What is Cost-Benefit Analysis?

Cost-benefit analysis (CBA) is a tool used to evaluate projects and help guide decision making in
public sector
• determine if a particular project is worthwhile
• choose between several mutually exclusive projects

Projects include government interventions such as infrastructure investments, policies, programs, and
regulations; eg,
• building a hydroelectric dam
• establishing a national day-care program
• introducing a regulation limiting particulate emissions

At its most basic level, CBA is a three-step process

1. identify and sum project’s positive impacts; ie, benefits
2. identify and sum project’s negative impacts; ie, costs
3. compare project’s total benefits to its total costs

Although CBA and financial analysis share some features, they are different
• CBA includes all major costs and benefits, monetary or otherwise
• financial analysis considers only monetary costs and benefits

REMARK CBA is sometimes called social CBA to emphasize its holistic societal perspective

CBA can be conducted at different points in a project’s life cycle

• before a project starts → ex ante CBA
• while a project is ongoing → in media res CBA
• after a project has finished → ex post CBA

Ex ante CBA is most common

© Clive Chapple. All rights reserved. Lecture Notes 1: page 1

Main Steps of CBA
1. Explain purpose of the CBA
2. Specify set of alternative projects
3. Decide who has standing
4. Identify impacts and select metrics
5. Predict impacts quantitatively over life of project
6. Monetize impacts
7. Discount costs and benefits
8. Compute net present value of each alternative
9. Perform sensitivity analysis
10. Make recommendation

Example CBA: The Coquihalla Highway

CBA of Coquihalla Highway used to illustrate main steps of CBA

Coquihalla is a four-lane highway from Hope to Kamloops

• Phase 1 opened in May 1986: Hope to Merritt (115 km)
• Phase 2 opened in Sep 1987: Merritt to Kamloops (80 km)

Cariboo
and North to Jasper,
Edmonton

97 5
Trans-Canada
East
1
Cache Kamloops
Creek 1
North
Salmon
1 Phase II Arm

Vernon
Merritt

Phase I Kelowna
Phase III
1
99
.
wy

Summerland
.Hq
Co

Princeton Penticton
N. Van.
Hope

Vancouver
Ge

Osoyoos
or

1 Canada
gi

99
a
St

United States
ra
it

Bellingham

© Clive Chapple. All rights reserved. Lecture Notes 1: page 2

Step 1: Explain purpose of CBA
The analyst should
• explain why the particular project or policy change is being considered
• remind audience that goal of CBA is maximizing allocative efficiency from a societal perspective; ie,
to maximize social net benefits

Step 2: Specify alternative projects

Identify the project options to be considered

Typically, projects can vary along many dimensions; eg, with Coquihalla highway
• scale: 2, 4, or 6 lanes
• tolls: none, low or high
• project timing: now or later

Evaluating options is costly (i.e., requires considerable time and effort) so usually only a small number of
options evaluated in detail

In Coquihalla example, two options considered

• highway with toll
• highway without toll

Step 3: Decide who has standing

Decision about standing determines which costs and benefits are included in the analysis
• effects on people with standing are included in analysis
• effects on people without standing are ignored

CBA is anthropocentric; ie, only human beings can have standing

Standing is usually determined by existing regulation or by agency/person sponsoring the CBA

© Clive Chapple. All rights reserved. Lecture Notes 1: page 3

Different perspectives can be adopted in CBA; eg, global, national, provincial, municipal

Perspective Who has standing

global everyone on planet
national only Canadians
provincial only provincial residents
municipal only municipal residents

Conducting CBA from multiple perspectives can provide useful information about the distribution of
project’s costs and benefits

In example, two perspectives are considered

• a global perspective
• a provincial (BC) perspective

Standing and Transfers

A transfer occurs when resources are reallocated from one person (or group) to another person (or group)
but not consumed

Ken Barb

resources
−−−−→

Has standing No standing

Ken Barb

resources
−−−−→

No standing Has standing

Ken Barb

resources
−−−−→

Has standing Has standing

© Clive Chapple. All rights reserved. Lecture Notes 1: page 4

 Feds do Feds don’t
have standing have standing
Type of Lane Benefits Costs Net Benefits Net Benefits
Regular $105M $50M
HOV $20M $50M

Treating transfers between groups with standing as costs or benefits

• is a common and often serious error in project evaluation
• frequently occurs in economic impact analysis

Step 4: Identify impacts and select metrics

Impacts are broadly defined as project inputs and outputs
• costs are typically associated with project inputs; ie, resources used by the project
• benefits are typically associated with project outputs; ie, goods/services produced by the project

