An introduction to Feasibility Study and Cost-benefit

analysis

11 November 2021
 OUTLINE

• 7 STEPS OF PROJECT DEVELOPMENT

• KEY PRINCIPLES
• FINANCIAL ANALYSIS
• ECONOMIC ANALYSIS
• RISK ASSESSMENT
7 STEPS OF PROJECT DEVELOPMENT
 7 STEPS OF PROJECT DEVELOPMENT
1. Presentation of the socio-economic. institutional and political context
1. Presentation of the socio-economic. institutional and political context

2. Definition of objectives
2. Definition of objectives

3. Project identification
3. Project identification

4. Technical feasibility & Environmental sustainability

4. Technical feasibility & Environmental sustainability

5. Financial analysis
5. Financial analysis

FNPV>0 FNPV<0
FNPV>0 FNPV<0

The project does not require financial The project does require financial support
The project does not require financial The project does require financial support
support
support

6. Economic analysis
6. Economic analysis

ENPV<0 ENPV>0
ENPV<0 ENPV>0

The society is better off without the project The society is better off with the project
The society is better off without the project The society is better off with the project

7. Risk assessment
7. Risk assessment
 CONTENT OF A FEASIBILITY STUDY

• Technical Description of the project

• Socio-economic context of the project  STEP 1
• Institutional and Legal framework
• Demand analysis  STEP 4
• Option and Technical Analysis  STEP 4
• Implementation Schedule  STEP 4
• Financial Analysis  STEP 5
• Socio-Economic Cost-Benefit Analysis  STEP 6
• Sensitivity and Risk Analysis  STEP 7
• Environment and climate change  STEP 4
 Presentation of the context (1)

• the socio-economic of the country/region that are

relevant for the project (i.e.: demography. GDP growth.
labour market…)
• the policy and institutional aspects including existing
economic policies and development plans
• the current infrastructure endowment and service
provision  bottlenecks!!
• The expectations of the population. e.g. any existence of
environmental instances
 Presentation of the context (2)

The presentation of the context is instrumental to:

 forecast future trends. especially for demand analysis;
 verify that the project is “appropriate” to the context where it
takes place.
Good Practices Common Mistakes

 The context is presented including only  Socio-economic context and statistics are
sectors that are relevant to the project presented without explaining their relevance
 The existing infrastructure endowment
and service presented with relevant  Socio-economic information are not based on
stats available official data and forecast
 The characteristics of the services to be
provided are presented in light of the  The political and institutional aspects are
existing development plans considered irrelevant
 Objectives definition

• The definition of the objectives should result from the

assessment of the regional and/or sectoral need.
• Project objectives should be defined in explicit relation
to the needs.
• As far as possible. the objectives should be quantified
through indicators and targeted.

Problem Project Solution

 Project identification (1)

A project is clearly identified when:

• the physical realizations that will be implemented consist
of a self-sufficient unit of analysis;
• the body responsible for implementation has been
identified. and its financial and technical capacity verified;
• the impact area. the final beneficiaries and all relevant
stakeholders are duly identified (“who has standing?”).

GOOD PRACTICE (!)

Individual investment measures are bundled into one single project when these are: i)
integral to the achievement of the intended objectives and complementary from a
functional point of view; ii) implemented in the same impact area; iii) owned by the
same beneficiary; iv) have similar implementation periods.
 Technical feasibility

Although engineering design and environmental appraisal

are not formally part of the CBA their results must be
concisely reported and used as main data source including:
• Demand analysis
• Options analysis
• Technical design
• Cost estimates  this is the basis for Financial Analysis
• Implementation schedule
• Environmental considerations, including EIA and
climate change
 Demand analysis

• Needs analysis vs. demand analysis

• Market analysis: analysis of supply / existing & planned
competing alternatives
• Ensure optimal scale and utilisation of project
• Risk of oversizing the project; sustainability
• Thorough assessment of demand risk and related prevention /
mitigating measures, for example:
• correct “optimism bias”
• availability of complementary products/infrastructure
• pricing strategy
• embed option to expand capacity at a later stage
 Options analysis

Ensure that the final selection of the best option is grounded on a rigorous
analysis of all possible options both at the generic/strategic level and the
technological level.

