Cost Benefit Analysis Procedures Manual: Version 1.1: November 2010

Cost Benefit Analysis Procedures Manual
Version 1.1: November 2010
CASADOC 257
Cost Benefit Analysis Procedures Manual Copyright Australian Government 2007 This work is copyright. Apart from any use as permitted under the Copyright Act 1968, no part may be reproduced by any process without prior written permission from the Commonwealth. Requests and inquiries concerning reproduction and rights should be addressed to the Document Control Officer, Knowledge Services, Civil Aviation Safety Authority, GPO Box 2005, Canberra ACT 2601 or posted to document.control.unit@casa.gov.au. Since the hard copy version is uncontrolled and will not be updated by CASA, it should not be relied upon for any regulatory purpose. The current, approved version of the manual can be viewed at any time via CASA's website at www.casa.gov.au. Copies of this manual are available from: http://casa.jsmcmillan.com.au/He/cat. You should always refer to the applicable provisions of the Civil Aviation Act, Civil Aviation Regulations and Civil Aviation Orders, rather than this manual, to ascertain the requirements of, and the obligations imposed by or under, the civil aviation legislation. Version 1.1: November 2010
Cost Benefit Analysis Procedures Manual Table of Contents

Approved by Head, Office of Airspace Regulation:
Table of Contents
Table of Contents
List of Effective Pages ............................................................................................................... v Preface .................................................................................................................................... vii Abbreviations .......................................................................................................................... xiii Glossary .................................................................................................................................... xv References ............................................................................................................................... xxi 1. Introduction .......................................................................................................................1-1
1.1 1.2 1.3 1.4 1.5 1.6 1.7 2.1 2.2 2.3 3.1 3.2 3.3 3.4 3.5 3.6 3.7 Introduction ......................................................................................................................... 1-1 Purpose of the Manual ....................................................................................................... 1-1 Background ......................................................................................................................... 1-2 Target Audience .................................................................................................................. 1-4 Purpose of Cost-Benefit Analysis ..................................................................................... 1-4 Purpose of the Methodology .............................................................................................. 1-5 Format of this Report ......................................................................................................... 1-6 Introduction ......................................................................................................................... 2-1 Cost-Benefit Analysis as Opposed to Cost-Effectiveness Analysis ............................... 2-1 Cost-Benefit Analysis Flowchart ....................................................................................... 2-2 Introduction ......................................................................................................................... 3-1 Project Identification .......................................................................................................... 3-1 Specification of Project Options ........................................................................................ 3-1 Defining the Base Case ...................................................................................................... 3-2 The Role of Value Management ......................................................................................... 3-2 Role of the Department of Defence ................................................................................... 3-3 Valuing Costs and Benefits ................................................................................................ 3-4 3.7.1 Quantitative and Qualitative Costs and Benefits ...................................................... 3-4 3.7.2 Valuation in Resource Cost Terms .......................................................................... 3-5 3.7.3 The Concepts of Sunk and Opportunity Costs ......................................................... 3-5 3.7.4 Externalities ............................................................................................................ 3-6 3.7.5 Value of Travel Time ............................................................................................... 3-6 3.7.6 Value of a Statistical Life ......................................................................................... 3-7 3.7.7 Residual Values ...................................................................................................... 3-9 3.7.8 Decommissioning Costs ........................................................................................ 3-10 3.7.9 Secondary Effects ................................................................................................. 3-10 3.7.10 The Rule of Half and the Concept of Consumer Surplus ....................................... 3-10 3.7.11 Option Values........................................................................................................ 3-11 i
2. Key Decisions ...................................................................................................................2-1
3. Principles of Cost Benefit Analysis .................................................................................3-1

