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Unformatted text preview: tio.” Guide to Cost-Benefit Analysis of Major Projects, In the context of EC Regional Policy, 1997 edition, European Union • European Union Identify step necessary for Cost-Benefit Analysis for major projects: 1 Project identification 2 Definition of objectives (unemployment, economic growth, reduce regional income inequality) 3 Feasibility and option analysis 4 Financial analysis 5 Socio-economic costs 6 Socio-economic benefits 7 Discounting 8 Economic rate of return 9 Other evaluation criteria 10 Sensitivity and risk analysis Expected financial internal rates of return of a sample of 400 major projects of the ‘first generation’ and ‘second generation’ combined average Number* of projects Energy 7.0 6 Water and environment -0.1 Transport Time horizon (years) in the appraisal of a sample of 400 major projects of the ‘first generation’ and ‘second generation’ combined average time horizon Number* of projects Energy 24.7 9 15 Water and environment 29.1 47 6.5 55 Transport 26.6 127 Industry 19.0 68 Industry 8.8 96 Other services 4.2 5 Other services 14.2 10 TOTAL 11.5 149 TOTAL 20.1 289 (*) Projects for which data were available. (*) Projects for which data were available. Source: Guide to Cost-Benefit Analysis of Major Projects, In the context of EC Regional Policy, 1997 edition, European Union Why Cost-Benefit Analysis • Objective of investment may not necessarily be profit, but other factors such as job creation (interesting to consider current stimulus package). • In public goods, for example non-toll highway, since no payment is taking place, evaluation must be based on other alternative. • For public goods, evaluation benefits is in terms of non monetary returns. The gain from an investment is for the society and not for investors. • The issue is how best to quantify the benefits other than monetary benefits from particular investment. Yet all those benefits must be put in a monetary term for comparison purposes • In NPV and IRR costs are both explicit. However, implicit cost and benefits, namely social costs are not taken into account. For example environmental impact of private investment often is not taken into account. • A number of issues emerges regarding decision for public goods: – How do we decide on the return on public goods if they are not traded (can we find a similar trade-able good such as a similar toll road ?) – If the government charges a fee for use of public goods, what should be the fee? ( for example, what is proper level of toll government collects?). After all in many cases government or the owner of public goods (even in the case of privatized toll road) has a monopoly power and therefore it can exploit this power. – What is the distributive effect of government subsidizing use of public good (or taxing it)? For example if a highway is build with tax money, but I never get to use that highway, why should I pay for it? – What is the externality of public goods (construction of a highway)? That is the businesses around the highway benefit from increase activities leading to increase in taxes • What rate of discount should be used in the calculation • Some of the decision on pubic goods could be politically motivated. The two critical issues are prices and decision to investment. • For example, price of water, electricity, toll and bridges, tuition on public universities are all political decision and are not fully driven by market forces. • But while decisions are politically driven, they must also have economic justifications. How do we measure the economic benefits, recognizing at the same time, that social benefits exceeds private benefits (measured purely by price charge for the use of particular good). Project type Number of cases (N) Rail Fixed-link Road All projects Average cost escalation (%) 58 33 167 258 Standard deviation 38.4 62.4 29.9 38.7 44.7 33.8 20.4 27.6 Level of significance (p) <0.001 <0.004 <0.001 <0.001 Inaccuracy of transportation project cost estimates by type of project (Fixed prices). Frequency (%) 40 30 Road Projects (N=58) 20 10 0 -80 -40 0 60 120 160 200 240 280 240 280 Cost escalation (%) 50 Frequency (%) 40 40 30 Road Projects (N=167) 20 10 0 -80 -40 0 40 60 120 Cost escalation (%) 160 200 Image by MIT OpenCourseWare. Europe Project type Other Geographical Areas North America Number Average cost Number Average cost Number Average cost of projects escalation Standard of projects escalation Standard of projects escalation Standard (N) (%) (N) (%) (N) (%) deviation deviation deviation Rail 23 34.2 25.1 19 40.8 36.8 16 Fixed-links 15 43.4 52.0 18 25.7 70.5 0 Road 143 22.4 24.9 24 8.4 49.4 All projects 181 25.7 28.7 61 23.6 54.2 64.6 _ 49.5 _ 0 _ _ 16 64.6 49.5 Inaccuracy of transportation project cost estimates by geographical locations (fixed prices). Image by MIT OpenCourseWare. Impact of Large Projects • Megta projects absorb a large amount of resources with substantial impact over a long term on the prices and outputs of...
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This note was uploaded on 07/25/2012 for the course ECON 111 taught by Professor King during the Spring '12 term at CSU Bakersfield.

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