EPEE3306 Management and Project Analysis

Group Assignment
Lecturer: Dr. Sharifuddin Bin ZainuddStudent: Students: Fan Hong Ken Lim Meng Teik Kong Kun EEE110027 EEE110054 EEE110710

17 DECEMBER 2013

Table of Contents
1.0 Background 2.0 Introduction 2.1 What is cost-benefit analysis used for? 2.2 Principles of Cost Benefit Analysis. 2.3 How to Use the Tool? 2.4 Why not use more conventional decision methods? 2.5 Advantages and disadvantages of using Cost-Benefit Analysis. 3.0 Time and discounting 4.0 CBA Measures 5.0 Example 1-Evaluating quantitatively 6.0 Example 2- Natural resource management investment decisions. 7.0 Example 3-Purchase a stamping machine 8.0 Example 4-Construction of a large dam. 9.0 Example 5-Techniques of valuation of a life 10.0 Conclusion 11.0 References 3 4 4 5 5 6 7 8 10 11 13 21 24 27 29 30

1. BACKGROUND
Cost-Benefit Analysis (CBA) estimates and totals up the equivalent money value of the benefits and costs to the community of projects to establish whether they are worthwhile. These projects may be dams and highways or can be training programs and health care systems. The idea of this economic accounting originated with Jules Dupuit, a French engineer whose 1848 article is still worth reading. The British economist, Alfred Marshall, formulated some of the formal concepts that are at the foundation of CBA. But the practical development of CBA came as a result of the impetus provided by the Federal Navigation Act of 1936. This act required that the U.S. Corps of Engineers carry out projects for the improvement of the waterway system when the total benefits of a project to whomsoever they accrue exceed the costs of that project. Thus, the Corps of Engineers had created systematic methods for measuring such benefits and costs. The engineers of the Corps did this without much, if any, assistance from the economics profession. It wasn't until about twenty years later in the 1950's that economists tried to provide a rigorous, consistent set of methods for measuring benefits and costs and deciding whether a project is worthwhile. Some technical issues of CBA have not been wholly resolved even now but the fundamental presented in the following are well established.

2. INTRODUCTION
Cost-benefit analysis (CBA) is a technique for evaluating a project or investment by comparing the economic benefits with the economic costs of the activity. Benefit-cost analysis has several objectives. First, CBA can be used to evaluate the economic merit of a project. Second the results from a series of benefit-cost analyses can be used to compare competing projects. CBA can be used to assess business decisions, to examine the worth of public investments, or to assess the wisdom of using natural resources or altering environmental conditions. Ultimately, CBA aims to examine potential actions with the objective of increasing social welfare. Regardless of the aim, all benefit-cost analyses have several properties in common. A CBA begins with a problem to be solved. For example, a community may have the goal of alleviating congestion on roads in an area. Various projects that might solve the particular problem are then identified. As an example, alternative projects to alleviate road congestion in an area might include a new highway, a public bus system, or a light rail system. The costs and benefits of these projects would be identified, calculated, and compared. Decisions are typically not made solely on the basis of CBA, but CBA is useful and sometimes required by law. Without a doubt, results from a CBA can be used to raise the level of public debate surrounding a project. In other words, it is a framework to assess the merits of an activity (project, policy) from the perspective of society (as opposed to a single individual). It involves: Measuring the gains and losses (benefits and costs) from an activity to the community using money as the measuring rod; and Aggregating those values of gains and losses and expressing them as net community gains or losses (see Pearce 1983).

2.1 What is cost-benefit analysis used for?

Cost-benefit analysis is used to help people make decisions. Depending on when the analysis is undertaken (before, during or after an activity), cost-benefit analysis can provide information to help assess: whether a project or activity will be or is worthwhile: o Should we invest in this project? o Which of these two projects should we support? Which project will give us the best pay off per dollar invested? Which project will generate the highest value to society once we have paid for it? whether a project or activity has been worthwhile.

In the process of conducting a cost-benefit analysis, the information generated may also inform: what it would take to make the potential benefits of a n activity actually materialize (what the pre-conditions for success in the activity are); and the progress of an activity and how it should proceed/be revised, based on the benefits and costs identified.

2.2 Principles of Cost Benefit Analysis.

One of the problems of CBA is that the computation of many components of benefits and costs is intuitively obvious but that there are others for which intuition fails to suggest methods of measurement. Therefore some basic principles are needed as a guide.

2.3 How to Use the Tool?

The following is a list of steps that comprise a generic cost benefit analysis. (1)Step One: Brainstorm Costs and Benefits First, take time to brainstorm all of the costs associated with the project, and make a list of these. Then, do the same for all of the benefits of the project. Can you think of any unexpected costs? And are there benefits that you may not initially have anticipated? When you come up with the costs and benefits, think about the lifetime of the project. What are the costs and benefits likely to be over time? (2)Step Two: Assign a Monetary Value to the Costs Costs include the costs of physical resources needed, as well as the cost of the human effort involved in all phases of a project. Costs are often relatively easy to estimate (compared with revenues). It's important that you think about as many related costs as you can. For example, what will any training cost? Will there be a decrease in productivity while people are learning a new system or technology, and how much will this cost? Remember to think about costs that will continue to be incurred once the project is finished. For example, consider whether you will need additional staff, if your team will need ongoing training, or if you'll have increased overheads. (3)Step Three: Assign a Monetary Value to the Benefits This step is less straightforward than step two! Firstly, it's often very difficult to predict revenues accurately, especially for new products. Secondly, along with the financial benefits that you anticipate, there are often intangible, or soft, benefits that

are important outcomes of the project. For instance, what is the impact on the environment, employee satisfaction, or health and safety? What is the monetary value of that impact? As an example, is preserving an ancient monument worth $500,000, or is it worth $5,000,000 because of its historical importance? Or, what is the value of stress-free travel to work in the morning? Here, it's important to consult with other stakeholders and decide how you'll value these intangible items. (4)Step Four: Compare Costs and Benefits Finally, compare the value of your costs to the value of your benefits, and use this analysis to decide your course of action. To do this, calculate your total costs and your total benefits, and compare the two values to determine whether your benefits outweigh your costs. At this stage it's important to consider the payback time, to find out how long it will take for you to reach the break even point the point in time at which the benefits have just repaid the costs. For simple examples, where the same benefits are received each period, you can calculate the payback period by dividing the projected total cost of the project by the projected total revenues: Total cost / total revenue (or benefits) = length of time (payback period).

