METHODOLOGICAL GUIDE TO SOCIAL COST-BENEFIT ANALYSIS

Draft Version 1

26 April 2011
The Methodological Guide to Social Cost-Benefit Analysis was drawn up in implementing by the Office of the Prime Minister of the Republic of Lithuania (the OPM) the project Improvement of Performance -Based Management (VORT). The Methodological guide was prepared by the public body Europos socialiniai, teisiniai ir ekonominiai projektai under Service Agreement No MPT-043 of 25 May 2010 concluded with the Office of the Prime Minister of the Republic of Lithuania.

DOCUMENT APPROVAL Office of the Prime Minister Signature: Name, surname, position: Date:

TABLE OF CONTENTS
ACRONYMS................................................................................................................................................................... 4 1. INTRODUCTION .................................................................................................................................................... 5 1.1. 1.2. 1.3. 1.4. 2. WHO ARE THE ADDRESSES OF THE METHODOLOGICAL GUIDE TO SOCIAL COST-BENEFIT ANALYSIS? ......................................... 5 WHAT IS A COST-BENEFIT ANALYSIS, WHEN IS IT CARRIED OUT AND WHAT ARE ITS ADVANTAGES? ............................................. 6 WHAT IS THE PLACE OF A COST-BENEFIT ANALYSIS IN THE PROCESS OF DECISION IMPACT ASSESSMENT IN LITHUANIA? .................. 8 IS THE COST-BENEFIT ANALYSIS THE ONLY TECHNIQUE FOR THE ASSESSMENT AND COMPARISON OF ALTERNATIVE DECISIONS? ...... 10

APPLICATION OF THE COST-BENEFIT ANALYSIS TECHNIQUE FOR PROPOSED DECISION IMPACT ASSESSMENT ...14 2.1. DESCRIPTION OF A PUBLIC POLICY PROBLEM AND JUSTIFICATION OF THE REQUIREMENT OF THE STATES ACTIONS ...................... 15 2.2. SETTING THE GOALS OF A PUBLIC INITIATIVE ................................................................................................................. 16 2.3. IDENTIFICATION OF REALISTIC ALTERNATIVE SOLUTIONS TO THE PROBLEM .......................................................................... 16 2.4. ASSESSMENT OF ALTERNATIVES ................................................................................................................................. 18 2.4.1. Setting the scope, assumptions and period of assessment ...................................................................... 18 2.4.2. Identification of costs, benefit and stakeholders that incur/receive them ............................................... 19 2.4.3. Estimation of costs and benefit in monetary terms .................................................................................. 21
2.4.3.1. 2.4.3.2. 2.4.3.3. 2.4.3.4. What costs and benefit should be included in the analysis? ................................................................................. 22 Real and nominal value .......................................................................................................................................... 23 Estimation of costs and benefit in monetary terms in the case of non-existance of market prices ...................... 24 Assessment of an administrative burden............................................................................................................... 29

2.4.4.

Estimating and discounting cash flows ..................................................................................................... 31

2.4.4.1. Estimation of cash flows ........................................................................................................................................ 31 2.4.4.2. Discounting ............................................................................................................................................................ 31

2.4.5.
2.4.5.1. 2.4.5.2. 2.4.5.3. 2.4.5.4.

Methods for assessing and comparing alternative options ...................................................................... 33

Net present value .................................................................................................................................................. 33 Internal rate of return ............................................................................................................................................ 36 Payback period....................................................................................................................................................... 38 Benefit-cost ratio ................................................................................................................................................... 40

2.4.6.

Assessment of risk and uncertainties ........................................................................................................ 40

2.4.6.1. Sensitivity analysis ................................................................................................................................................. 41 2.4.6.2. Scenario analysis .................................................................................................................................................... 42

2.5. 3.

SELECTING THE OPTIMUM ALTERNATIVE AND COMMENTS ON ITS IMPLEMENTATION ............................................................ 43

INSTEAD OF CONCLUSIONS: USEFUL TIPS AND MOST FREQUENT MISTAKES .......................................................44 RECOMMENDED FORMAT OF COST-BENEFIT ANALYSIS PRESENTATION .................................................46 EXAMPLES OF COST-BENEFIT ANALYSIS ..................................................................................................48 DISCOUNT FACTOR .................................................................................................................................49 GLOSSARY ...............................................................................................................................................50 RECOMMENDED BIBLIOGRAPHY .............................................................................................................52

ANNEX 1 ANNEX 2 ANNEX 3 ANNEX 4 ANNEX 5

ACRONYMS
B/C CFt EU FV II IRR NPV PV PDIA RoL Benefit/costs Cash flow over period t The European Union Future value Initial investment Internal rate of return Net present value Present value Proposed decision impact assessment The Republic of Lithuania

1. INTRODUCTION
1.1. Who are the addresses of the Methodological Guide to Social CostBenefit Analysis?

The legislation governing proposed decision impact assessment in Lithuania recommends employing the technique of either a cost-benefit analysis or a cost-effectiveness analysis in carrying out an expanded impact assessment. This document is a methodological guide that presents the main principles of social 1 cost-benefit analysis. The Methodological Guide is addressed to everyone wishing understand the application of the technique of cost-benefit analysis in order to evaluate the impact, costs and benefit of public initiatives. The Methodological Guide to Cost-Benefit Analysis is relevant to the employees of state institutions drafting legal acts and other decisions and wishing to more extensively assess the impact of public initiatives. The Methodological Guide was developed as a primer on economic analysis of public interventions providing persons without economic education or experience in applying the technique of cost-benefit analysis with the basic knowledge. Those wishing to gain understanding of more complicated points off cost-benefit analysis application are recommended to study a more extensive literature (several recommended sources of bibliography are indicated in Annex 5 to this Guide).
Purpose of the Methodological Guide This Methodological Guide is a primer on the economic analysis of public interventions designed for everyone wishing to get familiarised with the application of the cost-benefit analysis technique in order to evaluate the impact, costs and benefit of public interventions.

The Methodological Guide consists of several sections. The introductory chapter presents a brief overview of the purpose and advantage of applying the technique of cost-benefit analysis, its place in the process of decision impact assessment and possible variations of this technique. The Guides second chapter step by steps introduces the key principles of cost-benefit analysis for assessing the impact of public interventions. The final section presents the most frequent mistakes and useful tips on how to avoid them. Annexes provide additional relevant information: examples of cost-benefit analysis application, references to bibliography, definitions of the main terms, etc.

Cost-benefit analysis which is applied to estimate the requirement of public interventions is sometimes referred to as

a social cost-benefit analysis as it evaluates the benefit and costs of a decision for the public. Where a private entity carries out a cost-benefit analysis for a certain project he takes into account only the benefit and costs for himself.

In developing the Methodological Guide to Cost-Benefit Analysis account was taken of the academic literature in this field and the cost-benefit analysis methodologies of the institutions of other countries (e.g. Great Britain, New Zealand, the EU, etc.)

1.2.

What is a cost-benefit analysis, when is it carried out and what are its advantages?

States have limited resources which they use for addressing public problems. In addition to public expense for buying goods and services or for social assistance, the State also has a great impact on businesses and population when adopting various rules governing their activities (regulation) or setting taxes. The adoption of legislation itself does not cost much but the regulations laid down in legislation often make a great impact on the whole economy. In planning a public initiative it is always relevant to analyse whether or not a state intervention is necessary, which problems should be addressed first using the available limited resources, what methods of intervention implementation should be selected, and what is the envisaged impact of a public initiative (regulation, tax, assistance or public expenses) on society and its separate groups. The cost-benefit analysis is a widely applied technique of economic analysis which allows the determination and evaluation of economic costs and benefits, both direct and indirect, of a certain public initiative. These costs and benefits are expressed in terms of money. This technique is suitable for evaluating the net benefit of an intervention and comparing different alternatives of the intervention with each other. The cost-benefit analysis is carried out when the envisaged consequences of an intervention for the implementing organisation cover much more than financial consequences alone. The aim of the cost-benefit analysis is determine whether or not an intervention is necessary and whether or not it will contribute to public welfare. Another advantage of the cost-benefit analysis lies in the fact that it provides a uniform methodological basis for the assessment of the impact of a decision in various aspects.
Cost-benefit analysis a technique of economic analysis allowing the evaluation and determination of economic costs and benefit, both ditrect and indirect, of the particular public initiative.

The main features of the cost-benefit analysis are the following: cost-benefit analysis should be used for the evaluation and comparison of all (i.e. not only one) realistic alternative solutions/measures to the problem at issue; the consequences of a public initiative economic benefits and costs are assessed regardless of which public group or institution derives or incurrs tehm; it aims to estimate in monetary value all most important constituents of the initiatives costs and benefit (not only those having clear market value); cost-benefit assessment is based on the principles of (a) individuals willingness of pay for goods or services and (b) willingness to accept a compensation for negatives consequences. (For more information on these principles see chapter 2.4.3 of the Guide); assessment takes into account the impact of the time factor on the value of cost and benefit flows.

The cost-benefit analysis is often used to assess investment projects2; however, it is a flexible technique which can be applied for the assessment of initiatives of another type regulation, taxes, public sector reforms, etc. This technique may be employed both ex-ante (prior to initiative implementation) and ex-post (upon initiative implementation). Despite a number of advantages provided by the technique of a cost-benefit analysis for public initiatives assessment, certain difficulties are encountered during its application which are important to know and evaluate prior to starting the analysis. Firstly, the fullness and reliability of data are of major relevance in the cost-benefit analysis. Quality and complete data are sometimes unavailable and a lot of effort and resources (time, financial) may be required for their collection. Secondly, it is often more easy to evaluate the costs rather than benefit of decision implementation. The evaluation of benefit is more difficult in the cases when certain goods are not sold on the market (e.g. human health, security, clean environment). In certain cases the reliability of an analysis is too much dependent on the selected assumptions.
Figure 1 The advantages and difficulties of applying the cost-benefit analysis technique

Advantages of applying the cost-benefit analysis technique A uniform methodological basis for the quantitative evaluation and comparison of the costs and benefit of different public initiative alternatives Evaluation of both positive and negative consequences is possible Evaluation of initiatives benefit for the whole society
2

Difficulties of applying the analysis technique Full and reliable data are required

cost-benefit

It is often more easy to evaluate the costs rather than benefit of decision implementation

For instance, a cost-benefit analysis is mandatory when proving investment projects for EU structural support financing.

Can be applied for the assessment of public alternatives initiatives of different nature The carrying out of the cost-benefit analysis itself results in costs and therefore its benefit should be above the costs. (Furthermore, the cost-benefit analysis may be carried out at different levels of detail. In adopting a decision on the requirement to carry out the cost-benefit analysis of a particular public initiative and the level of its detail it is very important to observe the principle of proportionality, i.e. the level of detail of the analysis should depend on the importance, the envisaged impact extent and riskiness of a decision and data availability. In Lithuania it is
recommended to apply the cost-benefit analysis for assessing the impact of the most important decisions and only if the required data or resources to collect them are available.

