Debate 1

Topic: Monetary valuation is essential in the project

evaluation phase in order to bring environmental effects to
the forefront of decision-making

AGREE
Participant 1: Martin
Participant 2: Marly
Participant 3: Mark
DISAGREE
Participant 1: Anna
Participant 2: Garth
Participant 3: Jessica

Debate 2
Topic: Philosophical debate on the preservation of the
environment based on the intrinsic value of natural resources
vs. extrinsic value (i.e. value to humans)

AGREE
Participant 1: Raphael Dumas
Participant 2: Graeme
Participant 3: Rebecca
DISAGREE
Participant 1: Elle
Participant 2: Thomas
Participant 3: Alex

CIV324 Week 4
Feb 3, 2012
Single objective and multiple objective evaluation
methods
Feb 10: Case-study of a CBA for high-speed rail in the QuebecWindsor Corridor & guest lecture.
Feb 17: Sample problems, wrapping-up evaluation stage
March 2: Midterm exam, in-class, 3 hours. Course notes and
slides are allowed (in hard copy only)

M. Hatzopoulou

Methods of evaluating project alternatives

I. Economic evaluation techniques
Benefit-Cost Ratio
Net Present Value
Annual Worth
Rate of Return
II. Use of weighing schemes that produce a score for each
alternative
III. (To a lesser extent) Cost-Effectiveness Analysis illustrates
trade-offs but does not indicate which alternative is the best

Economic evaluation techniques

These techniques estimate the monetary value of the benefits
and costs for individual projects (or project alternatives) and
their comparative worth

Costs and benefits for each year of the useful life of a project
are estimated, discounted to a base year, and then compared
on the basis of some decision rule (e.g. ratio of benefits and
costs must be greater than 1)
Being able to compare different streams of monetary benefits
and costs over time requires that there be some method for a
fair comparison. This is found in the concepts of discounting
and capital recovery.

Economic concepts of discounting and capital recovery

The worth of an alternative is determined by estimating the
monetary return on capital investment. To do this, one needs to
estimate the Real Value of Money
If one invests $10,000 today with an interest rate of 10% per year;
at the end of year 1, the investment will be worth:
10,000 + (10,000 x 0.1) = 11,000
$10,000 now is equivalent to a future sum of $11,000 after 1 year
$10,000 is the present or discounted value of the future $11,000
Interest rate used when determining a future value
Discount rate used when discounting to the present

Economic concepts of discounting and capital recovery

If one invests $10,000 today with an interest rate of 10% per year:
At the end of year 1, the investment will be worth:
10,000 + (10,000 x 0.1) = 11,000
At the end of year 2, the investment will be worth:
11,000 + (11,000 x 0.1) = 12,100 or:
[10,000 + (10,000 x 0.1)] + 0.1 [10,000 + (10,000 x 0.1)]=
= 10,000 + 10,000 x 0.2 + 10,000 x 0.12
= 10,000 x (1 + 0.1)2
At the end of year n, the investment will be worth:
10,000 x (10,000 + 0.1)n
The equation used to compare sums of money that exist at two
distinct times is: F = P x (1 + i)n
F= future amount; P = present amount; i = interest rate per period;
n= periods of repayment

Economic concepts of discounting and capital recovery

The future value of present costs or benefits is: F = P x (1 + i)n
The present value of future costs or benefits is: P = F / (1 + r)n
i is the interest rate, r the discount rate

In P = F / (1 + r)n, 1/(1 + r)n is called the Present Worth Factor

Year

PWF @ r=5%

PWF @ r=10% PWF @ r=15%

0.95

0.90

0.87

0.90

0.82

0.75

0.86

0.75

0.65

0.82

0.68

0.57

0.78

0.62

0.49

10

0.61

0.38

0.24

20

0.37

0.15

0.06

Economic concepts of discounting and capital recovery

An important investment consideration is the present value of a
constant stream of equal payments over several periods
(common to home and auto mortgages)
F = A + A (1+ i) + A (1 + i)2 + A (l + i)3 + ...+ A (1 + i)n-1
F = future value sought through a series of equal payments
A = uniform payments required over n periods