2.4 Why not use more conventional decision methods?

People can make decisions in several ways. In the Pacific, common ways to make decisions are: voting systems; and consensus. Voting (democracy) draws on individuals perceptions about the pros and cons of an activity. The activity with the highest votes wins the right to proceed. Consensus based decision making focuses on different stakeholders reaching agreement on which activity to pursue (Lal and Holland 2010). Compared to cost-benefit analysis, both voting and consensus based decision making systems have limitations: Votes may bear little relation to the effect of the activity on human wellbeing (as measured by benefits and costs). Such a system is subject to political and emotive arguments. Consensus based decision making can be a time consuming and costly way to

make decisions when many people are involved in the process. There can be immense time and energy demands before people get to agree, especially where there are widely divergent opinions and/or numerous groups are involved. In other words, consensus decision making can have high transaction costs (Lal and Holland 2010).

2.5 Advantages and disadvantages of using Cost-Benefit Analysis.

Cost-Benefit Analysis is a valuable tool for decision making. It is most useful because it provides a starting point from which to begin evaluation of a project. Cost-Benefit Analysis forces project advocates and opponents to provide quantitative data to back up qualitative arguments. With Cost-Benefit Analysis actual data must be used to support the analysis. Typically, some subjective reasoning or value judgments come into play when deciding on projects or investments. While Cost-Benefit Analysis may not be able to include all the criteria which is deemed important in evaluation, it does allow interested parties to clearly define the issues involved. Cost-Benefit Analysis is also useful because it allows comparisons to be made between investments or projects. This comparison is made easier because all investments are evaluated using the same method. It then becomes easier to exclude obviously bad projects from consideration. While Cost-Benefit Analysis can be useful, there are some difficulties with its application. First, it requires that the analyst assign monetary values to all benefits and costs. As we know, however, there are numerous benefits and costs which are intangible and therefore difficult to value. For projects with an environmental impact, for example, it can be difficult to place a dollar value on the benefits and costs. While the value of timber may be easy to calculate, the value of a spotted owl may not. Another drawback with Cost-Benefit Analysis is the fact that results can be very sensitive to the choice of the discount rate. The entire result from a complex Cost-Benefit Analysis may hinge on the choice of a single number for the discount rate. For this reason, Cost-Benefit Analysis can be very controversial. The rate that is chosen can radically change the outcome of analysis (to convince you of this, try re-working the examples above using different discount rates). Finally, an important drawback with Cost-Benefit Analysis is that while most benefits and costs that arise in the present are known, many that arise in the future are unknown. A Cost-Benefit Analysis must be conducted using information that is available. This information will be limited by our current knowledge of benefits and costs. Some future benefits and costs cannot conceive, much less measured. However, the role of uncertainty plagues not only Cost-Benefit Analysis but also most other decision-making methods.

3. TIME AND DISCOUNTING

In many cases the timing of benefits and costs is an important aspect of the project under consideration. For this reason, dealing adequately with the timing of benefits and costs becomes a crucial part of the BCA. For example, what if the cost of constructing the dam is incurred this year, but the benefits of using the dam are not felt until next year, after the dam is completed. In this case will next year's benefits outweigh this year's costs? To deal with this kind of question, benefit-cost analysis uses a concept known as discounting. Discounting is a technique that converts all benefits and costs into their value in the present. Discounting is based on the premise that a dollar received today is worth more than a dollar received in the future. This bias toward the present arises because by placing a dollar in a safe investment today, you can increase its value to more than a dollar tomorrow. Another way of saying this is that a dollar received in the future is not worth as much as that same dollar received in the present. That is, the future value of the dollar is discounted. Discounting is the opposite of compounding. Not surprisingly, the rate at which a future value is discounted is closely related to the rate at which present values are compounded, namely the interest rate. As we know from compounding, if the interest rate is 5%, then a dollar placed in the bank today will be worth $1.05 a year from now. This means that if the interest rate is 5%, $1.05 to be received next year is worth only $1.00 today. Whenever the benefits and costs used in a benefit-cost analysis occur in the future, it is important to discount these future values to account for their present value. If the interest rate is r, then the following formula can be used to find the present value (PV) of an amount (Pt) received at some time t in the future:

To apply the formula, remember: PV is the present value of the amount invested; Pt is the dollar value of the future amount in time t; r is the discount rate; and t is the year in which Pt is realized. For example, suppose that in the example of the dam construction cited above the cost of dam construction ($1.1 million) is incurred at the beginning of the project (t=0), but the benefits ($1.2 million) arise one year later, after the dam is finished (t=1). Suppose the interest rate is 10%.

