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Assignment Questions EMCA5103 Project Cost Analysis and Appraisal

January 2010 Sr Dr. Zulkiflee Abdul Samad

Student Name: Anas Alam Faizli Student ID No. CGS 00385017


Center of Graduate Studies MPM Intake: January 2009

JANUARY SEMESTER 2010


PROJECT COST ANALYSIS AND APPRAISAL – EMCA5103
ASSIGNMENT (45%)

LECTURER
SR DR ZULKIFLEE ABDUL SAMAD

STUDENT
ANAS BIN ALAM FAIZLI
Assignment Questions EMCA5103 Project Cost Analysis and Appraisal
January 2010 Sr Dr. Zulkiflee Abdul Samad

Student Name: Anas Alam Faizli Student ID No. CGS 00385017


Center of Graduate Studies MPM Intake: January 2009

OPEN UNIVERSITY OF MALAYSIA (OUM)

Programme: Master of Project Management

Coordinator: Assoc Prof Ir. Dr. Kanesan Muthusamy

Module: EMCA5103 Project Cost Analysis and Appraisal


Credits: 3

Facilitator: Sr Dr. Zulkiflee Abdul Samad


Mob: 016-3946254 Email: zulkiflee1969@yahoo.com

Semester: January 2010

Date: 15th February 2010

ASSIGNMENT QUESTIONS

INSTRUCTIONS TO CANDIDATES:
Answer both questions. The answer for each question should be about 2,500 words.

1. Cost-Benefit Analysis (CBA) is a method of evaluating the relative merits of


alternative public investment projects in order to achieve efficient allocation of
resources. It helps to identify, portray and assess the factors which need to be
considered in making rational economic choices. However, there are still
misconceptions about CBA.

Discuss in detail three common misconceptions about CBA.

(50 marks)

In order to understand the origin of the Cost Benefit Analysis’s (CBA)


misconceptions are first by having a rough idea on what CBA is all about. Robert
Merton put this cleverly when he was quoted as saying that "a false definition of
the situation evokes a new behaviour which makes the original false
conception come true". A brief understanding of what CBA does will provide a
good solid head start to how these misconceptions came about.
The key underlying principle of cost-benefit analysis is the comparison of social
benefits with corresponding costs. If benefits exceed costs, decision-makers have a
case for proceeding with a project. If costs exceed benefits, and the decision-
Assignment Questions EMCA5103 Project Cost Analysis and Appraisal
January 2010 Sr Dr. Zulkiflee Abdul Samad

Student Name: Anas Alam Faizli Student ID No. CGS 00385017


Center of Graduate Studies MPM Intake: January 2009

maker proceeds with the project, then she or he is at least informed of the net cost
that society needs to bear.
Simply put, CBA is a framework or tool use to compare the pros (benefits) and
cons (costs) between project choices. Both needs to be quantified if possible, even
when it is not possible.
By execution, CBA is simply adding up all the expected gains (benefits) from the
project and subtracting all the losses, and then choosing the alternative that
maximizes net benefits.
Looking at the origin of CBA, The concept was introduced back in 1848 by an article
written by Jules Dupuit and was then further formalized by Alfred Marshall and
Pigou. These economists, and their numerous twentieth-century successors, have
assiduously debated and refined the underlying concepts within the broader and
coherent analytical construct of welfare economics.
It was later practiced by the Corps of Engineers in the United States thanks to the
Federal Navigation Act of 1936. The act calls for cost benefit-analysis requirement.
CBA was later adopted as a federal policy in 1939 by the United States. Slowly, all
government departments are depending on CBA. It is then heavily used by the
government and big corporations even until today to make economic decision and
help appraise projects. The last government instruction with regards to CBA was a
subsequent presidential Executive Orders (12291: Reagan 1980 and 12866:
Clinton 1993) have stipulated government requirements for the analysis of costs and
benefits of regulatory proposals prior to their adoption.
Throughout its history, cost-benefit analysis has been subjected to critical scrutiny
and attack for being overly focused on economic efficiency. Wildavsky (1966: 310),
for example, argued that economic perspectives should not ‘swallow up political
rationality’, and Peter Self argued (Coleman & Hagger 2001: 120–6) that
government-employed town planners, rather than ‘econocrats’, should determine the
character and amenity of new towns. As part of this reaction, according to Lichfield
(1993: 206), Italian and Dutch researchers in the 1970s began to work increasingly
with multi-criteria analysis, and Quinet (1993: 193) reports the same shift away from
cost-benefit analysis in France. In the UK, the then Department of Environment,
Transport and the Regions (1998) set out a ‘new approach to appraisal’ of road
projects that was based on five principal criteria: environmental impact, safety,
Assignment Questions EMCA5103 Project Cost Analysis and Appraisal
January 2010 Sr Dr. Zulkiflee Abdul Samad

