To identify project costs and benefits, the 'without' and 'with' project situations should be compared to one another. There are four basic steps to analyzing the economic viability of a project.
● Identify the economic cost and benefits;
● Quantify the costs and benefits;
● Value the cost and benefits; and
● Compare the benefits with the costs.
In identifying project benefits and costs it is important to distinguish between non-incremental and incremental outputs and between non-incremental and incremental inputs since non-incremental and incremental effects are valued in different ways. Non-incremental outputs are outputs that substitute for existing products, e.g., an old public market is replaced with a new one. Incremental outputs are outputs that expand supply to meet new demand, e.g., growing demand for water supply as the population grows. Non-incremental inputs are project demands that are met from existing supplies. Incremental inputs are project demands that are met by an increase in total supply of input, such as, an increase in demand for water is met by new source development.
The basic steps in economic analysis of PPP projects are described in detail below.
1. Identification and quantification of benefits
a. Direct productive project benefits - Producers' surplus approach is used for directly productive projects whose benefits will be in the form of production that is sold.
b. Indirect productive project benefits - Consumer surplus approach is used for indirectly produced projects where type and extent of expected benefits can be quantified through such variables as time and cost savings, increased assets, improved health, and so on, most of which have productive effects, as well welfare effects. A project may lower the price of the amount for all consumers. Unquantifiable benefits such aesthetics, social interaction and so on should be stated alongside with an estimate of the number of beneficiaries.
2. Identification and quantification of costs
a. System costs - total costs including all components in order to achieve the benefits and correspondingly, the total system benefits (for example, water extraction, treatment, transmission and distribution).
b. Sunk costs - costs of facilities already in existence and should not be included in the project costs provided their use in the project involves no opportunity costs.
c. Physical contingencies - represent the monetary value of additional real resources that may be required beyond the base cost to complete the project. (price contingency are not included in the economic costs)
d. Transfer payments - includes taxes and subsidies (deduct taxes, include subsidies).
e. Depletion premium - cost of using natural resources such as groundwater, oil, natural gas, or mineral deposits
f. External costs - all relevant effects that may include significant costs such air pollution, climate change, peace and order, political risks etc.
3. Valuation of economic costs and benefits (general considerations)
a. Economic cost and benefits should be values according to common criteria
b. Economic cost and benefits should be valued in constant prices that is in terms of the price level prevailing in the year in which the project is appraised.
c. Shadow pricing is applied to adjust market prices as to account for the effects of government intervention and market structure. Normally shadow price are applied to foreign exchange and unskilled labor.
4. Compare the benefits with the costs (evaluation considerations)
a. Alternative options - At least two options must be considered: a 'Do-Minimum' option and a 'Do-Something' option.
b. Project life of the alternative - The economic life of an alternative is the period of time during which it provides a positive benefit. The specific factors limiting the duration of economic life are:
● The economic life or period over which a need for the asset(s) is anticipated which is traditionally 20 years in the Philippines. This is what shall be used in the economic analysis.
● The physical life or period over which the asset(s) may be expected to last physically. Usually, physical life can be approximated to 50 years for salvage value estimates for new permanent constructions.
● The technological life or period before obsolescence would dictate replacement of the existing (or prospective) asset(s).
c. Social discount rate - No detailed work has yet been undertaken to assess an appropriate social discount rate. However, for the past several years NEDA has recommended that a social discounting rate of 15% be applied and this still prevails.
d. Shadow pricing - Specific "shadow pricing" factors will be applied to the market prices of labor and other local resource elements and to the foreign exchange elements of project costs and benefits. Again no extensive work has been undertaken in this area. However, NEDA has also recommended a shadow-pricing factor of 1.2 for foreign cost component and 0.60 for skilled labor, which is already being used in other feasibility studies.
e. Economic Viability
● Cost-benefit analysis (CBA)- CBA is a systematic evaluation of the desirability of a given intervention, which enables the decision makers to choose an option that maximizes the benefits minus cost. All future benefits and costs are then converted to their present value to make comparisons using a discount rate. The discount rates used in the calculation is 10%, 12% and 15%. Relevant economic indicators will be determined and considered in the recommendation for project implementation. These will include the following:
√ EIRR (economic internal rate of return)
√ NPV (net present value)
√ B/C (benefit/cost ratio)
√ FYBC (first year benefit-cost ratio)
√ NPV-cost ratio
√ Optimum timing
❖ Detailed economic analysis will be performed for each individual project component to determine their optimum timing of execution. A project, which is considered viable based on its internal rate of return over 30 years, does not necessarily imply that immediate construction is feasible because slow-maturing benefits may result to lower FYBC. Feasibility assessment will need to be undertaken to determine which component of the project will be postponed for construction until such time that the first year return will be acceptable.
❖ Evaluation of staged construction- The feasibility assessment analysis to be undertaken will include assessment of staged construction possibilities within a reasonable technical range and considering logical alternatives. The benchmark analysis to be undertaken will be used as a guideline in selecting staged construction options.
● Cost-effectiveness analysis (CEA)- Cost effectiveness analysis (CEA) is a type of economic evaluation that measures the maximum population served by the project where project benefits are not easily measured in monetary terms such as access. It compares the relative costs and outcomes (effects instead of outputs) of the project. The key performance indicator of CEA, which is used as the index in ranking projects in the pipeline, is cost-effectiveness ratio:
Cost-effectiveness ratio = Cost of Project | |
| Population served |
● Sensitivity Analysis- Project alternatives will be subjected to general sensitivity and risk analyses to determine the impact of variations in costs and benefits on the economic return on project investment and/or determine the robustness of the investment. The variances to be used are:
❖ 10% increase in cost and 10% decrease in benefits
❖ 10% decrease in cost and 10% increase in benefits
❖ 20% increase in cost and 20% decrease in benefits
❖ 20% decrease in cost and 20% increase in benefits
f. Distribution and Poverty Impact Analysis
Distribution analysis will be undertaken following the ADB Handbook for Integrating Poverty Impact in Economic Analysis of Projects. Benefits are distributed among various categories of stakeholders based on the major indictor Poverty impact ratio (PIR). PIR is defined as a simple ratio that shows whether the project will improve, maintain or worsen the income gap and is measured by the formula:
PIR = Benefits to the poor/Total economic benefits