Cost-Benefit Analysis

Harry F. Campbell is an Emeritus Professor of Economics at the University of Queensland, Australia.Richard P.C. Brown is an Honorary Associate Professor of Economics at the University of Queensland, Australia.

• List of figures xiList of tables xivList of examples xviList of Technical Notes xviiPreface xviiiAcknowledgements xxiiNotes to the instructor xxivChapter 1: Introduction to cost-benefit analysis 11.1 Introduction 11.2 The Referent Group 61.3 The structure of the cost-benefit model 81.4 The use of spreadsheets in cost-benefit analysis 111.5 The rationale for public projects 141.6 The role of the analyst 16 1.7 Further reading 17Exercises 17Chapter 2: Project appraisal: principles 192.1 Introduction 192.2 Project appraisal from an individual viewpoint 192.3 Investment opportunities in the economy as a whole 222.4 The algebra of NPV and IRR calculations 232.5 Annuities and perpetuities 302.6 The Rule of 72 342.7 Economic depreciation and the annual cost of capital 352.8 Treatment of inflation in project appraisal 362.9 Incorporating a risk factor in the discount rate 38 2.10 Further reading 39Exercises 39Chapter 3: Project appraisal: decision-rules 403.1 Introduction 403.2 Discounted cash flow analysis in practice 403.3 Discounting and the time value of money 413.4 Using Annuity Tables 443.5 Using investment decision-making criteria 45 The Net Present Value (NPV) criterion 45 The Benefit-Cost Ratio decision-rule 47 The Internal Rate of Return (IRR) criterion 48 Problems with the IRR decision criterion 51 Problems with the NPV decision criterion 53 3.6 Using spreadsheets 59 3.7 Further reading 64 Exercises 64Chapter 4: Private cost-benefit analysis: financial appraisal 684.1 Introduction 684.2 Benefits and costs measured as cash flows 69 Identifying project inputs and outputs 69 Valuing inputs and outputs at market prices 70 Characteristics of cash flows 70 4.3 Inflation and relative prices 724.4 Incremental or relative cash flows 744.5 Capital costs and the treatment of depreciation 764.6 Interest charges, financing flows and cash flow on equity 784.7 Taxation and after-tax net cash flows 834.8 The discount rate 844.9 Summary of the relationship between the Market Analysis and the Private Analysis 854.10 Derivation of project private cash flows using spreadsheets 85 4.11 Further reading 91Appendix to Chapter 4: Case Study of International Cloth Products 91 Exercises 97Chapter 5: Cost-benefit analysis and economic efficiency 995.1 Introduction 995.2 The competitive market 1005.3 Shadow-pricing project inputs and outputs 1035.4 Shadow-pricing marketed inputs 104 Materials 105 Labour 109 Capital 117 Land 118 Rules for shadow-pricing marketed inputs 118 5.5 Shadow-pricing marketed outputs 119 Rules for shadow-pricing marketed outputs 124 5.6 The efficiency pricing rules: summary 1245.7 Corrective taxation: the modified efficiency pricing rules 1255.8 How to determine which pricing rule to follow 1265.9 Shadow-pricing public funds 1285.10 Shadow-pricing foreign exchange 1335.11 The discount rate 1335.12 Worked examples 136 Efficiency analysis of the National Fruit Growers (NFG) Project 136 Cost-benefit analysis of the 55 mph speed limit 140 5.13 Further reading 141Appendix to Chapter 5: Economic Efficiency Analysis of the ICP Case Study 142 Exercises 146Chapter 6: The distribution of project net benefits 1496.1 Introduction 1496.2 How to identify Referent Group net benefits in practice 1506.3 Some examples of the classification of net benefits 154 Shadow-prices on project inputs 154 Shadow-prices on project outputs 160 6.4 Corrective taxation 1616.5 Further examples 1666.6 Lessons from the examples 1686.7 Worked example: Referent Group Analysis of National Fruit Growers’ (NFG) Project 1686.8 Further reading 171Appendix 1 to Chapter 6: Referent Group net benefits in the ICP Case Study 171Appendix 2 to Chapter 6: Incorporating the public funds cost premium in the ICP Case Study 177Exercises 180Chapter 7: Consumer and producer surplus in cost-benefit analysis 1827.1 Introduction 1827.2 Real versus pecuniary effects 1837.3 Consumer surplus 184 Aggregating consumer surplus measures 185 The significance of income distribution 186 7.4 Producer surplus 1867.5 Accounting for output price changes 186 Benefits of urban transport projects 187 Benefits of worker training 193 Producer benefits from an irrigation project 196 7.6 Accounting for input price changes 2017.7 Price changes in other markets 2037.8 Classification of consumer and producer surplus changes 2047.9 Further reading 205Appendix 1 to Chapter 7: Allowing for an increase in the skilled wage in the ICP Case Study 206Appendix 2 to Chapter 7: Compensating