We can write F = A [1 + (1 + i) + (1 + i)2 + (1 + i)3 + + (l + i)n-1]

This is a geometric ratio series equal to:
F = A [(1 - (1 + i)n / 1 - (1 + i)) 1]
Simplifies to F = A ((1 + i)n 1) / i

Economic concepts of discounting and capital recovery

Lets go back to: F = P x (1 + i)n

And lets replace F by A ((1 + i)n 1) / i
We obtain: A ((1 + i)n 1) / i = P x (1 + i)n
A will be equal to: A = P [ i x (1 + i)n ] / [(1 + i)n 1]

Capital Recovery Factor represents the proportion of an initial

investment that has to be recouped as benefits in each of n
periods in order to return the same value as was invested
E.g. The annual payment required over 10 years to return the
value of a present amount of $10,000 is:
A = 10,000 [0.1 x 1.110] / [1.110 - 1] = 1,627

Economic concepts of discounting and capital recovery

Annual
payment

Capital

year 1 11,000

1,627

9,373

year 2 12,100

1,627

10,310 8,682

year 3 13,310

1,627

9,551

year 4 14,641

1,627

year 5 16,105

1,627

year 6 17,716

1,627

year 7 19,487

1,627

year 8 21,436

1,627

year 9 23,579

1,627

year 10 25,937

1,627

10,000

7,923
8,715

7,088
7,797

6,169
6,786

5,159
5,675

4,047
4,452

2,825
3,107

1,480
1,627

Capital Recovery Factor (CRF)

Year

CRF @ r=5%

CRF @ r=10%

CRF @ r=15%

1.05

1.10

1.15

0.54

0.57

0.61

0.37

0.40

0.44

0.28

0.31

0.35

0.23

0.26

0.30

10

0.13

0.16

0.20

20

0.08

0.12

0.16

Concluding remarks on the concepts of

discounting and capital recovery
The value of money concept and associated equations are
extremely important components of project evaluation
In most cases, the time streams of benefits and costs of alternatives
are expressed in terms of present values (that is, one discounts to
the present time) or as equivalent annual costs
The selection of a discount rate can have a significant impact on the
level of discounted benefits and costs. The discount rate provides a
relative weighing of present costs vs. future benefits a value
judgement related to the alternatives being considered
It is often suggested that project evaluation should include a
sensitivity analysis with different discount rates (e.g. starting from a
low rate that reflects the current government borrowing rate for
capital to a high-rate that represents and expected private sector
return on capital)

Economic evaluation techniques

1.

Present worth method: Discount the costs and benefits of each

project alternative to their equivalent present value and obtain a
net worth

2.

Annual worth method: Determine the discounted annual

equivalent benefits and costs for each alternative and then obtain
an annual worth

3.

Benefit/Cost methods: Separating costs from benefits, discount to

their equivalent annual (or present) values and develop a
benefit/cost ratio

4.

Return-on-investment method: Find the interest rate that

balances present and future cash flows and compare it to a
minimum return rate

Economic evaluation techniques

Considering the example time stream of benefits and costs shown in Figure 1.
Costs represent the capital costs for construction, continuing costs of operation
and maintenance, and future costs of rehabilitation. Benefits represent changes
in the user and non-user benefits.
6

0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21
-2

-4

-6

-8

Benefits
Costs

Present Worth Method

Calculate Net Present Value:
NPVy,r = (pwfr,t)(benefitsy,t) - (pwfr,t)(costsy,t)

NPVy,r = net present value of project y with a discount rate r

pwfr,t = present worth factor with discount rate r and time t
benefitsy,t = benefits of project y in time period t
costsy,t = costs of project y in time period t
n = economic life of project y