The present value of the benefits are:

The present value of the costs are:

After the correction for the timing of benefits and costs (that is, on a present value basis), the benefits of the dam no longer exceed the costs of the dam and the dam looks like a less worthwhile investment. The reason for the change is that the discount rate now reduces the value of benefits because they occur in the future. As another example, suppose you are given the choice of two investments. The first pays you $210 today, but nothing thereafter. The second investment pays $100 today, and $115 next year (for a total of $215). The second investment looks better, right? Maybe or maybe not. It depends on the discount rate. If the discount rate is 5%, which is the better investment? We find out by applying the present value formula: PV of investment 1:

PV of investment 2:

Even though the second investment pays out a greater sum, after discounting the first deal looks like a better choice. This basic formula for discounting can be applied regardless of the length of the time horizon. There is no simple rule for choosing a discount rate. One method is to use the opportunity cost of capital as the discount rate. The opportunity cost of capital is the return that would be received if the funds being invested were invested in the private sector (say in a business or in the bond market). Often the discount rate is simply set equal to a well-publicized interest rate. For example, the cost to the federal government of borrowing can be used as a discount rate. The discount rate could also be derived from what is called the social rate of time preference (SRTP). The SRTP attempts to compensate for the fact that people prefer to consume now rather than later. Because of this preference, individuals might have a bias in favor of

projects that have benefits sooner rather than later. For some projects, society may want to take a longer-range perspective than individuals or businesses, and the SRTP tries to make this adjustment. For example, do you think construction of the Washington Monument would have passed a benefit cost analysis if people had a high preference for projects with immediate benefits?

4. CBA MEASURES
Several variations on the basic benefit-cost rule can be used to compare the benefits and costs of investments, projects, or decisions.

4.1 Net present value (NPV)

The net present value (NPV) is the current value of all project net benefits. Net benefits are simply the sum of benefits minus costs. The sum is discounted at the discount rate. Using this method, if the project has a NPV greater than zero then it appears to be a good candidate for implementation. The formula used to calculate the NPV is:

4.2 Benefit-cost ratio (BCR)

The benefit-cost ratio (BCR) is calculated as the NPV of benefits divided by the NPV of costs:

where Btis the benefit in time t and Ctis the cost in time t. If the BCR exceeds one, then the project might be a good candidate for acceptance.

4.3 Internal rate of return (IRR)

The internal rate of return (IRR) is the maximum interest that could be paid for the project resources, leaving enough money to cover investment and operating costs, which would still allow the investor to break even. In other words, the IRR is the discount rate for which the present value of total benefits equals the present value of total costs:
PV(Benefits) - PV(Costs) = 0.

In general, the IRR should be greater than the discount rate for a project to be accepted.

5. EXAMPLE 1-EVALUATING QUANTITATIVELY

The Basic Cost Benefit Analysis is a relatively simple and widely used technique for deciding whether to make a change. As its name suggests, to use the technique simply add up the value of the benefits of a course of action, and subtract the costs associated with it. Costs are either one-off, or may be ongoing. Benefits are most often received over time. We build this effect of time into our analysis by calculating a payback period. This is the time it takes for the benefits of a change to repay its costs. Many companies look for payback over a specified period of time for example three years. In its simple form, cost-benefit analysis is carried out using only financial costs and financial benefits. For example, a simple cost/benefit analysis of a road scheme would measure the cost of building the road, and subtract this from the economic benefit of improving transport links. It would not measure either the cost of environmental damage or the benefit of quicker and easier travel to work. A more sophisticated approach to cost/benefit measurement models is to try to put a financial value on intangible costs and benefits. This can be highly subjective is, for example, a historic water meadow worth $25,000, or is it worth $500,000 because of its environmental importance? What is the value of stress-free travel to work in the morning? These are all questions that people have to answer, and answers that people have to defend. The version of cost/benefit analysis we explain here is necessarily simple. Where large sums of money are involved (for example, in financial market transactions), project evaluation can become an extremely complex and sophisticated art. The fundamentals of this are explained in Principles of Corporate Finance by Richard Brealey and Stewart Myers this is something of an authority on the subject. For example, a sales director is deciding whether to implement a new computer-based contact management and sales processing system. His department has only a few computers, and his salespeople are not computer literate. He is aware that computerized sales forces are able to contact more customers and give a higher quality of reliability and service to those customers. They are more able to meet commitments, and can work more efficiently with fulfillment and delivery staff. His financial cost/benefit analysis is shown below:

5.1 Costs:
New computer equipment: 10 network-ready PCs with supporting software @ $2,450 each

1 server @ $3,500 3 printers @ $1,200 each Cabling & Installation @ $4,600 Sales Support Software @ $15,000

Training costs: Computer introduction 8 people @ $400 each Keyboard skills 8 people @ $400 each Sales Support System 12 people @ $700 each Other costs: Lost time: 40 man days @ $200 / day Lost sales through disruption: estimate: $20,000 Lost sales through inefficiency during first months: estimate: $20,000

Total cost: $114,000 Benefits: Tripling of mail shot capacity: estimate: $40,000 / year Ability to sustain telesales campaigns: estimate: $20,000 / year Improved efficiency and reliability of follow-up: estimate: $50,000 / year Improved customer service and retention: estimate: $30,000 / year Improved accuracy of customer information: estimate: $10,000 / year More ability to manage sales effort: $30,000 / year Total Benefit: $180,000/year Payback time: $114,000 / $180,000 = 0.63 of a year = approx. 8 months

Table 1

The payback time is often known as the breakeven point. Sometimes this is is more important than the overall benefit a project can deliver, for example because the organization has had to borrow to fund a new piece of machinery. The breakeven point can be found graphically by plotting costs and income on a graph of output quantity against $. Break even occurs at the point the two lines cross. Inevitably the estimates of the benefit given by the new system are quite subjective. Despite this, the Sales Director is very likely to introduce it, given the short payback time. Cost Benefit Analysis is a powerful, widely used and relatively easy tool for deciding whether to make a change. To use the tool, first work out how much the change will cost to make. Then calculate the benefit you will from it. Where costs or benefits are paid or received over time, work out the time it will take for the benefits to repay the costs. Cost Benefit Analysis can be carried out using only financial costs and financial benefits. You may, however, decide to include intangible items within the analysis. As you must estimate a value for these, this inevitably brings an element of subjectivity into the process.

