2. Step 2: Identify the benefits and costs
Steps
2.1 List the benefits and costs and classify them.
2.2 Leave out depreciation.
2.3 Be clear about the point of view of the CBA.
2.4 Set the appraisal period.
2.5 Be clear about whether you are working in real or nominal terms.
2.1 List the benefits and costs and classify them
Having specified the initiative (or initiatives if options are being assessed) and the Base Case, a good place to start a CBA is to prepare a list of all the benefits and costs. As explained in the introduction, CBA aims to be as all-encompassing as possible, taking into account all impacts on society. Table 1 provides a checklist that covers most of the benefits and costs associated with transport initiatives, with boxes 2, 3 and 4 providing supporting definitions and discussion.
The table distinguishes three types of benefits and costs:
- Monetised benefits and costs (see Part F3 Section 3.2) are always included in the CBA.
- Non-monetised benefits and costs (see Part F3 Section 3.2) are considered explicitly alongside the monetised benefits and costs in decision making. They should be described in qualitative terms and, where possible, quantified using physical units. In some cases, it may be possible to attempt to value non-monetised benefits and costs in dollar units, but this can involve expensive surveys that yield results with very wide margins of error.
- Secondary or flow-on impacts, are benefits and costs that are passed on, or redistributed, within the economy. The most accurate measurement of benefits and costs can usually be achieved by measuring them directly as close to their sources as possible. Therefore, it is better to measure them as the primary impacts listed in the first column of Table 1, rather than as secondary impacts. Counting both primary and secondary impacts in a CBA is double-counting and leads to distorted results.
Benefits and costs can be further classified according to whether they accrue before the initiative commences operation (investment costs) or during the operating phase.
The Guidelines presents guidance on the related process of benefits management, which is aimed at assessing whether an initiative actually delivers its expected benefits once it has been delivered. Box 4 in Part F3 compares the role of benefits in appraisal versus benefit management. Part F7 provides a full discussion of benefits management.
| MONETISED | NON-MONETISED | SECONDARY IMPACTS |
|---|---|---|
Investment costs
|
Amenity value Barrier effects on humans and on biodiversity Biodiversity and ecosystems Heritage Aesthetic value Culture Increased comfort, cleanliness and security for passengers Reduced damage to freight and reduced pilferage |
Employment (construction and operation phases) Tourism Land values Industry development Community spirit/pride Communication Connectivity Information sharing Social cohesion Increased incomes Access to services Production levels Productivity for industries |
Note: The list is not exhaustive.
* Some of these benefits could have a negative sign because they are disbenefits (e.g. increases in environmental externalities).
** In most cases, the reason these benefits and costs are ‘non-monetised’ is because it is too expensive to undertake the surveys necessary to produce reasonable estimates of the values people place on them. See NGTSM 2006 Volume 5, Section 2.9.2 for a brief discussion of the techniques available for estimating externality costs. For damage and pilferage to freight, consigners and transport operators are often unwilling to divulge the extent of the problem
Box 2: Economic benefit and cost terminology
The following definitions from the ATAP Guidelines Glossary (Part A2) are repeated here for the convenience of users.
