Download Cost-Benefit Analysis - The Climate Change Commission

Criteria for
Decision-Making in Project
or Policy Analysis
What criteria should we use in
determining the best option, policy or
project, or in establishing priorities, or
ranking problems and solutions?
Three Evaluation Techniques or
Criteria
Conventional or Extended Cost-Benefit
Analysis (maximum Net Present Value,
Benefit-Cost Ratio, Internal Rate of
Return)
Cost-effectiveness (least cost)
Multi-criteria Analysis (ranked
outcomes)
Cost-Benefit Analysis
In CBA our single criterion is optimum economic
efficiency.
CBA measures the flow of discounted costs &
benefits over time of various alternative
options/policies/projects for a given objective.
It is a tool to appraise and compare various
(marginal) investment projects or policies, and
determine which has the greatest net beneficial
effect (our criterion) over time.
Steps
1. Set up the baseline conditions, and identify the
referent beneficiary group(s).
2. Select a portfolio of alternative policies, projects or
interventions (PPI).
3. Identify potential (physical) impacts of the PPI.
4. Predict quantitative impacts over the life of the PPI.
5. Monetize all impacts.
6. Discount the impacts over time to find present
values. Why?
7. Sum: Add up the discounted benefits and costs.
8. Perform sensitivity analysis (at different discount
rates).
9. Determine and recommend the alternative with the
largest net social welfare value.
1. Establish the Baseline (Without PPI) Condition and
Evaluate with the With-PPI Condition
 The baseline line condition without intervention is
the BAU (status quo) situation & trend.
 The actual net benefit (or cost) values of the BAU
situation (w/out the project) must be compared with
(one or all the possible) ‘with-PPI’ conditions.
1. Defining the baseline conditions ad referent group
 Establish the baseline conditions for analysis,
the geographical and analytical boundaries, the
scope of analysis and the time horizon (life of
the PPI), and the significant assumptions.
 The referent group includes those whose
welfare will be accounted for when assessing
the costs and benefits of a particular PPI.
 Those affected by the PPI but not part of the
referent group may later be considered in an
extended CBA approach.
 Also for the extended CBA, the baseline must
include the ecological functions of the
ecosystem under study and the ecological
linkages between resource components.
2. Select the portfolio of alternative PPI
 Through policy research and stakeholder
consultation the range of options may be identified
and expanded at an early stage, but eventually
the analysts must select a small sub-set of the
attractive PPI alternatives.
 They must also identify and predict the
quantitative physical impacts associated with each
option, including the ‘with and without’ evaluation
framework over the life of the PPI.
 The specific characteristics of each alternative are
essential for those involved in the PPI in order to
estimate its costs and benefits.
Types of Adaptation: Autonomous & Strategic/
Policy-driven
Autonomous adaptation: Natural, spontaneously-occurring
adjustments at the household, firm or community level
to cope with the natural, if not unexpected variations in
environmental or local climatic conditions. Adaptation
may be motivated by market conditions/incentives or
communal motivations.
Strategic adaptation: Deliberate and pro-active adjustments
implemented through management policies and
collective decisions, mainly by the local leaders or
national government;
These adjustments are made in the short-term or longterm.
Autonomous
Short
-term
Long
-term
Strategic/ Policydriven
Changes in farm/firm
practices, crop varieties,
planting, management
schemes, production
schedules;
Disaster relief effort
Externally provided
information; improvements in
weather monitoring;
establishment of early
warning & emergency
Reallocation of resources, or
new investments; local
irrigation, erosion control,
flood protection, water
supply & storage facilities,
livelihood diversification
New policies, regulations,
subsidies, public
infrastructures & services,
projects in drought & hazard
areas, improvements in
adaptive capacity, provision of
safety nets
response systems; climate
risks & vulnerability
assessment.
Autonomous
(Individual,
micro level)
Short
-term
Medium
-term
Long
-term
Autonomous or
Strategic/ Policydriven (Sub-national)
Strategic/
Policy-driven
(National)
10 Strategic CC Adaptation Options
1.
Region/ nationwide flood-drought-disaster monitoring,
preparedness & mitigation programs (S)
2.
Groundwater recharge & storage reservoirs in depression
zones (H)
3.
Basin-wide rain harvesting facilities (M)
4.