6. EXAMPLE 2: NATURAL RESOURCE MANAGEMENT INVESTMENT DECISIONS.

Cost benefit analysis is one of the main ways that economists analyze major development proposals and environmental problems. It is similar to Net Present Value technique commonly applied in finance Cost benefit analysis works by identifying all the costs and benefits that would result from a particular resource use. These include non-money costs and benefits. Cost benefit analysis is potential but often difficult to do very well. The cost benefit analysis has a lot of the benefits are difficult to quantify. It also has a lot of the costs are very difficult to quantify such as the particularly net production changes. The stages in the application process are to identify all costs and benefits, measure them, discount them back to common time period, assess whether benefits is more than costs, assess who bears the benefits and costs, perform sensitivity analysis, and assess whether proposal is worth it. Below shows the cost benefit analysis for the tree clearing.

Impacts Property level - direct, medium term

Benefits

Costs

Income from improved pasture production

Cost of clearing trees, improving pasture, controlling regrowth

- indirect, longer term

Possible reduction in grazing pressure on rest of property

Reduced benefit of tree cover (eg shade, shelter, nutrient recycling)

Improved access for mustering

Pastoralists own value for risk of salinity, erosion Pastoralists own value for biodiversity loss

External impacts - Social value of land quality Possible reduction in land degradation on some properties Possible increased risk of salinity/erosion above landholder expectations and on other properties - Cost of greenhouse gases Impact of land clearing on greenhouse gas emissions - Social value of biodiversity Effect of tree clearing on biodiversity - Indirect effects of production Social value of positive effects on rural communities

Table

The impacts and the major problem in the past is that only financial costs and benefits were identified - many environmental and social ones ignored. Cost benefits analysis is not always easy to be sure what the outcomes will be of a project and it is not always agreement about what are important social and environmental impacts to include. The value of cost benefit analysis was to measure all the costs and benefits, normally do this in terms of dollar values, not always easy, because some items such as biodiversity protection are not traded in the markets. Some may need special non-market valuation techniques to handle these cases. The non-market valuation techniques such as revealed preference techniques such as travel cost method, used for recreation impacts and hedonic pricing method, used for housing/lifestyle impacts. The second non market valuation techniques such as averted expenditure techniques. The averted expenditure techniques is often used to estimate the value of indirect use benefits, such as storm protection benefits of mangroves. Besides, non-market valuation techniques can be stated preference techniques such as contingent valuation, choice modelling and these are capable of estimating non-use

values. The key techniques to use in relation to values for biodiversity but often complex, expensive and time consuming to apply. The estimating costs is one of the benefits of using competitive tenders is that they provide some estimates of landholder costs. Landholders identify the level of incentive required for them to change management. Landholder costs to improve water quality in Mackay. Below diagram shows the ascending relative bid value for 73 projects.

Ascending relative bid value (TBS3) for 73 projects

140.00 120.00 100.00

$/TBS

80.00 60.00 40.00 20.00 0.00 0 10 20 30 40 Bidders 50 60 70 80

The benefit transfer, instead of doing a separate valuation study each time, possible to borrow values from other or previous studies. Most studies focused on particular issues, and are not designed to transfer to other situations. The values may be sensitive to characteristics, the populations involved, the way the tradeoffs are framed, the scope at which the issue is pitched, and the scale of the tradeoffs. Three main approaches to benefit transfer the prospector, the systematic and the Bayesian. The Prospector is the searches for suitable previous studies and transfers results across. The Systematic is the designs a database of values suitable for benefit transfer. The Bayesian is the combines both a review of previous studies with potential data gathering. For my personal view, private sector does not bother about citizens or public. Meanwhile public sector such as government project, their cost benefit analysis will need to consider about publics thinking and concern about publics safety. Private sector only bother about own benefit and own profit. So as a conclusion, it is two different path in doing cost benefit analysis. It is more complicated when government or public sector proposes cost benefit analysis, on the other hand it is easier or brief when private sector proposes cost benefit analysis. For an example, government proposes a project such as building railway station or monorail. They will

need to concern about publics conveniences and some of the progress when the project is undergoing. Meanwhile private sector doesnt bother so much, they will just build and does not care about the publics. By the way, cost benefit analysis will able to help public and private sector to overcome their balance sheet or able to breakeven their losses or even make profit. So cost benefit analysis is important when undergoing a project. In a world of finite public and private resources, we need a standard for evaluating trade-offs, setting priorities, and finally making choices about how to allocate scarce resources among competing uses. Cost benefit analysis provides a way of doing this. The cost-benefit principle says that you should take an action if, and only if, the extra benefit from taking it is greater than the extra cost. Here are some examples where the principle might be built into evaluation, such as costs and benefits of subsidies are like the bio-fuel debate or subsidies, costs and benefits of the introduction of competition is part like the postal market liberalization, costs and benefits of different strategies designed to reduce income and wealth inequality are like the national minimum wage or a rise in the top rate of income tax. Cost benefit analysis is a technique for assessing the monetary social costs and benefits of capital investment project over a given time period. The principles of cost benefit analysis are like appraisal of a project, it is an economic technic for the project appraisal, widely used in business as well as government spending projects (for example should a business invest in a new information system). Incorporates externalities into the equation, it can include wider social/ environmental impacts as well as private economic costs and benefits so that externalities are incorporated into the decision process. In this way, cost benefit analysis can be used to estimate the social welfare effects of an investment. Cost benefit analysis can take account of the economics of time, as known as discounting. This is important when looking t environmental impacts of a project in the years ahead. Another example of the use of cost benefit analysis, Cost benefit analysis is widely used by government agencies in Canada and other countries to at least inform their analyses of regulatory change. Here we discuss cost benefit analysis as applied by the Ontario Energy Board, the Canadian Competition Bureau, the Treasury Board of Canada, the U.S. Environmental Protection Agency, and the government in the United Kingdom. A recent Ontario Energy Board (OEB) Staff Discussion Paper proposes a test for evaluating transmission infrastructure investments, which is essentially the Kaldor-Hicks decision standard used in cost-benefit analysis. The test approves a proposed transmission investment (among a set of alternative options in a majority of reasonable scenarios) if it maximizes the (present value) of market benefit less costs. In the proposed test, only direct costs and market benefits to consumers, producers, and distributors of electricity are counted, while indirect costs and benefits, such as those related to the effects of an investment on the Ontario economy as a whole, are not included in the analysis. The discussion paper makes it clear that transfers among consumers and producers are not to be counted as either

