Economic Analysis Concepts

Transcription

1 Economic Analysis Concepts

2 Questions & Decisions (1) Is the project justified?- Are benefits greater than costs? Which is the best investment if we have a set of mutually exclusive alternatives? If funds are limited, how should different schemes be ranked? When should the road be built or upgraded? 2

3 Questions & Decisions (2) What standard of construction should be used? What standard and frequency of road maintenance is optimal? Should staged construction be used? Are complementary investments required? 3

4 Appraisal Framework All appraisals need a framework or model for: a) Forecasting changes b) Evaluating those changes 4

5 Components of Economic Analysis (1) Costs and benefits are measured in money terms Road construction and maintenance costs are compared with estimates of the direct primary benefits going to road users and road agency Secondary benefits are usually ignored Economic prices are used in constant terms 5

6 Components of Economic Analysis (2) Costs and Benefits are forecast over the planning time horizon (usually between 10 and 20 years) Future Benefits are valued less as time progresses using the planning discount rate Costs and Benefits are compared using decision criteria such as NPV, IRR, etc. 6

7 Economic and Financial Prices The cost to the economy of road rehabilitation and maintenance may differ from the financial cost because of : taxes and duties shortage of foreign exchange under-employment The Government will usually be concerned with ECONOMIC costs. Contractors will usually be concerned with FINANCIAL costs. 7

8 Use of Economic Prices In an Economic Appraisal we use ECONOMIC (or SHADOW) prices NOT FINANCIAL prices Adjust financial prices as follows: Exclude all taxes and duties and subsidies Use the planning discount rate not financial market rate If overvalued exchange rate then value imports and exports more highly Use the opportunity cost of labor Standard Conversion Factors are now widely used for road construction costs 8

9 Benefits from Road Investment Changes in transport costs occur because of : Lower road roughness Shorter trip distance Faster speeds Reduced chance of impassability Reduced traffickability problems Change in mode 9

10 Project Costs Management (including design and supervision) Labor Equipment Materials Land, Resettlement, Environment 10

11 Primary Effects (1) Reduced vehicle operating costs (VOC) fuel and lubricants vehicle maintenance depreciation and interest Tire wear Crew time overheads Reduced journey time drivers, passengers and goods 11

12 Primary Effects (2) Changes in road maintenance costs Changes in accident rates Increased travel Environmental effects Change in value of goods moved 12

13 Secondary Effects Changes in agricultural output Changes in services Changes in industrial output Changes in consumers behavior Changes in land values Changes in income 13

14 Consumers Surplus Approach Captures primary benefits Advantages: Simple, cost based, traffic approach dependent on predicting changes in traffic Disadvantages: May not address critical factors promoting either rural development or social access 14

15 Normal and Generated Traffic Benefits Total Benefits = Transport cost savings to Normal traffic and growth Cost C1 + Additional benefits to Generated traffic C2 Demand Curve (Price Elasticity of Demand) T1 T2 Traffic Normal Generated 15

16 Generated Traffic Benefits Traffic induced by the road investment are traditionally valued at: Half the difference in transport costs Hence total generated transport cost benefits = Generated Traffic Volume x Change in Transport Costs per km x Distance x 1/2 16

17 Producers Surplus Approach Captures secondary benefits Advantages: Draws attention to changes in agricultural output (key economic activity in rural areas) Disadvantages: No reliable way of predicting response - impact studies give widely different answers - it could be based on agricultural supply price elasticities but this is almost never done; it requires very careful examination to use. For most projects benefits are just invented! 17

18 Producers Surplus P2 P1 Price & Costs per Unit of Output Increased Farmgate Price Lower Input Costs Output O1 O2 18

19 Coverage and Double Counting Any economic analysis should be designed to give maximum coverage of benefits But we must avoid double counting. Do not add primary and secondary benefits (e.g. changes in land values added to changes in transport costs) In a competitive economy the consumers surplus approach (used in HDM) should be adequate 19