Two-step approach:
1) comparison of strategic/generic options, normally based on MCA, for the
selection of e.g.
• the systemic solution best suited to meet the identified objectives of the project
• a short list of feasible technological options capable of delivering the desired
solution
• the location for its implementation
2) comparison of the short-listed options at the technological level, based on
quantitative methods (least cost, ENPV).
KEY PRINCIPLES
 KEY PRINCIPLES

CBA generally relies on the following key principles:

• A long-term perspective
• Calculation of performance indicators expressed in
monetary terms
• Incremental technique
• Shadow prices
• Microeconomic approach
 Long-term perspective

A long-term outlook is adopted (10-30 years), depending

on the sector of intervention. Hence the need to:
• Set a proper time horizon;
• Forecasting future costs and benefits on a long time
span (looking forward);
• Adopting appropriate discount rates to calculate the
present value of future costs and benefits;
• Taking into account uncertainty by assessing the
project’s risks.
 Project performance

CBA is performed giving a monetary value to all the positive (benefits)

and negative (costs) effects of the intervention.
The project overall performance is measured by a set of indicators,
namely:
• Financial Net Present Value (FNPV)
• Financial Rate of Return (FRR)
• Economic Net Present Value (ENPV)
• Economic Rate of Return (ERR)

allowing comparability and ranking for competing projects or alternatives.

 Incremental approach

CBA compares a scenario with-the-project

with a counterfactual baseline scenario
without-the-project.
− When a project consists of a
completely new asset, the without-the-
project scenario is one with no service;
− When a project aims at improving or
rehabilitating an already existing
facility, there are two possibilities:
Business as Usual (default option); Do
minimum (only when feasible and
credible)
Performance indicators are calculated on the incremental cash flows only
( = difference between the cash flows in the with-the- project and the counterfactual
scenarios).
 The choice of the counterfactual

Scenarios EURm NPV Net flows

Net benefit 1058
1 Proposed project 623
Investment 435
Net benefit 661
2 Do-minimum 632
Investment 29
Net benefit 442
3 Business As Usual 442
Investment 0

Results
1-2 Proposed project net of Do-
Net flows -9
minimum
1-3 Proposed project net of Business
Net flows 181
As Usual
Do minimum net of Business as
2-3 Net flows 190
Usual
 Shadow prices

• Shadow prices are defined as the marginal social value of

a good
• Empirically, shadow prices can be proxied either by
opportunity cost or willingness to pay or combination of
these two concepts.
 Opportunity cost

The opportunity cost of a good or service is defined as

the potential gain from the best alternative forgone,
when a choice needs to be made between several
mutually exclusive alternatives.
 Willingness to pay

• WTP is the maximum amount people would be willing

to pay for a given outcome they view as desirable

• Different techniques exist to empirically estimate it

 Microeconomic approach

• CBA is typically a microeconomic approach enabling the

assessment of the impact of a project on the society as a
whole through the calculation of the economic performance
indicators.
• IMPORTANT: While direct employment or external
environmental effects brought about by the project are
reflected in the indicators, indirect and wider effects (e.g. on
regional GDP growth) should be excluded.
FINANCIAL ANALYSIS
 Financial analysis

What is the project financial profitability?

Will the project be financially sustainable?

The answers to these questions are given

by the financial analysis of the project

Financial viability

Financial Financial
profitability sustainability
 Methodology

• CBA uses the Discounted Cash Flow (DCF) method:

• Only cash flows are considered (i.e.. no depreciation.
contingency reserves. etc.) over a given reference period
• Cash flows are discounted to present time using the Financial
Discount Rate
• The analysis should be carried out in constant prices at (no
inflation)
• The analysis should be carried out net of VAT, both on purchase
(cost) and sales (revenues), if this is recoverable by the project
promoter.
 Structure of financial analysis

Total investment cost Financial return on

investment – FNPV(C)

Operating costs and Financial sustainability

revenues

Sources of financing Financial return on

capital – FNPV(K)
 Investment costs
The residual value reflects the capacity of the
remaining service potential of fixed assets whose
economic life is not completely exhausted
Total investment costs. EUR thousands
Years
Total 1 2 3 4-9 10 11-29 30
Start-up and technical
costs 6 980 1 816
Land 1 485 757
Buildings 37 342 17 801
Equipment 11 355 23 273
Machinery 25,722
Initial Investment 126,531 8 465 75 176 42 890
Replacement costs 11 890 9 760
Residual value -4 265
Total Investment
152,655 8 465 75 176 42 890 11 890 9 760 -4 265
costs

