EUROPEAN COMMISSION
Regional Policy
EN
COST-BENEFIT ANALYSIS
in the framework of
EU Cohesion Policy:
6 steps for a good appraisal
Francesco ANGELINI
2007 - 2013
European Commission, DG for Regional Policy
Coordination Unit – Major Projects Team
Brussels, 28 May 2009
• What is CBA?
CBA is an evaluation method, a tool that
provides support for informed judgment
and decision making.
• When is CBA required?
Under the EU Cohesion Policy a CBA
CBA and
must be performed for “major projects”,
EU
that is projects with a total cost above
Cohesion
Policy
– €25m in the case of the environment
– €50m in other fields
– €10m under the IPA (candidate
countries)
2
Major projects in 2007-2013
• Over the 2007-2013 period some 950 major
projects are expected to be submitted for a total
investment value exceeding €125bn
Major projects budget (€)
4.574.306.400
Expected number of
Major projects
3.787.767.800
40
17.976.925.221
99.032.714.834
Transport
Environment
51
468
390
Energy
Others
6 steps
for a
good
appraisal
4
*
* Unless it is subject to State Aid rules
1. Context analysis & Objective definition
Step 1.
Context
and
objectives
5
• Analysis of the context within which the
project is going to be implemented (e.g.
GDP growth, demographic
developments, etc.)
• Definition of project objectives: target
socio-economic variables that are
quantitatively measurable.
• Consistency with EU and National
frameworks: the project is part of a larger
planning exercise!
2. Project identification
Step 2.
Project
Identification
6
• the object has to be 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 need to be
adequately covered (e.g. changes in
urban patterns, changes in the use of
other transport modes)
• Define whose costs and benefits are
going to be considered (‘who has
standing’?)
3a. Option identification
•
It aims to identify investment
alternatives along with their key
features. A crucial information of this
identification is the demand induced by
each alternative
•
At least two feasible options should
always be considered:
Step 3.
Feasibility
& Option
Analysis
 “Business as usual” (Do Nothing)
 Do Minimum Option
7
 Do Something Option
Note that CBA is carried out on an
incremental basis, i.e. on the
difference between
•
Incremental
approach
•
a scenario with the project (do
something or do minimum)
and a scenario without the project, ie
“business as usual” (do nothing or, in
some cases, do minimum)
Important implications for projects
expanding existing networks
8
3b. Feasibility analysis
Step 3.
Feasibility
& Option
Analysis
9
It identifies the options potential constraints
and related solutions with respect to the
following aspects:
• technical (e.g. technology, size, location)
• economic (e.g. capital, labour)
• regulatory (e.g. Natura 2000 sites)
• managerial (e.g. PPP, timing)
3c. Option selection
Step 3.
Feasibility
& Option
Analysis
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• Two/three feasible options should be
short-listed based on the results of the
feasibility analysis
• The most suitable feasible option should
then be chosen with a view to maximising
the project socio-economic impact as
gauged by the results of the economic
analysis (complemented by the risk
analysis results)
4. Financial analysis
•
•
•
Estimate the profitability of investment
(“C”) and national capital (“K”)
Determine the appropriate contribution
from the Funds
Check the project's financial sustainability
Step 4.
Financial Methodology: Discounted cash-flow (DCF)
Analysis • Only cash flows are considered (i.e., no
•
11
depreciation, contingency reserves, etc.)
over a given reference period
Cash flows are discounted to present
time
Reference period: number of years for
which forecasts are provided in the cost
benefit analysis. It should reflect the
economic useful life of the asset.
A residual value should be considered
where appropriate
CBA time
horizon
12
Sector
Energy
Water & Environment
Railways
Roads
Industry
Other services
Reference period
15-25
30
30
25
10
15
• A 5% financial discount rate in real
terms is recommended as a
benchmark for public investment
projects co-financed by the Funds.
Financial
discount
rate
13
•
Consistency must be ensured
amongst the discount rates used for
similar projects in the same
region/country
DIC: Discounted Investment cost
Funding gap
R%
Gross self-financing
margin
(100-R)%
DNR: Discounted Net Revenue*
What is
the
“Funding
gap”?
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The “funding gap” is the part of the investment
cost which is not going to be recoup by the
project net revenue.
Funding gap rate:
DIC  DNR
R
DIC
* Discounted net revenue = + discounted revenue
– discounted operating costs + discounted
residual value
The rationale of the EU grant
The EU grant targets the project “funding
gap”. The Community contribution aims to
guarantee a given level of financial
profitability so that the project can be
implemented.
Rationale
of EU
grant
FNPV (without EU
contribution) <0
FNPV/C
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EU grant
“funding-gap”
method
Financial sustainability
FNPV⇨0
FNPV/K
5. Economic Analysis
• It aims to assess the project economic
desirability. It differs from the financial
analysis because:
Step 5.
• It is carried out from the point of view of
the
whole
society,
while
the
financial
Economic
analysis is done from the point of view
Analysis
of the project owner(/operator)
• It also considers non-market impacts
(e.g. savings in travel times, changes in
externalities, etc.)
16
Rationale of the economic analysis
• The economic analysis is done at
shadow (accounting) prices:
• project’s inputs should be valued at
their opportunity cost (e.g. opportunity
cost of labour, depends on whether the
Economic
worker was previously employed or
Analysis
not)
• the outputs should be valued at
consumers’ willingness to pay (e.g.
WTP for improved water quality in
rivers).
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•
•
Economic
Analysis
1. From market to accounting (shadow) prices
2. Monetisation of non-market impacts
3. Inclusion of indirect effects (if relevant)
•
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Market prices may be distorted or even
absent; they do not always reflect
opportunity costs and willingness to pay.
From the financial analysis cash-flows,
need to find the economic costs and
benefits:
Recommended social discount rate:
–
–
5.5% for “Cohesion countries”
3.5% for other Member States
6. Risk assessment
It should be included in the CBA to deal
with uncertainty.
This is mainly done in two steps:
Step 6.
Risk
Assessment
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1) Sensitivity analysis: to identify the
project’s critical variables.
2) Risk analysis: by assigning
appropriate probability distributions to the
critical variables, expected values for the
financial and economic performance
indicators can be estimated.
Results of the risk analysis
• Risk analysis consists in the calculation of the
probability distribution of the project’s NPV (or
IRR) – both financial and economic.
• A helpful way of presenting the result of the risk
analysis is to express it in terms of cumulated
Step 6.
probability of the project’s NPV (or IRR).
Risk
Assessment
Cumulative Probability
120%
100%
80%
60%
40%
20%
0%
20
-10
-5
-4
-2
0
2
4
NPV
8
12
15
18
20
Assessment of acceptable levels of risk
• Often the baseline estimates for the NPVs
and IRRs (‘most likely’ values) are
reported. However, the criterion for project
acceptability should be that of the
expected value (or mean) of such
Step 6.
indicators, calculated in the risk analysis.
Risk
Assessment
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Risk prevention
• The results of the risk assessment should
be used to improve project design and
management. Risk mitigation measures
should be envisaged where relevant.
Economic Analysis
Financial Analysis
FNPV < 0
FNPV > 0
The project is worthwhile
and needs the contribution
from the Funds in order to
be financially feasible
The project is financially
profitable. It can be
implemented without the
assistance from the Funds
(unless there is State Aid)
EU grant
Funding-gap
method
FNPV ≈ 0, ENPV > 0
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The EU grant makes it possible for the
project to be implemented by providing a
specific level of financial profitability
DETERMINATION OF EU CO-FUNDING
Fundinggap
method
Reject the project: the
Community is better off
without the intervention
Risk assessment
and
Feasibility analysis
CBA
The project leads to a
more efficient allocation of
resources: it is worth
undertaking
ENPV < 0
PROJECT SELECTION
ENPV > 0
For more details on CBA for EUfunded major projects see:
• DG REGIO CBA guide
For more
info
http://ec.europa.eu/regional_policy/sources/docgener/guid
es/cost/guide2008_en.pdf
• DG REGIO working document n° 4
on CBA indicative methodology
http://ec.europa.eu/regional_policy/sources/docoffic/2007/
working/wd4_cost_en.pdf
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Thank you for your attention!
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[email protected]