Category: Cost Benefit Analysis

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Cost Benefit Analysis development Economics Policy

Understanding Appraisal Periods in Cost-Benefit Analysis: Insights for Long-Term Investments

Accurately determining the period of appraisal in cost-benefit analysis is vital for effective decision-making, particularly for finance ministry officials in Pacific Island nations. This strategic understanding significantly influences economic stability and growth in the region.

The period of appraisal refers to the time span over which a project’s costs and benefits are evaluated. Getting this right shapes the analysis and directly affects the perceived feasibility of a project. Selecting an appropriate timeframe ensures all relevant costs and benefits are considered, especially for long-term projects like infrastructure or environmental programs that might produce benefits years later.

The appraisal period should align with the expected life of the asset or investment. For projects with long lifespans, the period should cover decades to fully capture their potential benefits. Both short- and long-term economic benefits need to be accounted for. Furthermore, a well-defined appraisal period is significant in determining the relevance of residual values in project evaluation. Residual values represent the remaining worth of an asset at the end of the appraisal period. If this period is too short, the analysis may underestimate the project’s true value by overlooking residual worth.

Understanding the distinction between economic and financial analysis is also crucial. Financial analysis focuses on investor cash flow and profitability, while economic analysis examines the broader societal impact, including externalities. This broader perspective often requires a longer appraisal period than financial analysis.

It’s also essential to differentiate between the period of appraisal and the tenor of funding, which is the timeframe over which borrowed funds are repaid. Misalignment between the two can skew financial assessments and lead to underestimating a project’s long-term value.

When managing multiple projects, consistency in the appraisal period is vital. Using a consistent time horizon across similar projects enables meaningful comparisons and strategic planning, ensuring investment decisions align with national economic goals.

Equipped with this understanding, finance ministry officials can ensure investment strategies prioritise financial viability and broader economic benefits over each project’s entire lifespan.

#CostBenefitAnalysis #EconomicGrowth #InvestmentPlanning #SustainableInvestments #PacificIslands

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Cost Benefit Analysis development Economics

Appointment

Talofa! Lytton Advisory is pleased to announce that its Managing Director – Craig Lawrence – has been contracted by the Asian Development Bank as an Economist / Cost Benefit Analysis (CBA) expert to assist the Government of Samoa’s Ministry of Finance (MoF)  

Craig will be working with MoF officials to help strengthen the capacity of the Economic Policy and Planning team to produce timely cost-benefit analyses, improve data collection and provide advice to support decision making. 

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Cost Benefit Analysis Economics Infrastructure Local Government Lytton Advisory Policy

Five CBA Epiphanies

Healthcare business graph and data of Medical business growth, .Businessman analyzing data and growth chart, investment, financial and banking, Medical business report on global network.

I have been doing cost benefit analyses for a few years now. The concept is deceptively simple but provides a solid framework for insightful decision making.

It is a tool used to assess potential costs and benefits of a decision or project, usually in monetary terms. It is commonly used to evaluate the feasibility and potential impact of projects, policies and regulations.

Recently I have been thinking about the usefulness of the approach given that many major project often seem to float past this analysis.

Here are five epiphanies that might help CBA evangelists:

The true value of a decision lies not just in its financial cost and benefit, but also in its impact on people and the environment.

CBA forces us to weigh the pros and cons, but it’s important to remember that some benefits and costs are difficult to quantify and may have long-term effects that are not immediately apparent.

It should not be the sole factor in decision-making, as there may be intangible or ethical considerations that cannot be easily measured in financial terms.

CBA is a useful tool, but it is important to remember that it does not account for future uncertain events. Therefore, it should be used in conjunction with other decision making tools for a comprehensive evaluation.

Cost-benefit analysis can be misleading if it only looks at short-term financial gains and ignores long-term social and environmental costs. A more holistic approach should be used that accounts for all the potential impacts of a decision.

These are just some of the insights about CBA, but there are more that might be organisational or project relevant.

Is CBA a key driver of your organisation’s project appraisal process or just another compliance element in developing business cases?

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Cost Benefit Analysis Economics Lytton Advisory Waste Management

Why is cost benefit analysis important in waste management?

Cost-benefit analysis is a tool that can be used to evaluate the costs and benefits of different options for managing waste. It helps decision makers understand the trade-offs involved in different approaches to waste management and make informed choices about how to allocate resources.

There are many factors that can be considered when conducting a cost-benefit analysis of waste management options. These may include the upfront costs of implementing a particular solution, such as the cost of purchasing equipment or constructing a new facility. Other costs to consider might include ongoing operating costs, such as the cost of fuel or labor, as well as the potential costs of environmental impacts or regulatory fines.

On the other hand, the benefits of a particular waste management approach can include reduced environmental impacts, improved public health, and economic benefits such as the creation of jobs or the generation of income through the sale of recycled materials.

