Economic Benefits of Cycling Infrastructure

cycling-brisbane

Very pleased to see that my colleagues at Queensland Department of Transport and Main Roads and Aurecon will be presenting our analysis on the economic benefits of cycling infrastructure at the National Traffic and Transport Conference of AITPM in mid-August.  The abstract is available here:

https://www.aitpm.com.au/economic-benefits-of-cycling-infrastructure/

 

Image: Southbank, Brisbane. Source: Brisbane Tourism.

Cross River Rail Dice Roll?

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In this note we consider there is a 25% possibility that Cross River Rail may fail to achieve a positive economic net present value and explain how we arrive at that opinion.

Building Queensland reported in its cost benefit analysis summary that Cross River Rail produces a Net Present Value (NPV) of $966 million with a Benefit Cost Ratio (BCR) of 1.21. However, its summary did not publish the actual present value totals of the benefits or costs from the study. The full report is not available for public scrutiny.  Also, the government’s website for Cross River Rail has still not published the business case.

The BCR was expressed in terms of P50, which implies there is a 50% probability that it could be lower than 1.21. Similarly, if the NPV was expressed as P50 that implies a 50% probability the NPV could be less than $966 million. Interestingly, no formal sensitivity analysis was presented in the summary.

Is it possible to assess the probability that the net present value of the project could be less than zero or the benefit cost ratio less than one?

Using the NPV and BCR information from the summary we calculate the implied present value of benefits (B) and the present value of costs (C). Since NPV = B – C = $966 million, and BCR = B / C = 1.21, we can solve for C. This gives us a present value figure for C of $4,742 million. Therefore, the present value for B is $5,738 million.

Since we do not know the risk profile of these values, let’s assume variability in the estimates are normally distributed around the benefit and cost values implied by the NPV and BCR figures. This is a generous interpretation of the variability of the actual result compared to the estimate because we know that costs are typically skewed towards overruns and realized benefits fall short of estimates more often than exceed them.

We assume a standard deviation that is approximately 20% for each cost and benefit estimate. We assume in the absence of any guidance that the estimate is the mean for the purpose of this analysis. This applies both to costs and benefits. Under a standard normal distribution the estimate statistic is also a P50 estimate.

Benefits and costs in the tails of each distribution are likely to be extreme values. We assume that values in the 5% tails either side of the mean are not sampled. That is, values are drawn from a normal distribution that represents 90% of possible values for benefits and costs.

One final consideration – no correlation is assumed between benefits and costs. What it costs to build and operate Cross River Rail has no influence on the level of demand achieved. The same project is delivered irrespective of cost.

Running @Risk probability software over this, we find that running the NPV calculation through 1,000 iterations there is a 25% chance that the project will generate a negative NPV. No formal consideration is given to optimism bias, which would tend to increase this value.

Is this a risk worth taking? Hard to say because some of the fundamental information is still not in the public domain. Also, components of both benefit and cost may be well identified and estimated. As a consequence, their probability profiles might be within a much smaller range.

Within the project, further work would be required to minimise and mitigate risks that could affect benefit realisation or lead to increased costs. Release of further detail about the project would enable the public to assess this.

Image: Brisbane Times.

Make the Casino Work for You

rouletteNothing is more hair raising than exposure to risk without a sense of the level of that exposure.  This is especially true in capital investment decisions.

Monte Carlo simulations perform risk analysis by building models of possible results by substituting a range of values—a probability distribution—for any factor that has inherent uncertainty and significant impact on the final result.

By using probability distributions, variables can have different probabilities of different outcomes occurring.  Probability distributions are a much more realistic way of describing uncertainty in variables of a risk analysis and improve the quality of sensitivity analysis.

During a Monte Carlo simulation, values are sampled at random from input probability distributions.  This is done hundreds or thousands of times, and results in a probability distribution of possible outcomes.  It provides a much more comprehensive view of what may happen.

Advantages over deterministic, or “single-point estimate” analysis include:

  • Probabilistic Results. Showing how likely each outcome is.
  • Clearer Graphical Results. Visual presentation of probabilities.
  • Improved Sensitivity Analysis. Sharper sensitivity analysis to show what counts.
  • Scenario Analysis: Model repeated variations in combinations of factors to show which scenarios need further investigation.
  • Correlation of Inputs. Represent how, in reality, when some factors goes up, others go up or down accordingly.