| TERM | DESCRIPTION |
|---|---|
| Willingness-to-pay (WTP) | The maximum amount consumers are willing to pay for a given quantity of a particular good or service (rather than go without it). It indicates the value that consumers place on a given quantity of a good or service. The marginal WTP for a given quantity is the height of the demand curve at that quantity. The total WTP is measured as the total area under the demand curve up to a given quantity. Total WTP is comprised of consumers’ surplus plus the total money price paid by consumers’ times the quantity consumed. |
| Consumers’ surplus | The surplus of consumers’ willingness-to-pay over and above what they actually pay for a given quantity of a good or service. It is measured as the willingness-to-pay area under the demand curve above the price paid. |
| Resource cost / opportunity cost / social cost | The value forgone by society from using a resource in its next best alternative use. Reflects market prices where there is an absence of market failure. Where market failure exists, appropriate adjustments are required to estimate the true resource cost. |
| Private cost | Cost incurred by an individual transport user or service provider. Excludes external costs. |
| External cost | The cost of an externality – the cost imposed on third parties, including time lost from delays, non-internalised accident risks and environmental impacts. Valued at resource costs or willingness-to-pay. |
| Money price | The money price paid to use a transport service (such as a fare, toll or road user charge). |
| User cost | All private costs (in addition to the money price) incurred by a transport user in undertaking a door-to-door journey between origin and destination - waiting time, time in transit, unreliability, walking time, vehicle operating costs, parking, internalised crash risk, any health impacts, damage to freight, passenger discomfort, pick up and delivery costs for freight. Quality attributes (such as time and reliability) need to be expressed in dollar terms based on user valuations. |
| Generalised cost/ private generalised cost | The sum of money price and user cost. |
| Social generalised cost | The full cost to society to complete the door-to-door journey from origin to destination – the sum of user cost and external cost. Valued at resource costs or willingness-to-pay. |
| Perceived cost | The subset of private generalised cost that is actually perceived by the user. For example, car drivers may perceive time but not all vehicle operating costs. Valued at market prices. |
| Financial cost / money cost | Cash-flow expense incurred by purchasing resources through markets at market prices. |
Box 3: Resource and opportunity costs
The term ‘opportunity cost’ refers to the benefit that would accrue from using a resource in its next best alternative use. For example, the value of land in CBA (and financial analysis) should be the current market price, not the price paid for it in the past. ‘Resource cost’ is the opportunity cost of resources used, measured from the point of view of society as a whole.
Differences between private and resource costs arise when, for a given cost, the opportunities forgone are different for the individual incurring the cost and for society as a whole.
Taxes, subsidies, tariffs, import quotas and non-competitive pricing by producers can all cause resource costs to differ from private costs. Take the excise on fuel as an example. The cost to society of an extra litre of fuel consumed (excluding externalities) consists of the cost of earning the foreign exchange required to pay for importation of oil, plus refining, transport and storage costs. The private cost consists of this resource cost plus the tax, which is a ‘transfer’ to the government. Resource costs values used in CBAs are sometimes referred to as shadow prices.
To convert private costs to resource costs, it is usually sufficient to simply exclude taxes (fuel excise, goods and services tax), subsidies and tariffs from inputs such as fuel, tyres, vehicles and trains.
For labour costs, it is usually more correct in CBAs not to deduct income taxes and payroll taxes to obtain resource costs because of a different assumption about labour supply. The opportunity cost of additional labour resources is assumed to be forgone production elsewhere in the economy. The wage cost incurred by the employer measures the value of this production.
In rare cases, where labour would be otherwise unemployed, a shadow price below the market cost may be used. The shadow price is given by the following formula:
(pre-tax wage – income tax – payroll tax – unemployment benefit + presentation costs)/2
where presentation costs consist of items such as annualised relocation costs, transport to and from work, and special clothing. For further explanation and a derivation of this formula see NGTSM 2006, Volume 5, Section 2.3.5.
If production of an input causes an externality, the cost of the externality should be included in the resource cost.
Box 4: Generalised and perceived costs
Allowance for changes in the quality of transport services in CBAs can be simplified by using the ‘generalised cost’ concept.
To make a journey, transport users incur additional costs on top of the money price. The additional costs, termed ‘user costs’ here, fall into two categories: (1) negative quality attributes, and (2) costs incurred by transport users at the start and end of a trip to complete the door-to-door movement.
Time taken is usually the most important negative quality attribute, followed by unreliability. Unreliability can be measured in a number of ways. The ATAP Guidelines use the standard deviation of trip time for roads and average number of minutes late for public transport.
To incorporate them into generalised cost, time taken and unreliability need to be expressed in dollar amounts. Transport users will have a distribution of values for time and unreliability. Calculation of user costs for a group of users requires quality aspects to be costed at average values.
Examples of the additional costs of a door-to-door journey include:
- For passengers - waiting time, walking and parking
- For freight - pick-up, delivery and packaging. In some cases, these involve money costs and, in some cases, time lost.
