¶ … Economic Analysis Application of Cost Benefit Analysis

EU Proposed Project Overview

Traffic Forecast

Investment Costs

Positive Impact of the Project

Economic Net Present Value (ENPV)

Cost benefit analysis (CBA) is a systematic process of comparing and calculating the cost benefit of a project. Recent business uncertainties within business environment make increasing number of businesses to implement cost benefit analysis to make a sound investment decision. Cost-benefit analysis is also an explicit or implicit method to assess the benefits and costs of a project. Typically, an organization is likely to go ahead with a project if the Benefits (B) > Costs (C). Cost-benefit analysis is often used by private organizations or government to evaluate the desirability of a project. (Anthony, David, Aidan.). The CBA is used to analyze the expected benefits and costs. However, cost effectiveness analysis is closely related to cost benefit analysis. Although both concepts attempt to achieve the same objectives, however, cost-benefit analysis is used to ascertain viability of project outcomes that could be measured in monetary values. For instance, a firm's decision to embark on acquisition deal could be measured using the cost-benefit analysis. On the other hand, cost-effectiveness analysis measures an investment, which its outcome cannot be determined in monetary value. For example, the cost-effectiveness analysis could be used to determine the outcomes of government investment in education. (Levin, and McEwen).

Objective of this paper is to use quantitative techniques to determine the viability of a proposed European Union motorway project using a cost benefit analysis.

Application of Cost Benefit Analysis

The writer of this paper worked for EU (European Union) for some years. The experience that the writer gathered from EU enhanced his greater understanding on the strategy EU employed to select and determined a project's viability of member states. Typically, EU Cohesion policy makers use the cost-benefit analysis tool for the selection and financing a project. For example, National and Regional Authorities are planning investments on motorway project where the costs of the project worth more than €1 billion Euro. Thus, it is very vital that this project is carefully evaluated before implementing the project. The evaluation will reveal costs vs. The benefits of the project. Cost-benefit analysis is an important tool that assists EU to select a project from alternative projects. A case of investment in motor way embarked by the EU reveals the costs-benefit analysis of the investment.

EU Proposed Project Overview

Recent fast growth in the volume of traffic in the cities of the EU member states makes the organization to initiate a policy to embark on 72-kilometer motorway project to lower the volume of traffic and congestion problems. The EU foresees congestion problem in the future, if the project is not implemented which may ultimately lead to environmental pollution and consequently safety problems. The project objective is to reduce the transport emission as well as reducing the transport congestion. Additional benefits to derive from the project are to reduce the accidents. More importantly, motor vehicle owners will enjoy saving of vehicle operating costs' (VOC) due to the reduction of the kilometers traveled with the new free flow of traffic. However, actual quantitative benefits to derive from the project require the estimation of traffic forecast that reveals the actual demand that the project will generate.

Traffic Forecast

The report base the traffic forecast on the population and GDP growth. It is estimated that the increase in the population and GDP growth will increase the traffic and this is assessed against Business as Usual Scenario (BAU) Scenario. The paper uses the existing traffic data, demographic, socio-economic and macro-economic data to forecast the traffic. As being revealed in Table 1, the project will be divided in two categories:

Motor way free of charge

Toll motorway where there would be a charge for using the route.

Table 1:Traffic Forecast

Diverted from Existing network

New motorway Generated

Total from the motorway

Existing network

BAU scenario

Heavy vehicles

7,086

Passengers vehicles

114,542

New (free of charge) motorway

Heavy vehicles

5,867

1,200

7,067

1,219

Passengers vehicles

18,667

2,800

21,467

95,875

New tolled motorway

Heavy vehicles

4,889

5,129

2,197

Passengers vehicles

15,556

16,466

98,986

As being revealed in Table 1, the estimation of traffic forecast is based on the daily traffic at the opening fiscal year. The data reveal that the traffic will continue to grow because it is estimated that there would be population growth in the next few years. (European Commission ). The goal of traffic forecast is to determine whether the new project is likely to yield the estimated benefits. However, it is revealed the traffic free of charge option is higher than the toll motor. The next stage in the investment appraisal is to estimate the investment costs.

Investment Costs

The investment costs are the second step. Since the report has calculated the expected demand using the traffic forecast, it is critical to calculate the investment costs to determine the benefits to be derived from the project. The table 2 below reveals the total investment costs. The estimation is made for both free motorway and the tolled option and the costs components include materials, labor force, carriage and freight, and the technical life of the project is 70 years. The motorway construction is expected to complete within four years.

Table 2: Investment Costs (€Millions)

Free Motorway

Tolled Motorway

€Millions

€Millions

Works

59%

61%

Junctions

27%

26%

Land acquisition

60

7%

60

6%

General expenses

42

5%

42

5%

Other expenses

18

2%

18

2%

Total

Based on the data in Table 2, it is revealed that the estimation of investment costs for the free motor way will be €852 Million while the toll motor way is €895 Million. Based on the cost-benefit analysis, the project will generate positive impacts.

Positive Impact of the Project

The project will generate the following positive impact:

First, the project will save time and the operating costs because the new route is shorter.

Moreover, passenger will enjoy the advantages of traffic reduction due to the diversion of traffic towards new motor way, and this will increase speed and reduce congestion.

The data below calculates the overall benefits to be derived from the project:

Consumer Surplus

Gross producer's surplus

Government net revenues

Consumer surplus is calculated based on the reduction of traveling time. Typically, consumers are going to derive benefits from the reduction in costs of the car's fuel, and lubricants. Moreover, lorry owners will record benefits from the reduction of fuel lubricants, maintenance costs, insurance and driving costs. The overall travelling time will be reduced for car and lorry owners. (European Union).

Table 3: Consumer' Surplus

Passengers

Passengers trips (Millions)

Unit Benefits (€)

Benefits (€Millions)

BAU

Free of charge

Tolled

Free of charge

Tolled

Free of charge

Tolled

Existing traffic

32.2

32.2

32.2

1.48

0.40

47.6

12.9

Generated traffic

0.0

0.8

0.3

0.74

0.20

0.6

0.1

Total

32.2

32.9

32.4

48.2

12.9

Tons (Millions)

Freight

Tons (Millions)

Unit Benefits (€)

Benefits (€Millions)

BAU

Free of charge

Tolled

Free of charge

Tolled

Free of charge

Tolled

Existing traffic

2.1

2.1

2.1

2.4

0.2

5.0

0.5

Generated traffic

0.0

0.4

0.1

1.2

0.1

0.4

0.0

Total

2.1

2.5

2.2

5.5

0.5

As being revealed in Table 3, there is a general decline in the perceive costs per trip and translated in the increase in consumer surplus. Consumer benefits in monetary value for freight are €6 Million for both free of charge motorway and tolled motorway.

Table 4: Gross Producer's surplus

Revenues and costs (€Millions)

Benefits (€Millions)

BAU

Free of charge

Tolled

Free of charge

Tolled

Passenger

Motorway operator revenues

0.0

0.0

19.6

0.0

19.6

Car users unperceived operating costs

-76.4

-82.0

-77.9

-5.6

-1.5

Total

-76.4

-82.0

-58.4

-5.6

18.1

Freight

Motorway operator revenues

0.0

0.0

8.9

0.0

8.9

Trucks unperceived operating costs

-21.3

-26.1

-24.5

-4.7

-3.2

Total

-21.3

-26.1

-15.6

-4.7

5.7

Table 5: Government Net revenues

Fuel taxes

Total Revenue (€Millions)

Benefits (€Millions)

BAU

Free of charge

Tolled

Free of charge

Tolled

Passengers

68.8

73.9

70.2

5.0

1.3

Freight

23.7

29.0

24.8

5.3

1.0

The revenue generated from the new motor way is part of the producer surplus. As being revealed in Table 4 and 5, there are substantial advantages in the motorway performances making both users and society to be better off and there will be timesavings from the welfare point-of-view. The project also uses the net present value analysis to determine the viability of the project.

Economic Net Present Value (ENPV)

The paper uses the ENPV (economic net present values) technique and ERR (economic rate of returns) to determine the project viability. The project cash flow is also used to determine the net benefits of the free motor way and tolled motor way. From the data presented in Table 5, 6 and 7, it is revealed that the free motor way will yield a net present value of €212 Millions while the tolled motor way will generate a loss of €41 Million. However, both projects will yield positive economic returns. The economic rate of returns of free motor way is 7.8% while the ERR for the tolled motor way is 5%. Based n the findings, both free motor way and tolled motor way projects are viable projects.

Table 5: Economic Net Present Value (ENPV)

Free motorway

Tolled motorway

Discount Rate

5.5%

5.5%

ENPV (Millions of Euros)

-41.3

ERR (%)

7.8

5.0

B/C Ratio

1.3

0.9

Table 6: Tolled motorway Economic analysis (€Millions)

NUMBER OF YEARS

Cash Flow

1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

BENEFITS

Consumer's surplus

0.0

0.0

0.0

0.0

13.4

14.7

16.1

17.5

18.8

20.2

21.5

22.9

24.2

25.6

26.9

Time Benefits

0.0

0.0

0.0

0.0

37.1

38.7

40.3

42.0

43.6

45.2

46.8

48.5

50.1

51.7

53.3

Perceived Vehicle Operating Costs

0.0

0.0

0.0

0.0

-23.7

-24.0

-24.2

-24.5

-24.8

-25.0

-25.3

-25.6

-25.9

-26.1

-26.4

Gross Producer & Road User Surplus

0.0

0.0

0.0

0.0

23.8

24.0

24.2

24.4

24.6

24.8

25.0

25.2

25.4

25.6

25.8

Tolls

0.0

0.0

0.0

0.0

28.4

28.8

29.1

29.5

29.8

30.2

30.6

30.9

31.3

31.6

32.0

Not perceived Vehicle Operating Costs

0.0

0.0

0.0

0.0

-4.7

-4.8

-4.9

-5.1

-5.2

-5.4

-5.5

-5.7

-5.8

-6.0

-6.1

Net revenues for the State