costs or benefits, which implies that the effects of an investment on consumers and producers are weighted equally (in other words, a traditional non-weighted cost benefit analysis is proposed). The paper also notes that California, Australia, and New Zealand also use cost-benefit analyses when evaluating proposals for transmission investments. The Competition Bureau is the federal government agency responsible for enforcing the Competition Act. The Acts merger provisions prohibit mergers that substantially lessen competition, which is interpreted to mean that a merger will be prohibited if it is likely to enhance the market power of the merging firms. However, the Act also includes an efficiencies exception that permits the consummation of otherwise anticompetitive mergers under certain conditions. In particular, a merger that is likely to result in significant cost savings may be approved, if the cost savings are greater than, and offset the likely anti-competitive effects. The Competition Bureau has historically (although not consistently) interpreted the efficiency exception as mandating that a merger be prohibited only if the social costs of the merger, taking the form of higher prices to consumers, exceed the benefits of the merger, in the form of cost savings. The consumer harm from higher prices is calculated as the loss in consumer surplus, which is closely related to compensating variation. The cost saving to producers is calculated as producer surplus, which is the production-side analogue of compensating variation. A merger is prohibited if and only if the loss to consumers (measured as the loss in consumer surplus) exceeds the gain in producer surplus. This is the Kaldor-Hicks criterion, since it will challenge a merger if and only if the winners from a merger (producers) gain enough to hypothetically compensate losers (consumers), without actually requiring them to do so. In an important contested merger case (Superior Propane), the Competition Bureau advocated the use of balancing weights, but the Competition Tribunal initially rejected this approach and allowed the merger--which was expected to generate substantial efficiencies--on the basis of a total surplus standard. The Bureau appealed the Tribunals decision, and the Federal Court of Appeal granted the Bureaus appeal, remanding the case to the Tribunal and directing it to reconsider the efficiency defense, and in particular, to consider a broader range of anticompetitive effects arising from the merger. In its redetermination decision, the Tribunal increased the weight on the effects of the proposed merger on the lowest income quintile of consumers, relative to the weights on the effects on producers and wealthier consumers. In effect, the Tribunal moved from a traditional cost -benefit analysis in its initial decision, to a weighted cost-benefit analysis in its redetermination decision, in order to address income distribution concerns as it was directed to do by the Federal Court of Appeal. Another example is the US environmental protection agency. The U.S. Environmental Protection Agency (EPA) is authorized by Congress to adopt regulations under environmental and public health protection laws. A preliminary analysis of a proposed regulation is published in the Federal Register to elicit comments from the

public in accordance with the Administrative Procedure Act before being finalized. The EPA is bound by several laws and executive orders that serve to guide the federal regulatory development process. One of these is Executive Order 12866 which calls for the EPA to execute economic analyses based upon a collection of principles that make the regulatory system operate well for the American people. Performing such analyses requires the consideration of benefits and costs of various alternatives to a particular form of regulation, including that of non-regulation. 10 EPA evaluates regulations by addressing the following questions: Is it theoretically possible for the gainers from the policy to fully compensate the losers and still remain better off ; who are the gainers and losers from the policy and what are the associated economic changes? And; how did a particular groupespecially a group that may be considered to be disadvantagedfare as a result of the policy change? These questions are addressed by employing cost-benefit analysis to determine the net social benefits, economic impacts analysis (EIA) to establish winners and losers and equity assessment to examine subsets of the population, particularly those classified as disadvantaged. Government projects and policies almost always benefit some members of society while harming others. For example, when price regulation is introduced, consumers typically benefit (at least in the short term) from lower prices, while regulated firms suffer a loss in profits. When price regulations are removed or relaxed, prices can increase, and consequently consumers are harmed and producers benefit. Note however, that if the project passes a cost-benefit test, the winners in each case must benefit by more than the losers are harmed. As discussed above, projects that satisfy a cost-benefit standard may cause a redistribution of wealth that is deemed socially undesirable. We have explained how a cost-benefit analysis can be modified to account for wealth distribution concerns by weighting the effects of a project on favored groups (e.g. lower-income households) more heavily than the effects on other groups. An alternative (or complementary) approach compensates individuals or groups harmed by a project. Government policies to alleviate adverse distribution consequences may also be used to solidify political support from those harmed from a change. Re-training and compensation programs for workers harmed by trade liberalization policies are examples of government responses to significant changes that are aimed at addressing adverse distribution consequences and garnering political support. Consider the effect of tariffs and quotas on consumers and workers. These policies restrict the volume of imports, and their main purpose is to protect the jobs of workers in economic sectors that are vulnerable to imports. Studies have concluded that, in many instances, the jobs saved by import protection provide benefits for workers (in the form of continued employment in their current jobs) while harming consumers (in the form of higher prices for imports and domestically produced goods, and reduced quality and variety). In many cases the cost to consumers per job saved exceeds--often by a substantial margin--the earning of workers in the protected industry.