20 Economic Comparisons Economic analysis involves a comparison of With and Without project cases Forecasts are made of traffic, road condition, VOC and road maintenance effects for BOTH scenarios An unrealistic Without case (i.e. with little maintenance) can give a false result A range of With investment cases should be analyzed to find the best solution 20

21 Traffic Categories Normal traffic: Existing traffic and growth that would occur on road, with and without the investment Diverted traffic: Traffic diverted from another road with same origin and destination to as the project road as a result of the investment Generated traffic: Traffic associated with existing users of the road driving more frequently or driving further than before Induced traffic: Traffic attracted to the project road due to increased economic activity in the road s zone of influence brought about by the project 21

22 Benefits from Road Investment Transport cost savings for existing (or normal) traffic = Normal Traffic Volume x Change in Transport Costs per km x Distance Main changes in cost from: a) change in transport MODE b) reduced journey TIME c) reduced VOCs 22

23 Benefits of Upgrading to a Motorable Track Headloading C1 Costs Track Improved road C2 C3 T1 T2 T3 Traffic 23

24 Cost Effectiveness Against Standard of Road 95% of year, access established Marginal productivity 99% of year, access established Maintenance for roughness reduction 0 Maintenance expenditure $/km 24

25 Development Benefits Development benefits arise from a combination of increased traffic and reduced transport costs. Benefits may also include : Increased agricultural production Increased service provision Increased industrial activity 25

26 Estimating Benefits Normal traffic benefits: trips N * d 1 * (VOC 1 -VOC 2 ) Diverted traffic benefits: trips D * ((d 1 * VOC 1 )-(d 2 *VOC 2 )) Generated and Induced traffic benefits: trips G * d 2 * (VOC 1 -VOC 2 )/2 d 1 = existing road length d 2 new road length VOC 1 = vehicle operating costs per km without investment VOC 2 = vehicle operating costs per km with investment VOC data relates to each road section and its condition at the time 26

27 Economic Decision Criteria (1) Net Present Value NPV = (B 1 -C 1 )/(1 + r) + (B 2 -C 2 )/ (1 + r) (B n -C n )/(1 + r ) n Internal Rate of Return To calculate IRR, solve for r, such that NPV = 0 B 1, B 2 Bn = Benefits in years 1, 2 n C 1, C 2 Cn = Costs in years 1, 2. n r = Planning discount rate n = Planning time horizon 27

28 Economic Decision Criteria (2) Net Present Value/ Investment Cost NPV/ C = NPV/C i First Year Rate of Return FYRR B 1, C 1 C i = (B 1 -C 1 ) / C i = Benefits and Costs in year 1 after construction = Road investment costs Payback Period 28

29 Economic Decision Criteria (3) NPV IRR 3 NPV/C FYRR Project economic validity V.Good V.Good V.Good Poor Mutually exclusive projects V.Good Poor Good Poor Project timing Fair Poor Poor Good Project screening 1 Poor V.Good Good Poor Under budget constraint 2 Fair Poor V.Good Poor Notes: 1. check for robustness to changes in key variables (sensitivity analysis) 2. with incremental analysis 3. IRR may be indeterminate with NONE or MANY solutions. 29

30 Present Value Calculation Period Flow A0 A5 PV(A0) = A0 PV(A5) = A5 / (1 + i ) ^ 5 PV(Aj) = Aj / (1+ i ) ^ j PV(Aj) = Present Value of Aj Aj = Amount at year j i = Discount rate j = Year 30

31 Present Value at 12.0% Discount Rate 1.00 in Year 1 = Year 2 Year 3 Year in Year 5 = Year 6 Year 7 Year 8 Year in Year 1 0 = in Year 1 in Year 1 in Year in Year 15 = 0.20 in Year in Year 20 = 0.12 in Year 1 31

32 Discount Rate The discount rate is opportunity cost of capital in the public sector, ie the rate of return on marginal public sector investments The discount rate to be used will be given by the planning authority responsible for the project The World Bank traditionally has not calculated a discount rate for each project but has used 10 to 15 percent as a notional opportunity cost of capital in developing countries 32

33 Discount Rate Versus Interest Rate US discount rate around 4% 33

34 NPV and IRR The Net Present Value (NPV) of a project alternative relative to the without project alternative is the sum of the discounted annual net benefits. The Internal Rate of Return (IRR) is the discount rate at which the NPV is zero. 34

35 NPV Decision Rule 1. If the NPV is positive, for the chosen discount rate, then the alternative is acceptable. 2. If the NPV is negative, for the chosen discount rate, then the alternative is unacceptable. 3. If the NPV is zero, for the chosen discount rate, then the alternative is indifferent to the without project alternative. 35

36 NPV and IRR Calculation (1) Discount Net Rate (i) Discount Present 12.0% Rate (i) Present Investments Profits Present 0.0% 7500 or or Net Value Present 3.0% 6326 Year Costs Benefits Benefits Factor Value 6.0% 5281 a b c d = c-b e = 1/(1+i)^a f = d*e 9.0% % % % % % % % % -544 Total % % NPV = % % IRR = 29.3% 48.0%

37 NPV and IRR Calculation (2) NPV at 12% Discount Rate Net Present Value (M$) Internal Rate of Return 0.0% 10.0% 20.0% 30.0% 40.0% 50.0% 60.0% Discount Rate (%) 37

38 NPV Versus IRR Net Present Value (M$) NPV at 12% Discount Rate Internal Rate of Return 0.0% 10.0% 20.0% 30.0% 40.0% 50.0% 60.0% Discount Rate (%) - The IRR and NPV will not necessarily rank the alternatives by the same order - Always use NPV to compare project alternatives 38

39 Multiples Rates of Return Net Year Benefits NPV at 12% 0.64 IRR #1 10% IRR #2 20% Discount Rate NPV 0% % % % % % % % % % % % % % % % -5.9 Net Present Value (M$) Multiple Rates of Return % 5% 10% 15% 20% 25% 30% 35% Discount Rate (%) 39

40 No Rate of Return Year Net Benefits NPV at 12% 747 IRR #NUM! No Rate of Return Discount Rate NPV 0% % % % % % % % % % % % % % % % Net Present Value (M$) % 5% 10% 15% 20% 25% 30% 35% Discount Rate (%) 40

41 Same Rate of Return Net Benefits Project Project Year NPV at 12% IRR (%) 25% 25% Discount Project Project Rate 1 2 1% % % % % % % % % % % % % % % % Net Present Value (M$) Same Rate of Return % 5% 10% 15% 20% 25% 30% 35% Discount Rate (%) Project 1 Project 2 41

42 Incremental Rate of Return Alternative A - Base Investments Profits Present or or Net Value Present Year Costs Benefits Benefits Factor Value NPV = IRR = 100.0% MIRR = 100.0% B/C = 1.79 Alternative B - Base Investments Profits Present or or Net Value Present Year Costs Benefits Benefits Factor Value NPV = IRR = 20% MIRR = 20% B/C = 1.07 Alternative B - Alternative A Investments Profits Present or or Net Value Present Year Costs Benefits Benefits Factor Value NPV = IRR = 13% MIRR = 13% B/C =

43 IRR Reinvestment Assumption IRR IMPLICIT ASSUMPTION: ALL CASH FLOW VALUES WILL EARN THE IRR INTEREST RATE Discount Rate (i) 12.0% Future Value in Year 4 Investments Profits If You If You Receive or or Net Invest at and Invest at Year Costs Benefits Benefits 29.3% 29.3% a b c d = c-b Interest Interest = NPV= 3508 IRR= 29.3% Total

44 Modified Internal Rate of Return Modified Internal Rate of Return Calculation Financing Reinvestment Rate (i) Rate (i) 12.0% 12.0% Present Future Modified Net Value Value Cash Year Benefits of Costs of Benefits Flow a d = c-b Costs at Year 0 Benefits at Year TOTAL NPV = IRR = 29.3% 20.7% MIRR = 20.7% 44

