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Brussels, June 27, 2008

Updated and expanded edition of a guide providing guidance on project appraisals for investment projects funded by Structural Funds, Cohesion Fund, and Instrument for Pre-Accession Assistance.

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Brussels, June 27, 2008

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  1. Brussels, June 27, 2008 Guide to COST-BENEFIT ANALYSISof investment projectsStructural Funds, Cohesion Fund and Instrument for Pre-Accession NEW EDITION 2008

  2. The New Edition • The present Guide updates and expands the previous edition (2002), which in turn was the follow up of a first brief document (1997) and of a subsequent substantially revised and augmented text (1999). • The new edition builds on the considerable experience gained through the dissemination of the previous versions and particularly after the new investment challenges posed by the enlargement process. • The objective of the Guide reflects a specific requirement for the EC to offer guidance on project appraisals, as embodied in the regulations of the Structural Funds, the Cohesion Fund, and Instrument for Pre-Accession Assistance (IPA).

  3. The CBA Guide Team • Professor Massimo Florio, Scientific Director, CSIL and University of Milan • Dr. Silvia Maffii, Project Coordinator, TRT • Scientific Advisors • Dr. Giles Atkinson, London School of Economics and Political Science (UK) • Professor Ginés De Rus, University of Las Palmas (Spain) • Dr. David Evans, Oxford Brookes University (UK) • Professor Marco Ponti, Politecnico, Milano (Italy) • Project evaluation experts • Mario Genco • Riccardo Parolin • Silvia Vignetti • Research assistants • Julien Bollati • Maurizia Giglio • Giovanni Panza • Davide Sartori

  4. Table of contents (1) • Introduction and Summary • Chapter 1 - PROJECT APPRAISAL IN THE FRAMEWORK OF THE EU FUNDS 1.1 CBA scope and objectives 1.2 Definition of projects 1.3 Information required 1.4 Responsibility for project appraisal 1.5 Decision by the Commission • Chapter 2 - AN AGENDA FOR THE PROJECT EXAMINER 2.1 Context analysis and project objectives 2.2 Project identification 2.3 Feasibility and option analysis 2.4 Financial analysis 2.5 Economic analysis 2.6 Risk assessment 2.7 Other project evaluation approaches: CEA, MCA and EIA

  5. Table of contents (2) • Chapter 3 - OUTLINES OF PROJECT ANALYSIS BY SECTOR 3.1 Transport 3.2 Environment 3.3 Industry, energy and telecom 3.4 Other sectors • Chapter 4 - CASE STUDIES 4.1 Investment in a motorway 4.2 Investment in a railway line 4.3 Investment in an incinerator with energy recovery 4.4 Investment in a waste water treatment plant 4.5 Industrial investment

  6. Table of contents (3) • ANNEXES A: Demand analysis B: Discount rates C: Project performance indicators D: Shadow wage E: Affordability and evaluation of distributive impact F: Evaluation of health and environmental impacts G: Evaluation of PPP projects H: Risk assessment I: Determination of EU grant J: Table of contents for a feasibility study • GLOSSARY • BIBLIOGRAPHY

  7. Introduction and Summary • The introductory chapter presents the motivations, ambitions and some caveats of the suggested approach. • At the same time, it offers a concise summary of its key ingredients, both in terms of methodological assumptions and of some benchmark parameters.

  8. Chapter 1 • Chapter one provides a reminder of the legal base for the major project and co-financing decisions by the Commission, highlighting the main developments from the period 2000-2006: • CBA scope and objectives • Definition of projects • Information required • Responsibility for project appraisal • Decision by the Commission

  9. Managing authority A major projects enters within the indicative list of the OP Managing authority submits the application form AND encoded information STEP 1. Admissibility check Commission Services The Commission asks for missing information The application form and the encoded information is not complete. PROJECT INADMISSIBLE The project is complete. PROJECT ADMITTED TO APPRAISAL STEP 2. Methodology check (Commission services in consultation with EIB and external consultants if necessary) The Commission asks for explanation/ revisions The methodology is not consistent in some points CBA RESULTS ARE UNRELIABLE The methodology is sound CBA RESULTS ARE RELIABLE STEP 3. Commission decision The project is rejected The project is not desirable from a socio-economic point of view The project isdesirable from a socio-economic point of view The project is not in need of co-financing The project isin need of co-financing The project is not co-financed Calculation of EU grant Further assessment of the Commission services on the basis of information other than CBA

  10. Chapter 2 • Chapter 2 illustrates the standard methodology for carrying out a CBA. • It reviews the key information and the six analytical steps that a project examiner should consider for investment appraisal under the EU (Structural, Cohesion, IPA) Funds. • It is structured as a suggested agenda and check-list for the Member States and Commission officials or for the external consultants who are involved in assessing or preparing a project dossier.

