Cost-Benefit Analysis Financial and Economic Appraisal Using Spreadsheets

Now in its third edition, Cost-Benefit Analysis has been updated, offering readers the perfect introduction to project, programme and policy appraisal using basic tools of financial and economic analysis. The key economic questions of any social cost-benefit analysis are: do the benefits of the project or policy exceed the costs, no matter how widely costs and benefits are spread, and irrespective of whether or not project impacts, such as environmental effects, are reflected in market prices? And which group or groups of individuals receive the benefits and which bear the costs? This book addresses these questions with an emphasis on putting the theory presented in the book into practice. This third edition has several attractive features: Readers are encouraged to develop their own skills by applying the tools and techniques of cost-benefit analysis to case studies and examples, including an analysis of a project which is developed throughout the book. The book emphasizes the use of spreadsheets which are invaluable in providing a framework for the cost-benefit analysis. A dedicated chapter provides guidance for writing up a report which summarises the analysis which has been undertaken. New pedagogical features, including Technical Notes and Examples, have been added as an aid to readers throughout the text. An appendix provides 14 additional case studies which can be developed in class or as assignment projects. Additional material for instructors and students is provided through Support Material maintained by Routledge. This updated edition is an ideal text for a course on cost-benefit analysis where the emphasis is on practical application of principles and equipping students to conduct appraisals. It is also a useful handbook for professionals looking for a logical framework in which to undertake their cost-benefit analysis work.

List of figures xi List of tables xiv List of examples xvi List of Technical Notes xvii Preface xviii Acknowledgements xxii Notes to the instructorxxiv Chapter 1: Introduction to cost-benefit analysis 1 1.1 Introduction 1 1.2 The Referent Group 6 1.3 The structure of the cost-benefit model 8 1.4 The use of spreadsheets in cost-benefit analysis 11 1.5 The rationale for public projects 14 1.6 The role of the analyst 16 1.7 Further reading 17 Exercises 17 Chapter 2: Project appraisal: principles 19 2.1 Introduction 19 2.2 Project appraisal from an individual viewpoint 19 2.3 Investment opportunities in the economy as a whole 22 2.4 The algebra of NPV and IRR calculations 23 2.5 Annuities and perpetuities 30 2.6 The Rule of 72 34 2.7 Economic depreciation and the annual cost of capital 35 2.8 Treatment of inflation in project appraisal 36 2.9 Incorporating a risk factor in the discount rate 38 2.10 Further reading 39 Exercises 39 Chapter 3: Project appraisal: decision-rules 40 3.1 Introduction 40 3.2 Discounted cash flow analysis in practice 40 3.3 Discounting and the time value of money 41 3.4 Using Annuity Tables 44 3.5 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 64 Chapter 4: Private cost-benefit analysis: financial appraisal 68 4.1 Introduction 68 4.2 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 72 4.4 Incremental or relative cash flows 74 4.5 Capital costs and the treatment of depreciation 76 4.6 Interest charges, financing flows and cash flow on equity 78 4.7 Taxation and after-tax net cash flows 83 4.8 The discount rate 84 4.9 Summary of the relationship between the Market Analysis and the Private Analysis 85 4.10 Derivation of project private cash flows using spreadsheets 85 4.11 Further reading 91 Appendix to Chapter 4: Case Study of International Cloth Products 91 Exercises 97 Chapter 5: Cost-benefit analysis and economic efficiency 99 5.1 Introduction 99 5.2 The competitive market 100 5.3 Shadow-pricing project inputs and outputs 103 5.4 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 124 5.7 Corrective taxation: the modified efficiency pricing rules 125 5.8 How to determine which pricing rule to follow 126 5.9 Shadow-pricing public funds 128 5.10 Shadow-pricing foreign exchange 133 5.11 The discount rate 133 5.12 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 141 Appendix to Chapter 5: Economic Efficiency Analysis of the ICP Case Study 142 Exercises 146 Chapter 6: The distribution of project net benefits 149 6.1 Introduction 149 6.2 How to identify Referent Group net benefits in practice 150 6.3 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 161 6.5 Further examples 166 6.6 Lessons from the examples 168 6.7 Worked example: Referent Group Analysis of National Fruit Growers’ (NFG) Project 168 6.8 Further reading 171 Appendix 1 to Chapter 6: Referent Group net benefits in the ICP Case Study 171 Appendix 2 to Chapter 6: Incorporating the public funds cost premium in the ICP Case Study 177 Exercises 180 Chapter 7: Consumer and producer surplus in cost-benefit analysis 182 7.1 Introduction 182 7.2 Real versus pecuniary effects 183 7.3 Consumer surplus 184 Aggregating consumer surplus measures 185 The significance of income distribution 186 7.4 Producer surplus 186 7.5 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 201 7.7 Price changes in other markets 203 7.8 Classification of consumer and producer surplus changes 204 7.9 Further reading 205 Appendix 1 to Chapter 7: Allowing for an increase in the skilled wage in the ICP Case Study 206 Appendix 2 to Chapter 7: Compensating and equivalent variation 209 Exercises 215 Chapter 8: Non-market valuation 217 8.1 Introduction 217 8.2 Causes of market failure 217 8.3 Valuing environmental costs and benefits 219 8.4 Incorporating non-market values in cost-benefit analysis 223 8.5 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 243 8.8 Alternative approaches to environmental valuation 244 8.9 Non-market valuation: the value of life 245 8.10 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 248 Exercises 251 Chapter 9: Uncertainty, information and risk 253 9.1 Introduction 253 9.2 The value of information 255 9.3 An abbreviated cost-benefit analysis 257 9.4 The option of delay 257 9.5 Calculating the value of information 260 9.6 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 273 9.9 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 282 Appendix 2 to Chapter 9: Using the @Risk© (Palisade) Risk Modelling Program 285 Exercises 290 Chapter 10: Valuing traded and non-traded goods in cost-benefit analysis 292 10.1 Introduction 292 10.2 Traded and non-traded goods 292 10.3 Valuing traded and non-traded goods and services 293 10.4 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 298 10.6 Equivalence of the two approaches 298 10.7 Determinants of the shadow exchange rate 302 10.8 Further reading 308 Appendix to Chapter 10: Shadow-pricing foreign exchange in the ICP case study 305 Exercises 308 Chapter 11: Appraisal of the distribution of project benefits and costs 310 11.1 Introduction 310 11.2 Measuring the degree of inequality 311 11.3 Alternative measures of income distribution 313 11.4 Policies to change the income distribution 314 11.5 The use of income distribution weights in project appraisal: some illustrative examples 314 11.6 The derivation of distribution weights 316 11.7 Distributional weighting in practice 322 11.8 Worked example: Incorporating income distribution effects in the NFG Project 326 11.9 Inter-temporal distribution considerations 327 11.10 Further reading 331 Exercises 331 Chapter 12: Economic impact analysis 334 12.1 Introduction 334 12.2 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 348 12.5 Case study: The impact of the ICP Project on the economy 349 12.6 Further reading 352 Appendix to Chapter 12: The annual eco

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.