These can include also costs, e.g. for In the example, expenditures of EUR 11.9 and The residual value is
feasibility studies, borne before the 9.8 million are expected in year 10 and 20, considered with negative sign
start of the evaluation period, respectively, to replace short life equipment because it is an inflow.
although not eligible for EU funding. and machinery.
 Operating costs and revenues

Operating Revenues and Costs. EUR thousands

Years
Total 1-3 4 5 6 … 29 30
Service 1 0 11,355 11,423 11,492 … 11,979 11,979
Service 2 0 243 243 243 … 243 243
Total revenues 407,862 0 11,598 11,666 11,735 … 12,222 12,222
Personnel 0 1,685 1,685 1,685 … 1,685 1,685
Energy 0 620 623 626 … 648 648
General expenditure 0 260 260 260 ... 260 260
Intermediate services 0 299 299 299 … 299 299
Raw materials 0 2,697 2,710 2,724 … 2,821 2,821
Total operating costs 153,487 0 5,561 5,577 5,594 … 5,713 5,713
Net revenues 254,375 0 6,037 6,089 6,140 … 6,509 6,509

Personnel costs are assumed to be fixed along the

During the construction phase no reference period, while energy requirements are
operating revenues and costs usually occur. variable and follow the expected production growth.
 Analysis of profitability

From the point of view of the From the point of view of the
project itself regardless the national investor(s) without
way how it is financed considering the EU grant

Financial return on Financial return on

investment national equity (or capital)
 FNPV(C)  FNPV(K)
 Rationale of EU grant

FNPV (before EU
FNPV (after EU
contribution) <0 EU grant
contribution) >0

> “funding-gap”
FNPV/C method FNPV/K

Financial sustainability
 Financial return on investments (FNPV/C)

Calculation of the return on investment. EUR thousands

Years
1 2 3 4 5-9 10 11-29 30
Total revenues 11,598 … 12,011 … 12,222
Residual value 4,265
Total inflows 0 0 0 11,598 … 12,011 … 16,487
Total operating costs 5,561 … 5,662 … 5,713
Initial Investment 8,465 75,176 42,890
Replacement costs 11,890 9,760
Total outflows 8,465 75,176 42,890 5,561 … 17,552 … 5,713
Net cash flow -8,465 -75,176 -42,890 6,037 … -5,540 … 10,774
FNPV(C) - 34.284

FRR(C) 1.4%

A financial discount rate of 4 % has

been applied to calculate this value.
 Sources of financing

Main sources of financing:

• Union assistance (the EU grant)

• National public contribution (including. always. the
counterpart funding from the OP plus additional grants or
capital subsidies at central. regional or local government level.
if any)
• Project promoter’s contribution (loans or equity), if any
• Private contribution under a PPP, (equity and loans) if any
 Financial return on national capital (FNPV/K)

Calculation of the return on national capital. EUR thousands

Years
1 2 3 4 5-9 10 11-29 30
Total revenues 11 598 … 12 011 … 12 222
Residual value 4 265
Total inflows 0 0 0 11 598 … 12 011 … 16 487
Public contribution 3 148 27 956 15 950
Private equity 1 085 9 632 5 495
Loan repayment
1 789 1 789 1 789
(including interest)
Total operating &
5,561 … 17,552 … 5 713
replacement costs
Total outflows 4 233 37 588 21 445 5 561 … 19 341 … 5 713
Net cash flow -4 233 -37 588 -21 445 6 037 … -7 329 … 10 774
FNPV(K) 11 198
FRR(K) 5.4 %

The loan is here an outflow and is only included when

reimbursed. In this example, it is assumed to be paid In this example, replacement costs are self-financed
back in ten constant payments starting in year 5. with the project revenues. Accordingly, they are treated
as operating costs.
 Financial sustainability

• To verify that financial resources (project revenues included)

can consistently match disbursement year by year
• A project is financially sustainable when it does not incur the
risk of running out of cash in the future.
• The crucial issue here is the timing of cash proceeds and
payments.
• Sustainability occurs if the cumulated cash flow is positive for
all the years considered.
 Financial sustainability