  11. 1. Context analysis & Objective definition • The first logical step is a qualitative discussion of the socio-economic context and the objectives that are expected to be attained through the investment. • This discussion should include consideration of the relationship between the project objectives and the priorities established in the Operational Programme, the National Strategic Reference Framework and consistency with the goals of the EU Funds: • Socio-economic context • Definition of project objectives • Consistency with EU and National frameworks

  12. 2. Project identification • Identification means that : • the object is a self-sufficient unit of analysis, i.e. no essential feature or component is left out of the scope of the appraisal (“half a bridge is not a bridge”); • indirect and network effects are going to be adequately covered (e.g. changes in urban patterns, changes in the use of other transport modes); • whose costs and benefits are going to be considered (‘who has standing’?).

  13. 3. Feasibility and Option analysis • A typical feasibility analysis should ascertain that: • the local context is favourable to the project (e.g. there are no physical, social or institutional binding constraints), • the demand for services in the future will be adequate (long run forecasts), • the appropriate technology is available, • the utilisation rate of the infrastructure or the plant will not reveal excessive spare capacity, • personnel skills and management will be available.

  14. 3. Feasibility and Option analysis • The next step consists of identifying the range of options that can ensure the achievement of the objectives. • The basic approach of any investment appraisal aims to compare the situations with and without the project. • To select the best option, it is therefore helpful to describe a baseline scenario. This will usually be a forecast of the future without the project, i.e. the ‘business as usual’ (BAU) forecast. • Once the BAU scenario and a small number of ‘do-something’ alternatives have been identified, simplified CBA should be carried out for each option in order to rank them and choose the most promising.

  15. 4. Financial analysis • This should be based on the discounted cash flow approach. The EC suggests a benchmark real financial discount rate of 5%. • A system of accounting tables should show cash inflows and outflows related to: • Total investment costs • Total operating costs and revenues • Financial return on the investment costs: FNPV(C) and FRR(C) • Sources of financing • Financial sustainability • Financial return on national capital: FNPV(K) and FRR(K)

  16. Structure of financial analysis

  17. Investment costs Residual value should always be included at end year. It is considered with a positive sign in this table because it is an inflow, while all the other items are outflows. These are funds, not flows

  18. Operating costs & Revenues During the investment phase no operating revenues and costs occur.

  19. Financial return on investment Financial rate of return on investment is calculated considering total investment costs and operating costs as outflows and revenues as an inflow. It measures the capacity of operating revenues to sustain the investment costs. A discount rate of 5% has been applied to calculate this value.

  20. Sources of financing Loan is here an inflow and it is treated as a financial resource coming from third parties.

  21. Sustainability Loan here is considered at the moment it is reimbursed as an outflow. Financial sustainability is verified if the cumulated net cash flow row is greater than zero for all the years considered.

  22. Financial return on capital Financial internal rate of return on national capital is calculated with outflows including the national (public and private) capital when it is paid up, the financial loans at the time they are paid back, in addition to operating costs and related interest, while with revenues as inflows. It does not consider the EU grant.

  23. Financial analysis at a glance

  24. 5. Economic analysis • CBA requires an investigation of a project’s net impact on economic welfare. This is done in five steps: • Observed prices or public tariffs are converted into shadow prices, that better reflect the social opportunity cost of the good. • Externalities are taken into account and given a monetary value. • Indirect effects are included, if relevant (i.e. not already captured by shadow prices).

  25. 5. Economic analysis(2) • Costs and benefits are discounted with a real social discount rate (5.5% for Cohesion and IPA countries, and for convergence regions; 3.5% for Competitiveness regions). • Calculation of economic performance indicators: Economic Net Present Value (ENPV), Economic rate of return (ERR) and the benefit-cost ratio (B/C).

  26. From market to accounting prices

  27. The Shadow Wage • In an economy characterised by extensive unemployment or underemployment, the opportunity cost of labour used in the project may be less than the actual wage rates. • Under severe unemployment conditions and very low public unemployment benefits, the shadow wage may be inversely correlated to the level of unemployment.

  28. Examples of Externalities Benefits: • Advantages in terms of reduction of risk of accidents in a congested urban area as an effect of a project for the re-location of a manufacturing plant. • Individuals consuming vaccine against the influenza virus. Those who do not vaccinate themselves receive the benefit of a reduced prevalence of the virus in the community. Costs: • Water pollution by industries that adds poisons to the water, which harm plants, animals, and humans. • When car owners freely use roads, they impose congestion costs on all other users and harmful emissions to pedestrians.