If NPV is positive, the project/alternative is feasible from an

economic efficiency perspective

Illustrating the Present Worth Method

year
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21

Benefits Costs
0
6
1
4
1
2
3
1
3
1
3
1
3
1
3
1
3
2
4
1
4
1
4
1
4
1
4
2
4
2
4
3
4
2
5
2
5
2
5
2
5
2

NPV = 23.5801 - 18.6119

NPV=
4.9682

pwf
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

Discounted Benefits
0.0000
0.8264
0.7513
2.0490
1.8628
1.6934
1.5395
1.3995
1.2723
1.5422
1.4020
1.2745
1.1587
1.0533
0.9576
0.8705
0.7914
0.8993
0.8175
0.7432
0.6757
23.5801

Discounted Costs
5.4545
3.3058
1.5026
0.6830
0.6209
0.5645
0.5132
0.4665
0.8482
0.3855
0.3505
0.3186
0.2897
0.5267
0.4788
0.6529
0.3957
0.3597
0.3270
0.2973
0.2703
18.6119

Annual Worth Method

Discounted costs are summed and multiplied by the appropriate
Capital Recovery Factor
Recall that A = P x CRF; so we need first the present value

Same applies for the discounted benefits

In the previous example:
Equivalent Annual Costs = 18.6119 x CRF@20yrs = 2.1869
Equivalent Annual Benefits = 23.5801 x CRF@20yrs = 2.7707
Equivalent Annual Worth = 2.7707 - 2.1869 = + 0.5838

Useful to compare two project alternatives with unequal lives, in

other methods, alternatives have to be expanded to a common life

Rate of Return Method

Determines the discount rate at which the present value of both
the present and future costs will equal the present value of both
the present and future benefits
We are trying to determine the discount rate r in which:

(pwfr,t)(benefitsy,t) = (pwfr,t)(costsy,t)

When the discount rate is identified, it can be compared to a

predefined acceptable rate of return. If the calculated rate of return
is greater than the acceptable rate, the project can be considered
economically feasible.
In the previous example, it is 16% which means that if the desired
rate of return was set at less than 16%, the project would be
feasible

Benefit/Cost (B/C) Method

Develops a ratio of discounted benefits to discounted costs
[B/C] = (pwfr,t)(benefitsy,t) / (pwfr,t)(costsy,t)
If an alternative has a B/C ratio of less than 1, it is a likely
candidate for rejection
In the previous example, B/C = 23.5801 / 18.6119 = 1.267
which means that this project is economically feasible. BUT
when two projects are compared, it does not mean that the
project with the higher B/C ratio is the one to select!
B/C method requires steps beyond the initial calculation of
B/C ratios for each alternative

Incremental Benefit/Cost Method

Assessment between any pair of alternatives a and b is:
[B/C]b-a = [Bb - Ba] / [Cb Ca] where b is the higher cost alternative
which should be greater than 1 if alternative b is preferred over
alternative a
The best choice is the highest-cost alternative whose B/C ratios
with all lower-cost alternatives are greater than 1
This method assumes that the relative merit of a project is
measured by its change in benefits and costs, compared to the
next lower-cost alternative. Is a cost increment worth it compared
to the increment in benefits?

Steps for using the incremental B/C method

1. Determine the benefits, costs, and the resulting B/C ratio for each
alternative
2. Ignore alternatives with a B/C<1.0
3. List alternatives with a B/C >1.0 in order of increasing cost
4. Calculate the incremental B/C of the second lowest-cost alternative
compared to the lowest-cost alternative
5. If the incremental B/C >1, then pick the second lowest cost alternative,
else pick the lowest cost alternative
6. Continue in order of increasing costs to calculate the incremental B/C
for each alternative compared to the last-picked alternative