Student Name: Anas Alam Faizli Student ID No. CGS 00385017


Center of Graduate Studies MPM Intake: January 2009

economy, accessibility, and integration. Considerable effort has been made over the
last decade within European Union countries to reconcile cost-benefit analysis with
the multi-criteria analysis approach.
According to Bruce Hokin (2007), an experienced accountant (FCPA), the three
misconceptions about CBA are that CBA is only applicable to big businesses and
government. Secondly is that CBA is too complex for a layman to understand and
finally is that CBA takes too long time to learn.
According to Edward M. Gramlich (2003), there are three common
misconceptions about CBA. One is that CBA is a mechanical substitute for
common sense. Second is that it is unethical to use CBA for making public policy
decisions and finally regards the difference between a net improvement and a
confirmed cure.
What did Edward means by saying that CBA is a mechanical substitute for common
sense? CBA is a framework for organizing thoughts, or considerations. Nothing
more and nothing less. For all real world choice, there will always exist
considerations that cannot be easily quantified. CBA does not and should not try to
hide this uncertainty. The best way to deal with uncertainty is to quantify what can
be quantify and go as far as possible for those unquantifiable benefits versus costs.
Despite this being a popular misconception, cost-benefit analysis is not founded on
market prices alone. Benefits to society are measured as an aggregation of
individuals’ willingness to pay, and social costs reflect opportunities forgone. An
individual’s willingness to pay for water, for example, may be several thousands of
dollars a year. But the price actually paid for that water by an individual may be far
lower (perhaps just several dollars per year). The difference between the individual’s
willingness to pay and the price they pay is defined as the benefit generated from
the consumption of the water. Thus price alone does not define the benefit. It is the
willingness to pay net of the price. The net social benefit of making water available to
all the individuals in a community is the present value of the difference between the
sum of the residents’ net willingness to pay (their ‘consumers surplus’) and the sum
of the opportunity costs of the resources used in supplying the water. Simply
because a good or service is not marketed, and hence is not priced, does not mean
that it does not generate a benefit to society. So long as there is a willingness to pay
for the non-marketed good or service, there will be a benefit enjoyed. CBA is not a
Assignment Questions EMCA5103 Project Cost Analysis and Appraisal
January 2010 Sr Dr. Zulkiflee Abdul Samad

Student Name: Anas Alam Faizli Student ID No. CGS 00385017


Center of Graduate Studies MPM Intake: January 2009

mechanical substitute for common sense. CBA includes common sense in


judgement as it tries it level best to quantify as much as possible. CBA is extremely
quantitative, and it may factor out some excellent ideas that don’t present an
immediately apparent financial return. While cost/benefit analyses can also take into
account qualitative value, this is much more difficult to determine because it’s often
based on intuition. This open up the room for CBA misconceptions to appears.
Nonetheless, this form of analysis is extremely useful because it enables you to
frame an argument in terms of costs and benefits. And getting a project’s approval is
often contingent on that argument. Cost/benefit analyses are rife with assumptions
that are not varifiable, and it can be difficult to put a value on the non-tangible
aspects of a new project or initiative. One way to deal with this is to try looking at
what the cost would be if you didn’t implement the plan. This gives you an idea of the
worth of the project, including its non-tangible aspects.

The second major misconception on CBA is that it is unethical to use CBA to make
public policy decisions. Why is that? This is because public policy decisions always
involved weighty matters. Let put two decisions side by side. One is to construct a
bridge which construction workers might lose their lives and the other is to spend
on cancer research which might in turn save lives. The saving and or losing lives
are a big decision to make. So what do we do? Academics tend to shy away from
this and blame CBA to be helpless thus creating this misconception. Despite the fact
that some academician believes that such issues should not be turn to CBA, CBA
still does offer helps. What happen if the bridge workers are getting high wage to
build the bridge and is already aware of the risks involved? And the bridge workers
themselves opted to work for the bridge which is better than other jobs in town? Is it
possible to conclude that those risks are already incorporated into the market costs
of the project and this can then be weigh? Or do we choose to spend everything on
the cancer research which might not prove to be fruitful also? There has to be some
form of balance in terms of weighing this options and CBA will prove a tool that
can be used. In order for CBA not to be arbitrary or fetishist, some connection
between the currency of the economic analysis and human well-being must be
established. The monetary value of goods is usually chosen for this purpose,
because it is said to reflect the strength of individuals’ preferences for that good,
Assignment Questions EMCA5103 Project Cost Analysis and Appraisal
January 2010 Sr Dr. Zulkiflee Abdul Samad

Student Name: Anas Alam Faizli Student ID No. CGS 00385017


Center of Graduate Studies MPM Intake: January 2009

which in turn is a measure of the well-being provided by it. Yet various objections
have been raised regarding this approach. First, some goods and services—such as
most ecosystem services—are not traded in markets at all, and therefore no
monetary value can be ascertained. The social sciences have developed various
surrogate methods to rectify this deficiency, and “contingent valuation” (CV) has
been particularly influential. Through CV, economists seek to create hypothetical
markets by eliciting people’s “willingness to pay” (WTP) for the satisfaction of a
preference if there was a market. However, WTP has been criticized as an
inadequate proxy for market prices because of the ambiguity and limited reliability of
the stated preferences used in CV (as opposed to those revealed in the market).
There is also some doubt as to whether coherent preferences on policy issues are
actually susceptible to valuation and extractable through interviews or
questionnaires.
Second, preferences conceal well-known facts about human nature, and they are
therefore not always a suitable basis for policy decisions. For example, individuals
may adjust their aspirations to their perceptions of possibilities; preferences may be
misinformed or malformed, and they may therefore cause individuals to inflict harm
on themselves (e.g., the addict; the gambler) or on others (e.g., the murderer); and
preference satisfaction fails to accord the proper moral status to those beings that
are incapable of expressing a preference—whether human (e.g., children) or
nonhuman (e.g., animals).
Finally, where monetary valuation in a market is possible, that value may not be a
valid indicator of the wellbeing the good provides to society because of the
conceptual difference between a good’s monetary “exchange value” and its “use
value.” Gold, for example, has a high exchange value but a low value in actual use.
The use value of the air we breathe, by contrast, is infinite (it being a physical
necessity for our lives), while its exchange value is zero.
Once attributes of well-being have been valued, CBA requires that they be
aggregated into a single standard. They need to be compared across lives, so that
an increase in well-being for individual A in one dimension can be weighed against
the foregone improvement individual B would have experienced in another. This is
no easy task. It may be possible to make comparisons of well-being in an ordinal
sense—in the case of, say, health care, one person may be able to stipulate that he
Assignment Questions EMCA5103 Project Cost Analysis and Appraisal
January 2010 Sr Dr. Zulkiflee Abdul Samad