By comparing the costs and benefits of different options, decision makers can choose the solution that offers the greatest net benefit, or the greatest benefit after accounting for the costs. This can help them make informed decisions about how to allocate resources and achieve their waste management goals in the most effective and efficient way possible.

How often does your organisation undertake cost-benefit analysis?

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Climate Change Cost Benefit Analysis development Economics Infrastructure

Infrastructure Planning in the Pacific

Infrastructure investment planning in the context of Pacific Island nations requires a tailored approach that takes into account the unique characteristics and challenges of these countries. This is because Pacific Island nations have small populations, are geographically dispersed, and have limited resources. Therefore, infrastructure planning must be done in a manner that reflects their unique needs and priorities.

One of the best techniques for infrastructure investment planning in the context of Pacific Island nations is conducting a comprehensive needs assessment. This involves engaging with local communities and stakeholders to better understand their needs and priorities. This process is critical for identifying infrastructure gaps and prioritizing investment projects. Lytton Advisory considers this is best done at agency or infrastructure sector level.

Another important technique for infrastructure investment planning is taking a multi-sectoral approach. Infrastructure planning must take into account the interdependence of different sectors such as transportation, energy, water and sanitation, and telecommunications. A holistic approach is essential to ensure that infrastructure investments are aligned with the overall development goals of the country. In our view it also help more effective conversations with donors and private investors, helping countries retain greater sovereignty over national priorities.

Climate resilience is also a critical consideration in infrastructure investment planning in Pacific Island nations. These countries are particularly vulnerable to the impacts of climate change, and any infrastructure investment planning must take this into account. Projects should be designed to withstand extreme weather events and rising sea levels. Risk identification and mitigation are critical factors here.

Engaging the private sector can help to leverage additional resources and expertise for infrastructure development. Public-private partnerships can be a viable option for financing and delivering infrastructure projects. Private sector engagement can also help to promote innovation and efficiency in infrastructure development. However, the ability to engage the private sector also depends on national government capacity to see the commercial interests and incentives with great clarity.

Capacity building is critical to ensure that Pacific Island nations have the skills and expertise necessary to plan and implement infrastructure projects. This includes training in project management, procurement, and technical skills. By investing in capacity building, Pacific Island nations can become more self-reliant in planning and implementing infrastructure projects.

Sustainable financing mechanisms, such as green bonds and climate funds, can be used to finance infrastructure projects that have positive environmental and social impacts. This is important for ensuring that infrastructure investments are aligned with the overall sustainable development goals of Pacific Island nations. This also means identifying and avoiding some predatory financing practices as well, particularly where there might impose difficult burdens on the national treasury.

Finally, it is important to monitor and evaluate infrastructure projects to ensure that they are delivering the intended benefits and to identify areas for improvement. This includes tracking project performance against key indicators and engaging with stakeholders to gather feedback. By monitoring and evaluating infrastructure projects, Pacific Island nations can continuously improve their infrastructure planning and delivery processes. This is one of the hardest things to do, but has the potential to delivery greater informational value for future projects.

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Cost Benefit Analysis Economics

Opportunity Cost

Like many folk over the summer holiday, I played around with ChatGPT, a natural language AI.

Being an economist, I asked for the meaning of Opportunity Cost, a foundation concept in economics. The response was deadly boring.

So I asked it to flick a switch and give it as a sonnet:

Opportunity cost, a term so fine,
Refers to the cost of choice not made,
The next best option left behind,
When one decision is the one laid.

It’s something we encounter every day,
From big choices to the small and meek,
But often we don’t stop and weigh
The cost of what we choose to seek.

So think before you act, consider well,
The path you take and what it means to stray,
For opportunity cost will dwell
In every choice you make, come what may.

So choose with care and wisely weigh,
The cost of all the options in play.

ChatGPT

This might be all a bit too much for those in the C Suites, so here is your executive haiku:

Opportunity lost

When a choice is made and done

Cost of the next best.

ChatGPT

Enjoy!

Categories
Cost Benefit Analysis Economics Infrastructure

A Damming Idea

Tinaroo Dam Spillway (Source: ABC News)

Constrained water supplies in Far North Queensland are hindering economic development and can threaten water security of a number of towns. Inaction on supply has been driven by feasibility, concerns, funding gaps and worries about environmental sustainability. (1) In addition, politics focussing narrowly on dams as the supply solution runs the risk of missing other smart infrastructure and demand management opportunities to improve supply apart from just bulk storage. (2) Project proponents are also challenged often challenged by a user pay model required by the National Water Initiative. (3)

A strong evidence base of economically viable, financially feasible and prudently sustainable investments is needed to unlock these constraints. The balance between the public purse, private irrigator interests and environmental sustainability needs to be reset.

If considering just dams, what is an appropriate period of cost recovery? If an appraisal period is less than the economic life of the dam, usually an estimate of residual value would be included in the final year of the analysis. For example, a 25-year appraisal period for a 50-year asset, may include an asset value offset of up to 50% in the final appraisal year to ensure cost recovery over the appraisal period approximates around half of the expected use of the asset.

