Economic Evaluation

Economic evaluation are the methods for determining the value of a policy, project or
program. It is an important component of planning and management.

Project economic analysis aims to ensure that scarce resources are allocated efficiently, and
investment brings benefits to a country and raises the welfare of its citizens. All resource
inputs used by a project have an opportunity cost because, without the project, they could
create value elsewhere in the economy. An economically viable project requires that, first, it
represents the least-cost or most efficient option to achieve the intended project outcomes;
second, it generates an economic surplus above its opportunity cost; and third, it will have
sufficient funds and the necessary institutional structure for successful operation and
maintenance.

1. Purpose of Economic Evaluation

Good management consists primarily of making wise decisions; wise decisions in turn
involve making a choice between alternatives. Engineering considerations determine the
possibility of a project being carried out and point out the alternative ways in which the
project could be handled. Economic considerations also largely determine a project's
desirability and dictate how it should be carried out. A feasibility study determines the
proposed project: which way to do it, or whether do it at all.

In an engineering sense, feasibility means that the project being considered is technically
possible. Economic feasibility measures the overall desirability of the project in economic
terms and indicates the superiority of a single approach over others that may be equally
feasible in a technical sense. The ultimate objective of the economic analysis is to provide a
decision-making tool which can be used not only for the pilot project but also for
demonstration purposes.

2. Difference between Economic Analysis and Financial Analysis

Financial analysis focuses on the ways and means of financing a project and the financial
profitability. While economic analysis, on the other hand, is not concerned with the sources of
financing, but only with an analysis of the costs and benefits to the road-user and the
consequences to all sections of the society of a scheme, and establishing its economic viability
Economic analysis is essentially a study for the future; the analysis should, therefore, estimate the
future traffic, costs and benefits.
3. Different Cost Concept
 Investment Cost: the initial costs of design, engineering, purchase and installation, all of
which are assumed to occur as lump sum at the beginning of the base year for purposes of
making the Life Cycle Cost analysis.
 System Cost: means all costs related to the System, including but not limited to Capital
Costs, Finance Costs, Operation and Maintenance Costs, and Repair and Replacement
Costs. (if a project is part of a larger system and if project benefits do not accrue without
some other systems costs, these need to be included in the project costs).
 Sunk costs: Sunk costs are costs which has already incurred and cannot recover them again
now. These include money spent on advertising, conducting research, and acquiring
machinery.
 Opportunity costs: Opportunity cost refers to the loss of earnings due to opportunities
foregone due to scarcity of resources. 
 Social Cost: Refers to the cost of producing commodity to society in the form of
resources that are used to produce it.

4. Identification of Transportation Project Cost

4.1 Total Transportation Cost:

The total transportation cost is composed of:
1. Initial cost of construction
2. Periodic maintenance cost over the design life.
3. Road-user cost.
These three are interdependent, and the designer has to choose that alternative which makes
the sum of these three (or the total transportation cost) a minimum.

The road-user cost is composed of:

(i) Vehicle operating cost
(ii) Time cost
(iii) Accident cost.

4.2 Highway Costs:

The sum of the first and second components of total transportation cost is known as highway
costs. The initial cost of construction has to be appropriately phased over the period of
construction.

4.3 Economic Costs and Financial Costs:

Financial costs represent the actual cost of construction and maintenance. Economic costs are
based on the opportunity cost of each constituent, such as labour, materials and machinery. In
order to desire the economic costs, these constituents have to be isolated, quantified and
adjusted.

4.4 Shadow Pricing:

The domestic prices of many commodities are administrated by the government and are out
of line with rates in the international market. Adjustments needed in the prices of goods and
wages to make them truly reflect their market value comprise shadow pricing.

5. Identification of Transportation Project Benefits

The quantification of economic benefits from highway projects is usually much more difficult
than the determination of costs because,

(i) Some benefits like reduced vehicle operating costs are easily measured while indirect benefits
such as improved agriculture and accelerated economic growth cannot be measured easily.
(ii) Some direct benefits like value of passengers’ time savings, reduced noise and air pollution,
and improved aesthetics are difficult to quantify.
(iii) Future benefits are for future traffic, the forecast of which is difficult.
(iv) Benefits are dependent on the alternatives considered, and unless the best alternative is
chosen, real benefits may not be fully quantified. Benefits are derived by normal traffic as also by
diverted traffic and generated traffic.

5.1 Road-User Benefits:

(i) Vehicle Operating Cost (VOC) saving
(ii) Travel-time savings
(iii) Savings in accident costs
(iv) Savings in maintenance costs

5.2 Social Benefits:

(i) Improvements in administration, law and order, and defence.
(ii) Improvements in health and education.
(iii) Improvements in agriculture, industry and trade.
(iv) Improvements in environmental standards.
(v) Land appreciation in the vicinity of roads.
Since it is difficult to quantify social benefits, the direct road-user benefits alone are considered.

6. Methods of Economic Analysis

6.1 Net Present Value (NPV) Method:
In this method, the stream of costs/benefits associated with the project over an extended period of
time is calculated and is discounted at a selected discount rate to give the present value. Benefits
are considered positive and costs negative, and their summation gives their net present value
(NPV). Any project with positive NPV is treated as acceptable. In comparing more than one
project, a project with the higher NPV should be accepted .

6.2 Benefit-Cost and Net Benefit Analysis

Benefit-Cost analysis compares total incremental benefits with total incremental costs. Unlike
Cost-Effectiveness Analysis, Benefit-Cost Analysis is not limited to a single objective or
benefit. For example, potential highway routes may differ in construction costs and the
quality of service (speed and safety) they provide. Benefit-Cost Analysis places a value on
each incremental benefit and costs of each option. These are summed and compared. The
results can be presented as a ratio, with benefits divided by costs (which is why it is often
called “Benefit/Cost” or “B/C” analysis).

6.3 Internal Rate of Return (IRR) Method:

The internal rate of return is the discount rate which makes the discounted future benefits
equal to the initial outlay. In other words, it is the discount rate which makes the stream of
cash flows zero.