Evaluation of CBA

Experience and Key Issues

Bucharest, 10th October 2008

Ministry of Environment and Water Management

Managing Authority for SOP Environment
Venera VLAD

Content

CBA Objective and Context

Key issues of CBA

Demand Analysis

Selection of the preferred option

Alternatives Considered

Cost Benefit Analysis

Incremental Approach

Investment Plan

Sustainability Analysis

Affordability

Institutional and Environmental Analysis

Sensitivity and Risk Analysis

Application Form

EU Grant Calculation

Financial & Economic Indicators

Managing Authority for SOP Environment

Objectives of CBA

To ensure that the optimal option is selected (economical

analysis))
analysis

the project meets a real demand

optimum use is made of scarce resources
the project is designed in a cost effective manner
the project will be sustainable over time

To determine the funding gap of the selected option and to

calculate the eligible expenditure (financial analysis)
analysis)

To assess the robustness of the selected project option (risk

analysis))
analysis

according to article 55(

55(2) of regulation 1083/
1083/2006

To identify the risks at an early stage with a view to take mitigation

measures

Managing Authority for SOP Environment

Context: CBA Part of Project Preparation

Project Selection

Project Identification

Project Feasibility

Project Appraisal

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CBA Part of the Project Feasibility

Demand
Forecasting

Assess
Current Facilities
Define the Gap:
Project Objective
Define the
(technical) Options
Select the
Preferred Option

Environmental
Impact Analysis

Financial and Economic

Cost Benefit Analysis

Institutional
Analysis

Sustainability
Analysis

CBA Report

Managing Authority for SOP Environment

Demand Analysis

Variables that
determine
effective demand

The price customers have to

pay (price elasticity)
Service levels that are
provided
Alternatives for households
Legal requirements
Levels of income (income
elasticity)

Managing Authority for SOP Environment

Define Options and Least Cost Analysis

First ensure optimum use of existing facilities!
Then define the gap between demand and (potential) current output
of the facilities
Define technical and non
non--technical options (conceptual design level)
Normally based on alternative ways to produce the same output
Type of alternatives considered (growth/do nothing, one/several
treatment sites, treatment locations, discharge locations, treatment
technologies)
Financial assessment mode for comparison (Investment, O&M, NPV)
and
Economic comparison
comparison;; environmental and social benefits
Managing Authority for SOP Environment

Financial and Economic Analysis

Based on Incremental Demand and Preferred Technical Option

(Base Case)
Purpose is to estimate the net benefits of a project based on the
difference between the with
with
and without project situation
In financial prices:
prices: from the entitys point of view
In economic prices
prices:: from a nations point of view
Steps include

Identify the costs and revenues of a project

Calculate the net benefits
Calculate the Net Present Value (NPV) or Internal Rate of Return (IRR)
Compare with Financial/Economic Opportunity Cost of Capital

Managing Authority for SOP Environment

Incremental Approach

Situation without Project Scenario

Realistic hypothetical demand

O&M costs, tariff & revenues
working capital
cash--flow
cash
possible improvement, etc.
etc.

Situation with Project Scenario

Expanded service and enhanced performance due to investment and

capacity building, etc.

Tabular comparison of indicators with & without

project showing positive or negative impact

demand
O&M fixed and variable costs
losses
collection rates etc.
etc.
Managing Authority 9for SOP Environment

Assess Project Sustainability

Ensure that project benefits will sustain throughout the
lifetime of the project

Are the costs of the services affordable for the beneficiaries?

Is the enterprise able to generate sufficient revenues to cover for
all costs (including debt servicing)?
servicing)?
If there are subsidies, can the government sustain these over
time?
Is the entity able to properly operate and maintain the project
facilities?
Assess institutional sustainability
Assess environmental sustainability
Managing Authority for SOP Environment

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Institutional and Environmental Analysis

Institutional Analysis
Is the project entity able to manage the project and to operate
and maintain the facilities?
Is the project entity willing to take the necessary measures to
ensure the succesful implementation of the project (e.g. tariff
increases, legal measures)?
measures)?
Does the project entity have the necessary authority to
successfully complete the project ?
Environmental Assessment
Assess the environmental impact and risks of the project and
propose possible mitigative measures
Ensure that potential problems are identified, early addressed
and dealt with (e.g. MIMBY syndrome, Natura 2000)
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Risk and Sensitivity Analysis

Define how to measure the success of the project (often by taking

(E)NPV or (E)IRR)

Sensitivity analysis:
analysis: identifies quantitatively those key
parameters with the greatest impact on the project viability and
results (must be quantitative)

Risk analysis:
analysis: estimates the probability of changes in key input
variables and their impact on the main financial indicators
(should ideally be quantitative)

Calculate whether or not the project remains successfull under

adverse conditions, and/or
Calculate the switching value
Propose measures to mitigate the risk
risk..