Approved by Head, Office of Airspace Regulation: Version 1.1: November 2010
3.8
The Concept of Present Values and Discounting ........................................................... 3-12 3.8.1 Selection of a Discount Rate ................................................................................. 3-13 3.8.2 Price Year ............................................................................................................. 3-15 3.8.3 Selection of the Base Year .................................................................................... 3-15 3.8.4 The Evaluation Period and Economic Life ............................................................. 3-16 3.8.5 Treatment of Inflation and Interest Rates............................................................... 3-16 3.8.6 Relative Prices ...................................................................................................... 3-16 3.9 Decision Criteria ............................................................................................................... 3-18 3.9.1 Net Present Value ................................................................................................. 3-18 3.9.2 Benefit-Cost Ratio ................................................................................................. 3-19 3.9.3 Internal Rate of Return .......................................................................................... 3-20 3.9.4 Net Present Value per Dollar of Investment........................................................... 3-20 3.9.5 Payback Period ..................................................................................................... 3-21 3.9.6 Recommended Decision Criterion ......................................................................... 3-21 3.10 Allowing for Risk and Uncertainty ................................................................................... 3-21 3.10.1 Sensitivity Analysis ................................................................................................ 3-22 3.10.2 Risk Assessment................................................................................................... 3-24 3.10.3 Optimism Bias ....................................................................................................... 3-26 3.11 Issues and Limitations of Cost-Benefit Analysis............................................................ 3-27 3.12 Role of Multi-Criteria Analysis ......................................................................................... 3-29 3.13 Ex-post Evaluation............................................................................................................ 3-32 3.14 ALARP, Issues of Disproportionality and Cost-Benefit Analysis .................................. 3-33 3.15 Use of Spreadsheets ........................................................................................................ 3-34
4. The Cost-Benefit Analysis Checklist ...............................................................................4-1

4.1 4.2 5.1 5.2 5.3 Introduction ......................................................................................................................... 4-1 Cost-Benefit Analysis Checklist ........................................................................................ 4-1 Introduction ......................................................................................................................... 5-1 Cost Benefit Analysis Steps .............................................................................................. 5-1 Step 1: Define Objectives and Project Scope ................................................................... 5-1 5.3.1 The Importance of Objectives .................................................................................. 5-1 5.3.2 Proposal/Project Specification ................................................................................. 5-1 Step 2: Identify Project Options ......................................................................................... 5-2 5.4.1 Range of Options .................................................................................................... 5-2 Step 3: Identify Costs and Benefits ................................................................................... 5-3 5.5.1 Identify Quantitative Costs....................................................................................... 5-3 5.5.2 Identify Quantitative Benefits ................................................................................... 5-5 5.5.3 External Costs and Benefits .................................................................................... 5-5 5.5.4 Equity and Broader Distributional Considerations.................................................... 5-6 5.5.5 Presenting Incremental Costs and Benefits ............................................................. 5-6 Step 4: Discount Future Costs and Benefits.................................................................... 5-6
5. Cost Benefit Analysis Procedure.....................................................................................5-1
5.4 5.5
5.6
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5.7 5.8 5.9
5.6.1 DCF Analysis .......................................................................................................... 5-6 5.6.2 Discounting Parameters .......................................................................................... 5-7 Step 5: Calculate the Decision Criteria............................................................................. 5-7 Step 6: Sensitivity Analysis ............................................................................................... 5-7 Step 7: Identify Preferred Option ....................................................................................... 5-8
5.10 Step 8: Prepare Report ....................................................................................................... 5-9 5.10.1 Full Evaluation Report ............................................................................................. 5-9 5.10.2 Summary Reporting ................................................................................................ 5-9
6. Data Issues ........................................................................................................................6-1

6.1 6.2 Introduction ......................................................................................................................... 6-1 Standard Economic Values Report.................................................................................... 6-1
Revision History .................................................................................................................. RH-1
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Cost Benefit Analysis Procedures Manual List of Effective Pages

List of Effective Pages
Part Cover and verso Table of Contents, List of Effective Pages and Preface Abbreviations and Glossary References 1. Introduction 2. Key Decisions 3. Principles of Cost Benefit Analysis 4. The Cost-Benefit Analysis Checklist 5. Cost Benefit Analysis Procedure 6. Data Issues Revision History
No. of Pages 2 12 7 3 6 2 38 4 10 2 2
Version 1.1 1.1 1.1 1.1 1.0 1.0 1.0 1.0 1.0 1.0 1.1
Date of Issue 11/2010 11/2010 11/2010 11/2010 11/2007 11/2007 11/2007 11/2007 11/2007 11/2007 11/2010
Cost Benefit Analysis Procedures Manual List of Effective Pages

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Cost Benefit Analysis Procedures Manual Preface

