02 - Appraisal and Cost-Benefit Analysis - DME

Every time we're about to build or design a new transportation project, we should ask ourselves whether or not it is useful or if it make sense to do it. The assessment of this is called #Appraisal.

Appraisal

We should make sure that only projects that generate value for society are carried out.

In the economic view, value is created if the benefits achieved are greater than the cost generated.

Appraisal can be made:

• EX-ANTE: before accepting the project
• POST-ANTE: After the project was built, to better manage it

Appraisal approches

• #Social-economic approach (cost benefit analysis)
  • Welfare
  • Quality of life
• Financial approach
  • Evaluating if the project is profitable
• Macroeconomic approach
  • Employment
  • GDP
  • Economic activities
• Other approaches

Social-economic approach

The aim is to satisfy the social needs considering the actual context.

The evaluation can be done following 2 approaches:

• Evaluation by objectives
  • Cost effectiveness analysis
• Evaluation by effects
  • #Cost-benefit analysis (social profitability)
  • Multi-criteria analysis - best to choose among several options

Cost-benefit analysis

The cost-benefit analysis aims to evaluate the impact on the whole society of an investment in mobility.

We are only interested in what we generate. Transfers between agents from a society itself are neutral. For example, tolls are not a collective cost: The individual users pay them, but the gain is for the public, meaning the balance is 0.

The aim of CBA is to maximize efficiency, ignoring effects on equality: it doesn't matter if only a portion of the population is affected, positively or negatively. We only look at the population as a whole.

CBA stages

• There should always be at least one alternative. It can be: "do nothing"
• Identify costs and benefits
• Quantify costs and benefits
• Add all costs and benefits
• Interprete the results obtained and decision criteria
• Carry out a sensitivity analysis
• Compare the project to significant alternatives (including alternative "do nothing)

Costs in CBA

Costs, in #Cost-benefit analysis, are all the resources used by society to launch and manage the new project.

• Initial investment
• Maintenance
• Operation costs

Benefits in CBA

The benefits in #Cost-benefit analysis, are all the consequences of launching the action. They can be both positive and negative. Common beneftis are

• Reduction of emission
• Increase/decrease in noise pollution
• Reduction in traffic
• ...

Common methods to assess externalities

Net Present Value (NPV)

Net Present Value indicates in monetary terms the current value of the net benefits that occur throughout the period studied contrasted with the initial costs.

where:

• $I_0:$ Initial investment of the project
• $B_t:$ Profits of the project in period (year) $t$
• $C_t:$ Costs of the project in period (year) $t$
• $r:$ Discount rate (In EU, usually 3%)
• $n:$ Number of periods (years) for which the analysis is done

In the definition above, the initial investment is considered in year 0.

• [?] Shouldn't $t$ start from 0 in the benefits, if there are benefits even in the year of the initial investment?

A project is considered viable if $NVP>0$.

Internal Rate of Return (IRR)

The discount rate in the #Net Present Value (NPV) calculation can influence whether a project is considered viable or not. So, sometimes it is useful to calculate the discount rate such that the NPV is 0.

The Internal Rate of Return (IRR) is the discount rate such that the #Net Present Value (NPV) is 0: