The Geography of Transport Systems
FOURTH EDITION
Jean-Paul Rodrigue (2017), New York: Routledge, 440 pages.
ISBN 978-1138669574
Cost / Benefit Analysis
Authors: Dr. Brian Slack and Dr. Jean-Paul Rodrigue
1. The Framework
Cost-benefit analysis (CBA or COBA) is a tool employed to evaluate projects by providing with a set of values that are useful to determine its feasibility from an economic standpoint. Conceptually simple, its results are easy for decision makers to comprehend, and therefore enjoys a great deal of favor in project assessments. The end product of the procedure is a benefit/cost ratio that compares the total expected benefits to the total predicted costs. In practice CBA is quite complex, because it raises a number of assumptions about the scope of the assessment, the time-frame, as well as technical issues involved in measuring the benefits and costs.
Before any meaningful analysis can be pursued, it is essential that an appropriate framework be specified. An extremely important issue is to define the spatial scope of the assessment. Transport projects tend to have negative impacts over short distances from the site, and broader benefits over wider areas. Thus, extending a runway may impact severely on local residents through noise generation, and if the evaluation is based on such a narrowly defined area, the costs could easily outweigh any benefits. A similar issue concerns a port development project that would have negative local impacts, but being of strategic importance to a region or a nation. On the other hand defining an area that is too broad could lead to spurious benefits.
Because transport projects have long term effects, and because the analysis is carried out on a real term basis, the benefits and costs must be assessed using specific and pre-determined parameters. For example, when is the project start date, when will it be completed, over what period of time will the appraisal run, and what discount rate will be used to depreciate the value of the costs and benefits over the appraisal period? These and other parameters must be agreed upon. Costs and benefits are presented in nominal values, i.e. monetary values of the start year and discounted for inflation over the project period. Because most transport projects are assessed for a 30 year period employing different discount rates may influence greatly the outcomes.
2. Costs and Benefits
Costs associated with the project are usually easier to define and measure than benefits. They include both investment and operating costs. Investment costs include the planning costs incurred in the design and planning, the land and property costs in acquiring the site(s) for the project, and construction costs, including materials, labor, etc. Operating costs typically involve the annual maintenance costs of the project, but may include additional operating costs incurred, as for example the costs of operating a new light rail system.
Benefits are much more difficult to measure, particularly for transport projects, since they are likely to be diffuse and extensive. Safety is a benefit that needs to be assessed, and while there are complex issues involved, many CBA studies use standard measures of property savings per accident avoided, financial implications for reductions in bodily injury or deaths for accidents involving people. One of the most important sets of benefits are efficiency gains as a result of the project. These gains might be assessed by estimating the time savings or increased capacity made possible by the project.
Many other elements relating to social impacts, aesthetics, health and the environment are more difficult to assess. The latter, in particular, is a major factor in contemporary project assessment, and usually separate environmental impact analyses are required. Where possible these factors must be considered in CBA, and a variety of measures are used as surrogates for environmental benefits and costs. For example, the commercial losses of habitat destruction and property damage can be estimated. The difference in the values of properties adjacent to airports and those further away can be used to assess the costs of noise.
3. Results and Biases
Three separate measures are usually obtained from CBA to aid decision making:
  • Net Present Value (NPV): This is obtained by subtracting the discounted costs and negative effects from the discounted benefits. A negative NPV suggests that the project should be rejected because society would be worse off.
  • Benefit-cost ratio: This is derived by dividing the discounted costs by the discounted benefits. A value greater than 1 would indicate a useful project.
  • Internal rate of return (IRR): The average rate of return on investment costs over the life of the project.
The first two are broadly similar, though with significant differences. A project may have a high B/C ratio but still generate a smaller NPV. The results should be subjected to a sensitivity analysis. This would include considering the robustness of the predictions of costs and benefits, and usually involves the identification of aspects that would introduce uncertainty into the predictions. If certain elements are shown to be subject to variations (inflation, higher fuel charges etc.) various scenarios would be prepared, and the cost/benefit values re-evaluated.
Results in cost / benefit analyses tend to be notoriously inaccurate, as large infrastructure projects systematically have high cost overruns. An enduring bias concerns the underestimation of costs and the exaggeration of benefits, which often questions the usefulness and relevance of cost / benefit analysis. A major factor behind this bias is the inherent propensity for infrastructure promoters to portray projects as highly beneficial for the costs involved in order to secure approval and funding. To make matters worst, the projects that have the most exaggerated benefits and the highest cost overruns tend to generate much lower benefits than expected.