Student Name: Anas Alam Faizli Student ID No. CGS 00385017


Center of Graduate Studies MPM Intake: January 2009

or she feels better than someone who is in great physical pain—but not in a cardinal
sense. That is to say, a person cannot know exactly how much better he or she is.
Cardinality presupposes two characteristics of the currency used: (1) a number must
be attached to the outcome that represents the strength of the preference relative to
others, so that a health state of, say, 0.6 is three times better than one of 0.2; and (2)
the scale must have an equal interval property where equal differences at different
points along the scale are equally meaningful, so that boosting a patient from, say,
0.1 to 0.2 on that scale is of equal benefit to raising someone from 0.8 to 0.9.
Despite various methodological advancements, these requirements are still not met
for all CBAs.
CBA imposes a unitary standard on the valuation and comparison of goods, and
it thus subordinates other values to the new standard of monetary exchange value.
In environmental CBAs, for example, the existence value of nonhuman species, the
survival of which is deemed to be worth protecting, may be overridden by CBA
calculations. Their value cannot be priced in real or hypothetical markets because
the expected benefit of their survival does not accrue to those who might be asked to
reveal or state a WTP for their preference.
As far as human beings are concerned, similar predicaments present themselves:
is it permissible to kill one person because his organs could save the lives of four
patients whose names are on a donor waiting list? Most of us would consider this
option to be objectionable, but given the rationale of CBA it is justifiable, if not
mandatory, to proceed that way. What about people working in the highly risk oil
and gas industry? Should we shutdown all oil fields in that exist in the world? The
problem encountered here is that with CBA every individual counts as one, and
can thus be added up to, or traded against, someone else. In so doing, CBA will
override the intrinsic value of human life, a term that denotes our interest in our own
continued existence according to which we cannot be used solely as a means for
other individuals’ ends. Yet, this is what CBA would recommend us to do. Intrinsic
values are nonrelational; that is, they are not defined relative to some other human
being, species, or object, nor to the benefit it might provide to them.
The objections presented here are not a reason to reject CBA per se, for it does
provide relevant information. Yet they are a reminder that economic evaluations such
Assignment Questions EMCA5103 Project Cost Analysis and Appraisal
January 2010 Sr Dr. Zulkiflee Abdul Samad

Student Name: Anas Alam Faizli Student ID No. CGS 00385017


Center of Graduate Studies MPM Intake: January 2009

as CBA should be understood as an input into, rather than a substitute for, political
deliberation and judgment.
The third misconception regards the difference between a net improvement and a
panacea. Edward pointed out that government programs are usually over
advertised, i.e – program X can cure poverty. But when program X was
implemented and poverty still exists then the problem surfaced because the public
will presume that program X has failed when it has not. As Franklin and Lincoln had
said a policy measure is worth adopting if its benefits exceed its costs and
thereby makes a net improvement even if it doesn’t solve deep problems and issues.
Here the CBA will play its pivotal role to decide if a public policy decision is worth the
implementation. One such question is the comparison of the benefits and costs of
proposed policies – plays a truly useful role in making public policy decision, or is it
little more than a distraction of attention from more important perspectives on public
policy, or – worst of all – is it counter-productive, even antithetical, to the
development, assessment, and implementation of sound policy in for the public, in
term of environmental, resource, and energy realms. With an exceptionally talented
group of thinkers – including scientists, lawyers, and economists – now in key
environmental and energy policy positions within the government, the Department of
Safety and Health (DOSH), the Ministry of Energy and Communication, and the
Ministry of Finance, this question about the usefulness of CBA is of particular
importance.
For many years, there have been calls from some quarters for greater reliance on
the use of economic analysis in the development and evaluation of environmental
regulations. Most economists would argue that economic efficiency — measured as
the difference between benefits and costs — ought to be one of the key criteria for
evaluating proposed regulations. Because society has limited resources to spend on
regulation, such analysis can help illuminate the trade-offs involved in making
different kinds of social investments. In this sense, it would seem irresponsible not
to conduct such analyses, since they can inform decisions about how scarce
resources can be put to the greatest social good.
In principle, CBA can also help answer questions of how much regulation is
enough. From an efficiency standpoint, the answer to this question is simple —
regulate until the incremental benefits from regulation are just offset by the
Assignment Questions EMCA5103 Project Cost Analysis and Appraisal
January 2010 Sr Dr. Zulkiflee Abdul Samad

Student Name: Anas Alam Faizli Student ID No. CGS 00385017


Center of Graduate Studies MPM Intake: January 2009

incremental costs. In practice, however, the problem is much more difficult, in large
part because of inherent problems in measuring marginal benefits and costs. In
addition, concerns about fairness and process may be very important economic and
non-economic factors. Regulatory policies inevitably involve winners and losers,
even when aggregate benefits exceed aggregate costs.
Over the years, policy makers have sent mixed signals regarding the use of CBA in
policy evaluation. In America, as an example, the Congress has passed several
statutes to protect health, safety, and the environment that effectively preclude the
consideration of benefits and costs in the development of certain regulations, even
though other statutes actually require the use of CBA. At the same time, American
Presidents Carter, Reagan, Bush, Clinton, and Bush all put in place formal
processes for reviewing economic implications of major environmental, health, and
safety regulations. Apparently the Executive Branch, charged with designing and
implementing regulations, has seen a greater need than the Congress to develop a
yardstick against which regulatory proposals can be assessed. CBA has been the
yardstick of choice.
Even now, President Obama is considering putting in place a new Executive Order
on Regulatory Review. It is proven that CBA has a potentially important role to play
in helping inform regulatory decision making, though it should not be the sole basis
for such decision making. In order for this to happen 8 principles can be adhered
to:
First, CBA can be useful for comparing the favourable and unfavourable effects
of policies, because it can help decision makers better understand the implications of
decisions by identifying and, where appropriate, quantifying the favourable and
unfavourable consequences of a proposed policy change. But, in some cases, there
is too much uncertainty to use CBA to conclude that the benefits of a decision will
exceed or fall short of its costs.
Second, decision makers should not be precluded from considering the economic
costs and benefits of different policies in the development of regulations.
Removing statutory prohibitions on the balancing of benefits and costs can help
promote more efficient and effective regulation.
Assignment Questions EMCA5103 Project Cost Analysis and Appraisal
January 2010 Sr Dr. Zulkiflee Abdul Samad

