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5.1 Introduction
This Chapter details, step-by-step, the activities outlined in the framework for conducting
economic evaluation using CBA.
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5. Cost Benefit Analysis Procedure
5.4. Step 2: Identify Project Options
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It will be necessary to determine the level of detail required for the CBA as well as to
identify the beneficiaries of the project and how they are related to the stakeholders.
It is important that the proposal/project defined is not so broad that it is actually a program
of discrete proposals/projects. Conversely, the project defined should not itself be a
component of a discrete project. It must constitute a stand alone investment. Poor
specification of the project can lead to inappropriate assumptions and incorrect results.
It is recommended that at this initial stage of the CBA process, consideration is given to
the development of a consultation plan for industry stakeholders. This plan should include
the consideration of the need for/benefits to the process of having one or more formal
(structured) VM workshops as part of the process particularly in terms of answering a
number of the questions posed above (and in the following section) as well as those
identified in Chapter 4 section 4.2 (Steps 1 and 2).
It will be important to determine whether there are there variations on one basic identified
option eg, variations in the design and operational concepts.
The key question initially will be: What is the base case? Proposal options are evaluated
relative to a base case. CBA cannot be conducted without a base case. The base case
provides the benchmark against which the proposed project can be measured.
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5. Cost Benefit Analysis Procedure
5.5. Step 3: Identify Costs and Benefits
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Agreeing and defining the base case can be problematic and may benefit from use of a
VM workshop (as well as some ‘internal’ discussion with technical experts within the
organisation proposing the change proposal/project).
The stages of development and the years in which costs are to be incurred needs to be
specified. There may be costs incurred during a planning phase (eg, R&D, testing of
various technologies and equipment applications, user community consultation) as well as
in the implementation and operating phases of the change proposal or other initiative.
There may be a number of capital and other cost components incurred over time that need
to be included in the evaluation such as:
● Capital (or investment) items (eg, equipment or software) – typically one-off
expenditures necessary for the project/proposal
● Land acquisition and land restitution costs (including demolition, land clearance, site
preparation, removal of redundant equipment/facilities, etc)
● Construction costs (incl. professional fees)
● Upgrade or refurbishment costs
● Project management costs
● Decommissioning costs
● Transition costs eg, parts of the existing/current system need to operated and
maintained during the transition period to a new system. While not part of the base
case, these are costs associated with a new investment/change proposal
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5.5. Step 3: Identify Costs and Benefits
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● Recurrent costs:
❍ Operating, repairs and maintenance costs associated with the new system which
can accrue to civil and/or military users and can be ‘within’ CASA or external to
CASA
❍ Materials, supplies, utilities and other services
❍ Overheads – administration, personnel and training, for example
● User costs:
❍ Travel time
❍ Flying training time for military purposes
❍ Delays or increases in training sortie time for military operations
❍ Restrictions on access to facilities to one or more classes of user
❍ Accident costs
● New training and related implementation costs (eg, new documentation and
stakeholder consultation and communications)
● Safety and risk costs.
In quantifying user benefits, the analyst must determine who the users are and how many
users there are. There are likely to be multiple user groups involved, for example, one or
more classes of aircraft operators, passengers, air traffic control, military aircraft operators,
etc.
Quantification of safety and risk factors is not easy, but there are various approaches that
may be used which can be important considerations in project evaluation. In such a case,
it is better to quantify the intangibles in monetary terms so that assumptions can at least
be subjected to sensitivity tests. In any event, such items should be identified, a
qualitative description included and, where possible they should be given a subjective
weighting.
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5.5. Step 3: Identify Costs and Benefits
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It is possible to attempt to quantify some of these costs in monetary terms (eg, the SEV
has data on costs associated with air pollution/emissions and other externalities). Where
the analyst cannot attach monetary values to such effects, they should seek to ascertain
who are the ’winners’ and ‘losers’ and the impact of the gain or loss on the economy.
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5.6. Step 4: Discount Future Costs and Benefits
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For any particular project/proposal, some individuals (or groups in the community) may be
made better off and others made worse off. For example, people who stand to lose their
peace and quiet or local view due to increased airport capacity and those who gain greater
accessibility and improved air travel frequency will rarely compensate infrastructure.
Whilst CBA cannot resolve equity issues, it is important to draw attention to them by
qualifying the impacts of proposed policy changes on different parties. Equity and
distributional concerns should be considered and should be included in the overall
evaluation if they are likely to be significant. Where information is available, the ‘winners’
and ‘losers’ and the magnitude of their gains and losses should be identified and
discussed in the CBA report. This is to ensure that decision makers are aware of who may
‘gain’ and who may ’lose’ as a result of the project. The size and/or the nature of the
project and/or the significance of likely equity issues will influence the level of effort made
to assess the magnitude of the distribution of gains and losses between different groups.
The recommendation is that, at a minimum, impacted parties and the nature of these
impacts are identified.
Discounting satisfies the view that people prefer immediate benefits over future benefits
(social time preference) and it also enables the opportunity cost to be reflected
(opportunity cost of capital).
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5.7. Step 5: Calculate the Decision Criteria
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It recommended that at a minimum the NPV is calculated and that this should be the key
decision criteria as this is considered to provide a better measure of society’s wealth
maximisation than, for example, the internal rate of return of benefit-cost ratio. In other
words, in an unconstrained market, the option with the highest NPV provides the best
economic return. Where there is a budget constraint however, the NPV/i ratio facilitates
capital rationing and indicates the highest return per dollar invested. It is therefore
possible that an option may well result in a lower NPV but a higher NPV/i ratio than
another option.
While the other measures can be readily calculated eg, IRR, BCR and payback period,
they should be utilised only as supplementary indicators.
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5.9. Step 7: Identify Preferred Option
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As noted earlier, the development of one or more scenarios should be undertaken, with a
particular focus on a credible ‘worse case’ scenario where a number of assumptions
/variables are assessed in a pessimistic (but realistic) light.
In general, if the proposal/project can be justified under very adverse scenarios, then the
analyst can be confident that the project is robust.
The incorporation of any specific relevant risk analysis should be incorporated at this
stage.
1. The ranking of options by NPV and NPV/i and possibly BCR and IRR and other criteria
(eg, payback period) in the initial base evaluation.
2. The ranking of options by NPV and NPV/i in the subsequent sensitivity tests.
3. The weighting of costs and benefits which have only been quantified in physical units
or described in qualitative terms (‘intangibles’) between options, even though this is
inevitably subjective and somewhat arbitrary.
It is recommended to use NPV and NPVi for decision-making. Where a project is robust,
the ranking of options in the sensitivity tests will usually reflect the ranking of the initial
evaluation. However, the ranking of options in the sensitivity tests may vary in comparison
to the initial evaluation ranking in the case of less robust proposals/projects.
When the unquantified and external costs and benefits are broadly similar in nature,
ranking given by the cost-benefit criteria are usually sufficient and undisputed. However,
when there are significant differences in intangibles between options, a judgement
between competing options will need to be made. This may require an assessment of
whether the net intangible benefits of the second ranked options can be valued at the
difference in NPV between it and the first ranked option.
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5.10. Step 8: Prepare Report
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5.10. Step 8: Prepare Report
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