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Assessing Sustainability –

Project Appraisal via Cost


Benefit Analysis

Anthony Plumridge
OBJECTIVE FOR TODAY

• To understand cost benefit analysis in preparation


for next weeks seminars;

• To understand important aspects in relation to


implementing cost benefit analysis

• To understand a case study application to the


Hospitality sector, when taking account of
externalities
COST BENEFIT ANALYSIS (CBA)
CBA is a methodology for judging whether a proposed project
is desirable from the perspective of wider society. This entails
adding up all the benefits and all the costs of the project and
judging whether the former outweighs the latter.

It is based on the concept of optimum welfare according to


Wifredo Pareto:
A project should go ahead if it makes at least one party better
off without making any party worse off.

This is unworkable as it stands as almost all projects will make


at least one party worse off.

A modification of Pareto’s criteria was proposed in the 1950’s


by John Hicks and Nicholas Kaldor:
A project should go ahead if those made better off could more
than compensate those made worse off.
DISCOUNT RATE

Indicates how one values present consumption versus


future consumption

The higher the discount rate the more you value


present consumption relative to future consumption

The lower the discount rate the more you value future
consumption relative to present consumption

Government infrastructure project that have high


benefits in the future often apply a low discount rate
compared to private sector investments
IMPLEMENTING COST BENEFIT ANALYSIS
Definition of the project
• Resources used and outputs anticipated
• Population affected

Identification of project impacts


• Additionality
• Displacement
• Private costs and benefits
• External costs and benefits

Physical quantification of impacts

Monetary evaluation of impacts


• Using prices where available
• Adjusting prices
– For taxes and subsidies
– For market imperfections
• Calculating shadow prices for non-marketed costs and benefits.
– Contingent Valuation Method
– Travel Cost Method
– Hedonic pricing

Discount cost and benefit flows


• Choice of social rate of time preference.

Apply Net Present Value Test


An Illustration of Cost Benefit
Analysis

Villas all over island versus high rise resorts


(based on 1000 visitors)

• Private investment appraisal


• Social Cost Benefit analysis
Private investment appraisal
High rise Inflow Outflow Outflow Net flow Discount Net DCF
Year £M £m Capital £m
(Profit) Extern £m £m Factor £m
2004 2.50 15.00 -12.50 0.9091 -11.36
2005 2.50 2.50 0.8264 2.07
2006 2.50 2.50 0.7513 1.88
2007 2.50 2.50 0.6830 1.71
2008 2.50 2.50 0.6209 1.55
2009 2.50 2.50 0.5645 1.41
2010 2.50 2.50 0.5132 1.28
2011 2.50 2.50 0.4665 1.17
2012 2.50 2.50 0.4241 1.06

NPV = £1.73m per 1000 2013


TOTAL
2.50
25.00 15.00
2.50
10.00
0.3855 0.96
1.73

Villa Inflow Outflow Outflow Net flow Discount Net DCF


Year £M £m Capital £m
(Profit) Extern £m £m Factor £m
2004 6.50 35.00 -28.50 0.9091 -25.91
2005 6.50 6.50 0.8264 5.37
2006 6.50 6.50 0.7513 4.88
2007 6.50 6.50 0.6830 4.44
2008 6.50 6.50 0.6209 4.04
2009 6.50 6.50 0.5645 3.67
2010 6.50 6.50 0.5132 3.34
2011 6.50 6.50 0.4665 3.03
2012 6.50 6.50 0.4241 2.76
2013 6.50 6.50 0.3855 2.51

NPV = £8.12m per 1000 TOTAL 65.00 35.00 30.00 8.12


Externalities or Social Costs
Per 1000 visitors

Externality High rise Villa


Land take 2ha 100ha
Energy 100mw 1000mw
Water 100ml 10,000ml
Associated costs £mpa
Infrastructure 0.02 0.2
Land use 0.01 0.7
Landscape damage 0.05 0.38
Energy capacity 0.02 0.05
Water sourcing 0.01 0.1
Wildlife destroyed 0.01 0.04
Community services 0.01 0.07
Total external costs p.a. 0.13 1.54
Cost benefit Analysis
Villa Inflow Outflow Outflow Net flow Discount Net DCF
Year £M £m Capital £m
(Profit) Extern £m £m Factor £m
2004 6.50 35.00 1.54 -30.04 0.9091 -27.31
2005 6.50 1.54 4.96 0.8264 4.10
2006 6.50 1.54 4.96 0.7513 3.73
2007 6.50 1.54 4.96 0.6830 3.39
2008 6.50 1.54 4.96 0.6209 3.08
2009 6.50 1.54 4.96 0.5645 2.80
2010 6.50 1.54 4.96 0.5132 2.55
2011 6.50 1.54 4.96 0.4665 2.31
2012 6.50 1.54 4.96 0.4241 2.10
2013 6.50 1.54 4.96 0.3855 1.91

NPV = £-1.34m per 1000 TOTAL 65.00 35.00 15.40 14.60 -1.34

High rise Inflow Outflow Outflow Net flow Discount Net DCF
Year £M £m Capital £m
(Profit) Extern £m £m Factor £m
2004 2.50 15.00 0.13 -12.63 0.9091 -11.48
2005 2.50 0.13 2.37 0.8264 1.96
2006 2.50 0.13 2.37 0.7513 1.78
2007 2.50 0.13 2.37 0.6830 1.62
2008 2.50 0.13 2.37 0.6209 1.47
2009 2.50 0.13 2.37 0.5645 1.34
2010 2.50 0.13 2.37 0.5132 1.22
2011 2.50 0.13 2.37 0.4665 1.11
2012 2.50 0.13 2.37 0.4241 1.01
2013 2.50 0.13 2.37 0.3855 0.91
NPV = £0.93m per 1000 TOTAL 25.00 15.00 2.90 8.70 0.93
Conclusions
When all data on externalities is available and able to be
priced, then cost benefit analysis can be a very useful
tool to aid prioritisation and decision making for
sustainable development.

Often however, data on externalities and accurate


cost/pricing can be very difficult or impossible to attain.
Discounting and the choice of discount rate is a key issue
in CBA.

Applying cost benefit analysis without proper


incorporation of externalities that are accurately
costed/priced, can lead to the wrong decisions being
made. Multi-criteria analysis be applied as an alternative.
FURTHUR READING
Business students/non-economists
Field, BC & MK (2012), Environmental
Economics, McGraw Hill

Economists
Roger Perman et al, (2011), Natural
Resource and Environmental Economics,
4th. edition Prentice Hall (economists)

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