Illustration of incremental B/C method

Alternative Benefit

Cost

B/C

A
B

40,000
15,000

21,000
1,500

1.9
10.0

C
D

12,800
52,000

1,700
24,500

7.5
2.1

Cost
1,500

B/C
10.0

1,700
21,000
24,500

7.5
1.9
2.1

Alternative Benefit
B
15,000

C
A
D

12,800
40,000
52,000

Illustration of incremental B/C method

Alternative

Benefit

Cost

B/C

15,000

1,500

10.0

12,800

1,700

7.5

40,000

21,000

1.9

52,000

24,500

2.1

Comparison between B and C

(12,800 15,000) / (1,700 1,500) = -11 (Pick B, the lower cost)
Comparison between B and A
(40,000 15,000) / (21,000 1,500) = 1.28 (Pick A, the higher cost)

Comparison between A and D

(52,000 40,000) / (24,500 21,000) = 3.42 (Pick D, the higher cost)

HOMEWORK 3 (Part 1)
Rank the following alternatives based on the NPV and B/C methods
(at a discount rate of 10%). Also, use the incremental B/C to find the
best project alternative. Comment.
Project
Altern.

Year 1

Year 2

Year 3

Year 4

20

200

50

100

150

50

110

15

35

90

90

90

120

90

140

30

20

200

50

50

200

50

260

45

100

300

200

200

300

100

345

65

50

100

100

100

200

100

420

100

Methods of evaluating project alternatives

I. Economic evaluation techniques SINGLE OBJECTIVE
Benefit-Cost Ratio
Net Present Value
Annual Worth
Rate of Return
II. Use of weighing schemes that produce a score for each
alternative MULTIPLE ATTRIBUTES
III. (To a lesser extent) Cost-Effectiveness Analysis illustrates
trade-offs but does not indicate which alternative is the best

Multi-Attribute Assessment Methods

The economic evaluation techniques introduced today have
one major characteristic in common: the many dimensions of
a project are reduced to dollar terms to maximize the net
benefit. While these frameworks are capable of incorporating
environmental and social impacts, it is necessary to quantify
them in economic terms (monetary valuation)
To overcome the need to assign a dollar value to non-market
goods and services, rating approaches have been proposed.
These rely on the development of Measures of Effectiveness
characterizing different sustainability impacts of a given
project

Multi-Attribute Assessment Methods

Multiple Attribute Decision Making (MADM) refers to making
preference decisions over project alternatives that are
characterized by multiple, usually conflicting attributes
MADM problems are diverse and share the following common
characteristics:
Alternatives: A finite number of project alternatives
Attributes: Each problem has multiple attributes or criteria
Incommensurable units: Each attribute has different units of
measurement
Attribute weights: Expressing the relative importance of each
attribute
Decision matrix: where columns indicate attributes considered
in a given problem and rows list project alternatives

MADM Decision Matrix

Attributes
Project Alternative
Cost
GHG (tons) Noise (dBA) Land consumption Benefits ($)
(x1,000$)
(x 1,000 sq ft)
0 Do nothing
0
50
65
80
2,000
1
2,000
20
55
100
4,000
2
3,000
12
75
50
4,000
3
5,000
18
50
80
8,000

What else is needed to start evaluating this matrix?

MADM Decision Matrix

Attributes
Project Alternative
Cost
GHG (tons) Noise (dBA) Land consumption Benefits ($)
(x1,000$)
(x 1,000 sq ft)
Weight of attribute
0.25
0.20
0.15
0.15
0.25
0 Do nothing
500
50
65
80
2,000
1
2,000
20
55
100
4,000
2
3,000
12
75
50
4,000
3
5,000
18
50
80
8,000

So which is the best project alternative?

How do we evaluate the different alternatives?