REMARK Sometimes project inputs can be associated benefits rather than costs (eg, garbage used as
fuel for solid waste incinerator) and project outputs can be associated with costs rather than benefits (eg,
increased traffic noise from a new highway)

All significant impacts must be identified and cataloged

In Coquihalla CBA, impacts included

• time saved by travellers
• accidents avoided and lives saved
• reduced congestion on alternative routes
• highway construction and maintenance costs
• toll revenues

Impacts are typically reported in natural units at this stage in analysis; eg

• travel time saved: hours
• lives saved: lives
• construction labour used: hours of labour
• concrete poured: tonnes of concrete
• fuel saved: gallons of fuel

© Clive Chapple. All rights reserved. Lecture Notes 1: page 5

Step 5: Predict impacts over project life
Must predict impacts
• over project’s expected life; ie, period over which project is expected to generate significant
costs/benefits
• relative to a well-defined base case; ie, status quo or what would happen without project

water used
(106 m3=yr)
4.0

3.0

2.0 no rebate
rebate (worst case)
rebate
1.0 rebate (best case)
year
2025 2027 2029 2031 2033 2035 2037 2039

Step 6: Monetize all impacts

Monetization is
• process of assigning dollar values to impacts
• often the most difficult and/or controversial step of CBA
• particularly challenging for impacts involving non-market goods such as lives saved/lost or changes in
environmental quality

REMARK Developing valid monetary values for some non-market impacts requires considerable resources;
therefore, analysts typically use plug-in values (ie, values of non-market impacts drawn from previous
research) when available and appropriate (see Chapter 17 of Boardman for examples of plug-in values)

In the Coquihalla CBA

• value of leisure time saved: $13.1 per vehicle-hour (2016 $)
• value of lives saved: $978,685 dollars per life (2016 $)

If a government agency is unwilling or unable to monetize certain impacts (eg, value of lives saved or
lost), it cannot use CBA. But it can use closely-related alternatives such as cost-effectiveness analysis or
multi-goal analysis

© Clive Chapple. All rights reserved. Lecture Notes 1: page 6

Step 7: Discount costs and benefits
Economists generally agree that the further in the future costs and benefits occur, the less weight they
should be given in decision-making today

In CBA, the social discount rate (SDR) is an important parameter whose value
• indicates the extent to which future costs and benefits are worth less than present costs and benefits
• used to translate future costs/benefits into present values

Choosing an appropriate SDR is often difficult and controversial, but the value (or values) that must be
used is sometimes determined by regulation or by the agency requiring the CBA

Step 8: Compute net present value

A project’s net present value (NPV) is the present value (PV) (ie, the discounted sum) of the
project’s benefits minus the PV of the project’s costs calculated over the project’s expected life

NPV = PV of benefits − PV of costs

= PV of net benefits

In the Coquihalla example, NPV is affected by decisions about standing and tolling, resulting four different
NPVs

No Toll With Toll

Social Benefit Global Prov Global Prov
Time/operating cost savings 763.0 572.1 568.4 426.3
Safety benefits 70.5 52.8 49.3 37.0
New Users 1.6 1.2 0.6 0.4
Alternative route benefits 28.6 21.3 18.4 13.9
Toll revenues 0 0 0 73.2
Terminal value 104.3 104.3 104.3 104.3
Total Social Benefits 968.0 751.7 741.0 655.1

No Toll With Toll

Social Cost Global Prov Global Prov
Construction 661.8 661.8 661.8 661.8
Maintenance 14.9 14.9 14.9 14.9
Toll collection 0 0 16.4 16.4
Toll booth construction 0 0 0.6 0.6
Total Social Costs 676.7 676.7 693.7 693.7

No Toll With Toll

Global Prov Global Prov
Net social benefits 291.3 75.0 47.3 −38:6

© Clive Chapple. All rights reserved. Lecture Notes 1: page 7

Step 9: Perform a sensitivity analysis
Much of the prediction, quantification, and monetization in CBA is uncertain

water used
(106 m3=yr)
4.0

3.0

2.0 no rebate
rebate (worst case)
rebate (most likely)
1.0 rebate (best case)
year
2025 2027 2029 2031 2033 2035 2037 2039

Sensitivity analysis examines how changes in the values of key parameters affect NPV

Step 10: Make a recommendation

If a single project option is being considered
• recommend proceeding with project if NPV > 0
• recommend against proceeding with project if NPV < 0

If several mutually-exclusive project options are being considered

• recommend proceeding with highest NPV option if NPV > 0 for one or more options
• recommend against proceeding with project if NPV < 0 for all options

Final recommendation is typically affected by the results of the sensitivity analysis, distributional impacts,
and other factors outside scope of CBA (eg, political considerations)

© Clive Chapple. All rights reserved. Lecture Notes 1: page 8