On MEGA projects and
evaluation of their
economic and other
impacts
Heikki A. Loikkanen
Professor (emeritus) of urban
economics, University of Helsinki
Lecture at Aalto University, Dept. of Architecture,
September 28, 2016, Espoo
TOPICS TO BE COVERED
 WHAT TYPES OF MEGA PROJECTS
- PERSONAL, PRIVATE BUSINESS, PUBLIC, MIXED
- SHORT AND LONG: REVERSIBLE OR IRREVERSIBLE
 COST BENEFIT ANAYLYSIS OF PRIVATE & PUBLIC
PROJECTS (in this file)
 HELSINKI EASTERN METROLINE CASE
 Seppo
Laakso’s dissertaion has a chapter on this
 ON SPORTS AND CULTURAL MEGA EVENTS
 WC2005
IN HELSINKI (Summary report in English available)
 EUROVISION
SONG CONTEST 2007 IN HELSINKI (Summary of a
Finnish report available)
 UNFORTUNATELY, I CANNOT DELIVER ALL
PRESENTATIONS
2
Mega Project and Cost-Benefit Analysis (CBA)
1. Introduction
• CBA can be applied to evaluate investment
projects, which typically have a long lasting
cost and benefit structure
• Business investment (a special case of CBA)
• Railway, highway, power plant
• School, opera, environmental project
• Labour market reform (viewed as investment)
Heikki Loikkanen, NAPA 2016
Cost and revenue structure of a typical
investment project over time
Revenue
0
Time
Costs
Heikki Loikkanen, NAPA 2016
How to evaluate and choose which project
is best, and should it be realized?
- Assume that building takes 5 years, and then
investment brings revenue until year 20.
PROPOSAL
• if the sum of benefits B1+ ... +B20 , is greater
than the sum of costs C1+...+C20, then project
is worth realizing?
• WHAT IS WRONG WITH THIS CRITERION?
Heikki Loikkanen, NAPA 2016
2. Three investment criteria
Two projects x and z.
PRESENT VALUE (PV) CRITERION
PVi = B0i-C0i + (B1i-C1i)/(1+r) + ... + (BTi-CTi)/(1+r)T , i = x, z.
where r is the market interest rate.
Decision rule: what is it?
Heikki Loikkanen, NAPA 2016
CBA continues
Internal rate of return (ij )method
B0j-C0j + (B1j-C1j)/(1+ ij) + ... + (BTj-CTj)/(1+ ij)T = 0 ,
j = x, z.
Solve ij
Decision rule: what is it?
Heikki Loikkanen, NAPA 2016
Numerical example
The annual net benefits (revenue-costs) of projects x and z during three years
are:
•
project x: (-100, 0, 120)
•
project z: (-100, 115, 0)
•
In Figure 1 the present value function of project x intersects the
r-axis at value r= 9.5 %, and the PV function of z at value r= 11,5 %.
If the market rate of interest exceeds 9,5 % project x is unprofitable.
Project z becomes unprofitable if interest rate exceeds 11,5 %.
In our numerical example r* is the intersection point of two projects’PV
functions and it happens at interest rate level of 4,4 %.
DECISION RULE:
When the market rate of interest is below 4.4 % choose project x.
When the market rate of interest is above 4.4 % choose project z, but if the
interest rate exceeds 11,5 reject also project z and don’t realiza either
project.
Heikki Loikkanen, NAPA 2016
Figure 1 Investment criteria (NPV and Internal Rate of
Return)
Heikki Loikkanen, NAPA 2016
CBA continues
Benefit-cost ratio B/C
B= B0i + (B1i)/(1+r) + ... + (BTi)/(1+r)T , i = x,z
C = C0i + C1i/(1+r) + ... + CTi/(1+r)T , i = x, z
Decision rule: what is it?
Which of the three rules should be applied?
Always or depending on case?
Heikki Loikkanen, NAPA 2016
3. Evaluating public projects with CBA
Differences with private projects
Three baskets:
• items which have market prices (like in private projects),
• items which have to be assessed,
• items which cannot even be assessed but are worth
mentioning and evaluating in some way
Risks: how should they be taken into account?
Why applications of CBA are more art than science, and
what could be done to improve the use of CBA?
Heikki Loikkanen, NAPA 2016
Thank you
Heikki Loikkanen, NAPA 2016