Managing Authority for SOP Environment

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Affordability
1. Price of water service:
service : per m3 (investment,
O&M)
2. Affordability (%): (price x volume) /
household net income for the whole county
and priority municipalities
3. Keep price below 4% of the lowest income
deciles
mitigation strategy:
strategy: reduced quantity,
cross--subsidisation, government subsidy,
cross
others)

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for SOP Environment

Investment Plan
1. Investment
by
type
of
investment,
agglomeration, and phase including re
re-investment [real and nominal terms]
2. Foreign and local cost elements
3. Overall O&M cost profile (unit cost tables)
4. NPV (entire system up to target horizon of 30
years)

Managing Authority14
for SOP Environment

Key Issues of Application Forms

1.

Overall presentation (style, clarity)

2.

Completeness
provided

3.

Accuracy of financing calculation & financial

& economic indicators

4.

Sensitivity and risk documentation

of

information

and

details

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for SOP Environment

Funding Gap Calculation

All costs calculated with two
digits after the comma
30 years

5%

based on total eligible investment

about 93 80 % of 3)
about 25% of 5)
preferably but not necessarily
higher than O&M cost

about 70

90 % of 7)

calculated with two digits after the comma

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Managing Authority for SOP Environment

Eligible Expenditure Calculation

Operator
Eligible Investment
Total Investment CostscocoCosts =EC
finance
Net
Net revenues
revenue
Operating
revenues

Operating costs
Eligible Expenditure
Residual value

Construction

Operation
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Managing Authority for SOP Environment

Calculation of Funding Gap

R
Eligible
Investment
Costs =
DIC

Operator
co-finance

DNR

EC

DIC

DNR

DIC

Construction

Operation

Managing Authority for SOP Environment

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Calculation of EU Grant

Grant =

Eligible
(Investment)
Costs (EC)

DIC

DNR
CRpa1)
DIC

1)

CRpa= CoCRpa=
Co-Financing Rate per priority axis
85 % for CF (water); 80 % for ERDF (waste)

Construction

Operation

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Managing Authority for SOP Environment

Funding Gap Example

E.1.2 Main elements and parameters used for financial analysis
Value
Not discounted

Main Elements and Parameters

1 Reference period (years)
2 Financial discount rate (%) - real

Value
Discounted (NPV)

30
5.0%

3 Total investment cost (in euro, not discounted)

61,649,998

4 Total investment cost (in euro, discounted)

46,828,502

5 Residual value (in euro, not discounted)

12,279,417

6 Residual value (in euro, discounted)

2,841,180

7 Revenues (in euro, discounted)

41,030,621

8 Operating costs (in euro, discounted)

41,030,621

9 Net revenue (in euro, discounted) = (7) - (8) + (6)

2,841,180

10 Eligible expenditure [Art 55 (2)] (in euro, discounted) = (4) - (9)

11 Funding gap rate (%) = (10) / (4)

43,987,322

93.9%

Questions: What is unusual about this example?

Is it possible to raise the funding gap to 100%?

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Managing Authority for SOP Environment

State or Local Budget Cannot Contribute to

Non--Funding Gap
Non

Item

Initial

Revised

Total Eligible Investment

for Cluj-Salaj ( million)
Funding gap (%)

194.8

194.8

83.1

88

25.2
(12.9%)
137.5

23.5
(12.1%)
145.6

ROC Contribution
( million)
Grant ( million)

Managing Authority for SOP Environment

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Main Financial Indicators

Financial Net Present Value (FNPV):
(FNPV):
discounted value of project cashcash-flows
(costs and revenues) over time
Financial (Internal) Rate of Return (FRR):
(FRR):
discount rate for which the PV of project
revenues equals the PV of investment
costs (FNPV=0)