A full cost-benefit analysis is be carried out when most key elements of costs and benefit can be evaluated in terms of quantity and money and if a certain freedom of choice when formulating the goals and target results of an initiative (e.g. their modelling depending on alternatives costs is possible) exists. Where only part of the relevant costs and benefit are quantifiable a partial cost-benefit analysis is carried out (i.e. only part of important cost and benefit elements is evaluated). The outcome of analysis should be discussed taking into account the qualitative evaluation of other costs and benefit.

1.3. What is the place of a cost-benefit analysis in the process of decision impact assessment in Lithuania?
Lithuania, like most other countries, has set the requirement to assess the impact of proposed public policy decisions. The assessment of legal acts and other decisions is regulated by several different documents, which are indicated in Table 1.
Table 1 The legal acts and methodologies3 regulating impact assessment in Lithuania

Impact assessment methodology/ regulating legal act Resolution No 276 of the Government of the Republic of Lithuania of 26 February 2003 on the approval and implementation of the Methodology for proposed decision impact assessment (hereinafter referred to as the Methodology for PDIA) Resolution No 1244 of the Government of the Republic of Lithuania of 30 September 2009 on the approval of the Legislative Rules of Government of the Republic of Lithuania (hereinafter referred to the Government's Legislative Rules) Guidelines on budget programme assessment Methodology for ex-post assessment of decision impact

Assessment object Proposed decisions (strategic decisions, programmes, agreements, negotiation positions) Draft legislation

Programs Decisions

Order No 4-152 of the Minister for the Economy of the Republic of Legislation laying down Lithuania of 2 May 2006 on the approval of the Methodology for the information obligations hich determination and evaluation of an administrative burden on business are binding on business entities
3

In accordance with the regulatory framework effective during preparation of this Guide.

Methodology for the determination and evaluation of an Legislation laying down administrative burden on the citizens of the Republic of Lithuania information obligations and other persons whioch are binding on the citizens of the Republic of Lithuania and other persons

Assessment of the impact of proposed decisions and draft legislation in Lithuania The Methodology for PDIA defines a proposed decision impact assessment as a technique for improving the formation of the public policy and decision-making by state institutions and bodies. The material collected for impact assessment provides information to the decision making state institutions and bodies about possible alternative decisions and consequences of their implementation, thus creating conditions for choosing the most suitable solution to the problem. As prescribed in the Governments Legislative Rules, an institution or working group drafting a legal act must carry out an assessment of the impact of the envisaged legal regulation. When carrying out an assessment of the impact of the envisaged legal regulation, information is collected and analysed and on the basis thereof the possible positive and/or negative impact of the legal regulation provided for in the proposed legal act is evaluated in different aspects.
Source: Methodology for PDIA and Governments Legislative Rules

Proposed decision impact assessment may be of different level of detail, i.e. either a basic assessment or an expanded assessment may be carried out. The cases when an expanded impact assessment may be recommended are presented in Table 2.
Table 2 When should an expanded impact assessment be carried out? Recommended criteria and cases

1. 2. 3. 4. 5.

6. 7. 8.

Political, social sensitivity and importance of the question (political decision); When new regulation of the area of public relationships is established or essentially changed; When a legal regulation concept is being drafted; When a Government resolution is aimed at providing a project with the status of a project of national significance; When during inter-institutional coordination of a proposed decision one or more institutions identifies the need and proposes to carry out an expanded impact assessment and when a decision drafting institution or the Government adopts a decision to carry out such assessment; The minimum margin of the decision impact on the national budget is set; When, according to preliminary estimation, the administrative burden resulting from a decision will exceed the fixed number of hours; When preparing the Republic of Lithuania positions on EU legislation of major relevance to Lithuania.

! As an expanded assessment is carried out for the most important, significant decisions, it is
the technique of cost-benefit analysis or its variations that is recommended to be carried out during the expanded assessment (for more information see chapter 1.4).

1.4.

Is the cost-benefit analysis the only technique for the assessment and comparison of alternative decisions?

Cost-benefit analysis is the main and widely applied technique for quantitative assessment of the impact of alternatives. Several other applicable techniques of analysis are variations or partial analyses of the cost-benefit analysis. Cost-effectiveness analysis. A cost-effectiveness analysis is a variation of the technique of cost-benefit analysis. It is applied when planning to implement an initiative with a clear fixed goal (e.g. aimed at a certain established quantitative indicator to reduce infant mortality to a certain level, to create the established number of jobs, etc.) and when evaluation of the benefit of an intervention in monetary units is difficult. The cost-effectiveness analysis evaluates and compares only the costs (but not benefit) of alternative decisions assuming that all alternatives will lead to the achievement of the same goal. This technique is often applied to find the way of achieving the target results at the lowest costs. It cam also be applied for the purpose of identifying the alternative which will enable the achievement of better results at the same costs. The more clearly the goal and target results of an intervention are defined the easier is the carrying out of a cost-effectiveness analysis. The technique of cost-effectiveness analysis is not suitable when a particular initiative purses several different, complex, global goals.
Example 1: the case of cost-effectiveness analysis application For example, in order to reduce the number of traffic accidents in a certain area, the costeffectiveness analysis could be employed to compare the costs for one saved life of the following alternatives: (i) information campaign regarding road safety, (ii) improvement of road infrastructure, (iii) imposition of more stringent penalties, etc.

Figure 2 Advantages and weaknesses of cost-effectiveness analysis application

10

Advantage of cost-effectiveness analysis technique application It is an alternative to cost-benefit analysis when evaluation of benefit in terms of money is difficult but results are quantifiable

Weaknesses of cost-effectiveness analysis technique application It does not answer the question whether the public will enjoy net benefit after an initiative has been implemented (i.e. will benefit be greater than costs) Comparison of the alternatives allowing the Is not suitable when an initiative pursues several achievement of the same or very similar results is different goals possible Cost utility analysis. A cost utility analysis is another variation of the cost-benefit analysis. This technique compares relative effectiveness of alternative interventions in pursuance of two or more defined results/goals.
The aforementioned cost-effectiveness analysis as well as the cost utility analysis allow the evaluation of relative effectiveness of alternatives in pursuance of the defined goal or several goals (in the case of cost utility analysis). The measuring unit is most often non-monetary one.

Multi-criteria analysis. This technique enables the evaluation of the attractiveness of different alternatives by comparing them according to the selected criteria. These criteria may have a different level of importance in which case relative weights are attached to them. The multi-criteria analysis is based on the expert opinion of specialists carrying out an assessment (when establishing criteria, attaching weights to them, assessing alternatives according to each criterion, presenting their general evaluation) and it is, therefore, more subjective than other mentioned techniques of alternatives analysis4. Nevertheless, where the possibilities of evaluating the key costs and/or benefit in terms of money are missing, the technique of multicriteria analysis provides enhanced structural detail and transparency to decision assessment.
4

Objective indicators (e.g. price) can also be included.

11

The multi-criteria analysis, like other aforementioned techniques, does not answer the question whether or not the benefit of intervention implementation will exceed costs. In other words, the possibility that the optimum alternative is a do-nothing alternative (status quo) always exists.

Example 2: multi-criteria analysis Criteria [criterion weight] Non-weighed evaluations in scores Project is Project is Project is implemented implemented implemented by the by Supplier No by Supplier No institution 1 2 itself 20 100 65 80 50 78 82 90 96
44.4 88 73.8

Net present value [60 %] Elasticity [20 %] Reliability [20 %]

Total weighed score

In the example presented in the Table, the alternative when a project is implemented by Supplier No 1 in all probability would be considered the most attractive one.

Figure 3

Advantages and weaknesses of applying the multi-criteria analysis technique

Advantages of applying the multi-criteria analysis technique An alternative to the cost-benefit analysis when it is difficult to evaluate costs and/or benefit in terms of money. Provides enhanced structural detail transparency to decision assessment

Weaknesses of applying the multi-criteria analysis technique Does not answer the questions whether or not the public will experience net benefit after an initiative has been implemented (i.e. whether benefit will exceed costs) and Is based on the expert opinion of specialists carrying out an assessment (when establishing criteria, attaching weights to them, assessing

12

alternatives against each criterion, presenting their general evaluation) and it is, therefore, more subjective

13

2. APPLICATION OF THE COST-BENEFIT ANALYSIS TECHNIQUE FOR PROPOSED DECISION IMPACT ASSESSMENT
An assessment of the envisaged impact of any initiative shall be carried out in several steps: 1. 2. 3. 4. 5. Description a public life problem; Determination of the pursued goals, results and the target situation; Identification of realistic alternative solutions to the problem; Evaluation of alternatives and their comparison with each other; Upon determining the optimum alternative, discussion of its further implementation.
Figure 4
1 ingsnis Vieosios politikos problemos nustatymas Kokia yra vieosios politikos problema? Koks jos mastas, aktualumas? Ar valstyb turi j sprsti? Kas atsitiks, jeigu valstyb nesiims veiksm? 2 ingsnis Vieosios iniciatyvos tiksl nustatymas

Steps of decision impact assessment

3 ingsnis Reali problemos sprendimo alternatyv identifikavimas Kokie yra galimi problemos sprendimo bdai? Kurie i j laikytini realiais ir svarstytinais? traukite status quo kaip vien i alternatyv. 5 ingsnis Pasirinktos alternatyvos gyvendinimo vertinimas Kaip pasirinkta alternatyva bus gyvendinama? (atsakomyb, veiksm planas ir pan.) Pagal kokius rodiklius bus vertinama gyvendinimo skm?

4 ingsnis Alternatyv analiz

Koki rezultat norima pasiekti gyvendinant iniciatyv? Kaip inosime, ar valstybs veiksmai buvo skmingi?

Ianalizuoti problemos sprendimo alternatyvas: vertinti kiekvienos alternatyvos gyvendinimo snaudas, naud. Rekomenduotina, kai manoma, iam vertinimui naudoti snaud-naudos analiz.

Step 1 Identification of a public policy problem

Step 2 Determination of the public initiative goals

What is the problem of public policy? What is its extent and relevance?

What results are pursued through initiative implement ation?

Step 3 Identification of realistic alternative solutions to the problem What are possible solutions to the problem?

Step 4 Analysis of alternatives

Step 5 Evaluation of implementation of the selected alternative How will the selected alternative be implement ed? (responsib ility, action

To analyse alternative solutions to the problem: to evaluate the costs and benefit of implement

14

Should the State address it? What will happen if no actions are taken by the State?