Financial sustainability. EUR thousands

Years
1 2 3 4 5-9 10 11-29 30
Sources of financing 8 465 75 176 42 890
Total revenues 11 598 … 12 011 … 12 222
Total inflows 8 465 75 176 42,890 11 598 … 12 011 … 12 222
Initial investment 8 465 75 176 42,890
Replacement costs 11 890 9 760
Loan repayment
1 789 1 789 1 789
(including interest)
Total operating costs 5,561 … 5 662 … 5 713
Taxes 604 … -733 … 651
Total outflows 8 465 75 176 42 890 5,561 … 19 341 5 713
Net cash flow 0 0 0 6,037 … -7 329 … 6 509
Cumulated net cash
0 0 0 6,037 … 20 726 … 133 835
flow

The cumulated cash flow should be Financial sustainability is verified if the cumulated
zero (or positive) during the net cash flow row is greater than zero for all the
construction phase years considered.
ECONOMIC ANALYSIS
 Socio-economic benefits

• Time savings • Recovery of recyclable

• Safety improvements materials
• Reduced congestions and • Reduced odours
pollution • Energy recovery

• Reduced GHG emissions • Knowledge creation

• Increased energy supply • Human capital
• Increased energy development
reliability • Start-ups
 Rationale of Economic analysis

Financial analysis
Financial analysis Economic analysis
Project desirability for the Project desirability for the
investor society
 Market prices  Shadow prices
 Includes taxes and subsidies  Excludes transfer payments
 Direct costs and revenues  Externalities
 FDR  SDR
 Steps of economic analysis

1. Fiscal Transfer payments that do not represent real costs

corrections or benefits

Markets may be distorted and thus prices

2. From market
do not reflect social opportunity costs
to shadow prices

3. Inclusion non Some effects are not captured

market effect by observed prices

4. Assessment of
economic performance
 Willingness to pay (WTP)

• The WTP measures the maximum amount of people who

would be willing to pay for a given outcome that they view as
desirable
• The WTP approach is commonly used to estimate the outputs
produced by the projects (including externalities) [It can also
be used to value some inputs, e.g. land]
• The evaluation of the direct benefits related to the use of the
goods or services rendered by the project is carried out by
replacing the financial revenues with estimations of users’
WTP
 Techniques to estimate WTP

• Revealed preference methods  based on the observation

of the actual behaviour and, especially, on the purchases
made in actual markets
• Stated preference methods  are survey-based and elicit
people’s intended future behaviour in the market.
• Benefit transfer method  takes a unit value for a non-
market good estimated in an original study and uses this
estimate, after some adjustments, to value benefits (or costs)
that arise when a project is implemented elsewhere
 Techniques to estimate WTP

Cost and Stated preferences

effort (contingent valuation; choice
modelling )

Revealed preferences
Travel cost Hedonic prices
Cost of illness Defensive behaviour

Benefit transfer

Estimate reliability
RISK ANALYSIS
 Why risk analysis

• Risk analysis is a way of asserting how great is the residual

uncertainty contained in one’s observations
• In statistics, risk is related to the probability of an undesirable
event:
R= P x L
Where R=risk; P= probability; L = loss
• Risk is randomness which is measurable and can be described
by a probability distribution, while uncertainty is randomness
without a well-defined distribution.
 How to treat risk analysis

There are a number of methods used in practice to incorporate

risk and uncertainty into CBAs:

• Adjusting the expected NPV to take account of risk

aversion
• Sensitivity analysis
• Probabilistic risk analysis
• Qualitative risk analysis
 Qualitative risk analysis

Severity Residual
Probability
Probability Severity Risk level
Risk Matrix

Risk level

Prevention Mitigation
 Example

Prevention and/or Mitigation

Risk Level (P*S)
Adverse event

Probability (P)

Residual risk
Severity (S)

measures
Causes

Effect

Delay in service
start. Delay in Set up of a Project
Low establishing a Implementation Unit to be
Constructi contractor positive cash C III Moderate assisted by technical assistance Low
on delays capacity flow including for project management during
benefits implementation.
materialisation
Project Inadequate Investment costs The design of the project must be Mod
cost design cost higher than D V Very high
revised. erate
overrun estimates expected

Current revenue collection levels

exceed 99 % and revenue
Users will Reduction in the collection discipline among the
Users project revenues. population is good. As tariffs are
 Thank you

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