Cost-Benefit Analysis of Project Alternatives

Costs and Benefits of Alternatives

• When evaluating project alternatives, a comprehensive list of costs and benefits should be made.
• Costs and benefits can be categorized as direct and indirect:
  • Direct: Costs and benefits directly associated with the project.
  • Indirect: Costs and benefits that affect the surrounding community but not directly reflected in the project's finances.
• Externalities are indirect costs and benefits that may arise from a project:
  • Indirect benefits: Economic growth generated in surrounding areas.
  • Indirect costs: Negative factors like increased traffic, pollution, or crime.
• Intangible costs and benefits are not easily quantifiable in monetary terms.
  • Intangible benefits: Enhanced city pride and improved community attitudes.
  • Intangible costs: Environmental hazards and negative impacts on community well-being.

Estimation and Valuation

• Difficulties in Cost-benefit analysis:
  • Many costs and benefits are not measurable in monetary terms.
  • Future costs and benefits need to be estimated.
• Valuation of intangible costs and benefits:
  • Often controversial and challenging.
  • Non-marketable items can have high societal values (e.g., ecological damage, threatened species).

Measuring Future Loss or Gain

• NIMBY (Not In My Backyard) Factor: Local communities may oppose projects with widespread indirect benefits but specific costs to their area.
• Estimating Property Value Loss:
  • Causal regression models can be used to estimate the impact of project-related factors (noise, pollution) on property values.
  • Regression Model: Price = f(Noise, Pollution, Travel Time, Other Factors)
  • Coefficients in the model estimate the impact of each factor on property prices.
  • Example: A one-unit increase in noise level (decibels) might decrease property value by $5,000.
• Data Asymmetry:
  • Often, potential losers of a project have more knowledge and concern about their losses than potential gainers.
  • Organized groups can effectively oppose projects even if they benefit society overall.

Introduction of Time: Present Value Analysis

• Time Preference: The value placed on receiving benefits sooner rather than later.
• Discount Rate: Used to adjust future benefits and costs to their present values.
• Present Value (PV) Formula:
  • Calculates the current worth of future benefits and costs.
  • PV=∑t=0n(Bt−Ct)(1+r)tPV = \sum_{t=0}^n \frac{(B_t - C_t)}{(1+r)^t}PV=∑t=0n​(1+r)t(Bt​−Ct​)​
    • Where:
      • PV: Present value of the project
      • B: Benefit at time t
      • C: Cost at time t
      • r: Discount rate
      • n: Number of time periods
• Projects with Different Time Frames:
  • Projects with larger benefits in the future may be less desirable than projects with smaller but immediate benefits, depending on the discount rate.
• Zero Discount Rate:
  • Implies no time preference.
  • Future benefits and costs are not discounted.
• Valuing Non-marketable Items:
  • Difficult and can lead to controversy.
  • Consider qualitative effects when valuation is difficult.
• Time Saved:
  • Difficult to value in monetary terms, as time saved may not translate to increased working hours.
  • Can be estimated by considering factors like fuel savings and environmental benefits.
• Intangible Effects:
  • Report accurately to inform political decision makers.

Explore the intricacies of cost-benefit analysis in evaluating project alternatives. Understand the distinctions between direct and indirect costs, as well as tangible and intangible factors that can influence project success. This quiz will help deepen your knowledge in assessing externalities and their overall impact on community well-being.