Student Name: Anas Alam Faizli Student ID No. CGS 00385017


Center of Graduate Studies MPM Intake: January 2009

Third, CBA should be required for all major regulatory decisions. The scale of a
CBA should depend on both the stakes involved and the likelihood that the resulting
information will affect the ultimate decision.
Fourth, although agencies should be required to conduct benefit-cost analyses for
major decisions, and to explain why they have selected actions for which reliable
evidence indicates that expected benefits are significantly less than expected costs,
those agencies should not be bound by strict benefit-cost tests. Factors other
than aggregate economic benefits and costs may be important.
Fifth, benefits and costs of proposed policies should be quantified wherever
possible. But not all impacts can be quantified, let alone monetized. Therefore, care
should be taken to assure that quantitative factors do not dominate important
qualitative factors in decision making. If an agency wishes to introduce a “margin of
safety” into a decision, it should do so explicitly.
Sixth, the more external review that regulatory analyses receive, the better they are
likely to be. Retrospective assessments should be carried out periodically.
Seventh, a consistent set of economic assumptions should be used in calculating
benefits and costs. Key variables include the social discount rate, the value of
reducing risks of premature death and accidents, and the values associated with
other improvements in health.
Eighth, while CBA focuses primarily on the overall relationship between benefits and
costs, a good analysis will also identify important distributional consequences for
important subgroups of the population.
From these eight principles, we concluded that CBA can play an important role in
legislative and regulatory policy debates on protecting and improving the natural
environment, health, and safety. Although formal CBA should not be viewed as
either necessary or sufficient for designing sensible public policy, it can provide an
exceptionally useful framework for consistently organizing disparate information, and
in this way, it can greatly improve the process and hence the outcome of policy
analysis.
If properly done, CBA can be of great help to agencies participating in the
development of environmental regulations, and it can likewise be useful in evaluating
agency decision making and in shaping new laws.
Assignment Questions EMCA5103 Project Cost Analysis and Appraisal
January 2010 Sr Dr. Zulkiflee Abdul Samad

Student Name: Anas Alam Faizli Student ID No. CGS 00385017


Center of Graduate Studies MPM Intake: January 2009

Thus it is bad misconceptions that public policy decision makings using CBA cannot
provide the complete panacea for solving the problems.

It is worth to also note that according to Bruce Hokin is that CBA is very complex for
layman to understand and is difficult to learn. Personally, I had the same
misconceptions before reading about the cost benefits analysis. It sounds very
complex as the CBA serves as a project decision tool. This is a wrong
misconception. Let us take two case studies to show how simple CBA is used.

Case Study #1:


Background Checks
A negligent hiring case decided in a New Jersey court ruling in 2003 resulted in a
jury award of $40 million to the family of a 74-year-old woman who was stabbed to
death by a home health care worker. The agency that employed the worker was
found liable for 40% of damages because it reportedly failed to conduct a
background check despite the worker's disclosure of a prior burglary conviction. A
background check would have also revealed the worker was previously fired from
another agency. The judge in the case reduced the award to $2 million, with an
option to the plaintiffs to retry the case on damages only. The case was later settled.
Total Cost: With 600 employees, and an average remover of 100% in nurse aides,
conducting annual criminal and employment checks at $30 per check would have
cost the agency a maximum of $18,000 annually.
Total Benefit: It is estimated that the employer's negligent hiring liability in the case
was $800,000 and its legal fees were $200,000. Thus, an employee screening
program could have provided a total benefit of $1,000,000 in savings.

Analysis Outcome: By subtracting total cost ($18,000) from total benefit


($1,000,000), we arrive at a positive $982,000 outcome.
Payback Period: In dividing the cost ($18,000) by the benefit ($1,000,000), we
arrive at a payback period of slightly less than one week annually.
The company was founded in 1988, but even if it had conducted background checks
on the same number of employees since its inception, its total screening investment
($288,000) would still have paid for itself in about four and a half years.
Assignment Questions EMCA5103 Project Cost Analysis and Appraisal
January 2010 Sr Dr. Zulkiflee Abdul Samad

Student Name: Anas Alam Faizli Student ID No. CGS 00385017


Center of Graduate Studies MPM Intake: January 2009

Case Study #2:


