There is no uniform or standard approach for conducting economic analysis of projects. Various models are used across the world for such analysis. However, the underlying principles in the economic analysis are the same; it is the methodology that may vary. Given below are indicative steps that are involved in an economic analysis.

1. Define objectives and scope of project

2. Identify options - the widest possible range of realistic options should be identified at the earliest possible stage of the planning process. The first option to be considered is the base case of "do nothing", i.e. what happens if the status quo is maintained? Doing nothing does not necessarily mean "spending nothing", e.g. upgrading fire safety, where the base case in effect becomes the "minimum essential expenditure option". The base case must be realistic. Doing nothing may involve cost penalties, loss of life or property (for example by not upgrading a facility for fire hazard or disaster) or confer positive benefits. One of the benefits of "doing something" may be the avoidance of high maintenance costs. Appraisals must report on all feasible options and clearly explain why potential options may not have been evaluated.

3. Identify quantifiable costs: Assumptions underlying all economic cost estimates should be made explicit in the evaluation. The degree of accuracy desirable will vary with the significance of the project, data availability and cost of obtaining missing data.

4. Identify quantifiable benefits: would include the following benefits:

a. Avoided costs-incremental costs which are unavoidable if nothing is done, but may be avoided if action is taken

b. Cost savings-verifiable reductions in existing levels of expenditure if a programme proceeds

c. Revenues-incremental revenues from introduction of the project

d. Benefits to project beneficiaries not reflected in revenue flows-while difficult, attempts should be made to quantify these, with assumptions and methodologies clearly explained, and

e. Residual value of asset (if any).

5. Calculate Net Benefits: Quantifiable economic costs and benefits over the project life need to be expressed in net present value terms. Sensitivity analysis should be undertaken to test the robustness of results under different scenarios, using different assumptions about some or all of the key variables. Agencies should note that in a constrained budgetary situation, economic performance indicators such as ENPV and Cost to Benefit Ratio measures are important considerations for budget funded projects and programs.

6. Identify qualitative factors and summarise results - Quantifiable costs and benefits are only part of an economic appraisal. Other aspects such as environmental considerations, social or regional impacts, resource availability, funding, distribution of benefits and costs, etc. will also have to be taken into account in choosing between competing options and projects. Some of these may be quantifiable to some extent but where they are not, qualitative aspects of options or projects should be discussed in the appraisal. The report on the appraisal should include a clear summary of results, and indicate the preferred option.

As part of economic analysis, the observed prices or public tariffs pertaining to a project are converted into shadow prices that better reflect the social opportunity cost of the goods. The externalities and indirect/remote effect of the project are also taken into account and assigned monetary values. All costs and benefits that are associated with the project are discounted by a real social discount rate. A feature of economic analysis is the use of accounting shadow prices based on social opportunity cost using a social discount rate (SDR), instead of the observed prevailing prices, which may not represent the true cost. The results of the market analysis, and the technical, social and environmental, financial cost assessment and risk analyses are all inputs for the economic analysis. Finally, the economic performance indicators such as the economic net present value, economic rate of return and benefit/cost ratio of the project are calculated.

Specialist advisers are usually a part of the team engaged to carry out the economic viability assessment.

Social Discount Rate (SDR)

The SDR is the discount rate used in the economic analysis of investment projects. It reflects the social view on how future benefits and costs should be valued against present ones. It may differ from the financial discount rate when the capital market is inefficient (for example, when there is credit rationing or asymmetric information or because of the myopia of savers and investors).

SDR measures the rate at which a society would be willing to trade present consumption for future consumption. It is also referred to as the Social Time Preference Rate and is one of the most critical inputs in economic analysis.