Managing Authority22
for SOP Environment

Financial Indicators in Application Form

/ C means: looking at the project as a whole

/ K means: looking at the project from the
perspective of the Member State (or the national
capital, i.e. ignoring the EU grant)
Managing Authority for SOP Environment

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Recommended values
FNPV/C:: must be negative for infrastructure
FNPV/C
(i
(i..e. non statestate-aid) projects
 FRR/C
FRR/C:: must be less than discount rate (5 %
real discount rate requested in WD
WD4
4)
 FNPV/K
FNPV/K:: must be higher than FNPV/C (by
definition) but may still be negative
 FRR/K
FRR/K:: must be higher than FRR/C (by
definition) but not excessive (not higher
than 6%)


Managing Authority24
for SOP Environment

Example
E.1.3 Main results of the financial analysis
Main Elements and Parameters
1 Financial rate of return (%)
2 Net present value (euro)

Without Community assistance

FRR/C

With Community assistance

FRR/K

-4.6% (FRR/C)
-41,196,032 (FNPV/C)

31.9% (FRR/K)
3,787,558 (FNPV/K)

Questions: Would you accept an application form with these values?

Why / why not?

Managing Authority for SOP Environment

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More Examples

Which of the following public infrastructure

projects would you reject for EU support?
1. FNPV = - 20m, FRR/C = -1.8%, FRR/K = 3.1%
2. FNPV = - 15m, FRR/C = 2.5%, FRR/K = 5.2%
3. FNPV = 0.5 m, FRR/C = 5.2%, FRR/K = 15%

Managing Authority for SOP Environment

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Objective and Criteria of Economic Analysis

Objective: Test whether a project yields a greater
Objective:
net economic output than other next best
investment opportunities in the national
economy represented by the social discount rate
Criteria::
Criteria
Net Present Value:
Value: discounted value of economic
net
benefits
is
positive
(ENPV>0
(ENPV>
0)
Economic Internal Rate of Return:
Return: projects
economic internal rate of return exceeds rate of
next best alternative
(EIRR > Social Discount Rate = 5.5%) (12%
12% - 18%
18%)
Benefit / Cost ratio: economic benefits to costs
ratio of the project is clearly above one (B/C>1)
(1.2 1.8)
Managing Authority27
for SOP Environment

Approach of Economic Analysis

EC Guide to CBA of investment project, 2002

Document the net economic
output of the project by
adjusting its financial net
value to (i) add the cost and
benefit of social externalities
and (ii) correct to accounting
values market prices
distorted by taxes, social
transfer and subsidies

Phase 1: correct taxes,

subsidies, and other
transfers;


Phase 2: add
externalities;

Phase 3: conversion of
market prices into
accounting prices.

Managing Authority28
for SOP Environment

More Examples
Which of the following public infrastructure projects
would you accept for EU support?
A. FNPV = - 20m, FRR/C = -3.5%, FRR/K = 3.1%,
ENPV = - 0.5m, ERR = 5.0%
B. FNPV = - 14m, FRR/C = -1.9%, FRR/K = 5.2%,
ENPV = 18m, ERR = 7.5%
C. FNPV = 0.5m, FRR/C = 5.5%, FRR/K = 15%,
ENPV = 35m, ERR = 9.8%

Managing Authority for SOP Environment

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Sensitivity Analysis Approach (WD4)

Testing

the impact of a 1 % change in

input parameters on key indicators
(FRR/C, FNPV/C, ERR, ENPV)
Minimal scope of input parameters to be
tested:: investment costs, operating
tested
costs, operating revenues, external
project benefits
Those that lead to a more than 5 %
change
are
considered
critical
variables
Managing Authority for SOP Environment

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Sensitivity Analysis Approach (WD4)

Identification

of switching values
values,
,
which are the values of the tested input
variables that would lead to an
economic and/or financial NPV of 0
Intended
to
provide
additional
information to clarify what input
variables have the most critical
influence on the projects financial
parameters
Managing Authority for SOP Environment

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Risk Analysis
Provide a framework for contingency
allocation
Determine the probability of individual
inputs having given values
Calculate the probability that key outputs
will have given values
Link this calculation to the calculation of
the grant
List all the key variables and assumptions
Managing Authority for SOP Environment

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Thank you for your kind attention!

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