Background Checks
A 2000 negligent hiring case in Kansas City, Kansas resulted in a $500,000
settlement against a plumbing firm that hired a convicted felon with a history of drug
abuse. The employee used money from a customer to buy crack cocaine and later
returned to burglarize the customer's home and beat the customer to death. Because
the plumbing firm had reportedly failed to check the hire's prior employment
references or conduct a criminal background check, the case settled for the
maximum amount permitted under Kansas law in a wrongful death/survival claim.
Total Cost: Industry data shows plumbing and other construction industry firms are
typically small, with less than 10 employees, and experience an average of 60%
turnover. If we assume the plumbing firm in the case had 10 employees, and
conducted extensive background checks--including criminal checks, employment
checks, and drug testing--on six new hires at an estimated cost of $100 per hire, the
firm's total annual employee screening cost would be just $600.
Total Benefit: Employee screening could have saved this company $500,000 in
settlement fees and an estimated $100,000 in legal fees, for a total benefit of
$600,000.
Analysis Outcome: By subtracting the total cost ($600) from the total benefits
($600,000), a positive outcome of $599,400 is calculated.
Payback Period: In dividing the total cost ($600) by the total benefit ($600,000), we
arrive at a payback period of just one working day or eight hours annually.
This company has been in business since 1957, and the cost for conducting
background checks since its inception would have cost $28,200, based on steady
staffing and turnover levels. According to the same formula, this larger up-front
investment would have paid for itself in just over two years.
The two case study shows that CBA is a straight forward tools to gauge project costs
and benefits. It is purely weighing the costs over the benefits which any layman
could understand and figure out. The tough part is how to manage the
unquantifiable non-tangible values. That is the biggest challenge for CBA.
Assignment Questions EMCA5103 Project Cost Analysis and Appraisal
January 2010 Sr Dr. Zulkiflee Abdul Samad

Student Name: Anas Alam Faizli Student ID No. CGS 00385017


Center of Graduate Studies MPM Intake: January 2009

There will be many more misconceptions on CBA that will pop out during its
implementation, but understanding how CBA actually works will definitely clear the
air and helps understand and use CBA in project cost, analysis, appraisal and select
decision making process. Use CBA!
Assignment Questions EMCA5103 Project Cost Analysis and Appraisal
January 2010 Sr Dr. Zulkiflee Abdul Samad

Student Name: Anas Alam Faizli Student ID No. CGS 00385017


Center of Graduate Studies MPM Intake: January 2009

2. When demand and supply schedules are given or assumed, market prices
and quantities can be observed, and it remains only for the Cost-Benefit
Analysis (CBA) to interpret them properly. However, many times in a CBA
study there will be changes in quantities for which there is no market.

For markets that do not exist, explain in detail how CBA can infer valuations
for loss of life, capital values and time saving.

(50 marks)

As explained in previous question, CBA is able to deal with both quantitative and
qualitative analysis. For markets that do not exist, and where there is no pre-set
monetary value such as for loss of life, capital values and time saving there are
several ways on how CBA can infer the valuations. However, in many cases these
numbers can be changes by the projects to justify its ends. They might alter the risk
of death, health or safety, or perhaps they may waste or save time, etc. These
changes will affect the benefits of the project. How do we manage and analyst this
kind of situation then? One method proposed by Edward is to find an allied market
where the price or quantity change can be used to infer valuations for the missing
market. We will try to cover the 3 biggest non tangible values:-
⎯ Loss of Life
⎯ Capital Values
⎯ Time Saving
Let go for the first one, LOSS OF LIFE. How much is a man worth? Is it priceless?
Or there is a price tag to it? In order to make CBA works for non tangible and for
those that market does not exist, we need to quantify a uniform number to make it
works. This however will be subjective but we will do our level best to make it
closest to the situation that we are going to weigh the CBA, both pros and cons.
This issue is definitely the most controversial in nature as it affects human life which
is priceless.
CBA when involving policy action such as the risk of death in implementing safety
belts, research for cancer, road improvements, speed limits, construction works,
nuclear technology implementation, always face this issue. It is acceptable that
human lives are priceless and should not be valued with monetary value but in order
for CBA to work and in order for policy decision can be implemented; we need to
Assignment Questions EMCA5103 Project Cost Analysis and Appraisal
January 2010 Sr Dr. Zulkiflee Abdul Samad

Student Name: Anas Alam Faizli Student ID No. CGS 00385017


Center of Graduate Studies MPM Intake: January 2009

infer valuation on human live. This is so that we are able to make policy decisions
and continue to proceed with the betterment of human lives. If not, nothing can be
done. There will be no projects. There will be nothing once it involves risks no
matter how small to the human populations. So how do we do it?
Two methods have been identified and use for this. It is called the discounted future
earning (DFE) approach. Often used in lawsuits, involves the simple addition of the
future earnings of the deceased. These earnings are discounted by the rate of the
interest to adjust for the fact that earnings later are worth less than earnings now.
The assumption underlying such a calculation of DFE is to let the labour market
value the worth of a person. The problem is that is very definitely the wrong allied
market. The earnings of the person represent the marginal product of the person’s
labour services to an employer. If the person is already retired, this method yields
no value at all to his or her life. If the person is a minority member or a woman, the
DFE approach imputes less value than to a white male of the same age and
experience. And the method does not even count the value a person may place on
his or her own life. Many people, even if they have low wages and DFEs are quite
reluctant to put their lives at risk.
The theoretical problem with the DFE standard is apparent from a close examination
of what is gained and lost. The true gain is that some person gets to enjoys life
longer. Hence the person, not that person’s employer, should do the valuation. And it
should be a valuation of that person’s life not just the person’s labour services.
Therefore, a much better market valuation would be one where workers get to say
how much compensation they require to subject themselves to risk of loss of life,
precisely the approach of the RC standard.
The best such RC valuation comes from a different use of the labour markets.
Workers on some jobs have a very low statistical probability of dying on the job,
while workers on the other jobs have essentially no risk of dying on the job. Careful
studies of relative wage rate that hold constant education, experience , region, and
so forth have found that workers in the risky jobs get paid more, presumably
because workers in these jobs are aware of their job risk and require some
compensation for undergoing it. Working out the RC from these compensating wage
differentials yields an RC value of human life of from $2.5 million to $5 million in
1988 dollars, from five to ten times what one would get from a DFE standpoint. This
Assignment Questions EMCA5103 Project Cost Analysis and Appraisal
January 2010 Sr Dr. Zulkiflee Abdul Samad