45 Benefits X Cost Alternative B 80 Benefits Alternative A Costs 45

46 Net Benefits X Costs (Efficiency Frontier) Alternative B Net Benefits (NPV) Alternative A Costs 46

47 Comparison of Alternatives When comparing project-alternatives, the Net Present Value (NPV) is used to select the optimal project-alternative (alternative with highest NPV) The Internal Rate of Return (IRR) or the B/C ratio are not recommended to compare alternatives of a given project Project Alternatives NPV Optimal Alternative: Highest NPV

48 Projects Ranking Projects When comparing the economic priority of different projects, a recommended economic indicator is the NPV per Investment ratio Selected Alternative Overlay Reseal Overlay 48 NPV/Investment P R I O R I T Y

49 Budget Constraints Simple Methodology Projects Selected Alternative NPV Investment NPV per Investment Available Budget Overlay Reseal Overlay P R I O R I T Y Reseal Budget Constraint Cut Off Overlay

50 Budget Constraints Optimization Projects Alternatives Available Budget NPV Evaluates all possible combinations of projectalternatives to find the combination that maximizes the NPV of the overall network for the given budget constraint. P = Number of projects A = Number of alternatives C = Number of possible combinations C= A ^P

51 HDM-4 Optimization Example (1) Section 1 Option Cost NPV A 2 4 B 5 7 C 7 8 Section 2 Option Cost NPV A 1 3 B 3 6 C 5 8 What is the recommended program for a budget of 5? 51

52 HDM-4 Optimization Example (2) B C B C A A dnpv/dcost Cost Section 1 Section 2 52

53 HDM-4 Optimization Example (3) A, 2-B 1-A, 2-C 1-B, 2-C 1-C, 2-C A, 2-A Combination of project alternatives that maximizes the NPV of the network 53 Cost Network

54 Appraisals & Post Evaluations (1) An Appraisal is carried out before an investment is made. Everything is uncertain. A Post evaluation may be made say 5 years after the investment. The investment is known and 5yrs of with case are known. The without case is unknown as is the remainder of the with case. 54

55 Appraisals & Post Evaluations (2) In Both Cases forecasting and evaluation models are required to come to an answer. Hence we can never be certain about the viability of an investment! 55

56 Sensitivity Analysis Consequences of changes on inputs Investment Costs (e.g. +15%) Traffic Growth Rate (e.g. = zero) Generate Traffic (e.g. = zero) Value of Time (e.g. = zero) A = Investment Costs Increase (e.g. +15%) B = Road User Benefits Decrease (e.g. - 15%) C = A and B together 56

57 Switching Values Analysis Inputs that yield a NPV equal to zero Investments Costs Normal Traffic Traffic Growth Rate Generate Traffic Investment Cost Road User Benefits 57

58 Risk Analysis Inputs vary at the same time following some defined distributions Normal Traffic Frequency Distribution 35% 30% 25% 20% 15% 10% 5% Country Africa Region Project Road Management Initiative Road Road from Point A to Point B Option 2 Upgrade to ST Internal Rate of Return Upgrade Road to Surface Treatment Standard Minimum 4.2% Maximum 22.7% Average 11.9% Standard Deviation 3.5% Median 11.7% Percentile 25% 9.4% Percentile 50% 11.7% Percentile 75% 14.1% Probability that IRR is less than 12% 50% Probability that IRR is greater than 12% 50% 0% Multiplier Factor Upgrade Road to Surface Treatment Standard 8% 7% Frequency Distribution 14% 12% 10% 8% 6% 4% Project Investment Costs Frequency Distribution 6% 5% 4% 3% 2% 1% 2% 0% 0% Multiplier Factor % 6.0% 7.1% 8.1% 9.1% 10.1% 11.2% 12.2% 13.2% 14.2% 15.3% 16.3% 17.3% 18.3% Internal Rate of Return 19.4% 20.4% 21.4% 22.4% 23.5% 24.5%

59 Rural Transport Infrastructure Farm Household/ Village Sub-village Typical Transport Infrastructure Path Path/Track Track/ Earth Road Market Center Earth Road/ Gravel Road District Headquarters 1-2 lane Gravel / ST Road Regional Headquarters 2 lane AC** Road Capital/ Port Typical Traffic Porterage NMT NMT 0-5VPD 5-50VPD 1-5 km 1-10 km 5-20 km Share of Asset Value Share of Network Length 40% 20% 0% NMT >100VPD >1500VPD VPD km km km 40% 20% 0% Responsability Type of Network Community Local Government Rural Transport Infrastructure Provincial/Central Government Trunk or Provincial Road Tracks Roads Highways 59

60 Rural Transport Infrastructure Rural Transport Infrastructure Primary, Secondary and Municipal Roads Road Network Tertiary Secondary Primary Functional Classification Access Collector Arterial Responsibility Community Local Government Regional & National Municipal % of Road Network N.A % +- 10% +- 10% 1 to 2 earth or gravel 1.5 to 2 gravel or paved Physical Characteristics tracks lanes lanes 2 or more paved lanes Normally sections with 1 to 5 kms Normally sections with 5 to 20 kms Normally sections with 20 to 100 kms Normally sections with 50 to 200 kms Traffic Characteristics Mostly NMT < 50 AADT + NMT AADT > 500 AADT Economic Evaluation No No Yes Yes Social Evaluation Yes Yes Complimentary No Financial Evaluation No No No Tolls Technical Evaluation No Yes Yes Yes Environmental Evaluation No Yes Yes Yes Safety Evaluation No Yes Yes Yes Focus on social evaluation (cost effectiveness indices, community priorities and multi-criteria analysis) 60

61 Social Benefits: Why the Concern? There is unease with conventional appraisal based primarily on transport cost savings to traffic There is a strong desire at community and national levels for better access and mobility which is frequently not matched by standard measured economic benefits The rich world governments subsidise rural transport. Should the same happen for developing countries? Isolation is a recognised characteristic of poverty There is a feeling that a minimum degree of access and mobility is a basic human right Development has moved away from a narrow definition of economic development towards concern with livelihoods and meeting Millennium Development Goals The issue is particularly important when roads are impassable to motor traffic 61

62 Economic & Social Benefits Consumers and producers surplus approaches are very economic in orientation. Yet roads provide social benefits including improved access to health and education facilities and improved social mobility that cannot be easily translated into conventional economic benefits. Although they may have important long term economic consequences. Improved health and education and more secure social networks increase long term earning capabilities but so far the economic forecasting framework does not include this. When roads are impassable to motorized traffic we know that the quality of health care and schooling falls. Drug supply and supervision drops. Likewise no NGO, government agency or commercial enterprise will establish or support a service which cannot guarantee all year round access. 62

63 Indices and Ranking Widely used for feeder road planning; there are many different approaches e.g. i) cost of improvement / population ii) estimated trips / cost Advantages: Speed, simplicity, transparency, many factors can be incorporated Disadvantages: How do we value widely different factors? (adding up apples and pears); weightings are not stable ; cannot easily address questions of road standards, timing etc, ; possible double counting 63

64 Example of Two Indices i) Andhra Pradesh (India) cost effectiveness = cost of upgrading/ population served But no measure of condition change and no importance to traffic ii) Airey & Taylor 1st for impassable roads rank = cost per head of establishing basic access 2nd when access is there: estimated trips x access change prioritization index = rehabilitation cost per km 64

65 Community Priorities Community priorities now often form an important part of feeder road appraisal. It is possible just to ask communities to rank the investments they prefer- both within the road sector or between roads and other investments. Advantages: Community acceptability, use of community knowledge Disadvantages: Sectional interest groups may dominate voting, community knowledge of area or road impact may be poor 65

66 Cost Effectiveness Analysis (CEA) Compares the cost of interventions with its predicted impacts and it is used where the benefits cannot be measured in monetary terms, or where the measurement is difficult It includes provisions that (a) the objectives of the intervention are indicated and are clearly part of a ampler program of objectives (such as reduction of the poverty); and (b) the intervention represents the smaller cost alternative of obtaining the indicated objectives It produces effectiveness indicators, such as Total Beneficiary Population per Investment or Investment per Beneficiary Population 66

67 CEA Comparison of Alternatives To compare project-alternatives, the investment cost is used to select the optimal alternative The selected alternative is the one with the lowest investment cost that will achieve the objective of the program Project Alternatives Investment Optimal Alternative: Lower Investment 67

68 Projects Eligibility with CEA To assess if a project is eligible, an acceptable effectiveness indicator threshold is defined Projects Investment per Population (U$/person) 50 Effectiveness Indicator Threshold Example 150 Eligible Not Eligible

69 Effectiveness Indicator Threshold Frequency of Projects Reasonable ? Investment per Population (US$/person) 69 Non Reasonable? Evaluate Universe of Projects and Available Budget

70 Possible CEA Indicators Investment Cost per Total Beneficiary Population 100 US$ per person Total Beneficiary Population per Investment Cost 0.01 persons per US$ Total Beneficiary Population per Investment Cost in thousands of dollars 10 persons per 1,000 US$ Etc. 70

71 Options for Beneficiary Population Rural beneficiary population o Effectiveness = (rural beneficiary population) / Investment Poor beneficiary population o Effectiveness = (poor beneficiary population) / Investment Mixed beneficiary population Etc. o Effectiveness = (poor persons non poor persons) / Investment 71

72 Total Beneficiary Population (1) Total Beneficiary Population = Directly Benefited Population + Indirectly Benefited Population The Directly Benefited Population is the one that lives next on the road, defined for example to 2.0 km at each side of the road, and the population in the ends of the road, depending on its characteristics and the use of the road The Indirectly Benefited Population is the population that lives in other roads near the road in consideration, who use the project road to arrive at the main population center of the region or at a main road 72

73 Total Beneficiary Population (2) D Main Population Center B C E F A Village For example, for the road section B-C: Directly Benefited Population = Population along section B-C plus on towns B and C Indirectly Benefited Population = Population along section A-B plus on town A 73

74 Multi Criteria Analysis (MCA) (1) It adopts criteria such as traffic, proximity to educative, health, and economic centers, etc. To each section, a number of the points is assigned to each criteria that correspond to the fulfillment of the criteria The added number of the points that each section receives is computed simply adding the points assigned for each criteria, or with the use of a more complex formula, for example, weighting the criteria by their perceived importance 74

75 Multi Criteria Analysis (2) It produces a priority indicator The indicators used in a MCA reflect implicit economic and subjective evaluations If the weights and the points are decided and assigned on a participative way, the MCA has the potential to be a good participative method for planning based on implicit a socioeconomic estimates Nevertheless, it tends to be applied by planning consultants or in isolation without the consultation with the users and communities affected by the project 75

76 Multi Criteria Analysis (3) The result of the MCA, is often, unfortunately, not transparent, specially if many factors are considered and a complicated formula is also applied Therefore, if it is adopted, this method must be used very carefully and to be maintained simple, transparent, and participative 76

77 Multi Criteria Analysis Example (1) Level of poverty of the influence area (Low, Medium, High) Potential for economic development of the influence area (Low, Medium, High) Importance of the road given by local consultation process (Low, Medium, High) Provision of access of social services of the road (Low, Medium, High) Problems of transitability of the road (Low, Medium, High) Functional classification level of the road (Low, Medium, High) Existence of public transport (Low, Medium, High) 77

78 Multi Criteria Analysis Example (2) Population Poverty Agricultural Area Traffic Functional Classification Priority Index Location on Basic Network Beneficiary Population per km Factor Poverty Percent Factor Percent of Area of Influence Factor Daily Traffic (AADT) Factor A=4 B=3 C=2 D=1 Factor Yes = 1 No = 0 Factor 9, % % % % , % % % % % % % % Health Centers Schools Public Transport Environment Feasibility Yes = 1 No = 0 Factor Yes = 1 No = 0 Factor Yes = 1 No = 0 Factor Yes = 1 No = 0 Factor Priority Index Factor = Value / Maximum Value 78