, 1*IV/1 Environmental externalities: noise, air pollution, greenhouse gasses emission, water pollution, soil contamination, ecosystem degradation, vibrations, landscape deterioration
1*V – location; technical design; production plan; description of the infrastructure capacity and the expected utilization rate; cost estimates; estimation of the financial needs for project realization and operations are imported in the BCA as a key input of the financial analysis;
implementing timing
1*I Fiscal corrections: prices for input and output must be cosidered net or VAT; prices for input should be considered net or direct and indirect taxes; prices (e.g. tariffs) used as a proxy for the value of outputs should be considered net of any subsity and other transfer grants by a public entity
1*I Risk assessment should be the basis for risk management, which is the identification of strategies to reduce risks, including how to allocate them to the parties involved and which risks to transfer to professional risk management institutions, such as isurance companies,
1*II Such variables are those whose variations, be they positive or negative have the largest impact on the project’s financial and/or economic performance;
1*II/I For example; „revenue” is a compound variable, which depends on the two independent items „quantity” and „tariff”, both on which should be analysed