Trans-basin distribution from surplus to deficit area (H)
5.
Estuarine/ wetlands establishment/ expansion (M)
6.
Septic tank-sewerage-sludge/ wastewater treatment (H)
7.
Mangrove replanting for shoreline protection (S,M)
8.
Flood walls & storm surge barriers (H)
9.
Provision of safety nets to the most vulnerable groups
(S,M)
10. Improve education and health systems; reduce risk of
malaria, cholera, and other water-associated disease
infection (S,M)
If individuals or government do not undertake
adaptation measures, what would happen? –
The damages, costs of CC will fully materialize.
What are these?
Adaptation expenditures (at a given P,T) reduce climate
change damages (partially, not fully). Hence,
Gross benefit of adaptation = Avoided (reduction in)
damages
Spending for adaptation presupposes
Gross benefit of adaptation > Cost of adaptation
Avoided damages - Cost of adaptation = Net benefit
of adaptation (+)
Costs of CC w/o adaptation - Gross benefit of adaptation
= Residual damage > 0
Objective: Increase benefits (Reduce residual damage);
Decrease costs of adaptation (Increase net benefits)
Cost of Climate Change,
Adaptation Cost, Residual Damage
Cost of CC
Cost of CC w/o Adaptation
Net Benefit of Adaptation
Cost after Adaptation
Cost of Adaptation
Residual Damage
T2016
Global mean
temperature
Avoided Damages = Gross Benefit of Adaptation
Net Benefit of Adaptation = Avoided Damages – Cost of Adaptation
Residual Damage = Cost of CC without Adaptation – Gross Benefit of
Adaptation
3. Identify potential (physical) impacts of
the PPI
• Once the particular PPI has been
specified, all the experts in the relevant
fields involved will identify the potential
impacts of the PPI within the identified
project boundary (pilot site, community,
province, region).
• All direct/indirect, fixed/ variable, and
tangible/ intangible impacts must be fully
described.
4. Predict the quantitative impacts over the life of the
PPI
• PPI have impacts over extended periods of time.
• Analysts have to predict the magnitude of all impacts in
terms of measurable units over the life of a particular PPI.
E.g. the area of irrigation, the amount of electricity, or
the amount of water supply that can respectively be
measured in hectarage, KWH (kilowatt hour) and cubic
meters, and in terms of PhP.
If there are impacts on ecological functions and economic
values that cannot be quantified or measured
immediately in physical or monetary units, e.g. social and
cultural impacts, the analysts must provide descriptive
information.
If the required information may not be available for
prediction, the analysts may state their assumptions in
order to estimate anticipated impacts.
5. Monetize all impacts
 Present impacts in monetary terms so that the
costs and benefits (including avoided costs) can be
compared.
 Only primary benefits, like beneficiary employment
and income generated are included. The
conventional costs include capital equipment,
operations and maintenance, but not interest
payments and depreciation. Whether the market
cost of particular resources employed in the project
include subsidies or taxes must be determined to
respectively eliminate under(over) valuation.
 Secondary benefits, like improvement in quality of
life are not included. They do not represent a net
addition to community income.
How to account the costs and benefits
Value of a resource (input) = marginal opportunity cost
= highest amount that someone is willing to
pay for it in an alternative use
In accounting for PPI impacts, their true value or
opportunity costs must be used in evaluation.
Value of a benefit = amount that someone is willing to
pay for it
In extended CBA, the cost of environmental and social
externalities must be accounted in the impacts.
What impacts should be considered and
valued in extended CBA?
Positive and negative impacts (e.g. of
river improvement: fishing versus sand
and gravel)
On-site and off-site impacts (coral
pulverization versus decline fish catch in
the region)
Physical, socio-economic & psychological
impacts
Near and long-term impacts
Internal and external
6. Discount for time in order to account
for present values
Before adding the positive and negative
impacts of a PPI, the monetary costs and
benefits that occur at different time periods
have to be adjusted at a given discount rate.
Future costs and benefits have to be
discounted by an appropriate discount rate
so that they are comparable and can be
evaluated on the same time base, the
present period.
Why? Because the decision is to be made in
the present period.
At a given future period or
at the end of the project,
The option with the maximum stream of
discounted net benefits (relative to other
options) is chosen.
This option provides the ‘most efficient’
resource use & distribution.
At the start of the period when the option is
implemented, what is the Net Benefit?
Over time
Both future benefits and costs must be
discounted
Review of the Steps
1. Set up the baseline conditions, and identify the
referent beneficiary group(s).
2. Select a portfolio of alternative policies, projects or
interventions (PPI).
3. Identify potential (physical) impacts of the PPI.
4. Predict quantitative impacts over the life of the PPI.
5. Monetize all impacts.
6. Discount for time to find present values. Why?
7. Sum: Add up the discounted benefits and costs.
8. Perform sensitivity analysis (at different discount
rates).
9. Recommend the alternative with the largest net
social welfare value.
7. Add up the benefits and the costs
Sum up all the discounted (benefits less costs)
of all respective PPI options to obtain their
particular projected net benefits.
Compare the Net Present Value (NPV) of the
various PPIs. Compute also and compare their
respective Benefit-Cost Ratio (B/C ratio) and
Internal Rate of Return (IRR).
Given only one potential project, it is viable to
proceed when the project’s:
NPV of social benefits > 0,
B/C ratio > 1, and
IRR > social discount rate.
CBA calculates the sum of the discounted flow of
net benefit (receipts Bi minus costs or expenditures
Ci) over time arising from a PPI.
NPV = i Bi – Ci =
(1+r)i
i Bi
(1+r)i
- i Ci
(1+r)i
The NPV of alternative options are compared
and the largest is chosen.
Year
Receipts
Expenditures
Net
Receipts
Discounted
Net
Receipts
0
0
100
-100
-100
1
50
10
40
2
50
10
40
3
45.005
10
35.005
A project’s
CBA and NPV
at different
discount rates.
Discount
Rate
Net
Present
Value
0.05
4.61
0.075
0
0.10
- 4.28
The value of P100 at a future time
Discount
Rate %
Years
25
50
100
200
0.5
2.0
3.5
7.0
88.3
60.95
42.3
18.43
77.9
37.15
17.9
3.4
60.7
13.8
3.2
0.12
36.9
1.9
1.03
0.0001
The value of NPV is very sensitive to the choice of
discount rate. The longer the project lifetime, the
more negligible would be the value of B, C in the
future.
8. Perform sensitivity analysis (in 2
aspects): Why?
To deal with uncertainty;
This would require the identification of uncertain
variables that may affect the magnitude of
impacts and the valuation per unit impact.
 To know the effect of different discount rates on
the valuation of benefits and costs.
Appraisal under Uncertainty and the
Expected NPV (Above Project)
Year
Net
Receipts
(Above
Project)
Net Receipts
under
uncertainty
Net
Receipts
under less
uncertainty
PV with
discount
rate 0.075
0
-100
-100
-100
-100
1
40
35
38
35.35
2
40
35
38
32.88
3
35.005
25
31.003
24.96
NPV at
7.5% = 0
NPV at 7.5%
= -17.03
Expected
NPV
-6.81
What can we conclude?
What would NPV be at 5%?
Proceed if NPV > 0
Purpose and Questions for Sensitivity Analysis
 What are the uncertain variables, their min and
max values and the probability of particular
values?
 Must know how ‘sensitive’ are the outcomes to
changes in the uncertain factors and events. Is it
worthwhile to spend additional money to obtain
more precise data?
 Is it possible to act and limit uncertainties (e.g.
by redesigning the project components or by
simply keeping a watchful eye when managing
the project)?
 Sensitivity analysis helps us to communicate to
decision makers the extent of the uncertainty
and risk in the PPI.
Steps in risk analysis
Given the NPV model and the identified
uncertain variables, we can determine all the
possible NPV outcomes with these
uncertainties, i.e. construct an Investment
Results Table.
Determine the frequency with which various
NPVs occur in the results.
On this basis, predict the likely range of the
NPVs and the probabilities of various NPVs
within that range.
Interpret this information to identify the best
alternative investment options.
10 Strategic CC Adaptation Options
1.
Region/ nationwide flood-drought-disaster monitoring,
preparedness & mitigation programs
2.
Groundwater recharge & storage reservoirs in depression
zones
3.
Basin-wide rain harvesting facilities
4.
Trans-basin distribution from surplus to deficit area
5.
Estuarine/ wetlands establishment/ expansion
6.
Septic tank-sewerage-sludge/ wastewater treatment
7.
