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Cost Benefit Analysis Economics Lytton Advisory

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.

Categories
Infrastructure

What Price Data?

When we look at infrastructure services we should also consider the context in which they are provided.

Currently I am on assignment in PNG.  Telekom here in the past week has slashed mobile broadband top up prices by 50% to around A$25 per gigabyte (GB).  It sounds impressive and may have a meaningful impact.  However even that level it is still eyewateringly expensive compared to Australia.  But stop and think about it in the context of purchasing power.

Some data I looked at recently suggested GDP per person in PNG was probably A$2,500.  In Australia GDP per person is around $45,000, some eighteen times the level in PNG. Depending on the definition the actual figures can vary but consider that as a rough context for income.

If Australian’s faced the same share of GDP spent on broadband top ups as in PNG that would look iike a cost of $450 per GB.  How fast a rate of uptake would you expect if Australia faced that price?  Mind you it was not that long ago we were paying those prices for dial-up.

This also supports earlier analysis by the International Telecommunications Union:

“By early 2013, the price of an entry-level mobile-broadband plan represents between 1.2-2.2% of monthly GNI p.c. in developed countries and between 11.3- 24.7% in developing countries, depending on the type of service.”

See: http://www.itu.int/en/ITU-D/Statistics/Documents/facts/ICTFactsFigures2013-e.pdf

Clearly further, lower prices are needed in PNG along with relative increases in GDP per person.  The digital divide remains huge and the context remains relevant whether you are looking at PNG or Australia.

Image source: comparebroadband.com.au

Categories
Infrastructure

Infrastructure and Human Development

I am currently in Port Moresby on an assignment.  It is a three hour flight from Brisbane but a world away in many other respects.  The UN releases reports on human development.  Some contrasts are quite stark.

PNG       Australia    Measure

0.411      0.933         Human Development Index

157th      2nd            Human Development Index rank

7.25        23.3           Population (million)

17.07       950.65      GDP (US$billion 2011)

2,381       42,278      GDP per capital (US$ 2011)

0.617       0.113        Gender inequality (lower is better)

62.42       82.5         Life expectancy at birth

When we look at infrastructure it makes you think vey hard about what is important.  It really is all about context.

Sources:
http://hdr.undp.org/en/countries/profiles/AUS
http://hdr.undp.org/en/countries/profiles/PNG

Categories
Infrastructure

Accuracy and precision are different things, especially for infrastructure

The effort invested in ‘getting it right’ should be commensurate with the importance of the decision – Daniel Kahneman

Accuracy is the absence of error; precision is the level of detail. Often in infrastructure planning and analysis we see an unnecessary need for precision in the early stages with not much emphasis on accuracy.

Effective problem solving requires always being accurate but only being as precise as is helpful at any given stage of problem solving. This is about delivering analysis that is sufficient to proceed to the next stage in developing an infrastructure project. Many project approval gateway processes recognize this, but it is often poorly implemented.

Early in the problem solving process, accurate but imprecise methods, rather than very exact methods, will allow consideration of all reasonable approaches and minimize the tracking of needlessly detailed data. In this way, less apparent but potentially higher value options and scenarios can be considered and compared with the standard approaches.

Categories
Infrastructure

Better Infrastructure Planning

Better infrastructure planning avoids presuming a solution.

Often we get locked into assumptions about the nature of the problem, its causes and desirable solutions. Wise infrastructure planners step back – examine what caused the problem, what caused the causes, and what caused those causes. This reveals possibilities very different from what end users envisage, but meet the true need most effectively.

A proper needs analysis is critical. If overlooked, huge value is often lost – for society, for the economy and for business.

Categories
Transport

Valuing Toowoomba’s Second Range Crossing

What value can we put on the capital cost per vehicle using the $1.6 billion Toowoomba Second Range Crossing?

Let’s assume: in a 25 year appraisal period traffic volumes grow 3.5% p.a.; some 75% of some 23,000 vehicles per day divert to the crossing; and a 4% real discount rate. How does just under $12 a vehicle sound?

Bump traffic growth to 6% p.a., raise diversion to 85% diversion, and trim the discount rate to 3%, and you get just over $6.

Sets a bar, doesn’t it?

This project will only show a net economic benefit if benefits that are eventually identified are multiples of this.

Categories
Climate Change

Climate Change Impacts on Transport

So how important is the impact of climate change on transport infrastructure?  Very important in developing countries it seems.  We have just completed a present cost analysis of this at a river crossing in the Solomon Islands. It looked out over a 25 year period.

In the absence of downscaled climate forecasts and detailed hydrological data a scenario analysis was developed.  Baseline asset performance in the absence of climate change was assessed against a range of climate change scenarios using actual flood event and cost data. This created estimates of days service lost as well as maintenance, repair and replacement costs.  Five different socio-economic impacts driven by service levels were also assessed identifying wider economic costs.

The upshot is that just at this one crossing the economic present cost of climate change is equivalent to around 5% of the current national transport budget. Any climate change adapation measure that fully mitigates that for less cost will increase economic welfare.  The analysis provides a rational basis for an adaptation budget when considering possible engineering design changes.

Categories
Economics

Q and A

At Lytton Advisory we say that providing commercially oriented economic solutions is all about ‘where infrastructure meets money’. In this Q and A, Lytton Advisory Principal Craig Lawrence explains what this means.

Q: So who are economists and what do they do?

A: Economists working with Lytton Advisory are typically postgraduate qualified professionals. We study, develop, and apply theories and concepts from applied microeconomics and write about economic policy. We study the firm and how its commercial operation affects its financial performance, as well as how groups of firms within an industry compete against one another, and how an industry meets the needs of a market.

Q: How does that relate to the development of infrastructure?

A: Because benefits are spread out over a long time and across a wide range of stakeholders. If all the benefits and costs were accrued in one year we could easily see whether the infrastructure was delivering and how risk was defined.

Q: Is it ever that simple?

A: No. Large capital costs of investing in economic infrastructure are recouped through small amounts of use by large numbers of stakeholders over a long period of time. Economic analysis helps identify where the risks are in building and operating infrastructure, ensuring risk is properly attributed to those best able to handle it. Invariably there are also significant social and environmental impacts that need to be considered.

So we help figure out:

  1. Why specific economic and social infrastructure is required and how users may benefit
  2. What infrastructure can cost to build, operate and maintain
  3. How external factors such as exchange rates, interest rates and technology impact on infrastructure project economics
  4. Whether infrastructure provides a sufficient rate of return to its owners, governing authorities and the wider community, as well as identifying in what form that return occurs – financial, economic, social, or environmental
  5. Who is best placed to bear the various risks around building and financing infrastructure

Q: When do you get involved in an infrastructure project?

A: We provide front-end advice and clarity before anybody even starts building; we do mid-project evaluation to ensure that the project remains commercially and economically valid; and we do post-project evaluation to ensure that infrastructure continues to deliver the right results.

Categories
Climate Change

Climate Change Adaptation in the Pacific

Climate change is recognised as a serious risk to economic infrastructure.

In Australia a wide range of work has been underway. A lot of research is coordinated through the National Climate Change Adaptation Research Facility (http://www.nccarf.edu.au/). This is part of focus at the national level on climate change adaptation (http://http://www.climatechange.gov.au/climate-change/adapting-climate-change).

Lytton Advisory is currently working on climate change adaptation issues in the Pacific.