  29. Focus: Environmental Externalities • Three main methodologies can be applied for estimating the monetary value of changes in environmental goods: • Revealed Preference Methods • Stated Preference Methods • Benefit Transfer Method

  30. Focus: Environmental Externalities

  31. Social Discounting A generally used formula for estimating the social discount rate from the growth rate can be expressed as follows: r = eg + p where: r = real social discount rate of public funds expressed in an appropriate currency; g = is the growth rate of public expenditure; e = elasticity of marginal social welfare with respect to public expenditure; p = rate of pure time preference.

  32. Economic rate of return

  33. 6. Risk assessment A project appraisal document must include an assessment of the project risks. Again, five steps are suggested: • Sensitivity analysis: identification of critical variables, elimination of deterministically dependent variables, elasticity analysis, choice of critical variables, scenario analysis. • Assumption of a probability distribution for each critical variable.

  34. 6. Risk assessment (2) • Risk analysis: calculation of the distribution of the performance indicator, typically FNPV and ENPV). • Discussion of results and acceptable levels of risk. • Discussion of ways to mitigate risks.

  35. Sensitivity analysis

  36. Probability distribution of critical variables

  37. Risk analysis

  38. Levels of risk in the different project phases

  39. Other evaluation approaches • Cost-effectiveness analysis • Multi-criteria analysis • Economic Impact Assessment • These approaches should be see as a complement of CBA and NOT as a substitute.

  40. Chapter 3 • Chapter 3 includes outlines of project analysis by sector. • The outlines are based on the approach described in Chapter 2 and follow the suggested steps. Each sector presents a general description of possible project objectives as well as the main inputs for the financial and economic analysis. • As uncertainty and risk concerning variable trends and values are important points to be considered when appraising investment projects, a list of the most critical factors has been included for each sector.

  41. Chapter 3 • Transport • Transport networks • CBA of High Speed Rail investment in Europe • Ports, airports and intermodal facilities • Environment • Waste treatment • Water supply and sanitation • Natural risk prevention • Industry, Energy and Telecommunication • Industries and other productive investments • Energy transport and distribution • Energy production and renewable sources • Telecommunications infrastructures • Other sectors • Education and training infrastructures • Museums and cultural sites • Hospitals and other health infrastructures • Forests and parks • Industrial zones and technological parks

  42. Transport – Project Objectives Objectives: • reduction of congestion by eliminating capacity constraints on single network links and nodes, or by building new and alternative links or routes; • improvement of the performance of a network link or node, by increasing travel speeds and by reducing operating costs and accident rates through the adoption of safety measures; • shift of the transport demand to specific transport modes; • completion of missing links or poorly linked networks; • improvements in accessibility for people in peripheral areas or regions.

  43. Transport – Project Identification Typology of investments: • New infrastructures (road, rail, ports, airports) to satisfy increasing transport demand • Completion / extension/ renovation of an existing infrastructure • Investment in safety measures on existing links or networks • Improved use of the existing networks (i.e. better use of under-utilised network capacity) • Improvement in intermodality (interchange nodes, accessibility to ports and airports) • Improvement in networks interoperability • Improvement in the management of the infrastructure

  44. Transport – Demand and GDP There is a strong positive correlation between GDP and the distance travelled by passengers and goods: goods transport tends to grow faster than GDP while, at least recently, passenger demand has tended to grow at a slower rate. In terms of elasticity, goods elasticity to GDP is above 1 while for passengers it is below 1.

  45. Transport – Financial Analysis

  46. Transport – Economic Analysis • Variations in the consumer’s surplus: change in generalised transport costs, which incorporate the money costs travel, (i.e. the perceived cost: fares, tariffs and tolls, and vehicle costs perceived by the users); • Variations in road user producer’s surplus: the unperceived costs (e.g. tyres, maintenance and depreciation)of the private the road users enter into the calculation of the road users producer’s surplus as they are considered as producers of the services they supply to them selves (car users) or to their customers (trucks); • Variations in operator producer’s surplus: profits and losses of infrastructure managers, if available, and transport service operators; • Variations in taxes and subsidies for the government; • Variations in external costs (emissions, noise, etc.).

  47. Transport – Economic Analysis (2) HEATCO recommended values of travel time savings

  48. Transport – Economic Analysis (3) DG TREN recommended values for CO2 emissions

  49. Transport – Economic Analysis (4) HEATCO recommended values for casualities avoided

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