Done poorly or with low quality input data, the results can be potentially misleading – producing a level of certainty on the basis of some very uncertain assumptions.

Lytton Advisory holds an @Risk software licence which enable us to provide this type of probabilistic analysis to clients, helping them make better informed decisions. Examples of how we have applied this for clients include:

  • Estimating financial costs of schedule delay on a major metropolitan public transport project.
  • Assessing probability of breaching a cost contingency levels on a +$500 million infrastructure program.
  • Building probabilistic NPV profiles in cost benefit analyses given uncertainty about key economic inputs.

Contact us today to find out how we might be able to help you.

Opportunity Cost

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Whenever a choice is made, something is given up.  Opportunity cost values an economic resource as the value of its next highest valued alternative use.  It is normally expressed in terms of a relative price.  For example, if a shipwrecked sailor can catch 10 fish or harvest 5 coconuts per day.  The opportunity cost of producing one coconut is two fish.

Opportunity cost is useful when the costs and benefits of choices vary.  By expressing one option in terms of foregone benefits of another, marginal costs and benefits of each option can be compared.  Sometimes these costs and benefits are not reflected in the price we pay for goods or services.

Is the value of the next best thing what you really give up?  Opportunity cost is such a fundamental concept in economics as well as everyday life.

Can we make better decisions without it?

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This Micro Brief is part of an ongoing series provided by Lytton Advisory as a general public information service.  These concepts underpin modern economic analysis.  Find out more about smarter capital investment decisions using economics at www.lyttonadvisory.com.au.

Reducing Red Tape

Red tape reduction remains on the Government’s agenda in Queensland. Significant work has been done on a social and human services blueprint by the Department of Communities, Child Safety and Disability Services. See:

https://www.communities.qld.gov.au/gateway/reform-and-renewal/social-investment/social-and-human-services-investment-blueprint

I am pleased to have played a small part in this. See:

https://www.communities.qld.gov.au/resources/reform-renewal/social-investment/red-tape-reduction-cost-estimate-final-report.pdf

Introducing Cost Benefit Analysis

How do you find out what an economic cost benefit analysis should contain?

Reference materials run to hundreds of pages, with detailed explanations depending on the nature and purpose of the investigation and the field under consideration.

I thought a simple introduction would help explain what is involved and prepared Intro to CBA for my clients.

Cheat Sheet for Reviewing a Cost Benefit Analysis Report

Suppose you are given a cost benefit analysis.  Without an economics degree, how do you know it has been properly completed?

Economic CBAs are a decision support tool used to determine the net benefit to an economy of a proposed course of action, a policy or a project.  A ‘do something’ case is typically compared to a ‘business as usual’ case to identify incremental changes in benefits and costs, explicitly recognising that not doing a project has implications as well.  Costs and benefits occur in different time periods and values are brought to the present to enable comparison of net economic benefits.

If you are wading through one of these reports here is a cheat sheet with questions you can ask the analyst to pierce the veil of certainty these reports often convey.  It is based on longstanding advice the Commonwealth Government has given its own agencies when confronted with this kind of economic analysis.

Ask the following questions:

  1. What questions does the study attempt to answer?
  2. What alternative strategies are considered?
    1. Do you have any comments on the way the choices could have been set out?
    2. Are there other choices that could/should have been considered at the same time?
  3. Are you happy with the cost estimates made?
    1. Are the methods of evaluation satisfactory?
    2. Are any relevant costs omitted?
  4. Is the study based on reliable evidence?
    1. What further information would you require?
    2. Is such information available and, if so, where and from whom?
  5. Are you happy with the methods of benefit measurement employed in the study?
    1. If not, what method or approach would you propose?
    2. If yes, are you content with the values derived?
  6. Does the study allow for:
    1. Uncertainty (or errors) in the expected costs and benefits?
    2. The differential timing of costs and benefits?
  7. Finally, assuming you were advising the decision makers, what would be your recommendation?

Any analyst should have no problems or hesitancy answering these.  If they do, the report probably needs more work.