Student Name: Anas Alam Faizli Student ID No. CGS 00385017


Center of Graduate Studies MPM Intake: January 2009

value is also higher than that implicit in all but two of 44 proposed, rejected, or
adopted rules recently analyzed by the Office of Management and Budget. Hence a
careful use of the RC standard would make society quite conservative about
decisions that endanger lives.
Stanford economists have demonstrated that the average value of a year of quality
human life is actually closer to about $129,000. Stefanos Zenios and his
colleagues at Stanford Graduate School of Business used kidney dialysis as a
benchmark. Every year dialysis saves the lives of hundreds of thousands of
Americans who would otherwise die of renal failure while waiting for an organ
transplant. It is also the one procedure that Medicare has covered unconditionally
since 1972 despite rapid and sometimes expensive innovations in its administration.
To tally the cost-effectiveness of such innovations Zenios and his colleagues ran a
computer analysis of more than half a million patients who underwent dialysis,
adding up costs and comparing that data to treatment outcomes. Considering both
inflation and new technologies in dialysis, they arrived at $129,000 as a more
appropriate threshold for deciding coverage. "That means that if Medicare paid an
additional $129,000 to treat a group of patients, on average, group members would
get one more quality-adjusted life year," Zenios says. Based on patient surveys, one
"quality of life" year is defined as about two years of life on dialysis.

Insurance companies also often do valuation on human lives. WHAT is 'human life
value' (HLV)? Yes, it is indeed difficult to put a price tag or insurance amount to a
person's life. But it must be done so that those who are left behind do not suffer
financially from the loss of an earning member. HLV is a concept used to calculate
the amount of life insurance cover that a person needs. HLV is your expected life
time earnings, that is, the income you are expected to earn over the remainder of
your working life.

Factors that needs to be considered while computing HLV:


1. Time frame during which you need to provide for your family
Say, your spouse, 25, is your sole dependent. After evaluating her health etc, she is
expected to live to be 75. This means, you’ll need to financially support her for 50
years (75 - 25 years).
Assignment Questions EMCA5103 Project Cost Analysis and Appraisal
January 2010 Sr Dr. Zulkiflee Abdul Samad

Student Name: Anas Alam Faizli Student ID No. CGS 00385017


Center of Graduate Studies MPM Intake: January 2009

2. Map out different expense events


These includes marriages, education expenses and other fund requirements of your
child, until the age the children are ready to be independent.
3. Household expenses
Observe current household expenses and run a rough estimate of future household
expenses as well.
4. External factors
Account for external factors like inflation and calculating how much more money in
the future will be equivalent to the money spent in the current time.
5. Debt liabilities and Income by way of returns
Account for the remainder of the loans that would need to be paid over time and also
factor in income from various investments you have made.
6. Medical expenses and emergency funds
Calculate an estimate of how much money should be set aside for medical expenses
and also account for emergency funds that will be set aside.

Follow these points to arrive at an approximation of the sum of money you will need.
This is your human life value from an insurance company stand point. However,
this need to recalculate from time-to-time as people’s lifestyle is likely to change over
a period of time and unexpected expenditure is likely to crop up.

Let us take a case study where www.humanforsale.com has a quiz that tells how
much a human live is worth. The quiz asks for your physical factor, mental factors,
lifestyle factors, and a personality factors. Each questions answered will provide the
monetary value attached to it. It is interesting to see how the portal website came
out with a figure. For this case study, I have used my own personal data to come out
with the figures. The websites also provide the reasoning why it gives such amount.

See below:
Physical Factors
Gender: Male - $200,000
Women are given $135,000 to start and men are given $200,000 to start.
Assignment Questions EMCA5103 Project Cost Analysis and Appraisal
January 2010 Sr Dr. Zulkiflee Abdul Samad

Student Name: Anas Alam Faizli Student ID No. CGS 00385017


Center of Graduate Studies MPM Intake: January 2009

Age: 30 - $20,000
This one is pretty simple. We valued younger people more than older people.
Ethnicity: Asian - $130,000
Different races were valued differently.
Height: 5'8 - ($10,000)
Height plays a very important rols in our lives. Especially in how we are treated by
others. British and Polish researchers have now provided statistical proof for a fact
that many men have always suspected: tall guys have a better chance...
Weight/Body Type: 156 lbs. / Average - $0
Discrimination is as much a fact of life for fat people as it is for other people outside
the "norm." Fat people earn less money, are turned down for... Find out more...
Hair Color: Black - $5,000
Do blondes really have more fun?
Eye Color: Brown - $1,000
The average person blinks about... Find out more...
Handed: Right - $5,000
Approximately 8 to 15% of the adult population is left-handed.
Body Hair: Somewhat Hairy - $1,000
Shoe Size: 8 - $0
The largest feet in the world belong to a Mr Matthew McGrory who lives in America
whose feet are a whopping size...
Bald: No - $15,000
20/20 Eyesight: Yes - $5,000
Do carrots really improve your vision?
Athletic Ability: Average - $35,000
Attractiveness: Above Average - $100,000

Mental Factors
IQ: 130 - $162,525
Why is IQ so important?
SAT Score: NA - $0
HS GPA: 3.3 - $28,500
Assignment Questions EMCA5103 Project Cost Analysis and Appraisal
January 2010 Sr Dr. Zulkiflee Abdul Samad

Student Name: Anas Alam Faizli Student ID No. CGS 00385017


Center of Graduate Studies MPM Intake: January 2009

Education: Degree - $45,000


Bilingual: Yes - $0

Lifestyle Factors
Income: Ok! - $45,000
Profession: Engineering/Architecture - $0
Alcohol: Never - $0
Smoker: Yes - ($50,000)
Pot: No - $10,000
Drugs: No - $10,000
Exercise: Occasionally - $5,000
Divorced: No - $0
Comitted Felony: No - $15,000
Watch Television: Occasionally - $5,000
Sitting too close to the TV could... Find out more...
Sexuality: Straight - $0

Personality Factors
Style: Above Average - $45,000
Artistic Ability: Average - $30,000
Sense of Humor: Average - $30,000
Addictive Personality: No - $10,000
Give to Charity: Yes - $0
Adult Content: Seldom - $0
Gamble: Never - $0

You are worth exactly $1,804,050 !!

The way the website valuate human lives might not be the best criteria used but
however it has given us the general idea on how human lives can be evaluated. I
have no problem though being evaluated at USD1.8 Million.
Assignment Questions EMCA5103 Project Cost Analysis and Appraisal
January 2010 Sr Dr. Zulkiflee Abdul Samad

Student Name: Anas Alam Faizli Student ID No. CGS 00385017


Center of Graduate Studies MPM Intake: January 2009

CAPITAL VALUES
Capital values are often changing. It is normal that upon implementing a project, the
capital or land values in the area is affected. Congesting traffics, noisy airports,
polluting factories and much other issue created from a project is able to lower land
values. There is no market in the allied market to fill up in the gap. Project can
also increase land value when there is a new road or highway build which will
increase business possibilities for land in a certain area. If there is a new
development in the area or a new shopping complex built can also cause the land
value to increase and vice versa. Edward provided a simple calculation with three
independent variables. Let’s take a look at how Edward does this. The logic here is
very simple. Suppose the value of land in an area (L) can be expressed as
(1) L : f(N,P,T,Z)

Where N refers to noise, P to pollution, T to travel time to some central location, and
Z to all the factors. An airport is going to be built near a particular community that will
affect the first three independent variables. It will raise noise levels and lower land
values, it will increase pollution and again lower land value, but it will reduce travel
time to various places and raise land values. How should the airport be evaluated? I
will not be going all technical with the calculation but will explain as much layman
term as possible for a concept known as the hedonic regressions.

According to Wikipedia, hedonic regression, also known as hedonic demand


theory, is a revealed preference method of estimating demand or value. It
decomposes the item being researched into its constituent characteristics, and
obtains estimates of the contributory value of each characteristic. This requires that
the composite good being valued can be reduced to its constituent parts and that the
market values those constituent parts. Hedonic models are most commonly
estimated using regression analysis, although more generalized models, such as
sales adjustment grids, are special cases of hedonic models.

An attribute vector, which may be a dummy or panel variable, is assigned to each


characteristic or group of characteristics. Hedonic models can accommodate non-
linearity, variable interaction, or other complex valuation situations.
Assignment Questions EMCA5103 Project Cost Analysis and Appraisal
January 2010 Sr Dr. Zulkiflee Abdul Samad

Student Name: Anas Alam Faizli Student ID No. CGS 00385017


Center of Graduate Studies MPM Intake: January 2009

Edward also shows how statisticians can estimate the hedonic regressions to give
the relevant partial derivatives. For examples, the partial derivatives δL/δN is the
impact of one unit changes in noise levels on land values. The net impact of the
proposed airport (A) on land values in this community is given by what is known as
the total derivative
(2) dL/dA = (δL/δN) (dN/dA) + (δL/δP) (dP/dA) + (δL/δT)(dT/Da)

The first bracketed expression in each term is from regression, the impact of noise,
pollution, and travel time on land values. The second bracketed term must be taken
from physical information about the airport – usually an environmental impact
statement will require this sort of information on what the airport is likely to do with
these values in surrounding areas. The net impact of the airport on this community is
then the sum of each change on land values. It could obviously come out either as a
plus or minus, depending on whether the good things outweigh the bad really is a
CBA in general, and indeed equation community in question, with the partial
derivatives from the hedonic regression answering the all-important valuation
question. If the airport is good thing, land values in the community will rise.

Having laid out the method, one can raise several questions about it. First, of course,
is that as in the loss of life example previously discussed, our allied market has to
work. If prospective buyers and sellers of land do not have the right information to
alter land values appropriately, or if for any other reason it is impossible to infer
proper valuations from land prices, the allied market approach to benefit-cost
analysis will break down.
Second, it should be kept in mind that CBA through allied market capital values
replaces all elements in the CBA. If there were expected to be atmospheric pollution
that would cause an expected increase in cancer deaths, it would be double-
counting to let pollution lower capital values through equation (2) and then tally the
expected losses of lives in addition. Presumably these heath risks are already
counted in regression, if the allied market is not working in the first place, and they
should not be double-counted. This difficulty means that it can be very tricky to use
this method: the analyst has to know what the market is and is not already counting,
and counts everything once but not more than once.
Assignment Questions EMCA5103 Project Cost Analysis and Appraisal
January 2010 Sr Dr. Zulkiflee Abdul Samad

Student Name: Anas Alam Faizli Student ID No. CGS 00385017


Center of Graduate Studies MPM Intake: January 2009

In Malaysia, real estate appraisal is known as Property Valuer. Valuer is a


professional who has been educated and trained to determine the value of fixed
property, execute feasibility studies and provide expert advice on property related
matters. An independent Valuer can provide impartial and motivated reports on the
value of real or limited rights in land.
The Valuer requires a combination of a number of professional qualities and
capabilities, and needs a thorough knowledge and understanding of the interacting
influences which create, maintain or diminish the value of property or rights therein.
The Valuer does not invent value, but interprets market forces, which determine
the value. Valuer is a profession closely related to real estate. A Valuer determines
the value of property based upon market conditions at a given time.
One of the frequent applications of the Valuer's skill is to determine values for
purchase or sale, and for insurance purposes.
Valuers are qualified to undertake valuations in all classes of properties, including
commercial and industrial properties; all types of residential properties, agricultural
and special use properties. However, most Valuers tend to specialize and do not
undertake the full range of valuations. It is therefore vitally important for clients to
select and appoint a registered Valuer with the relevant practical experience
required to undertake the specific valuation.
While it is essential as professional, the Valuers are governed by The Board of
Valuers, Appraisers and Estate Agents under provision of Valuers, Appraisers and
Estate Agents Act 1981. Its primary function is to regulate the Valuers, Appraisers
and Estate Agents practicing in Malaysia.
All this method can be used to infer valuations for capital values or land values.

TIME SAVING
How can we calculate the value of time and put monetary value on it? As
everything is getting faster and faster, development projects tend to be created to
save times. This is so true for transportation issues for travelling from point A to
point B. Time saving is valuable but what is the method to calculate it? The natural
allied market is the labour market. An hour saved is an hour that could be profitably
used for production, which means that the hourly wage rate that makes firms
indifferent between buying and not buying the last unit of labour should give the
Assignment Questions EMCA5103 Project Cost Analysis and Appraisal
January 2010 Sr Dr. Zulkiflee Abdul Samad

Student Name: Anas Alam Faizli Student ID No. CGS 00385017


Center of Graduate Studies MPM Intake: January 2009

implicit marginal valuation of time saved, at least for small changes in time saved.
Putting it another way, the value of a hour created by some time saving innovation is
the amount firms would have to be bribed to part with an hour from a productive
worker-the wage rate. All we have to do is to figure out which wage rate. Unlike most
prices that might be used to value output, wage rates vary tremendously by
occupation, region, and so forth, so one should probably use some average.
But there is a more difficult conceptual problem involving the implicit assumption that
all hours of time are perfect substitute. The subway may saved worker time at the
commuting hours, roughly the time that presumably would be saved were firms
induced to give up the requisite amount of hours. Would this be the same as the
value of vacation time saved by an internal translation of one into the other.
With all of these problems for each of these attempts to use allied markets, it is clear
that they should be used rather carefully. Trying to use allied markets to fill in some
missing values may be the best that can be done in a wide variety of cases, but the
investigator should try to ensure that this allied market satisfies minimal assumptions
for giving proper valuations. And as always, the investigator should use sensitivity
analysis to deal with what can often be wide uncertainties in knowing how allied
market outcomes should be interpreted.

Let do a simple calculation by putting dollar value to time. If we can save staff 2
minutes a day looking for information on the intranet, we can multiply this out by the
number of staff and the days in the year to get a huge productivity benefit. This can
then be used to justify the intranet redevelopment, and to demonstrate the benefits
of improving intranet usability.
The time saved can be multiplied by the average staff salary to get the figure.
Thus, a company with poor intranet usability would save $3 million per year if it
improved its intranet usability to an average level. And a company with average
intranet usability would save $2.4 million per year if it improved its intranet to the
usability level found in the best 25%.
Going still further, we can then compare the savings between “bad” and “good”
intranets, and even calculate economic benefits:
If we improved all the intranets in the world to the usability level achieved by the best
25% in our study, the world economy would save $311,294,070,513 per year for the
Assignment Questions EMCA5103 Project Cost Analysis and Appraisal
January 2010 Sr Dr. Zulkiflee Abdul Samad

Student Name: Anas Alam Faizli Student ID No. CGS 00385017


Center of Graduate Studies MPM Intake: January 2009

sixteen test tasks alone. Adding the likely savings from company-specific tasks leads
us to an estimated $600 billion in total annual productivity improvements. This level
of intranet productivity is a modest goal; we could realistically achieve it with an
investment of about $31 billion per year in intranet usability.
Assuming further usability improvements — up to the very best level we found for
each study task — could save the world economy $1.3 trillion per year when we
include estimated improvements in company-specific tasks.
This numbers are very huge but we cannot be looking at the cash benefit? So how
do we do it? How much time spent on the intranet versus working in the front line
systems? And furthermore, saving world economy of $1.3 trillion per year? Can
we get this as cash or equivalent. In practice, there are only two really ways to
realise the benefits: increase the number of tasks that can be done by the same staff
or lean management by reducing the headcount. Time saving and productivity is
indeed a complex issue. If we are able to save this 2 minutes a day for each
personnel, will they be spending this time in a productive ways? Or perhaps they will
continue to spend it for Facebook or reading news paper and other non-productive
issues? However this method of calculation will be difficult to be accepted by the
financial people. So how do we do this?

There is another alternative on how to calculate exactly how much time is worth
for every person. Perhaps we can start by calculating how much a person is making
and from there we can calculate how much he is actually earning per day and divide
it into 24 hours to know how much a person is earning every hour. Example Mr X is
earning RM240 per day. Divide this into 24 hours to calculate even the rest time and
the leisure times after work. This means Mr X time is worth RM10 per hour. By
doing this you can infer valuation to time saving of Mr X.

In conclusion, to infer valuations on the non tangibles where market do not exist is
very subjective but if it is done properly and can be accepted by the population, it
should be done as the CBA will allow for good methods to analyze and make a
public policy decision.
Assignment Questions EMCA5103 Project Cost Analysis and Appraisal
January 2010 Sr Dr. Zulkiflee Abdul Samad

Student Name: Anas Alam Faizli Student ID No. CGS 00385017


Center of Graduate Studies MPM Intake: January 2009

REFERENCE

1. Edward M. Gramlich , A Guide to CBA, Waveland Press, Inc. (1998)


2. S. L. Tang, Economic Feasibility of Projects: Managerial and
Engineering Practice, The Chinese University Press (2003)
3. Harold Kerzner (2006) Project Management: A Systems Approach to
Planning, Scheduling, and Controlling, John Wiley & Sons Inc.
4. Bruce Hokin (2007), 5 Steps to Cost Benefit Mastery
5. http://www.time.com/time/health/article/0,8599,1808049,00.html#ixzz0kbGy0gZE