To cite just two examples, it has been estimated that voluntary export restraints (essentially a type of import quota) in the U.S. automobile sector in the 1980s cost U.S. consumers US$105,000 to $241,235 annually per job saved. Voluntary export restraints on automobiles in Canada have been estimated to have cost Canadian consumers C$179,000 to $207,166 per job saved. In both cases, the costs to consumers clearly exceed workers earnings (which are probably overestimates of the benefits of import protection, since many workers can presumably obtain employment in other economic sectors, although at lower wages). In instances such as these, there is considerable scope for enhancing economic efficiency by eliminating trade restrictions. At the same time there is an argument for compensating workers in some form, on distributional grounds and also to gain the support of workers (and their unions) to ensure that they do not use their political power to prevent the reforms. As discussed below, monetary payments and/or various forms of transitional assistance have been used in the past for these purposes. Governments respond to significant changes in the economic circumstances of individuals using both ex ante and ex post policies. Ex ante policies are put in place before a significant change occurs, to alleviate the negative impact of the change. Ex post policies are implemented in response to a particular change; examples include relief payments when natural disaster occur. It is important to note that government policies that are aimed at correcting undesirable wealth redistribution can often make matters worse, by creating inefficiencies that at least partly offset the efficiencies projected to occur from the project. There are a variety of programs and mechanisms that can be used by governments which can both compensate losers from government projects and also gain their political support. Below we discuss ways that can be used to compensate and/or facilitate transitions for workers and firms. The overview of cost-benefit analysis, explains how it can be implemented, and briefly discusses some mechanisms for compensating individuals harmed by a policy and easing their transition to the post-policy world. CBA is a decision standard with an associated range of methodologies for implementing the standard. Except in the simple (and very rare) case where a policy decision benefits all individuals equally and harms no one, policy makers are required to compare the benefits of the policy to winners with the costs borne by others, and then decide whether the benefits are worth the costs. The first step is to calculate the benefits to individuals who gain from a policy and the costs to individuals who are harmed. Benefits and costs can be either monetary or non-monetary, but to facilitate comparisons all the effects of a policy are monetized, using various methodologies discussed in this paper. Under the Kaldor-Hicks decision criterion that underlies CBA, a policy change merits approval if the monetized benefits to individuals exceed the monetized costs; that is, if those who benefit from the change could, hypothetically, compensate the individuals harmed by the change, while still remaining better off. It is in this sense that the

benefits exceed the costs. CBA does not require that compensation actually be paid, only that there is enough of a benefit created by the change to offset the costs. In its basic form, a CBA based on the Kaldor-Hicks decision criterion does not take into consideration any adverse wealth distribution effects. In order to address such concerns, the criterion can be modified to increase the weight placed on the costs or benefits to favored groups, such as the less wealthy. Alternatively, adversely affected individuals can be compensated, either through existing mechanisms such as employment insurance and publicly funded retraining, or through specialized programs aimed at the compensating the losers from a particular policy change. In this paper, we discussed delayed implementation, grandfathering, and allocation of financial transmission rights as compensation mechanisms for firms harmed by changes to the electricity market structure. Compensation mechanisms can also be used to promote political support among individuals and groups who are harmed by the policy change.

7. EXAMPLE MACHINE

3-PURCHASE

STAMPING

As the Production Manager, you are proposing the purchase of a $1 Million stamping machine to increase output. Before you can present the proposal to the Vice President, you know you need some facts to support your suggestion, so you decide to run the numbers and do a cost benefit analysis. You itemize the benefits. With the new machine, you can produce 100 more units per hour. The three workers currently doing the stamping by hand can be replaced. The units will be higher quality because they will be more uniform. You are convinced these outweigh the costs. There is a cost to purchase the machine and it will consume some electricity. Any other costs would be insignificant. You calculate the selling price of the 100 additional units per hour multiplied by the number of production hours per month. Add to that two percent for the units that aren't rejected because of the quality of the machine output. You also add the monthly salaries of the three workers. That's a pretty good total benefit. Then you calculate the monthly cost of the machine, by dividing the purchase price by 12 months per year and divide that by the 10 years the machine should last. The manufacturer's specs tell you what the power consumption of the machine are and you can get power cost numbers from accounting so you figure the cost of electricity to run the machine and add the purchase cost to get a total cost figure. You subtract your total cost figure from your total benefit value and your analysis shows a healthy profit. All you have to do now is present it to the VP, right? Wrong. You've got the right idea, but you left out a lot of detail.

7.1 Running the Numbers Means All the Numbers

Lets look at the benefits first. Don't use the selling price of the units to calculate the value. Sales price includes many additional factors that will unnecessarily complicate your analysis if you include them, not the least of which is profit margin. Instead, get the activity based value of the units from accounting and use that. You remembered to add the value of the increased quality by factoring in the average reject rate, but you may want to reduce that a little because even the machine won't always be perfect. Finally, when calculating the value of replacing three employees, in addition to their salaries, are sure to add their overhead costs, the costs of their benefits, etc., which can run 75-100% of their salary. Accounting can give you the exact number for

the workers' "fully burdened" labor rates. In addition to properly quantifying the benefits, make sure you included all of them. For instance, you may be able to buy feed stock for the machine in large rolls instead of the individual sheets needed when the work is done by hand. This should lower the cost of material, another benefit. As for the cost of the machine, in addition to its purchase price and any taxes you will have to pay on it, you must add the cost of interest on the money spent to purchase it. The company may purchase it on credit and incur interest charges, or it may buy it outright. However, even if it buys the machine outright, you will have to include interest charges equivalent to what the company could have collected in interest if it had not spent the money. Check with finance on the amortization period. Just because the machine may last 10 years, doesn't mean the company will keep it on the books that long. It may amortize the purchase over as little as 4 years if it is considered capital equipment. If the cost of the machine is not enough to qualify as capital, the full cost will be expensed in one year. Adjust your monthly purchase cost of the machine to reflect these issues. You have the electricity cost figured out but there are some cost you missed too.

7.2 More Costs

The typical failure of a cost benefit analysis is not including all the costs. In the case of the stamping machine, here are some of the overlooked costs: Floor Space Will the machine fit in the same space currently occupied by the three workers? Installation What will it cost to remove the manual stampers and install the new machine? Will you have to cut a hole in a wall to get it in or will it fit through the door? Will you need special rollers or machinists with special skills to install it? Operator Somebody has to operate the machine. Does this person need special training? What will the operator's salary, including overhead, cost? * Environment Will the new machine is so noisy that you have to build soundproofing around it? Will the new machine increase the insurance premiums for the company?