Step 1: Attribute normalizing

Normalized ratings have dimensionless units and the larger the
rating, the more preference an attribute has.
For cost attributes offering decreasing monotonic utility, take
inverse ratings. The transformed benefit attribute (from cost)
follows the same normalization process:
Linear normalization: rij = xij / xj*
where xj* is the maximum value of the jth attribute.
Vector normalization: rij = xij/sqrt(sumi (xij2))
2
xij
50
20
12
8

xij
2500
400
144
64

sumi (xij2)

3108

Sqrt (sumi (xij2))

55.75

rij
0.897
0.359
0.215
0.143

Step 2: Attribute weighting

The role of weight serves to express the importance of each attribute
relative to the others. Often, weights from ranks are generated:
Arrange attributes in a simple rank order (most important first) and
assign 1 to the most important and n to the least important attribute
(assuming n attributes). If two attributes are tied, their mean ranking
can be taken. The weights can be obtained from:
Rank reciprocal weights

Rank sum weights

Ranking n attributes at the same time may be difficult, rankings can be

obtained from a set of pair-wise judgements

Step 3: Scoring Methods

Involve an index formulation of a system
The two most commonly used scoring methods are:
Simple additive weighing (SAW)
Involves taking the weighted sum of the normalized, weighted,
attributes
Vi is the value of alternative i
wj is the weight of attribute j
rij is the normalized rating of alternative i with respect to attribute j

Weighted Product Method

Normalization is not necessary if the attributes are connected by
multiplication
The weights become exponents associated with each attribute value;
a positive power for benefit attributes and a negative power for cost
attributes

Step 3: Weighted Product Method

Involves taking the weighted sum of the normalized, weighted, attributes

Vi is the value of alternative i

wj is the weight of attribute j

This method requires that all ratings be greater than 1. If an attribute has
fractional ratings, all ratings in that attribute are multiplied by 10Z to meet
this requirement
Alternative values obtained by the multiplicative method do not have a
numerical upper bound
It is often convenient to compare each alternative value with a standard
or ideal value by computing a value ratio

HOMEWORK 3 (continued)
Use the weighted sum and the weighted product
method to rank the different project alternatives.
Does the best alternative remain the same under
the two methods?
Attributes
Project Alternative
Cost
GHG (tons) Noise (dBA) Land consumption Benefits ($)
(x1,000$)
(x 1,000 sq ft)
Weight of attribute
0.25
0.20
0.15
0.15
0.25
0 Do nothing
500
50
65
80
2,000
1
2,000
20
55
100
4,000
2
3,000
12
75
50
4,000
3
5,000
18
50
80
8,000

Multi-objective Assessment Methods

Limitations
Just like the economic evaluation approaches, multi-objective
methods are associated with limitations:
Subjective weighing procedures raise the question of
whose values are being applied in the assessment. If the
weights do not reflect the true preference of the (project
owner, community, politicians?); the entire approach may
not be very helpful
The rating approach does not provide useful information
on whether the costs of alternatives are justified by the
benefits expected

Methods of evaluating project alternatives

I. Economic evaluation techniques SINGLE OBJECTIVE
Benefit-Cost Ratio
Net Present Value
Annual Worth
Rate of Return
II. Use of weighing schemes that produce a score for each
alternative MULTIPLE ATTRIBUTES
III. (To a lesser extent) Cost-Effectiveness Analysis illustrates
trade-offs but does not indicate which alternative is the best

Cost Effectiveness Evaluation

Estimates the level of goals and objectives attainment per
dollar of net expenditure e.g.
Kg of GHG reduced/$
sq ft or decontaminated land / $
CE evaluation lies in the development of an efficiency frontier

Choosing an alternative over another depends on the

willingness of the decision-maker to trade-off a level of
effectiveness for cost (is the additional benefit worth the
added costs?)

Cost Effectiveness Evaluation

Cost
$
1
20
1
5
5
15
20
20

120

P8
100

80
GHG

P1
P2
P3
P4
P5
P6
P7
P8

GHG
(Kg)
20
70
30
20
25
50
40
100

P2
60

P3

40

P6

P5

P7

20

P1

P4

10

15
Cost ($)

20

25

Learning outcomes and the muddiest point

Five volunteers to prepare each a 3 min presentation, 5 slides
illustrating:
What they learnt the best over the past few weeks, their
own highlights
Their muddiest point

Volunteer 1:
Volunteer 2:
Volunteer 3:
Volunteer 4:
Volunteer 5: