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ECONOMIC ANALYSIS

ECONOMIC ANALYSIS. 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?.

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ECONOMIC ANALYSIS

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  1. ECONOMIC ANALYSIS

  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?

  3. Questions & Decisions 2. • What standard of construction should be used? • What standard and frequency of road maintenance is required? • Should stage construction be used? • Are complementary investments required?

  4. 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 • Secondary Benefits are usually ignored • Economic prices are used using constant prices

  5. 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. Economic Prices • Adjust forTaxes, Dutiesand Subsidies • Use the planning discount rate not the financial market rate • If exchange rate is overvalued, then value Imports and Exports more highly • If there is under employment of labour, then Unskilled labour is valued less than market rate • If there is a shortage then Skilled labour may be valued at more than market rate

  7. Project Costs • Management • Labour • Equipment • Materials • Land

  8. Primary Effects 1 • Reduced vehicle operating costs (VOC) • fuel and lubricants • vehicle maintenance • depreciation and interest • overheads • Reduced journey time • drivers, passengers and goods

  9. Primary Effects 2 • Changes in road maintenance costs • Changes in accident rates • Increased travel • Environmental effects • Change in value of goods moved

  10. Secondary Effects Due to changes in: • Agricultural output • Services • Industrial output • Consumer behaviour • Land values

  11. Coverage & Double Counting • Economic analysis should be designed to give maximum coverage of benefits • Avoid double counting: do not add primary and secondary benefits (e.g. increases in land values added to changes in transport costs) • Consumer surplus approach should be adequate (in a perfectly competitive economy)

  12. Economic Comparisons • Economic analysis involves a comparison of “With” and “Without” cases • Forecasts are made of traffic, road condition, VOC and road maintenance 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 analysed to find the best solution • A minimum investment approach often gives the best economic results and should be tested

  13. Traffic Categories • Normal traffic: Existing traffic and growth that would occur on the same road, with and without the investment • Diverted traffic: Traffic diverted from another road to the project road as a result of the investment • Generated traffic: New traffic induced by the investment

  14. Consumer Surplus Approach Transport cost savings for Normal traffic Total Benefits = + Cost Additional Benefits from Generated Traffic C1 C2 Demand Curve T1 T2 Traffic

  15. Estimating Benefits Normal traffic benefits: tripsN * d1 * (VOC1- VOC2) Diverted traffic benefits: tripsD * ((d1 * VOC1)-(d2*VOC2)) Generated traffic benefits: tripsG * d2 * (VOC1- VOC2)/2 d1 = existing road length d2 new road length VOC1 = vehicle operating costs per km “without”investment VOC2 = vehicle operating costs per km “with” investment VOC data relates to each road section and its condition at the time

  16. Economic Decision Criteria • Net Present Value NPV = (B1- C1)/(1 + r) + (B2- C2)/ (1 + r)2 + …+ (Bn- Cn)/(1 + r )n • Internal Rate of Return To calculate IRR, solve for r, such that NPV = 0 B1, B2…Bn = Benefits in years 1, 2 … n C1, C2…Cn = Costs in years 1, 2 …. n r = Planning discount rate n = Planning time horizon

  17. Economic Decision Criteria • Net Present Value/ Investment Cost NPV/ C = NPV/Ci • First Year Rate of Return FYRR = (B1- C1) / Ci B1 , C1 = Benefits and Costs in year 1 after construction Ci = Road investment costs

  18. Project Alternative I

  19. Project Alternative II

  20. Economic Decision Criteria: Summary NPV IRR 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 * Poor V.Good Good Poor Under budget constraint ** Fair Poor V.Good Poor * check for robustness to changes in key variables ** with incremental analysis

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