7.3 Accurate Cost Benefit Analysis

Once you have collected ALL the positive and negative factors and have quantified them you can put them together into an accurate cost benefit analysis. Some people like to total up all the positive factors (benefits), total up all the negative factors (costs), and find the difference between the two. I prefer to group the factors together. It makes it easier for you, and for anyone reviewing your work, to see that you have included all the factors on both sides of the issues that make up the cost benefit analysis. For the example above, our cost benefit analysis might look something like this: Cost Benefit Analysis - Purchase of New Stamping Machine (Costs shown are per month and amortized over four years) Purchase of Machine.................... -$20,000 Includes interest and taxes Installation of Machine ..................... -3,125 Including screens & removal of existing stampers Increased Revenue.......................... 27,520 Net value of additional 100 units per hour, 1 shift/day, 5 days/week Quality Increase Revenue ..................... 358 Calculated at 75% of current reject rate Reduced material costs ...................... 1,128 Purchase of bulk supply reduces cost by $0.82 per hundred Reduced Labor Costs....................... 18,585 3 operators salary plus labor o/h New Operator ................................. -8,321 Salary plus overhead. Includes training Utilities............................................ -250 Power consumption increase for new machine Insurance......................................... -180 Premiums increase Square footage ...................................... 0 No additional floor space is required Net Savings per Month ........................... $15,715

Your cost benefit analysis clearly shows the purchase of the stamping machine is justified. The machine will save your company over $15,000 per month, almost $190,000 a year.

8. EXAMPLE 4-CONSTRUCTION OF A LARGE DAM.

Suppose society is considering the construction of a large dam. The dam and resulting reservoir will provide numerous benefits and entail many types of costs. Here we simplify the story for the sake of our example. First consider the cost of building the dam. We assume the cost of construction is $500,000 for materials and $600,000 for labor. Now consider the benefits. Once the dam has been built, people will be able to go swimming, boating, and fishing in the reservoir. The total value of these recreational benefits is $400,000. The dam is also expected to provide flood control benefits for downstream residents. The saving due to this flood control is estimated as $300,000 in reduced damages to homeowners or farmers. The dam also produces electricity valued at $500,000. Since the total benefits are $1,200,000 and the total costs are $1,100,000, the benefits exceed the costs and dam construction appears to be a good investment. Benefit-cost analysis has been used to compare the benefits and costs of the project. However, to know whether society should actually build the dam, other information is needed. For example, it will be necessary to compare the dam project with other possible uses of the funds. It might be the case that a $1.1 million investment in education could lead to more than $1.2 million in benefits. If so, the dam might be a good use of society's resources, but perhaps not the best use of those resources. The example used above ignores the issue of time. In comparing the benefits and costs of the dam we didnt really consider when those benefits and costs occurred. But in many cases the timing of benefits and costs is an important aspect of the project under consideration. For this reason, dealing adequately with the timing of benefits and costs becomes a crucial part of the BCA. For example, what if the cost of constructing the dam is incurred this year, but the benefits of using the dam are not felt until next year, after the dam is completed. In this case will next year's benefits outweigh this year's costs? To deal with this kind of question, benefit-cost analysis uses a concept known as discounting. Discounting is a technique that converts all benefits and costs into their value in the present. Discounting is based on the premise that a dollar received today is worth more than a dollar received in the future. This bias toward the present arises because by placing a dollar in a safe investment today, you can increase its value to

more than a dollar tomorrow. Another way of saying this is that a dollar received in the future is not worth as much as that same dollar received in the present. That is, the future value of the dollar is discounted. Discounting is the opposite of compounding. Not surprisingly, the rate at which a future value is discounted is closely related to the rate at which present values are compounded, namely the interest rate. As we know from compounding, if the interest rate is 5%, then a dollar placed in the bank today will be worth $1.05 a year from now. This means that if the interest rate is 5%, $1.05 to be received next year is worth only $1.00 today. Whenever the benefits and costs used in a benefit-cost analysis occur in the future, it is important to discount these future values to account for their present value. If the interest rate is r, then the following formula can be used to find the present value (PV) of an amount (Pt) received at some time t in the future:

To apply the formula, remember: PV is the present value of the amount invested; Pt is the dollar value of the future amount in time t; r is the discount rate; and t is the year in which Pt is realized. For example, suppose that in the example of the dam construction cited above the cost of dam construction ($1.1 million) is incurred at the beginning of the project (t=0), but the benefits ($1.2 million) arise one year later, after the dam is finished (t=1). Suppose the interest rate is 10%. The present value of the benefits are:

. The present value of the costs are:

. After the correction for the timing of benefits and costs (that is, on a present value basis), the benefits of the dam no longer exceed the costs of the dam and the dam looks like a less worthwhile investment. The reason for the change is that the

discount rate now reduces the value of benefits because they occur in the future. As another example, suppose you are given the choice of two investments. The first pays you $210 today, but nothing thereafter. The second investment pays $100 today, and $115 next year (for a total of $215). The second investment looks better, right? Maybe or maybe not. It depends on the discount rate. If the discount rate is 5%, which is the better investment? We find out by applying the present value formula: PV of investment 1:

PV of investment 2:

Even though the second investment pays out a greater sum, after discounting the first deal looks like a better choice. This basic formula for discounting can be applied regardless of the length of the time horizon. There is no simple rule for choosing a discount rate. One method is to use the opportunity cost of capital as the discount rate. The opportunity cost of capital is the return that would be received if the funds being invested were invested in the private sector (say in a business or in the bond market). Often the discount rate is simply set equal to a well-publicized interest rate. For example, the cost to the federal government of borrowing can be used as a discount rate. The discount rate could also be derived from what is called the social rate of time preference (SRTP). The SRTP attempts to compensate for the fact that people prefer to consume now rather than later. Because of this preference, individuals might have a bias in favor of projects that have benefits sooner rather than later. For some projects, society may want to take a longer-range perspective than individuals or businesses, and the SRTP tries to make this adjustment. For example, do you think construction of the Washington Monument would have passed a benefit cost analysis if people had a high preference for projects with immediate benefits?