How will we know whether the States actions proved to be successful ?

Include status quo as an alternative

ation of each alternative .The recommen dation is to use the costbenefit analysis for this evaluation , where possible

plan, etc.) What indicators will be used to assess the success of implement ation?

The technique of cost-benefit analysis is in particular useful when making the fourth step of impact assessment as it allows the determination, evaluation and comparison of the costs and benefit of different alternatives and the identification of the optimum solution to the problem. Other chapters of this Methodological Guide more extensively describe the application of the cost-benefit analysis technique for the assessment of public initiative alternatives. However, prio to that, attention is also paid to the previous steps of impact assessment they present brief recommendations on how the problem at issue and the pursued goals should be described and alternative solutions to the problem be identified. These analytical steps are of great importance as if any of these steps is implemented incorrectly the subsequent analysis of the costs and benefits of a decision may be of little use.

2.1.

Description of a public policy problem and justification of the requirement of the States actions

The definition of a public policy problem and the description of the reasons behind it is an important first step to the formulation of the goal of States intervention and possible alternative solutions to the problem. In order to properly describe the problem at issue it is recommended to discuss several points.
What is the problem? What is the problem? What is its extent and relevance? How was the situation changing within a certain period of time? How is it likely to change what are forecasts, tendencies? What public groups, economic sectors are affected most? What reasons lie behind the problem situation? Do the available policy instruments help to resolve (or aggravate) the problem? Does the problem arise from (not from) the interventions under implementation/implemented, applicable regulation? How would the problem develop if no action is taken by the State? 5

?
5

Prepared in accordance with the 2009 European Commissions Impact Assessment Guidelines. January 2009. SEC(2009) 92 // http://ec.europa.eu/governance/impact/commission_guidelines/commission_guidelines_en.htm

15

The description of a situation should provide information about the nature, extent and reasons of the problem. An overview of the reasons and factors predetermining the problem is in particular relevant if the aim is to deal with the problem but not to treat its symptoms. In describing the problem it is important to justify the necessity of States actions to address it. Generally, a public intervention is based on the defects of market/regulation or social (redistribution) arguments. In considering the appropriateness of States intervention/regulation it is important to consider whether or not the States actions will result in additional distortions of the markets or the costs greater than benefit.

2.2.

Setting the goals of a public initiative

If, taking into account a problem analysis, the States intervention seems to be necessary, the goal of an intervention has to be formulated. The goal of a public intervention should be clearly linked with a solution to the identified problem and elimination of the underlying reasons. Failure to formulate a clear goal of an intervention poses a risk of ineffective use of resources in addressing the problem. Furthermore, in this case it is impossible to effectively monitor the course of intervention implementation and evaluate whether the States actions produced the desired results.
What is the goal of a public intervention? What is aimed by decision implementation? What would be considered to be a successful result of decision implementation? Are the pursued goals clearly relating to the problem and underlying reasons? Are the goals formulated so as to reflect a positive change? (e.g. decreased crime rate, cleaner environment, higher energy safety) Do the pursued goals and objectives comply with the strategic and/or other policy goals and objectives? Is the success of the set goal or objective measurable? 6

Formulation of the goal of a policy intervention creates a basis for the discussion of possible alternative options of a decision.

2.3.

Identification of realistic alternative solutions to the problem

A subsequent step following the setting of the goals of an intervention is to identify the alternatives allowing the achievement of these goals. A set of possible alternative options will be different in each particular case. Sometimes it can include only two alternatives the State should not deal (status quo) and deal with the problem. Nevertheless, in the majority of cases more than two alternatives may and should be considered: for instance, alternatives regarding regulation, alternative forms of regulation or different methods and measures of decision implementation. Alternatives may be relating to the content or form of a decision. In the case of a more relevant decision, a larger number of alternatives should be evaluated.

Prepared in accordance with the 2006 European Commmissions Impact Assessment Guidelines. January 2009. SEC(2009) 92 // http://ec.europa.eu/governance/impact/commission_guidelines/commission_guidelines_en.htm

16

Example 3: alternatives
Alternavtives for regulation Examples Pollution tax Payments for the termination of the agricultural activity Educational campaigns aimed at increasing traffic safety Trade in greenhouse gas operating permits Alternative forms of regulation Type Examples Setting of mandatory regulations Regulatory legislation Self-regulation economic operators, by their The Code of Ethics of Journalists and Publishers own initiative, set standards and requirements Licences for dentists and dental hygienists, dental care for their activities institutions issed by the the Chamber of Dentists Co-regulation economic operators and state Protection of minors against the harmful information in the institutions jointly control a certain area of media activity Performance-based regulation Setting exhaust gas rates by giving car producers freedom in choosing how to implement the standards (U.S.) Implementation alternatives: a few exmpales Different standards or procedures depending on the specificity of a regulated entity (e.g. large, small enterprises) Services are provided by a state institution, private sector, cooperation of the private and public sector Improved implementation of the existing instruments or initiatives Different time of implementation, different level of initiative implementation Interim/permanent measures Actions at regional, national or international level Lease, acquisition, construction, repair Source: The Guide to decision impact assessment of Ireland, Great Britain, and the authors information Taxes Subsidies Information campaigns Trade in pollution permits Type

At the start of the analytical process the recommendation is to identify and discuss the largest possible number of alternative solutions to the problem whose set should be subsequently reduced taking into account their viability and reality. A clear justification for rejecting particular alternatives and deciding not to apply them any longer should be provided. It is always necessary to formulate the status quo alternative as it not only reveals the imminent consequences in case of States failure to take actions but also provides a starting-point for the comparison of all alternatives (i.e. status quo alternative is considered to be the baseline scenario).

! In the stage of formulating alternative options for the problem it is important to hold the largest
possible number of consultations (both formal and informal) with stakeholder and society groups.

When discussing the possible alternative options for the problem it is appropriate to take into account the following principles and advice7:

Prepared in accordance with the 2009 European Commissions Impact Assessment Guidelines. January 2009. SEC(2009) 92 // http://ec.europa.eu/governance/impact/commission_guidelines/commission_guidelines_en.htm

17

Alternatives should be realistic the practice of considering only the do-nothing alternative, the proposed alternative decision and a radical unrealistic alternative should be avoided. The recommendation is to avoid preconception even though one of the alternatives seems to be too innovative its topicality may change (increase) upon change of certain circumstances. Where a regulatory framework already exists in a certain area, the alternatives of ensuring better implementation and the observance with the provisions should be considered . Less can mean more where a regulatory framework already exists in a certain area but does not allow the achievement of the desired results, the introduction of new additional instruments can be not the best decison. The appropriateness of simplifying the applicable instruments, increasing their consistency or maybe refusal thereof should be considered. On the basis of the best practices, in each case it is recommended to discuss whether an alternative to classical legal regulation would be a more appropriate instrument. For instance, maybe an information educational campaign would be sufficient? In selecting alternatives for an analysis it is relevant to take into account the alternatives that would be supported by different stakeholder, public groups; however, this should not be overestimated. Alternatives should compete they should produce different options for the problem. Costs and benefit should be equally assessed with regard to each alternative it is important to avoid the practice of highlighting the benefit of one alternative but the costs of the others. This is one of the most common deficiencies of impact assessment.

2.4.

Assessment of alternatives

As it has already been mentioned, the application of cost-benefit (or cost-effectiveness) analysis for quantitative evaluation and comparison of alternative decisions is useful. The cost-effectives analysis includes several steps: (1) indication of assessment assumptions; (2) identification of the public groups to be impacted by a decision; (3) indication of a positive impact and possible negative consequences to be experienced by public groups due to the planned public intervention; (4) calculation of the envisaged changes of costs and benefit; (5) estimation of the key costs and benefit in terms of money; (6) comparison of alternatives against the set criteria; (7) performance of a market analysis with the aim of achieving more reliable results of assessment. Each of these steps is more extensively described in further sections of this chapter. 2.4.1. Setting the scope, assumptions and period of assessment There are several assumptions on the basis of which the cost-benefit analysis is carried out: a decision may have an impact on various economic sectors as they are interrelated (general equilibrium); intangibles are included into analysis if they can be reliably evaluated; all related costs/investments are assessed;

18

costs and benefit are evaluated from the perspective of the national economy (i.e. not the perspective of the Government or an individual institution); generally, the period covered by the cost-benefit analysis depends on the useful life of fixed assets (e.g. if a new information system is introduced). However, it is impossible to establish such period for part of public policy decisions (e.g. for health policy instruments etc.). In such a case the recommended period of analysis is 20 years. A longer period is relating to great uncertainty; furthermore, in many cases cost and benefit flows lose their significance in the distant future due to discounting.8
Table 3 Assumptions accepted during cost-benefit analysis

Scope of analysis

Period of analysis

Assumption National economy Assessment covers the impact on all economic sectors (general equilibrium approach) A maximum of 20 years

Intangibles

Taxes Social discount rate

Possible variations -Assessment covers the impact on a particular sector (partial equilibrium approach) Another assessment period can be set. E.g. a period longer than 20 years may be relevant for the assessment of certain decisions, when an important part of costs and/or benefit is likely to appear in the long-term period (e.g. in the fields of children education, nuclear energy, etc.). To be included if are realiably Not to include and to carry out a measurable qualitative assessment if realiable measurement is impossible Prices without taxes are used -Proposed interest rate on Eurobonds Another size of the discount rate is set issued on behalf of the State

2.4.2. Identification of costs, benefit and stakeholders that incur/receive them An assessment of alternative options for a public problem should be started from the identification and overview of the consequences of each alternative. The matter of primary importance is the identification of society groups to be impacted by the decision (directly, indirectly) and indication of the consequences (positive, negative) to be faced by these groups and when.

! In analysing the costs and benefit of an alternative decision it is necessary to indicate

which society groups, how and when will be impacted as benefit and costs often unevenly distribute within society or over time. For example, a certain proposal may be useful for consumers but may result in adjustment costs for enterprises. Costs and benefit may be unevenly distributed among macro and micro enterprises, start-ups, etc. A decision to apply certain measures aimed at protecting consumers against non-quality products may create a situation when consumers have the chance to choose only more expensive goods/services, while certain groups of suppliers gain a competitive advantage over other suppliers, etc.
8

Exceptions are possible the impact (benefit or costs) of some decisions can be significant in the distant future too as for instance, in the field of nuclear energy, in the cases of environmental impact, etc.

19

Positive consequences economic benefit the gain in the welfare of society and stakeholder groups resulting from the decision at issue. Economic costs are related with the actual use of resources in the economy and reflect the best possible alternative of the use of resources, i.e. opportunity costs. The opportunity costs mean the costs of the best opportunity (alternative) lost to use the available resources. In each case it is important to find out what are the alternative ways/opportunities of using resources (e.g. investment in the public transport system instead of building new roads). Tables 4 and 5 indicate the types of the most frequently occurring costs.
Table 4 Types of costs

Costs Monetary

Type Quantitative fixed costs Quantitative variable costs Quantitative semivariable costs

Nonmonetary Nonmonetary

Quantitative Qualitative

Example Remain constant regardless of activity/production volumes (e.g. office building lease costs are constant regardless of the number of people working in the building) Vary subject to activity/production volumes (e.g. electricity costs may increase when the number of persons working in the building increases) Include fixed and variable components (e.g. building maintenance costs part of which is planned, while another part changes in proportion to activity/production) A larger number of consumer complaints, road traffic accidents Decreased employee competence

Source: Adapted according to HM Treasure Guidance9 Table 5 Most frequent types of costs

Type of costs Budget expenses

Implementation expenses

Sustained by state institutions implementing a decision Financial direct expenses from State and municipal budgets and other funds Administrative expenses of state institutions Human resources required for intervention implementation Policy implementation, monitoring, supervision expenses

Sustained by decisions target groups/society groups --

Compliance expenses Uniform implementation expenses see above

Expenses relating to the selection of the most acceptable manner of the observance of requirements Direct expenses sustained by regulated or intervention-impacted entities seeking to comply with the established requirements. These costs include an administrative burden (for more

HM Treasury. The Green Book. Appraisal and Evaluation in Central Government. Treasury Guidance. London. // http://www.hm-treasury.gov.uk./media/3/F/green_book_260907.pdf

20

Type of costs

Sustained by state institutions implementing a decision

Adjustment expenses

Sustained by decisions target groups/society groups information about its assessment see chapter 2.4.3.4.). Costs sustained because of the redistribution of resources which is encouraged by behavioural change predetermined by a policy instrument (production/consumption).

Source: The European Commissions Impact Assessment Guidelines 10

In analysing alternative decisions is is necessary to describe, as far as possible, the expected change in physical measures: for instance, how many new lives will be saved, how much of peoples time will be saved, how many accidents will be prevented or how the environmental pollutionlevel will be reduced after the decision has been adopted. The cost-benefit analysis requires a clear indication of how the initiative will affect consumption, health, security, leisure duration, etc., i.e. the items on which human welfare depends.11 It is equally important to explain why such (as described) impact is expected causal relationships should be explained. As quantitative evaluation of all the consequences is often impossible, major focus should be laid on the key elements of the benefit and costs. 2.4.3. Estimation of costs and benefit in monetary terms The aim of economic benefit and cost estimation in monetary terms is to determine whether or not the benefit of a certain initiative is worth the sustained costs and to compare which alternative is more attractive. The estimation of costs and benefit in monetary terms is the most difficult stage of the analysis. The most common recommendation is to estimate in monetary terms only the most important consequences of a decision. In adopting a decision on which costs and/or benefit require a more extensive assessment, the recommendation is to use the criterion of significance and the principle of proportionality. In other words, two questions should be asked: Are/is these/this costs/benefit significant and relevant? Costs and benefit are considered to be significant if they can lead to the conclusion on which alternmative should be considered optimum. Inessential elements of costs and benefit should not be analysed. Can these/this costs/benefit be reliably and effectively calculated? If the efforts and resources necessary for the calculation of certain costs/benefit are greater that the benefit of results of this process, a quantitative assessment of such costs/benefit is inappropriate. In this case the recommendation is to carry out a qualitative assessment of the potential impact. Further this chapter reviews which costs and benefit should be assessed and how should they be calculated in terms of money.

10

European Commission. Impact Assessment Guidelines. January 2009. http://ec.europa.eu/governance/impact/commission_guidelines/commission_guidelines_en.htm 11 Kuodis R. Lietuvai silytinas kat naudos analizs modelis. // http://www.ekonomika.org/

SEC(2009)

92

//

21

2.4.3.1. What costs and benefit should be included in the analysis?

Table 6 presents information about the costs and benefit to be included and not to be included in the analysis.
Table 6 Costs/benefits to be included/not to be included in the analysis

Costs/ benefit Sunk costs

Capital and operating expenses Depreciation/amortisat ion

Financial transactions

Contingencies

Taxes

Deadweight loss
12

Comments on inclusion/non-inclusion in the analysis Sunk costs mean the costs which were incurred prior to the assessment period in question. For instance, such costs include instrument planning, feasibility study development costs. These costs should not be included in the analysis as they result from previous decisions and decisions on another (alternative) use of these funds may no longer be accepted. Cost-benefit analysis should include all cost flows relating to the decision regardless of whether these are capital or current expenses, operating or one-off expenses. Depreciation/amortisation is an accounting term which in the most general sense means annual impairment in the real value of tangible assets 12 . Depreciation deductions have no direct economic effect and therefore should not be included in the cost-benefit analysis. Furthermore, if both the costs of assets acquisition and the depreciation deductions were included in the analysis this would mean a duplicate calculation of these costs. Where assets need to be upgraded during the assessed period, replacement investments should be included in that period in which they are made. Cost-benefit analysis generally does not include the costs of financial transactions, for instance interest. The reason is that the cost-benefit analysis is relating to a certain increase/decrease in the supply of certain resources (the result of decision) on the scale of the entire economnot but not to the redistribution of funds within economic sectors. Additionally, these costs (interest) are indirectly included in the discount rate and therefore the inclusion of interest in the analysis would mean a duplicate calculation of financial expense. Where intangible costs/benefit make part of the envisaged costs/benefit of a decision, they should be included in the cost-benefit analysis. For instance, the assessment of a decision on fitting up new office premises should cover all construction contingencies (e.g. as regards increased work volume or work delay). In the case of lower-scope decisions the value of contingent costs may be estimated by calculating the impact of a contingent event by the probability of that event. Large-scale decisions should use quantitative techniques of risk assessment (for more information on risk assessment see chapter 2.4.6). Cost-benefit analysis should use priceswithout taxes, i.e. excluding the value added tax (VAT) and other indirect taxes. The correction of market prices as regards taxes is of particular relevance in the cases when the impact of taxation may have the key influence on the decision-making. Where the system of taxes applicable to alternative decisions substantially differs, such a correction is necessary in order to avoid inadequate comparison13. Deadweight loss means net costs which are incurred by the public due to

Where the assessment period coincides with the economic life period the residul value will equal zero. It should be noted that regular maintenance of assests is not the same as depreciation/depreciation; maintenance is the real use of economic resources and its costs have to be included in the cost-benefit analysis. 13 HM Treasury. The Green Book. Appraisal and Evaluation in Central Government. Treasury Guidance. London. // http://www.hm-treasury.gov.uk./media/3/F/green_book_260907.pdf

22

Costs/ benefit

Behavioural effects

Externalities

Transfer payments

Comments on inclusion/non-inclusion in the analysis deviations from the equilibrium of economys competitiveness. This generally happens due to additional taxes or regulation. For example, increased taxes on certain goods or services create a situation when part of consumers buy less of these goods or services than they would if the taxes were not raised. In other words, the deadweight loss (sometimes referred to as a surplus burden) means the loss in welfare due to behavioural changes caused by taxes. The inclusion/non-inclusion of deadweight losses in the cost-benefit analysis should be evaluated on a base-by-case basis. As a general rule, these costs should be included in the analysis if they are sufficiently significant compared to the total costs and benefit of a decision and could impact the decision on the optimum alternative. Public interventions, particularly regulation, often have an effect on economic operators behavioural changes. However, in many cases behavioural changes caused by a public intervention are difficult to interpret and quantify. Therefore, the inclusion of these changes in the cost-benefit analysis should be considered on an individual case basis taking into account their importance when compared to the total costs/benefit of a decision and the impact on the decisions as regards the optimum alternative. A decision may also have an impact, either negative or positive, on persons who are not directly relating to it. This is especially relevant in the case of decisions relating to the environment and health. The inclusion of externalities in the cost-benefit analysis should be considered on an individual case basis. As a general rule, externalities should be included in the analysis if they are quantifiable and of sufficient significance to make an impact on the decision as regards the optimum alternative. All assumptions relating to the assessment of externalities should be properly explained and justified. Non-quantifiable external effects must indicated and explained. Transfer payments mean single-direction payments in exchange for which no goods or services are provided. Such costs include social security benefits, oldage and disability pensions, student grants, sickness benefits, etc. 14 These payments should not be included in the cost-benefit analysis as they have an impact on the re-distribution of public welfare only, but do not themselves impact the costs/benefit on the entire economic scale.

2.4.3.2. Real and nominal value

The costs and benefit of a decision should be evaluated at the real but not nominal value (i.e. the cost of acquisition of a good or service). The influence of inflation should be respectively eliminated from the analysis. An exception is applied only where the price of a good or service is expected to decrease/increase compared to the price of all the other products and services. In this case a relative change should be evaluated and integrated into analysis. Below are presented several examples of relative price changes: high-tech products whose price is likely to drop (e.g. the most recent computer technologies); high-tech products whose price is likely to grow (e.g. technologies in the area of health, defence equipment); limited natural resources (e.g. oil);

14

Subsidies paid to exporters, farmers, producers. etc. shall not be considered to be transfer payments.

23

wages and the price of other costs which are likely to increase more rapidly than the total rate of inflation. In summary, in carrying out the analysis, the price of goods or services should be considered as constant within the entire period of decision implementation (i.e. regardless of the effect of inflation), except for the cases when it is possible to reasonably foresee that the price will change when compared to the price all the other goods/services.
2.4.3.3. Estimation of costs and benefit in monetary terms in the case of non-existance of market prices

The costs and benefit of a decision should be calculated on the basis of real market prices. However, in practice, situations are frequent when the market prices cannot be used for public intervention assessment: At the presence of market imperfections or due to States regulation the price of a good or service does not always reflect its real value. For example, where a certain good is subsidised, its price may be lower than the real value of resources necessary to produce it. In this case the price of a good/service would be equal to the sum of the price of the good and the unit of good/service in the amount of the subsidy. In the cases of taxation differences between different alternatives at issue, when applying subsidies or in the cases of monopolistic pricing, market prices should be corrected. Where a good is not sold in the market the market price does not exist. For instance, there is no market price for clean air, saved lives, nature preservation, etc. The economic value of such goods can be estimated using indirect value determination approaches for instance, by revealing relative preferences of individuals with respect to them, making a comparison with other similar goods with the market value. It is assumed that consumers can estimate the significance of non-market goods for their welfare. For instance, a consumer wishing to live in a cleaner environment may be willing to pay a certain amount of money for that. The largest amount of money he would agree to pay expresses his willingness to pay and shows how an individual estimates the improvement of environmental quality compared to other goods and services he would acquire for the same amount. On the other hand, knowing about the deterioration of environmental quality an individual can agree to a monetary compensation of a certain amount, which, in his opinion, offsets the damage caused to his welfare. The smallest amount an individual would agree to accept for negative consequences is his willingness to accept a compensation. It shows how an individual estimates the deterioration of quality in the context of other goods that can be acquired for money. Willingness to pay for non-market goods or accept a compensation for negative consequences differs between individuals. Therefore, in order to identify what impact on the welfare of the whole society (in the opinion of society members themselves) was made by the change (e.g. improvement or deterioration of environmental quality) it is necessary to aggregate the willingness to pay for non-market goods or accept compensation for incurred damage of all the individuals affected by the change. The aggregated willingness to pay or accept a compensation reflects the estimation of the change in welfare in terms of money.

24

Example 4: willingness to pay and accept a compensation

The gain or loss of society relating to the changes of environmental quality can be evaluated in two aspects: Willingness to pay for the improved environmental cleanness (What amount of money we would agree to pay for living in a cleaner environment?) Willingness to accept a compensation for the refusal of improved environmental cleanness (what monetary compensation we would agree to accept for our refusal to live in a cleaner environment?) Willingness to pay for the avoidance of deterioration of environmental quality (what amount of money we would agree to pay for the avoidance of deteriorarion of environhmental quality?) Willingnss to accept a compensation for the deterioration of environmental quality (what monetary compensation would we agree to accept for the deteriorated environmental quality?).
The first and the fourth measures of economic value describe the in individuals (s) monetary budget, which, in the aspect of benefit (welfare) level, offsets (compensates) the change of environmental quality. The second and the third cases reflect the change in revenue which, in the aspect of benefit, corresponds to the change in environmental quality. In other words, the first and the fourth cases concern either a decrease or increase in welfare in monetary terms in exchange for improvement or deteriorartion of environmental quality. Thus, the estimation starting-point is the original level of welfare (before the changes) of an individual. The second and the third cases concern an increase or decrease of individuals budget instead of gain or loss in environmental quality. In this case the estimation

starting point a new level of individuals welfare (after the changes).

Several methods used for the estimation of the price of non-market services/goods are presented in Table 7. These methods can be divided in two groups: revealed preference methods and stated preference methods. Both groups of methods allow the identification of individuals willingness to pay for a non-market good/service in one case this is done directly (stated preference testing), in another indirectly (revealed preference testing).
Table 7 Estimation of costs and benefit in monetary terms in the case of a non-market price: methods

Revealed preference testing

These are indirect methods for estimating the value of non-market goods. These approaches imply that similar situations in which individuals made decisions on making of a certain payment for the foreseen benefit are analysed (e.g. farmers who contributed to flood-protection work in order to minimise flood risks to their farms). This allows a conclusion on how many individuals would agree to pay for the expected benefit of the decision to be adopted. The two most frequent methods of revealed preference are the following: Hedonic pricing. In applying this method, various characteristics of market-traded goods/services are analysed in order to indirectly estimate the value of non-market goods/services. For instance, the value of a lake pier could be estimated by comparing the price of a house on a lake shore with the price of a similar house located

25

elsewhere. Travel cost analysis method. In applying this method individuals willingness to pay is estimated on the basis of the travel costs necessary to reach a particular place. For instance, the value of a park could be calculated as an amount of costs incurred by persons travelling to that park (including travel time). Nevertheless, such a method of calculation can show only the minimum value of the park as it ignores the price the consumer would be willing to pay (consumer surplus).15

Stated preference testing

The stated preference methodologies were developed taking into account the weaknesses of revealed preference tests. In this case, in order to forecast consumers behaviour with respect to non-market goods consumer surveys are carried out. The surveys evaluate individuals (i) willingness to pay for a certain non-market good and/or (ii) willingness to accept a compensation for negative consequences of initiative implementation.

Figure 5 presents the scheme of the process of intangibles estimation in terms of quantity.

15

Consumer surplus the value consumers receive over and above what they actually have to pay.

26

Figure 5

Intangibles estimation scheme

Is the impact measureable and quantifiable? AND Does a market price exist?

NO

YES

Revealed preference methods applied: Hedonic pricing Travel cost analysis

Is estimation of costs and benefit in monetary terms possible?

YES

NO

Stated preference methods applied: Willingness to pay Willingness to accept compensation

Is estimation of costs and benefit in terms of money possible?

NO

YES

To perform qualitative assessment of intangibles

To calculate benefit and/or costs

Source: Adapted according to the Impact Appraisal Guidance of Great Britain16

16

HM Treasury. The Green Book. Appraisal and Evaluation in Central Government. Treasury Guidance. London. // http://www.hm-treasury.gov.uk./media/3/F/green_book_260907.pdf

27

Table 8 discusses certain cases of intangibles which are most frequently used during the public intervention analysis.
Table 8 Estimation of costs and benefit in monetary terms in the cases of non-market price: examples

Value of time

In ideal conditions, an individuals salary is a monetary unit of the stimation of his time. In simple economic models an individual chooses between leisure and working durations: whether to refuse a leisure hour and increase consumption (i.e. to receive more consumption goods) by the quantity equal to his hourly pay or to reduce work (increase leisure time) by an hour and reduce consumption (i.e. to receive less consumption goods) by the quantity equal to his hourly pay. Therefore, in order to estimate the economy of time due to, for instance, improved transport system, the salaries of persons using this transport system may be used. For example, if a quicker underground or automation of the traffic lights system reduced the time necessary to go to/from work by 30 minutes, and the salary is LTL 10/hour, the value of time savings is LTL 5 per day. Upon calculating and summing up the values of time saved by each person the total value of time saved over a time unit is obtained. In order to evaluate decisions having an impact on the probability of death (e.g. in the area of transport, public order and healthcare) two main methods can be applied. Constructive method it estimates what a person would have earned if he stayed alive (until his/her standard age of death). This is done by extrapolating his/her employment history, comparing it with the revenue history of other persons holding a similar position. The weakness of this method is that it does not distinguish between a living duration and the related being alive. This is the reason why, according to this method, upon retirement a persons life has a zero value as there is no loss of revenue. Revealed preference method (previously discussed in Table 7). This method estimates the value of life by analysing how much additional revenue a person needs in order the increase of probability of his death is compensated. This revenue is reflected by the market wage for more risky jobs. For instance, some professions have a much higher probability of death than others. Persons in riskier jobs generally require compensations for additional risk. By selecting a riskier occupation they show their agreement to a higher probability of death if this means higher revenue. One of the methods used to assess the environmental impact of a public initiative is a contingent valuation method. This is a survey-based method intended for estimating the value of non-market goods. The aim of a survey or an interview is to find out respondents willingness to pay for a public asset, how much an individual is willing to pay for positive quantitative and qualitative changes of natural resources. During the survey a resident can be asked how he/she evaluates particular actions of the state policy aimed at the preservation or improvement of natural resources, or whether or not he/she would be willing to additionally pay, in the form of taxes, for positive changes. An individual can also be asked what amount would be sufficient to him to refuse a certain public asset.

Value of life

Value of natural resources

Source: R.Kuodis. Lietuvai silytinas kat naudos analizs modelis.

28

Example 5: estimation of the price of saved life years Robert E. Hall and Marc Lieberman48 presented systemised information on the costs for one saved life in the U.S. by applying different instruments. In order to increase the number of saved life years by one: 1. doctors advice to give up smoking to a smoking patient costs 150 US dollars; 2. mammography for early breast cancer diagnosis (every 3 years, for women aged 50-64) 2 700 US dollars; 3. heart transplantation 157 821 US dollars; 4. safety belts in school buses 2 760 197 US dollars; 5. anti-terrorist security measures at airports around 8 000 000 US dollars; 6. ban on asbestos use in automatic transmissions over 66 000 000 US dollars.
Source: Robert E. Hall and Marc Lieberman (2005), Macroeconomics: Principles and Applications, SouthWestern Publishing.

It is important to note that the aforementioned methods for estimating the value of public assets without a market price require a lot of resources and therefore should be applied taking into account the extent of the initiative impact, accessibility of information necessary for analysis and the available resources. Furthermore, if the aforementioned methods do not lead to the estimation of costs and benefit in terms of money with sufficient accuracy, such estimation may be misleading rather than useful. In this case the recommendation is to carry out either a sensitivity analysis for the main (critical) variables (for more information see chapter 2.4.6) or a qualitative cost-benefit analysis.
2.4.3.4. Assessment of an administrative burden

An administrative burden is an element of costs and therefore, where this relevant 17, should be evaluated in terms of quantity during the assessment of the costs and benefits of a decision. The administrative burden means the costs incurred by business operators, residents, state and municipal institutions in performance of the statutory obligations18 to provide information to state and municipal institutions and their authorised persons about their activities and products as well as other statutory information19. To estimate the administrative burden resulting from regulation in terms of quantity a special methodology is designed the so-called standard cost model. It has received a wide application at EU level and within EU Member States. The model can be used for the assessment of a particular legal act, a provision or a group of legal acts. The administrative burden assessment consists of several main steps. In brief it can be stated the first steps include identifying which legal norms lay down information obligations, what is their nature and what actions are to be taken by business operators, citizens, state institutions or other
17 18

i.e. where a decision provides for the establishment or change of the information obligation. Information obligations is a wide term it covers such actions as a duty to declare, register, apply for a licence, an obligation to deliver reports, provide information to third parties (e.g. to indicate information on product labels), certification of products or processes, inspections, etc. 19 Order No 4-152 of the Minister for the Economy of the Republic of Lithuania of 2 May 2006 on the approval of the Methodology for the determination and evaluation of an administrative burden on business.

29

entities in order to implement these requirements. Afterward, a quality assessment of the burden is carried out. Costs attributed to the administrative burden are the following: time spent on implementation of the statutory information obligations; other costs incurred during information obligation implementation. In order to estimate the magnitude of administrative burden at enterprise, institutional or personal level it is necessary to asses the hourly rate of work of a person carrying out the action of information obligation implementation, the length of the working time spent for performing information actions, related additional costs (e.g. transport, software acquisition costs, etc.) and the frequency of carrying out the information obligation. Assessment of the total administrative burden on a state, regional or sectoral scale takes into account the number of entities that must implement the set information obligation.
Formula for calculating the administrative burden The annual administrative burden caused by a duty to provide data is calculated according to the following general formula:

Administrative burden (AB) = P x Q

Where: P the price of performing a standard information action (the hourly rate of work of the person carrying out an information action multiplied by the working time (in hours) spent on the information action) Q quantity (the number of entities carrying out an information action multiplied by the frequency information action carried out within one year)

In Lithuania special methodologies have been developed for the estimation of the administrative burden which are to be followed during assessment, i.e.: The administrative burden on business entities shall be assessed in accordance with the Methodology for the determination and estimation of an administrative burden on business approved by Order No 4-152 of the Minister for the Economy of the Republic of Lithuania of 2 May 2006. The administrative burden on the population shall be assessed in accordance with the Methodology for the determination and evaluation of an administrative burden on the citizens of the Republic of Lithuania and other persons approved by Resolution No 213 of the Government of the Republic of Lithuania of 23 February 2011. In the course of preparation of this Guide the Ministry of the Interior of the Republic of Lithuania was instructed to develop a special methodology for the estimation of an administrative burden on state and municipal institutions. A quantitative administrative burden estimation can be facilitated by special calculators. During the preparation of this Methodological Guide the development of Lithuanias electronic database of an administrative burden on business (calculator) was started. It is being developed on the basis of the EU administrative burden calculator Starter kit.

30

2.4.4. Estimating and discounting cash flows

2.4.4.1. Estimation of cash flows

Nearly every decision is relating to cash flows. The cash flows show how much money will be received and spent during each period of decision implementation. This information serves as a basis for a quantitative assessment. Net cash flows are calculated by deducting cash ourflows from cash inflows.
Net cash flow estimation formula Net cash flow = Cash inflows Cash outflows

Where cash inflows exceed cash outflows, a net cash flow is positive, where the received amount of cash is below the spent one, a net cash flow is negative (see Example 6).

Example 6: net cash flows An institution plans to upgrade its fine accounting software for a total of LTL 10 million. After the system is upgraded, the current costs (IT staff, employee training) will increase by LTL 20 million compared to those before system upgrading. However, the new software should help to save costs relating to the collection of fines as the controlling agencies will receive reliable information in a timely manner and the system will automatically send reminders to pay the fine, etc. Therefore, the upgrading of the system is expected to result in savings of LTL 65 million per year. The upgraded system is planned to be used for three years and afterward to be upgraded again.
Net cash flow calculation

Year Forecast cash inflows Forecast cash outflows (-) Forecast net cash flow 0 0 100 -100 1 65 20 45 2 65 20 45 3 65 20 45

Net cash flows are calculated on a yearly basis for the entire period of implementation of the decision in question. Where the implementation period of a decision is shorter than four years, the forecasting of monthly cash flows is advisable.
2.4.4.2. Discounting

A traditional view is that in the more distant future costs or benefit are incurred or derived the less relevant to us they are as most people would prefer receiving an asset of the same volume and quality now but not after two or more years. Furthermore, according to the value for money principle, a litas received after a year does not have the same value as a litas is worth today as a

31

litas received today can be invested and more than one litas received after a year. Respective economic estimations reflect these preferences. In many cases cash flows occur in different periods. Therefore, future inflows or future outflows should be discounted.

Discount factor Discounting means adjusting the future value for the current period. The present value of future cash is determined by using a discount factor, i.e. the number which makes the future inflows and outflows equal to the current inflows and outflows: 1 Discountfactor ( f ) (1 i) n Where: i discount rate; n year.

A discount rate used for the assessment of a public decision is referred as a social discount rate. In the assessment of long-term decisions the selection of a discount rate is essential: an initiative which seems to be good applying a low discount rate may be bad at a higher discount rate.
Before a study enabling the determination of the discount rate applicale to public decision-making is carried out in Lithuania it advisable for this purpose to use the discount rate on eurobonds issued on behalf of the State.

Present value calculation A discounted cash flow is obtained by multiplying the calculated net cash flows by the discount factor: Futurevalu e( FV ) Present value (PV) = n (1 i) or 1 Futurevalue( FV ) x (1 i)n where: i discount rate; discount factor.

32

For the convenience of calculation, discount factors for a 30-year period at a discount rate of 1 % to 10 % are presented in Annex 3 to this Methodological Guide.

Example 7: cash flow discounting Proceeding with the illustration presented in example 6 the present value of cash flows is calculated:
Calculation of the present value of cash flows

Year Forecast cash inflows Forecast cash outflows (-) Forecast net cash flow Discount factor = 1/(1 + 10%)n Present value = Current value x Discount factor 0 0 100 -100 1.0000 -100 1 65 20 45 0.9091 40.9 2 65 20 45 0.8264 37.2 3 65 20 45 0.7513 33.8

2.4.5. Methods for assessing and comparing alternative options The net present value method is most frequently used for the assessment and comparison of alternative options for a decision. Other assessment methods that can be employed for assessing alternative options for decisions: an internal rate of return, payback period and benefit/cost ratio. In order to enhance the reliability of decision-making (particularly when assessing complicated decisions), the recommendation is to use several assessment techniques: e.g. one main and another ancillary technique. The methods of alternative assessment and comparison are in more detail presented in further sections of the Guide.
2.4.5.1. Net present value

Net present value is one of the most important performance indicators of a decision alternative. The net present value (hereinafter referred to as the NPV) indicator is the sum of discounted cash flows over the period of decision implementation/application.

Net present value calculation The NPV is calculated according to the formula:
n

NPV
t 0

CFt xft

CF0 (1 i)0

CF1 CFn ... 1 (1 i) (1 i) n

where: CF cash flows; f discount factor; i discount rate; n the last year of the period; t the number of years from the beginning of a decision.

33

It should be noted that cash flows in the early years are usually negative and only become positive after a certain period. As their value deceases with time, negative cash flows in the early years of decisions existence are weighted more than the positive cash flows of the subsequent periods. Therefore, accurate identification of the initial assumptions is needed when applying the NPV method. The value of the discount factor (discount rate) and the choice of the time horizon are crucial for the calculation of the NPV (see Figure 6).
Figure 6 Inter-dependence of net present value and discount rate

The NPV shows (measures) the benefit of an alternative (the improvement of societys wefare resulting from the decision i.e. the added value created for society in terms of money), calculated at the todays value of money. If the NPV is positive (>0), a decision is generating the net benefit. The NPV allows a comparision of different afternatives of a decision and making a decision on the most acceptable one. The recommendation is to consider the net present value as the main criterion which allows a concludion on the attractiveness of different decision alternatives.

In the case of projects of commercial nature the alternative with the highest NPV is generally selected. However, in the case of public decisions when all incurred costs and derived benefits are difficult to quantify. the NPV should be only one of the criteria for decision assessment, alternative acceptance/rejection. In other words, a decision with the highest NPV indicator is considered to be the most attractive if other conditions are equal. If alternatives differ in some aspects, the NPV is not the only criterion to be followed in adopting a decision on the most acceptable alternative. For instance, one of decisions (alternatives) may generate a noticeably higher net intangible benefit. A negative (<0) NPV also does not serve as the basis for rejecting a decision as other important factors of quality can have an influence.

34

Example 8: net present value (NPV) Proceeding with the illustration presented in example 6 the NPV is calculated:
Net present value calculation

Year Forecast cash inflows Forecast cash outflows (-) Forecast net cash flow Discount factor = 1/(1 + 10%)n Present value = Current value x Discount factor Total present value (i.e. the NPV)

0 0 100 -100 1.0000 -100 -100

1 65 20 45 0.9091 40.9 -59.1

2 65 20 45 0.8264 37.2 -21.9

3 65 20 45 0.7513 33.8 11.9

35

Example 9:

use of NPV calculators

For NPV calculation it is recommended to use automatic calculators, such as Microsoft Excel. With this software the NPV is calculated observing the following procedure: The calculation function NPV is selected from the list of functions in cell B5 and the required variables of the formula are entered: 10 % discount rate (cell A1); net cash flows (cells B2:B4). The first cash flow (cell B1) is not included in NPV calculations and not need be discounted (see Excel extract below). Where the first net cash flow emerges in the coming period (not straight off), such a cash flow has to be discounted and the formula has to be the following: =NPV(B1:B4).

2.4.5.2. Internal rate of return

Another important indicator of decision assessment, based on the time value of money principle, is the internal rate of return (IRR). The internal rate of return (IRR) indicator is particularly useful if the determination of the proper discount rate is difficult. IRR is a discount rate at the presence of which the present values of expected payments (outflows) are equal to the present values of expected inflows, i.e. the NPV of all net cash flows generated by a decision is equal to a zero. In other words, the NPV indicator describes the relative possible level of payments (outflows).

36

Internal rate of return calculation The internal rate of return is calculated according to the formula:
n

NPV
t 0

St (1 IRR )t

CF0 (1 IRR )0

CF1 CFn ... 1 (1 IRR ) (1 IRR ) n

Graphic results of IRR calculations are presented in Figure 7.

Figure 7 Internal rate of Return

Value of the IRR indicator can be calculated automatically applying the appropriate financial functions of data processing software (e.g. Microsoft Excel) (see Example 10). The IRR indicator, like the NPV indicator, can be used for the comparison of several alternative decisions: by assuming that all the other factors are identical the decision with the highest IRR would be considered as the best. However, it is noteworthy that the IRR criterion does not allow the differentiation of different decisions: for instance, if the IRR is the only criterion of the comparison of alternatives, the decision whose NPV is one thousand litas and IRR is 25 % will be more attractive than the decision with the NPV of 1 million litas, and the IRR 20 %. Therefore, the recommendation is to analyse the NPV and IRR indicators at the same time in choosing the decision.

37

Example 10: use of IRR calculators The IRR can be calculated using automatic calculators, such as Microsoft Excel. In using this software the IRR is calculated in the following manner: From the list of functions select the IRR calculation in Cell B5 and enter the respective variables of the formula net cash flows (cells B1:B4) (see Excel extract below). The result of the calculation is the IRR of around 17 %, i.e. in this case, upon choosing any discount rate below 17 % the NPV will be above 0.

2.4.5.3. Payback period

Payback period is another criterion often used for decision assessment. The payback period indicator shows what the number of periods required to cover primary costs. In other words, the payback period is a time (in years) over which the benefit generated by the decision covers primary costs, i.e. the point at which the total net cash flows of the decision exceed a zero (>0).

38

Payback period calculation

If PI is a primary investment (primary costs), CFt cash flow over period t, the payback period n is the value which satisfies the condition:
n

PI
t 1

CFt

Where CFt a cash flow at the end of period t, the payback period n is determined from the dependence:
n

PI
t 1

CFt x

1 (1 f )t

The particular payback period can also be calculated according to the following formula:

PP

n pp

PI na CFa

where: PP payback period; npp year before full covering of investment; PIna the amount of non-covered investment at the beginning of the payback year; CFa the amount of the net flow of the full payback year.

Example 11: payback period calculation As the analysis of Example 8 above shows, the total net present value of a decision will go over 0 in the third year. Thus, in this case the payback period will be four years.