and equivalent variation 209 Exercises 215Chapter 8: Non-market valuation 2178.1 Introduction 2178.2 Causes of market failure 2178.3 Valuing environmental costs and benefits 2198.4 Incorporating non-market values in cost-benefit analysis 2238.5 Methods of non-market valuation 224 The production approach 225 The utility approach 230 8.6 Revealed and stated preference methods of applying the utility approach 233 Revealed preference methods 234 Stated preference methods 240 8.7 Benefit Transfer and Threshold Analysis 2438.8 Alternative approaches to environmental valuation 2448.9 Non-market valuation: the value of life 2458.10 The Pandemic 8.11 Climate Change 8.12 Further reading Appendix to Chapter 8: The annual benefits of the Virginia Creeper Trail as measured by the Travel Cost Method 248Exercises 251Chapter 9: Uncertainty, information and risk 2539.1 Introduction 2539.2 The value of information 2559.3 An abbreviated cost-benefit analysis 2579.4 The option of delay 2579.5 Calculating the value of information 2609.6 The cost of risk 262 The theory of risk aversion 262 Dealing with project risk 265 9.7 Risk modelling 267 Use of discrete probability distributions 268 Joint probability distributions 269 Continuous probability distributions 270 9.8 Using risk analysis in decision-making 2739.9 Modelling risk in spreadsheet applications using ExcelSim© 274 Modelling a "random walk" 279 9.10 Further reading Appendix 1 to Chapter 9: Incorporating risk analysis in the ICP Case Study 282Appendix 2 to Chapter 9: Using the @Risk© (Palisade) Risk Modelling Program 285Exercises 290Chapter 10: Valuing traded and non-traded goods in cost-benefit analysis 29210.1 Introduction 29210.2 Traded and non-traded goods 29210.3 Valuing traded and non-traded goods and services 29310.4 Worked example: domestic and international price structures 294 Evaluation of an import-replacing project in real terms 294 Evaluation of an import-replacing project in money terms 295 10.5 Summary of the two approaches to valuation: border versus domestic prices 29810.6 Equivalence of the two approaches 29810.7 Determinants of the shadow exchange rate 30210.8 Further reading 308Appendix to Chapter 10: Shadow-pricing foreign exchange in the ICP case study 305Exercises 308Chapter 11: Appraisal of the distribution of project benefits and costs 31011.1 Introduction 31011.2 Measuring the degree of inequality 31111.3 Alternative measures of income distribution 31311.4 Policies to change the income distribution 31411.5 The use of income distribution weights in project appraisal: some illustrative examples 31411.6 The derivation of distribution weights 31611.7 Distributional weighting in practice 32211.8 Worked example: Incorporating income distribution effects in the NFG Project 32611.9 Inter-temporal distribution considerations 327 11.10 Further reading 331Exercises 331Chapter 12: Economic impact analysis 33412.1 Introduction 33412.2 Multiplier analysis 334 The closed economy 334 The open economy 339 Crowding out 340 Cost-benefit analysis of fiscal stimulus 341 The employment multiplier 342 12.3 Inter-industry analysis 342 Inter-industry analysis and the national income multiplier 345 Inter-industry analysis and employment 346 12.4 General equilibrium analysis 34812.5 Case study: The impact of the ICP Project on the economy 349 12.6 Further reading 352Appendix to Chapter 12: The annual economic impact of the Virginia Creeper Trail 350 Exercises 352Chapter 3: Writing the cost-benefit analysis report 35413.1 Introduction 35413.2 Contents of the report 355 The Executive Summary 355 The Introduction 355 The Methodology 355 The Analysis 356 The Conclusion 356 13.3 Other issues 357Appendix to Chapter 13: Report on International Cloth Products Ltd.: Spinning Mill Proposal 357 Appendix 1: Case study assignments 371A1.1 South Australian Olive Oil Project 372 A1.2 Walnuts Tasmania Project 376A1.3 A tuna cannery in Papua New Guinea 380A1.4 Urban water supply in South-East Queensland 383A1.5 The Scottish Highlands and Islands remote dental care program 388 A1.6 The Defarian Early Childhood Intervention Program (DECIP) 392 A1.7 A pulp mill for Tasmania? 399A1.8 Qingcheng Water Project 403 A1.9 Highway Project 2012 409A1.10 International Mining Corporation (IMC) Copper Mining Project 416A1.11 Comparative Levelized Cost of Electricity: Renewables vs CoalA1.12 Cost-Benefit Analysis of the Proposed Repeal of Water Saving RegulationsA1.13 Cost-Benefit Analysis of the Proposed Extension to the Mount Beno Walking Trail A1.14 Cost-Benefit Analysis of a Proposed Drug Court Program in the State of Euphoria, Federal Republic of OzAppendix 2 Discount and Annuity Factors 424Glossary 427Index