Chapter 6 Flashcards
What is cost-benefit analysis?
Project justification is measured as worth to the community. To evaluate a project’s benefit to the community, a CBA will compare the benefit with the overall cost, to deliver and sustain the project. If overall benefits are demonstrated to exceed the expected costs, a project is considered economically viable.
What two tools are used in project evaluation?
- Cost Benefit Analysis (CBA)
* Multi criteria analysis (MCA)
What is a multi criteria analysis?
-Evaluate project against a no.of criteria
(Economic, social, environmental, cost, financing, jobs)
-Can be quantitative/qualitative
-Evaluation of a project against a complete set of objectives and used to ensure that the project meets key government objectives (not only economic)
❖ Open for political abuse: need to be transparent (weighting of inputs)
What is economic efficiency?
• optimal allocation of resources in the community ‐ if resource allocation changes, no individual can
theoretically be made better off without another being at least equally worse off. Must have technical (prerequisite) and allocative efficiency
Learn consumer surplus (NB)
discuss and illustrate consumer surplus and rule of half
What is shadow pricing? why is it used?
The market price for goods and services may not accurately reflect the real resource cost or economic value (subsidisation, tax). The shadow price is a non-market determined price that has been calculated to approximate the economic value of the resource involved in the provision of goods or services
What is discounting and why is it important?
Account for
• time value of money
• alternative use of financial capital could have been applied (opportunity cost of money)
• Individual’s willingness to value a fixed nominal amount of money at different points in time
• Concept of perceived risk
• Use discount rate ‐ rate at which future cash flows must be adjusted to reflect the current values of those cash flows
What is the implication of discount rates in developed/undeveloped countries?
The implication on the discounting of future benefits is that due to the low discount rate for developed countries, the future benefits will be higher in the present worth compared to countries with the same potential future benefits, but with a higher discount rate (such as developing countries).
List the decision criteria available for selection, their parameters and their use case scenarios
Benefit‐Cost Ratio (B/C) – small / large projects
•If the BCR is greater than 1, a project is viable
•If the BCR is less than 1, a project is not viable
•Prioritise independent projects
Net Present Value (NPV) – favour large projects
•If the NPV is greater than 0, a project is viable
•If the NPV is less than 0, a project is not viable
•Prioritise mutually exclusive projects
First Year Rate of Return (FYRR)
•IF the FYRR is greater than the discount rate, immediate construction is warranted
•IF the FYRR is less than the discount rate, construction should be delayed
•Prioritise independent projects
Present worth of cost (PWOC)
•Minimum present worth of cost
•Prioritise mutually exclusive projects
Allocative efficiency:
achieved when no individual can be better off without making someone equally worse-off
Technical efficiency:
when there is no possibility to shift resources to an alternative and increase output