It is noteworthy that the payback period method has several important drawbacks: First, as net cash flows are not discounted, the time value of money is ignored. Second, the payback period indicator does not take into account the cash flows received after the payback period, i.e. it ignores later consequences of a decision. Third, this indicator allows the estimation of time but not the value of a decision. When assessing decision alternatives, the payback time is calculated for each of them and the obtained values are compared with each other. Like in the case of the previously discussed methods, the shorter the payback period is the more attractive the decision is if other conditions are the equal. In the case of a significant difference between decision alternatives, the recommendation is to carry out the payback period analysis in parallel with other assessment indicators (NPV and IRR) or apply the payback period as a limitation in making a decision.

39

2.4.5.4. Benefit-cost ratio

The last of the discussed decision assessment criteria is the benefit-cost ratio (B/C ratio).

Benefit-cost ratio calculation

The benefit-cost ratio (hereinafter B/C ratio) is defined by the formula:

B C

n t 0 n t 0

PV (inf)

PV (outf )[9]

where: PV(inf) total net cash inflows in the present value over period n; PV(outf) total net cash outflows in the present value over period n.

If the value of the B/C ratio is higher than one, a decision is considered to be acceptable as the benefit generated by it (measured by the present value of the total net inflows) is higher than the incurred costs (measured at the present value of the total net outflows). The higher is the value of the B/C ratio the higher is the value of the alternative in question. 2.4.6. Assessment of risk and uncertainties The previous chapters described how costs and benefit should be evaluated in order to compare different alternatives of a decision. Unfortunately, the forecast and actual costs and benefits will always differ. These differences can be predetermined either by certain shortcomings in the performed cost-benefit analysis or the risk, uncertainties of decision implementation. Risk is described as a possible deviation from the planned (expected) results of a decision. It can also be defined as a potential quantifiable probability of events20 the bigger are the changes of decision results and variations of their probabilities upon change of parameters, the bigger is the risk of decision implementation. Another risk-related term is uncertainty inaccurate, incomplete information about decision implementation conditions, in other words indefiniteness. Risk may arise from this uncertainty. Often the terms of risk and uncertainty are used as synonyms; however, it should be noted that it is only the risk that can be quantified, analysed and managed. In order to achieve successful implementation of an initiative, it is important to analyse related risk and possible consequences in advance. Such an analysis allows the selection of an acceptable alternative that meets the desired result and willingness to take a risk. The level of detail of a risk analysis should be decided on a case-by-case basis taking into account the scope of an initiative,

20

Probability is a quantitative measure of an event and defined as a percentage probability of event.

40

the degree of uncertainty of the key costs and benefits, and willingness to take a risk by the main stakeholder groups. Depending on the complexity of a decision, risk can be assessed using several methods. They are more extensively described in subsequent chapters.
2.4.6.1. Sensitivity analysis

The main technique for risk assessment is a sensitivity analysis. Sensitivity is understood as the response of assessment results to the changes of the main parameters (e.g. discount rate, life price, etc). The parameters whose changes, both negative and positive, have the major impact on the implementation results of an initiative are referred to as the critical parameters. The critical criteria vary according to the specific initiative and should be identified on a case-by-case basis. As a general criterion, the recommendation is to consider those parameters for which an absolute variation of 1 % gives rise to a corresponding variation of 1 % (one percentage point) in the NPV. The sensitivity analysis gives answers to two very important questions: (1) Would it be worth implementing an initiative if some main assumptions did not display? (2) Are there any actions to be taken in order to minimise risk prior to the implementation of the specific alternative? The process of sensitivity analysis comprises several steps. The identification of variables: for instance, the price (rate of inflation, energy prices, goods and services prices, real salaries, etc), demand (the number of population, volume of traffic, etc), investments (duration of construction, hourly labour costs, cost of land, cost of means of transport, cost of equipment, etc), quantitative parameters for benefits (sick rate avoided, mortality rate avoided, etc). It should be noted that the variables in question have to be, as much as possible, independent variables. Therefore, in order to avoid double-counting caused by internal dependencies the redundant deterministically dependent variables must be eliminated. These risk variables can be eliminated by choosing more significant risk factors, i.e. the factors with a wider range of impact. Additionally, variables should, as far as possible, be analysed in their disaggregated form (e.g. revenue is a compound variable but either quantity or price or both separately may be critical). Upon choosing the significant variables their impact elasticities can be evaluated, i.e. how much a change in variables impacts a change in the PNV or the IRR. Each time during the analysis it is necessary to change one variable (to assign a new value (higher or lower) to each variable) and identify the outcome of this change for the NPV or the IRR, thus noting the differences compared to the base case. The examples of the sensitivity analysis result is presented in Figure 8: considering the general criterion for the selection of the aforementioned 'critical variables (a variables variation of 1 % gives rise to a corresponding variation of at least one percentage point in the NPV) in this case the critical variables of demand and productivity.

41

Figure 8

Sensitivity analysis

Parameters energy cost price of other inputs demand productivity Source: European Commission. Guide to Cost Benefit Analysis of Investment Projects, July 2008.

2.4.6.2. Scenario analysis

A scenario (option) analysis is carried out for the selected critical variables. The scenario analysis is a form of sensitivity analysis. While under standard sensitivity analysis the influence of each selected variable on the decisions results and performance measures is analysed separately, scenario analysis studies the combined impact of determined sets of values assumed by the critical variables taking into account the correlation among these variables. A scenario may be any event or state of sufficient probability which can have a significant impact on several parameters of the decision at a time. Usually, apart from the extensively analysed main (basic) scenario for decision implementation, pessimistic (with worsened decision assumptions) and optimistic (with improved decision assumptions) options are analysed. The key assessment indicators, NPV, IRR, etc, are calculated for each of these options. In order to define the pessimistic and optimistic scenarios of a decision it is necessary to choose for each critical variable their minimal and maximal values in the range defined by the probability of these values. Below is presented an example of the scenario analysis (see Table 9).
Table 9 Example of scenario analysis

Criterion Assumptions Investments New jobs

Measurin g unit LTL job

Optimistic scenario 1,000,000 50

Baseline case

Pessimistic scenario 1,250,000 35

1,100,000 40

42

Criterion Operating costs Results NPV IRR

Measurin g unit LTL/year LTL Per cent

Optimistic scenario 100,000 800,000 8.7

Baseline case 120,000 357,000 6.5

Pessimistic scenario 130,000 -123,000 3.3

Source: V Centrin projekt valdymo agentra. Vieojo sektoriaus investicini projekt rengimo metodika, 2006.

Sensitivity analysis can take different forms from asking simple questions what, if.? as regards snall- and medium-scale decisions to detailed models intended for the analysis of largescale, important programmes or strategies.

2.5. Selecting the optimum alternative and comments on its implementation

On the basis of the calculation results of the costs and benefits and different alternatives of a decision and taking into account the importance of non-quantifiable elements, a conclusion regarding the optimum alternative is issued. It should be noted that the final decision on the alternative to be implemented is most often the matter of a political decision. Having completed the evaluation of decisions alternatives and proposed the most acceptable alternative, it is advisable to present comments on the procedure for the implementation, assessment and monitoring of this alternative. For instance, the following questions could be discussed:
How will decision implementation be organised and monitored?

What body will be responsible for decision implementation? Will decision implementation be possible considering budget limitations? How will functions be distributed among institutions and other participants? How will communication, data exchange be carried out? What will be the procedure for the monitoring and assessment of the appropriateness of decision implementation? (indicators, process, responsibilities, etc) What additional steps are to be taken in order to implement the proposed decision?

43

3. Instead of conclusions: useful tips and most frequent mistakes

This chapter briefly presents the questions to be asked by oneself when carrying out/after completion of the cost-benefit analysis. It also indicates the most frequent mistakes to be avoided during the cost-benefit analysis21 1. Have you included all costs and benefits? The analysis should include all costs even if they do not actually involve spending cash. For instance, it should evaluate the value of land, of existing buildings, and of all services provided by other state institutions. The only costs that can be ignored are those that have already been incurred or those common to all alternatives. Residual values should be estimated and included, whatever the length of the analyses period. 2. Should costs and benefit be equally evaluated for each alternative? The practice of highlighting the benefit of one alternative and the costs of another should be avoided. 3. Have you miscounted the use of real economic resources as a benefit? For example, the costs of building a stadium (materials, labour etc) is not a benefit to the economy. Often the jobs created by such projects are just a transfer from some other project. 4. Are all costs and benefits realistically valued? Was the risk of exaggerated optimism taken into account? What are the data on the implementation of similar initiatives? 5. If the net present value is very high, why hasnt the initiative been implemented earlier? A high net present value suggests a large return. If the net present value if very large, a useful check is to ask why the initiative hasnt been implemented earlier. 6. Are there any variables that influence the results of the initiative? Often there are one or two variables that drive the whole project, usually the price, capital cost and the level of benefits. As these costs/benefits can be hard to estimate, the recommendation is check the robustness of the analysis by undertaking a sensitivity analysis. 7. Have you considered too few alternatives? Decisions where there are no realistic choices are rare. There is always the do-nothing/status quo alternative and there will usually be choices as to the size, scope, form, or timing of initiatives. 8. Have you confused real and nominal values? All costs and benefits in an alternatives analysis should be evaluated by removing the impact of inflation. Changes in the price of particular goods and services relative to the general price level should be taken into account. Common examples of relative price changes are changes in real wages and the real exchange rate. 9. How have you selected a time horizon for the analysis? Time horizons need to be set in relation to the economic lives of non-current assets. Residual values should be included in the analysis for any assets that have some value beyond the appraisal period. 10. What about uncertainties in the analysis? Plans and forecasts seldom turn out as expected in practice during initiative implementation. Sensitivity analysis is the preferred technique for allowing for risk and uncertainty.

21

Prepared on the basis of the Cost Benefit Analysis Primer of New Zealand.

44

11. Have you evaluated all relevant elements? Factors such as environmental effects and similar should not be ignored if they cannot be quantified. At least a qualitative description of the effects of this kind should always be included in the analysis. 12. Have you discounted future costs and benefits? Costs and benefits occurring at different points of time are not equally valuable and should therefore be discounted. 13. Have you used average or marginal costs and benefits in calculations? The use of average instead of marginal costs could significantly distort the analysis. 14. Have you included interest on borrowed capital in the analysis? Even though the payments of interest on borrowed capital are financial costs, they have no significance as far as the economic cost-benefit analysis is concerned. The real resources used for initiative implementation labour, materials, equipment are the same regardless of the source of financing. 15. Have you excluded depreciation deductions from the analysis? Depreciation is an accounting device that does not necessarily reflect the real use of resources. Depreciation should not be included in the analysis in which case that would mean double-counting (i.e. capital costs would be doubled).