Mangrove replanting for shoreline protection
8.
Flood walls & storm surge barriers
9.
Provision of safety nets to the most vulnerable groups
10. Improve education and health systems; reduce risk of
malaria, cholera, and other water-associated disease
infection
CBA calculates the sum of the discounted flow
of net benefit (receipts Bi minus cost expenditures
Ci) over time arising from PPI.
NPV = i Bi – Ci = i Bi - i Ci
(1+r)i
(1+r)i
(1+r)i
The NPV of alternative options are compared & the
largest is chosen.
CAUTION: Check out the ranking and the
discounted B-C ratio
Compare alternative scenarios using
chosen decision criteria
Project
X
Y
Z
PV (C)
100
50
50
PV (B)
200
110
120
NPV
BC-R
100
60
70
2.0
2.2
2.4
Given a 100 budget. Based on their NPV, projects may
be ranked in the order of X, Z, Y. But while X has a
cost of 100, both Y and Z are affordable also at the
same budget of 100, and their combined NPV would be
130 = NPV (Y) + NPV (Z)).
Ranking by NPV does not give the right answer. We
must also consider the Benefit- Cost Ratio.
How to obtain the Internal Rate of Return
NPV = Σ NBt (1+ r) –t = 0
IRR is the discounted rate (r) at which the
NPV is zero.
It shows the actual return of a project.
Note: it is viable to proceed when the
IRR > social discount rate, or
the project’s B/C > 1, or
the NPV of social benefits > 0
9. Recommend the alternative with the
largest net social welfare value
 This is the most efficient project (highest positive
net benefit value), assuming costs are not
understated and benefits are not overstated.
 Note: Because traditional CBA may not fully
capture the intangible impacts (i.e. social costs,
environmental damage or negative externalities
are not valued in the market nor given in
monetary terms), extended CBA must be
undertaken.
 We need to apply valuation techniques in order
to quantify and monetize the intangible impacts.
To reiterate: In contrast to financial analysis, a
full or extended cost-benefit analysis
1. Includes the non-financial benefits of
improved environment quality (health,
aesthetic, recreation, etc.)
2. Considers costs to society as opposed to
costs to private individuals. Social costs
include subsidies, environmental damages,
public ‘bads’.
Extended CBA
With Bd as the discounted sum of the
development benefits over time and Cd as the
discounted development costs of the project,
and ignoring environmental impact
NPV = Σt ﴾Bd - Cd ﴿(1+ r) –t
If NPV > EC
where EC is the present value of the stream
of the project’s environmental impacts over
the lifetime of the project, then the project
should go ahead.
Additional Info: Qualifications to be made
In conclusion, we must state the
omissions, uncertainties, and biases that
were not evaluated in policy analysis.
Specifically, what impacts, environmental
costs and benefits that could have been
valued were omitted?
What uncertainties were not subjected to
analysis; and what distributional
consequences from the impacts and
evaluated options were not considered?
Other Considerations (Distributional)
 List all beneficiaries and parties affected by the
project.
 Value the effects of the benefits and the
externalities of the project on their welfare as it
would be valued in money terms by them.
 How is the NPV distributed? Who obtains the
benefits and bears the costs?
 Determine if there is an uneven distribution of the
benefits and the externalities.
 A project is said to be ‘efficient’ if the benefits
gained fully compensate the losers. The gains, in
principle, compensate the losses, even if the
gainers do not actually compensate.
 Who is the assumed decision maker, implementer
of a PPI?
Rationale for Cost-Effectiveness Analysis
Calculating benefits may be difficult at
times, because of unavailable or
unreliable data.
Hence, making an efficient choice based
on a comparison of benefits & costs may
not be possible.
The available basis of policy decision is the
information on project cost (e.g. to
achieve the max. acceptable/threshold
pollution level).
Given a policy target, the decision criterion becomes
the least expensive means to achieve the policy
objective.
This entails a cost-effectiveness analysis (CEA) of the
various means/options to realize the specified
objective.
It measures the cost (C) per unit outcome (B) while
CBA measures the (B – C).
e.g. The goal of air quality improvement involves the
following independent options: 1) agency
monitoring/ inspection, 2) fuel improvement, 3)
tax, etc. The cost of implementing each option may
be compared to determine their relative
effectiveness.