A Benefit-Cost Analysis Primer

Kevin Keller, PG, CGWPHDR Engineering, Inc.

American Railway Development Association

American Railway Development Association (ARDA)Since 1906, ARDA has provided a forum for the North

American railroad community to meet and effectpositive change:

“The objectives of the Association are to foster theindustrial, real estate, natural resources, market

development activities and environmental concernsof the North American railroads; and through the

advancement of ideas and education of its membersfurther promote the effectiveness of railway

development and related work.”

ARDA MembershipARDA encourages membership from all classes of

railroads throughout North America. Members alsoinclude professionals from other associations, agencies,and railroad service partners that have a direct effect onrail business today. ARDA’s membership variety providesa wide perspective on issues facing the railroad industry

in the 21st Century.

www.amraildev.com

Why Require a BCA?President’s commitment to data-driven

decision-makingRequirement from TIGER I and II

No funding for projects for which C > BValue of BCA in project selection

BCA quality matters more than size of the B/C ratio

Focus your analysis on how it demonstrates need for your project

USDOT Definition“A benefit-cost analysis attempts to measurethe dollar value of the benefits and the costs

of a specific project to all the members of society on a net present value basis.”

USDOT Requirement“DOT expects to identify and report onthe benefits of the projects that it funds

with TIGER Discretionary Grants. Tothis end, DOT will request that

recipients of TIGER DiscretionaryGrants cooperate in Departmental efforts

to collect and report on informationrelated to the benefits produced by the

projects that receive TIGERDiscretionary Grants.”

Benefits“The benefits that DOT reports on may include the following: (1) Improved

condition of existing transportation facilities and systems; (2) improved economic competitiveness in the form of reduced travel time, less traffic congestion, improved trip reliability, fewer vehicle miles traveled, or lower vehicle operating costs; (3) long-term growth in employment, production or other high-value economic activity; (4) improved livability of communities across the United States through expansion of transportation options, efficiency, and reliability; (5) improved energy efficiency, reduced dependence on oil and reduced greenhouse gas emissions; (6) reduced adverse impacts of transportation on the natural environment; (7) reduced number, rate and consequences of surface transportation-related crashes, injuries and fatalities; (8) greater use of technology and innovative approaches to transportation funding and project delivery; (9) greater collaboration with state and local governments, other public entities, private entities, nonprofit entities, or other nontraditional partners; (10) greater integration of transportation decision making with decision making by other public agencies with similar public service objectives; or (11) any other benefits claimed in the project’s benefit-cost analysis.”

So What is a Benefit-Cost Analysis?BCA is distinct from:

Financial analysisEconomic impact analysis

Costs and benefits refer to changes in welfareAre people made better off by the proposal

“...an analysis which quantifies in monetary terms as many of the costs and benefits of a proposal as feasible, including items for which the market does not provide a satisfactory measure of economic value.”

UK Treasury (2003), Appraisal and Evaluation in Central Government

Benefit-Cost Analysis BasicsWhat is the purpose of the BCA?

Benefit Cost Analysis measures the creation or erosion of real economic value

“Value” denotes welfare or quality of lifeTIGER III project selection & BCA

BCA quality matters more than size of the B/C ratio

Focus your analysis on how it demonstrates need for your project

Basic RequirementsProject Summary

Base case (“no-build”) Project description Justification and impact on long-term outcomesAffected population(s)Expected economic benefitsAlternativesMonetized estimates of benefits & costs

Year-by-year stream of benefits and costsDiscounted to present value (3% & 7%)Replicable methodologyDemonstrate Independent Utility

CORE BCA Principlesi. Costs & benefits estimated on incremental basis

against realistic baseline (generally not status quo)ii. Reasonable alternatives considered and evaluated

e.g., smaller scale and more focused projects

iii. Costs & benefits expressed in monetary terms (constant dollars) and estimated over project’s useful life

iv. Discounting i.e., OMB Guidance for TIGER

v. Summation of benefits & costs, and estimation of NPV

BCA vs EIAEconomic Impact Analysis (EIA) focuses on

local benefits – JOBS CREATEDIgnores costs to other localitiesIncludes transfer payments as “impacts”Payrolls, tax revenues, real estate investments

BCA focuses on national benefits (including local)Nets out costs to other areas

Includes only productivity increases resulting from job creation, increases in property values

Defining Projects for Appraisal:Concept of “Independent Utility”

• Parts or phases with “independent utility”: i) are Eligible Projects, and ii) satisfy selection criteria

• Implications for BCA: does part/phase funded by TIGER has independent utility?

– YES: benefits & costs of part/phase only

– NO: benefits & costs of entire project (or entire portion with independent utility)

• In all cases:

– benefits & costs must be related to same

– no “leverage”

Time Horizon“Both benefits and costs must be estimated for

each year after work on the project is begun and for a period of time at least 20 years in

the future (or the project’s useful life, whichever is shorter), and these streams of

annual benefits and costs must be discounted to the present using an appropriate discount rate, so that a present value of the stream of benefits and a present value of the stream of

costs is calculated.”

Focus on Project Selection CriteriaPrimary Selection Criteria

Long-Term Outcomes State of good repair Economic competitiveness Livability Environmental sustainability Safety

Job Creation and Near-Term Economic ActivitySecondary Selection Criteria

InnovationPartnership

Benefits –Livability

Livability benefits are often associated with:Accessibility for Improved access to jobs,

amenitiesAccessibility for disadvantaged communities

Land use changes linked to transportationTransit and bicycle-pedestrian improvementsAffordability (transportation, housing)

At least show ridership/usershipTry to estimate value per userIncreases in property values may indicate value

Benefits –Economic Competitiveness

Benefits in this category typically include:Lower operating costsTravel time savingsSavings to passengers, carriers, and shippersImprovements in reliability

Take care in estimating:Job creation benefits (focus on productivity increases)Omit multiplier effectsCan include increases in labor and land productivity - But

avoid double-counting

Benefits –SafetySafety benefits are typically associated with

reducing fatalities, injuries, crash costs, and hazmat releases

Benefits should be based on good crash data and valid analysis of cause

Recommended input values for injuries, property damage, and other data are available in USDOT TIGER NOFA

Benefits –State of Good RepairState of Good Repair benefits can

include:Reducing long-term maintenance and repair costs (life-

cycle costs)Travel time savings (from preventing closures of facilities,

lack of speed and weight restrictions)Other user benefits from better pavement, improved safety

Need to consider benefits and costs of alternativesReplacement vs. rehabilitation

Risk analysis

Benefits –SustainabilityEnvironmental sustainability benefits are

typically from reduced emissionsGreenhouse gases (e.g., CO2)SOxNOxParticulate matter (PM)Volatile organic compounds (VOC)

Recommended values are available in NOFA

Mapping Benefit Metrics into Long-Term Outcome Criteria

BENEFIT-COST ANALYSIS CATEGORIES OF BENEFIT

LONG-TERM OUTCOME CRITERIA

State of Good Repair

Economic Competitiveness Livability Sustainability Safety

Savings in Facility and Equipment O&M √ √

Savings in Users’ Vehicle Operating Cost √ √

Savings in Travel Time √ √

Improvements in Travel Time Reliability √ √

Economies of Agglomeration and Increased Land Value √ √

Budgetary Savings to Low-Income Users √

Reductions in Environmental Emissions √ √

Accident Cost Savings √ √

Selecting Input ValuesWherever possible use recommendations

provided in NOFA, including:

Variable Recommended Source

Discount rate OMB Circular A-94

Value of time US DOT Guidance

Value of life and injuries

US DOT Guidance

Crash costs NHTSA CAFE 2011 RIA

Criteria pollutant emissions

NHTSA CAFE 2011 RIA

Social cost of carbon Interagency Working Group Guidance

Transparency at every levelInput XQ

1 Input XQ2

IntermediateOutput YQ

1Input XQ

4

Input XQ3

Input XQ5

Intermediate Output YQ

2

Quantity Component

YQ

(Units)

Intermediate Output YV

1

Input XV2

Input XV3

Value Component

YV

($ per Unit)

Input XV1

Metric Y($)

Product

Distribution of Benefits & Costs“Applicants must clearly identify which population will be affected by any particular benefit.” (p. 38735)

Options How is it Measured? Data Sources Comments

Distribution of benefits and costs by population group

Estimation of benefits and costs accruing to specific groups based on information collected through user surveys or location data (e.g., place of residency, work, etc.). Assessment may also be qualitative, using a severity scale.

User Surveys; U.S. Census Bureau, American Community Survey; Local Housing Authorities

Detailed data available for assessing distribution based on current demographic and socio-economic characteristics. Forecast likely to be sketchy for some groups.

Distribution of benefits and costs by geography

Estimation of benefits and costs based on where they occur; or where trips originate; or where trips terminate. Assessment may also be qualitative, using a severity scale.

Transportation Models; U.S. Census Bureau, American Community Survey; Local Housing Authorities

Detailed data on O/D and trip making available from travel demand models. Exact location of effects may be difficult to assess and/or forecast for some metrics.

CostsProvide costs from all sources (local, State, other Federal

grants, private)Direct capital costs: construction, design, land acquisitionBeyond capital costs:

O&M, rehabilitation, life-cycle costsExternal costs: noise, congestion, pollutantsCost to users during project construction: increased delay, vehicle

operating costs Costs of whole project should be compared with benefits of

whole project (no “leveraging”)Or, if TIGER funds only a part of a project, you can compare

costs and benefits for TIGER-funded portion only But only if that portion has independent utility

Dealing with Uncertainty

Sensitivity or “elasticity” analysis:

change value of assumptions and model parameters one at a time and report impact on BCA metrics

identify critical variables

discuss “robustness” of BCA

Ideally applied through transportation model as well

“Applicants should (…) discuss any uncertainties associated with the estimates.” (p. 38738). “A ‘very useful’ economic analysis provides sensitivity analysis to show how changes in key assumptions affect the outcome of the analysis.” (p. 38733)

Parameters Change in Parameter Value

New NPV

Change in NPV

New B/C

Ratio

Economic Development Benefits

25% of Full Appreciation Value -$51.0 -174% 0.72

50% of Full Appreciation Value $1.8 -97% 1.03

75% of Full Appreciation Value $54.6 -20% 1.34

Value of Time

30% Reduction in Recommended Value $64.2 -6% 1.38

20% Increase in Recommended Value $71.3 +4% 1.44

Low Income Ridership

50% Reduction in the Number of Low Income

Riders$65.4 -4% 1.39

100% Increase in the Number of Low Income

Riders$74.5 +9% 1.46

Fuel Costs

EIA Low Case Scenario (-38%) $67.2 -2% 1.40

EIA High Case Scenario (+45%) $70.0 +2% 1.43

Shadow Pricing of Labor

About 10% Reduction in Labor Cost $77.1 +13% 1.49

Capital Cost Estimate 25% Reduction $98.4 +44% 1.73

Annual O&M Cost Estimate 25% Reduction $80.7 +18% 1.54

Presenting BCA Outcomes“Benefits should be presented, whenever possible, in a tabular form showing benefits and costs in each year for the useful life of the project.” (p. 38725)

“ (…) applicants should include qualitative discussion of the categories of benefits and costs that they were not able to quantify (…)” (page 38725)

• We are typically providing a 2 to 5 page summary for inclusion in the application and a technical appendix with supporting information.

Job Creation & Near-Term Economic Activity

Two approaches to estimating job creation:CEA May 2009 memorandum

$92,000 of government spending creates 1 job-year 64% direct and indirect; 36% induced

Input / Output model IMPLAN, calibrated for study area

Quarter-by-quarter projections of job-hoursJob creation should not be included as benefits in

BCA“Shadow pricing” of labor costs may be considered

CBA Project RatingCBAs are reviewed and rated by US DOT

Review teamVery UsefulUsefulMarginally UsefulNot Useful

BCA - Lessons LearnedALWAYS document and provide reliable

sources for data and calculationsBe realistic in assumptions and estimatesQualitative discussion helps supplement

understanding for difficult-to-measure benefits & costs

Consider the viewpoint of objective reviewersAre estimates plausible and reasonable?

Focus on overall evaluative process, not just the B/C ratio

Parting Words…

BCA is an opportunity to objectively demonstrate the need for your project

Highlight benefits that are well-documented and align well with program’s selection criteria

Don’t forget about true costs of the projectDocument, document, documentBe realistic in your assumptions and

estimates