The value of waiting time is usually different from the value of in-vehicle time.
The different components of user cost, all expressed in dollar terms, are simply summed. The generalised cost is the sum of user costs and the money price of the main mode of transport used.
When estimating benefits of transport initiatives using prices defined in terms of generalised costs, it is necessary to define supply costs as ‘social generalised costs’. Social generalised costs are the full costs to society of a door-to-door journey, including costs of negative quality attributes, valued in resource terms. While the private and resource values of time and other quality attributes will be the same, taxes and subsidies could cause private and resource costs of vehicle operation to diverge. Hence, social and private user costs may differ.
Transport users may ignore some costs when making decisions. Car drivers may see fuel and other vehicle operating costs as a fixed cost they pay periodically, rather than a variable cost that changes with distance and speed. ‘Perceived cost’ is derived by deducting from generalised cost the costs that users are assumed not to perceive.
See NGTSM 2006 Volume 5, Section 2.3.5, for further discussion.
2.2 Leave out depreciation
Never include depreciation of capital assets in a CBA, because the full cost of the asset to society is taken into account when the resources are consumed to create the asset. This means that to also include depreciation would lead to double-counting. Depreciation is a bookkeeping entry designed to spread capital costs over time in order to facilitate comparisons with operating profits for performance monitoring. For financial analysis, exclude depreciation on the grounds that it is not a cash flow. For financial analyses carried out after tax, depreciation is relevant where it affects taxation payments.
2.3 Be clear about the point of view of the CBA
CBAs are normally undertaken from the point of view of society as a whole. They may be undertaken from the point of view of a subset of society such as people living in a particular state, territory or region. If a CBA is undertaken from the point of view of a subset of society, indicate it clearly and never present the regional result in isolation from the whole-of-society result.
CBAs from the point of view of a state, territory or region can be extremely difficult to carry out in practice because of the problem of distinguishing between benefits that accrue to people within the area and benefits that accrue to people outside the area. A regional CBA is therefore likely to have a higher margin of error.
2.4 Set the appraisal period
The appraisal period should be set at the expected life of the asset created by the initiative in its intended use, plus the construction period. It is usual to assume a 30-year life for road initiatives (except bridges, which have much longer lives) and a 50-year life for rail initiatives. Intelligent transport system (ITS) initiatives have shorter lives, normally 10 years. The mode specific guidance contains typical economic lives for some infrastructure assets. Prepare forecasts of benefits and costs for each year of the initiative’s life.
When comparing options with different lives for a particular initiative, make adjustments to ensure a valid comparison. There are two ways to do this:
- Find a common multiple of the lives (for example, 150 years for a 30-year road initiative and a 50-year rail initiative)
- Convert the NPV to an annuity over the initiative’s life.
Note that adjusting for different lives is necessary only for estimating NPVs to compare mutually exclusive options. It is not required for ranking initiatives by BCR to satisfy a budget constraint.
Where jurisdictions set maximum appraisal periods (for example, 30 years) that are shorter than the life of the assets, add a residual value to allow for net benefits beyond the end of the appraisal period (see Section 4.3 on residual values).
2.5 Be clear about whether you are working in real or nominal terms
It is usual to undertake CBAs in real terms and financial analyses in nominal terms. In proposals that include both a CBA and a financial analysis, ensure that the assumptions are consistent and, in so far as possible, show how the two analyses relate to each other (for example, by links within a spreadsheet). There should be inflation adjustments that convert between the CBA in real terms and the financial analysis in nominal terms.
Provided real or nominal prices are used consistently, the end results should be identical. Discounting nominal values at a nominal discount rate produces the same discounted result as discounting real values in real terms. The reason is that using a nominal discount rate converts nominal prices back into present day dollars. The relationship between a real and a nominal discount rate is as follows:
where i is the nominal discount rate, r is the real discount rate and f is the inflation rate. If working in nominal terms and the inflation rate varies, allow the nominal discount rate to vary accordingly.