45

ANNEX 1 Recommended format of cost-benefit analysis presentation

[NAME OF THE INSTITUTION]

[TITLE OF THE DOCUMENT]

Report version [version number]

[place, date]

46

TABLE OF CONTENTS Summary 1. Background information and problem description 2. Objectives of the proposed decision
3. Alternative solutions to the problem 3.1. Status quo alternative - baseline case 3.2. Alternative No 1: [name] 3.x. Alternative No n: [name]

4. Alternatives impact analysis

4. 1. Status quo alternative (Baseline case) 4. 2. Alternative No 1: [name] 4.x. Alternative No n: '[name] 4.x. Conclusion on the optimum alternative

6. Comments on the implementation, monitoring and assessment of the optimum alternative 7. Conclusions

47

ANNEX 2

Examples of cost-benefit analysis

Examples will be prepared during the implementation of VORT-3 project after pilot expanded assessments have been carried out.

48

ANNEX 3

Discount factor

Factor for translating individual amounts to the net present value (discount tariff)
Discount rate Year 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 1.00% 1.0000 0.9901 0.9803 0.9706 0.9610 0.9515 0.9420 0.9327 0.9235 0.9143 0.9053 0.8963 0.8874 0.8787 0.8700 0.8613 0.8528 0.8444 0.8360 0.8277 0.8195 0.8114 0.8034 0.7954 0.7876 0.7798 0.7720 0.7644 0.7568 0.7493 0.7419 2.00% 1.0000 0.9804 0.9612 0.9423 0.9238 0.9057 0.8880 0.8706 0.8535 0.8368 0.8203 0.8043 0.7885 0.7730 0.7579 0.7430 0.7284 0.7142 0.7002 0.6864 0.6730 0.6598 0.6468 0.6342 0.6217 0.6095 0.5976 0.5859 0.5744 0.5631 0.5521 3.00% 1.0000 0.9709 0.9426 0.9151 0.8885 0.8626 0.8375 0.8131 0.7894 0.7664 0.7441 0.7224 0.7014 0.6810 0.6611 0.6419 0.6232 0.6050 0.5874 0.5703 0.5537 0.5375 0.5219 0.5067 0.4919 0.4776 0.4637 0.4502 0.4371 0.4243 0.4120 3.50% 1.0000 0.9662 0.9335 0.9019 0.8714 0.8420 0.8135 0.7860 0.7594 0.7337 0.7089 0.6849 0.6618 0.6394 0.6178 0.5969 0.5767 0.5572 0.5384 0.5202 0.5026 0.4856 0.4692 0.4533 0.4380 0.4231 0.4088 0.3950 0.3817 0.3687 0.3563 4.00% 1.0000 0.9615 0.9246 0.8890 0.8548 0.8219 0.7903 0.7599 0.7307 0.7026 0.6756 0.6496 0.6246 0.6006 0.5775 0.5553 0.5339 0.5134 0.4936 0.4746 0.4564 0.4388 0.4220 0.4057 0.3901 0.3751 0.3607 0.3468 0.3335 0.3207 0.3083 5.00% 1.0000 0.9524 0.9070 0.8638 0.8227 0.7835 0.7462 0.7107 0.6768 0.6446 0.6139 0.5847 0.5568 0.5303 0.5051 0.4810 0.4581 0.4363 0.4155 0.3957 0.3769 0.3589 0.3418 0.3256 0.3101 0.2953 0.2812 0.2678 0.2551 0.2429 0.2314 6.00% 1.0000 0.9434 0.8900 0.8396 0.7921 0.7473 0.7050 0.6651 0.6274 0.5919 0.5584 0.5268 0.4970 0.4688 0.4423 0.4173 0.3936 0.3714 0.3503 0.3305 0.3118 0.2942 0.2775 0.2618 0.2470 0.2330 0.2198 0.2074 0.1956 0.1846 0.1741 7.00% 1.0000 0.9346 0.8734 0.8163 0.7629 0.7130 0.6663 0.6227 0.5820 0.5439 0.5083 0.4751 0.4440 0.4150 0.3878 0.3624 0.3387 0.3166 0.2959 0.2765 0.2584 0.2415 0.2257 0.2109 0.1971 0.1842 0.1722 0.1609 0.1504 0.1406 0.1314 8.00% 1.0000 0.9259 0.8573 0.7938 0.7350 0.6806 0.6302 0.5835 0.5403 0.5002 0.4632 0.4289 0.3971 0.3677 0.3405 0.3152 0.2919 0.2703 0.2502 0.2317 0.2145 0.1987 0.1839 0.1703 0.1577 0.1460 0.1352 0.1252 0.1159 0.1073 0.0994 9.00% 1.0000 0.9174 0.8417 0.7722 0.7084 0.6499 0.5963 0.5470 0.5019 0.4604 0.4224 0.3875 0.3555 0.3262 0.2992 0.2745 0.2519 0.2311 0.2120 0.1945 0.1784 0.1637 0.1502 0.1378 0.1264 0.1160 0.1064 0.0976 0.0895 0.0822 0.0754 10.00% 1.0000 0.9091 0.8264 0.7513 0.6830 0.6209 0.5645 0.5132 0.4665 0.4241 0.3855 0.3505 0.3186 0.2897 0.2633 0.2394 0.2176 0.1978 0.1799 0.1635 0.1486 0.1351 0.1228 0.1117 0.1015 0.0923 0.0839 0.0763 0.0693 0.0630 0.0573

Source: HM Treasury. The Green Book. Appraisal and Evaluation in Central Government. Treasury Guidance.

49

ANNEX 4
Term Administrative burden

Glossary

Definition costs incurred by business operators, residents, state and municipal institutions in performance of the statutory obligations to provide state, municipal institutions or persons authorised by them with information about their activities, products or any other statutory information. Benefit any gain in the welfare of society or groups of persons from the implementation of the specific initiative (program, project, other intervention). Consumer surplus the difference between what a person is willing to pay for a commodity and the amount he/she actually is required to pay. Contingent a survey-based method which identifies the value of non-market valuation goods. Surveys and interviews that are aimed to find out individuals willingness to pay for a public good, i.e. how much the individual is prepared to pay for positive and negative changes of natural resources or accept a compensation for possible negative consequences. Costs are relating to actual resource use in the economy and reflect the best alternative uses that the resources could be put to. Cost-benefit an economic analysis method for identifying and quantifying all analysis (both direct and indirect) economic costs and benefits of a particular public initiative. Cost-effectiveness compares the costs of alternative ways of producing the same or analysis similar outputs/benefits. Deadweight the impact that would be achieved even if a public initiative (programme, project) were not implemented. Discounting the process of adjusting the future values costs and benefits to present values using a discount rate. Discount rate the rate at which future values are discounted to the present Externality costs / benefits received or costs borne by third parties that are not benefits directly relating to the intervention. Hedonic pricing is one of the methods of revealed preference testing which analyses various characteristics of goods/serves sold in the market in order to estimate the value of non-market goods/services. Intangibles costs and benefits that are easily quantified in terms of money. Internal rate of the discount rate which results in a Net Present Value equal to return zero. Monte Carlo the risk analysis method which employs the assessment of analysis probability of occurrence of various circumstances. Future events are simulated with computer in order to evaluate the variability of the outcome, its parameters are assigned random values and probabilities, the combinations of parameters are made. Multicriteria a method for evaluating and comparing alternatives when

50

Term analysis

Definition alternatives are evaluated according to the selected criteria. Most often they are assigned relative weights reflecting relative importance of different criterion. Net present value the sum that results when the expected costs are deducted from the discounted value of the expected benefit. Operating costs expense on investment operations, including daily or special maintenance costs but less depreciation or capital costs. Opportunity costs The aggregate of goods and services that could have been acquired if funds had not been spent on the selected goods or services or for other purposes. It is the value of refused resources and lost opportunities resulting from the choice of another alternative. Residual value the net present value of assets at the end of the final year of the period selected for evaluation analysis. Revealed identification of individuals willingness to pay for a nonpreference market good on the basis of consumer behaviour in similar or associated markets. Risk a possible deviation from the planned/expected results. Scenario analysis a variant of sensitivity analysis that studies the combined impact of determined sets of values assumed by the variables on computation results taking into account the inter-dependence of variables. Sensitivity analysis the analysis carried out by estimating how the calculation results change upon changing various assumptions (variables). Social discount rate the discount rate used by the Government. Stated preference survey-based identification of the individuals willingness to pay for a non-market good. Travel cost analysis one of the methods of revealed preference testing, which seeks to put a value on the individuals willingness to pay for nonmarket assets estimated on the basis of the costs of travel to the particular place. Willingness to the amount of money (compensation) an individual is prepared accept to accept in exchange for refusal of a certain good/service. Willingness to pay the amount of money an individual is prepared to pay for a good or service.

51

ANNEX 5

Recommended bibliography

Bibliography of the cost-benefit analysis method 1. Boardman, A. E., Greenberg, D. H., Vining, A. R., Weimer, D. L. (2006), Cost-Benefit Analysis: Concepts and Practice, 3d ed., Prentice-Hall. 2. Kuodis R. Lietuvai silytinas kat naudos analizs modelis. 2009. // http://www.ekonomika.org/

Guidelines on the cost-benefit analysis 3. European Commission. Directorate General Regional Policy. Guide to Cost Benefit Analysis for Investment Projects. Structural Funds, Cohesion Fund and Instrument for Pre-Accession. 2008 // http://ec.europa.eu/regional_policy/sources/docgener/guides/cost/guide2008_en.pdf 4. HM Treasury. The Green Book. Appraisal and Evaluation in Central Government. Treasury Guidance. London. // http://www.hm-treasury.gov.uk./media/3/F/green_book_260907.pdf 5. New Zealand Treasury. Cost Benefit Analysis Primer. 2005. // http://www.treasury.govt.nz/publications/guidance/costbenefitanalysis 6. Office of Management and Budget. Circular No. A-94 Revised. 1992 // http://www.whitehouse.gov/omb/circulars/a094/a094.html#6 7. V Centrin projekt valdymo agentra. Vieojo sektoriaus investicini projekt rengimo metodika, 2006. The Republic of Lithuania legislation governing decision impact assessment 1. Resolution No 276 of the Government of the Republic of Lithuania of 26 February 2003 on the approval and implementation of the Methodology for proposed decision impact assessment. 2. Resolution No 1244 of the Government of the Republic of Lithuania of 30 September 2009 on the approval of the Legislative Rules of the Government of the Republic of Lithuania 3. Order No 4-152 of the Minister for the Economy of the Republic of Lithuania of 2 May 2006 on the approval of the Methodology for the determination and evaluation of an administrative burden on business 4. Order No 213 of the Government of the Republic of Lithuania of 23 February 2011 on the approval of the Methodology for the determination and evaluation of an administrative burden on the citizens of the Republic of Lithuania and other persons.

52