Similarly, where a dam is considered by policy makers to be a catalytic piece of infrastructure that supports and enables economic growth opportunities, an argument that there are economic externalities needs to be established. In effect, this means that not all the economic benefits are being captured by the users – providing a basis for partial public funding alongside expected user revenues. This externality argument is the logical basis for identifying the level of offset to user revenues. It presupposes both other uses for water as well as downstream benefits captured by non-users.

As a starting point, getting the evidence together to make the preliminary case for the residual value argument and a market failure argument around significant externalities is critical.

References:

  1. Parliamentary Library (Australia) Water Management https://www.aph.gov.au/About_Parliament/Parliamentary_Departments/Parliamentary_Library/pubs/BriefingBook45p/WaterManagement
  2. For example, the Sustainable Rural Water Use and Infrastructure Program https://www.agriculture.gov.au/water/mdb/programs/basin-wide/srwuip
  3. National Water Initiative pricing principles (https://www.agriculture.gov.au/water/policy/nwi/pricing-principles)

Categories
Cost Benefit Analysis Economics Infrastructure Transport

A $7 Crossing

Kangaroo Point Pedestrian Bridge artist impression
Kangaroo Point Crossing, Artist Impression
Source: Brisbane City Council

Brisbane City Council has announced a program to construct five ‘green’ bridges across the Brisbane River. [See https://www.brisbane.qld.gov.au/traffic-and-transport/roads-infrastructure-and-bikeways/five-new-green-bridges-across-brisbane] Analysis of the crossing at Kangaroo Point appears most advanced.

There is a handy infographic on Council’s website. Unfortunately, details of how the benefits have been calculated are not publicly available.

What we do know is that Council intends to spend $190 million to build the bridge. Council believes trips per day will rise from 5,300 in 2021 to 6,100 in 2036.

Making a couple of assumptions, we can work out the level of benefit per trip required for this to cover the capital costs. First we assume a 25 year evaluation period (2020-2044) and a 7% real discount rate. We also assume the asset has a 50 year life and include an offset residual value on the capital cost. The capital cost attributable to the evaluation period is a present value of $172.5 million.

Then we extrapolate the average crossings, which rise on an annualised basis from 1.9 million trips in 2021 to 2.4 million trips in 2044. This implies some 54 million trips will take place (2021-2044). However, using trips as a stand in for benefits, a trip today has a stronger present value than a trip tomorrow. The present value of all the trips had they occurred today is 24.5 million.

The capital cost per trip is $3.18 undercounted. In discounted terms, this is $7.03.

Given ratepayers are paying for it, one would hope Council is confident benefits are at least $7.03 per trip in benefits.

Do you think that is the case?

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Cost Benefit Analysis Economics Infrastructure Lytton Advisory

Economics of Infrastructure Podcast

Image result for podcast

Thanks to Gene Tunny, Principal at Adept Economics, for inviting me onto his new podcast series – Economics Explained. We discussed the nature of infrastructure, the services these assets supply and how good economic analysis helps select better infrastructure projects. Gene and I have collaborated on a number of projects over the last two years. He is a leading independent economist who blogs regularly at queenslandeconomywatch.com.

You can listen to the podcast here: https://queenslandeconomywatch.com/2019/09/16/economics-of-infrastructure-interview-with-craig-lawrence-of-lytton-advisory/

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Cost Benefit Analysis Economics Infrastructure Lytton Advisory Policy

6th Anniversary

Economic Effects of Infrastructure Investment and its Financing

Today marks the sixth anniversary of Lytton Advisory as an independent economic consulting practice. Over that time, we have worked on a wide range of economic issues. This has taken us to places as diverse as the Solomon Islands, Papua New Guinea, Kuwait and Saudi Arabia.

We have never lost our enthusiasm for helping clients make smarter capital investment decisions. Neither have we wavered in our passion for proper planning, prioritisation and funding of infrastructure. In more recent years, our work has been around leading project teams of committed, experienced economists and professionals to bring high conviction analyses to our clients. Good cost benefit analysis is at the heart of what we do.

In the first half 2019 founder, Craig Lawrence took, in effect, a sabbatical from the practice to lead the establishment of the Economic and Social Infrastructure Program in PNG. This $130 million 4+4 year Cardno-delivered, Australian Government funded program seeks to improve the quality of planning, prioritisation and funding of infrastructure to achieve economic outcomes and social development goals for Papua New Guineans.

Whether it is: developing an investment manual to incorporate climate change adaptation in infrastructure development decisions in the Solomons; a full cost pricing algorithm for food and drug regulatory services in Saudi Arabia; or generating savings from waste transfer station closures that fund a ten-year capital works program – Lytton Advisory is up for the challenge. At every stage, it is about driving value for the clients and communities affected by infrastructure.

We are excited about the future for infrastructure, its contribution to sustainable economic and social development, and how emerging economic incentives, new social paradigms and innovative technologies are shaking up these services.