9. EXAMPLE 5-TECHNIQUES OF VALUATION OF A LIFE

The social value of a life comes from the value that others put to an individuals life. But, statistical methods are less condemnable since they place the determination of life in the actual behavioral actions of people. Individuals make decisions every day that reflect how they value health and mortality risky. For example, the construction of a highway is costly in terms of human lives. Workers know or have a perception of the probable risks and voluntarily assume the risk at a certain wage. On the other hand people know or subjectively assume that buying certain products is riskier or less risky that other products at a certain price difference. The rationale of the techniques of valuation of a life is based in the determination of the regulation efficiency in terms of cost-benefit. Cost-Benefit analysis has been in the literature since long time ago. Departing from the Kaldor-Hicks efficiency criteria to the sharper Scitovsky definition, such mechanism has been used in economics as a standard in policy and economics decision. In fact, several sustained that public policy was only justified if it produced social gains in excess of social losses so that it was possible for winners from the policy to compensate losers. The maximization, then, is a procedure of expected lives saved; this is the number of lives saved due to the probability of reduction risk. In fact, the adoption of regulation not necessarily implies a risk reduction, but a chance of risk reduction. So, if a policy is determined to save 50 lives in a period of 10 years, with an 80% chance, this means that the expected number of lives saved is 40, and therefore the statistical value of lives must not be the net number but the expected number. Therefore, if the problem of regulation is to reduce risks and increase safety, the goal of such policies should be measured by the number of lives saved. Life then has a value relative to other ends and therefore, there is a tradeoff between life and legal policy ends. Indeed, the question, how much a life values, is only raised to determine if certain policy will be cost efficient or not. Regulators cannot tell how much is the government investing in saving a life by simple dividing their budget for the expected number of lives saved. They must, previously, determine if it is worth to spend certain amount of money in the reduction of three, six or one hundred lives. Therefore, reduction of mortality risks, as a government policy, must comply with certain criteria which lead to a reasonable decision. Several criteria had been proposed to determine the reasonability of such policy measures. Rationality requires that the allocation of resources be done in order to attain the highest possible wealth fare at the lowest possible effort. As the risk-risk analysis is, the benefit-cost analysis seems to be the most important mechanism to attain such reasonability in policy decision making.

In conclusion, in death risks lives saved are simply benefits. The problem, in the side of the costs is not hard to hurdle since the costs of such programs are usually easy to monetize if they all are not monetary. The problem becomes harder when it is necessary to monetize lives in average. This means, not particular lives of particular people with particular incomes and income trends, but to determine a value for a human life in statistical terms, in a way that allows commensurability

10. CONCLUSION
Cost Benefit Analysis (CBA) is one decision-making tool that can help provide assurance around these questions. Quantifying all costs and benefits in monetary terms makes it possible to quantitatively rank alternative proposals: between a given proposal and the status quo; or between competing proposals. Decision-makers can be provided with a consistent basis for assessing proposals and can be better informed about the implications of using economic resources. By reducing the positive and negative impacts of a project to their equivalent money value Cost-Benefit Analysis determines whether on balance the project is worthwhile. The equivalent money value are based upon information derived from consumer and producer market choices; i.e., the demand and supply schedules for the goods and services affected by the project. Care must be taken to properly allow for such things as inflation. When all this has been considered a worthwhile project is one for which the discounted value of the benefits exceeds the discounted value of the costs; i.e., the net benefits are positive. This is equivalent to the benefit/cost ratio being greater than one and the internal rate of return being greater than the cost of capital.

11. REFERENCES
1. Pearce, D. 1983, Cost benefit Analysis, 2nd edition, Macmillan, London. 2. Smith, R. and Biribo, N. 1995. Marine Aggregate Resources Tarawa Lagoon, Kiribati - Including Current Meter Studies at Three Localities, September, SOPAC Technical Report 217. 3. Lal, P. and Holland, P. 2010. Integrating Economics into Resource and Environmental Management: Some recent experiences in the Pacific, IUCN: Gland, Switzerland and Suva. 4. Boardman, A.E., D.H. Greenberg, A.R. Vining and D.L. Weimer (1996). Cost Benefit Analysis: Concepts and Practice. Englewood Cliffs, NJ: Prentice Hall. 5. Cohn, E. (1972). Public Expenditure Analysis, with Special Reference to Human Resources. Toronto: Lexington Books. 6. Gittinger, J. P. (1982). Economic Analysis of Agricultural Projects. Baltimore: Johns Hopkins University Press. 7. Boardman, N. E. (2006). Cost-benefit Analysis: Concepts and Practice (3rd ed.). Upper Saddle River, NJ: Prentice Hall. ISBN 0-13-143583-3. 8. Campbell, Harry F.; Brown, Richard (2003). "Valuing Traded and Non-Traded Commodities in Benefit-Cost Analysis". Benefit-Cost Analysis: Financial and Economic Appraisal using Spreadsheets. Cambridge: Cambridge University Press. ISBN 0-521-52898-4. Ch. 8 provides a useful discussion of non-market valuation methods for CBA. 9. Dunn, William N. (2009). Public Policy Analysis: An Introduction. New York: Longman. ISBN 978-0-13-615554-6. 10. Newell, R. G. (2003). "Discounting the Distant Future: How Much Do Uncertain Rates Increase Valuations?". Journal of Environmental Economics and Management 46 (1): 5271. doi:10.1016/S0095-0696(02)00031-1.

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