Foreword
Preface
As a Commonwealth government authority, CASA must ensure that its decision-making processes are effective, fair, timely, transparent, consistent, properly documented and otherwise in accordance with the requirements of the law. Most of the regulatory decisions CASA makes are such that conformity with authoritative policy and established procedures will be conducive to the achievement of these outcomes. From time to time, however, decision-makers will encounter situations in which the strict application of policy, in the making of a decision involving the exercise of discretion, would not be appropriate. Indeed, in some cases, the inflexible application of policy may itself be unlawful. This preface and the following Introduction, explains the way in which the policy and processes set out in this manual are to be used by all CASAs personnel when making decisions in the performance of their functions, the exercise of their powers and the discharge of their duties. It also explains the processes to be followed if it appears that a departure from policy is necessary or appropriate.
Mandatory Use of Policy and Procedure Manuals
This manual is one of the set of manuals and other documents which comprise CASAs authorised document set. The authorised document set contains the policy, processes and procedures with which CASA personnel are expected to comply when performing assigned tasks. All CASA personnel are required to have regard to the policies set out in this manual. Except as described in the Introduction, CASA decision-makers should not depart from these policies, processes and procedures.
John F. McCormick Director of Aviation Safety
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Introduction
Regulatory Decision Making
Where the legislation provides for one, and only one decisionthe correct decisionis the only decision open to CASA. However, most of the decisions CASA makes involve the exercise of discretion. In such cases, there may well be more than one acceptable or correct decision. In these cases, the law requires that CASA makes the preferable decision, that is, the most appropriate decision, having regard to the overriding interests of safety and the obligation to be fair. In all such cases, CASA is bound to act in accordance with the applicable rules of administrative law. These rules govern how CASA arrives at the preferable decision in any given case. Adherence to these rules is a requirement, not an option. Decisions and actions taken in contravention of these rules are unlawful, unenforceable, and in most cases invalid. CASA is legally accountable for the decisions it makes, and CASA decisionmakers are obliged to avoid the appearance, as much as the reality, of unlawful decisionmaking. Sound and lawful regulatory decision-making is generally governed by the 10 rules of administrative law summarised below. Adherence to these rules is essential to CASAs obligations of accountability and good governance. 1. Natural Justice (Procedural Fairness) Hearing Rule. Persons affected by CASAs decisions have a right to be heard. To be meaningful, the hearing rule normally requires that CASA provides persons with notice (usually in advance) that a particular decision is going to be taken, and the reasons for the decision CASA proposes to take. Without notice and a statement of reasons, there may be little point to providing a person with an opportunity to be heard. Rule Against Bias. Decision-makers should not have a personal or pecuniary interest in the outcome of their decisions. Neither may decision-makers prejudge (or pre-determine) matters in respect of which they are called upon to make a decision. 2. A decision-maker must not act for improper purposes. Even if the purposes for which a particular decision are lawful, the decision may only be taken for the purposes specifically authorised by the law under which the decision has been taken. 3. A decision-maker must not take any irrelevant considerations into account in coming to a decision. 4. A decision-maker must take all relevant considerations into account in coming to a decision.
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Note: Applicable Policy is Always a Relevant Consideration. 5. A decision-maker must act on the basis of evidence, not mere supposition or speculation. 6. A decision-maker must not formulate requirements in vague or uncertain terms. 7. A decision-maker must not inflexibly apply policy (although departures from policy will normally need to be justified). 8. A decision-maker must not act under dictation (although this does not preclude adherence to formal directions, compliance with lawful conditions in relation to the process by which a decision is taken or the obligation to consult in the process of considering a decision). 9. A decision-maker must decide the matter within a reasonable time. 10. A decision maker must not act in a way that is manifestly unreasonable. A decision must not be so unreasonable that no reasonable person would make such a decision.
Note: The meaning and application of these principles, and related considerations of administrative law, are covered more fully in the induction and orientation training undertaken by all CASA employees. Any questions in relation to these matters should be referred to the Legal Services Division.
Departure from Authorised Policy
Adherence to CASAs authorised policies will almost always produce an appropriate decision. As said, however, from time to time there will be circumstances in which the strict application of policy may not result in the preferable decision. In these cases it may be appropriate (and possibly necessary) to depart from otherwise applicable policy. Any departure from policy must be justified in order to ensure that it:

Is genuinely necessary in the interests of fairness Does not inappropriately compromise the need for consistent decision-making; and, of course Is not in conflict with the interests of safety.
Without fettering a decision-makers discretion, it is therefore expected that appropriate consultation will occur before a decision is made that is not the product of the policies and processes set out in this manual. The prescribed consultation process is described below.
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Consultation Process
Decision-Makers Responsibilities When a decision-maker believes there is a need to depart from policy he or she is expected to consult with his or her direct supervisor. This process should be initiated in writing:
Setting out the pertinent facts and circumstances Identifying the provisions of the policy normally applicable Stating why the application of that policy would not result in the making of the preferable decision in the circumstances to hand Specifying the approach the decision-maker believes is more likely to result in a preferable decision.
Supervisors Responsibilities In considering a consultative referral, the decision-makers supervisor should:
Advise the decision-maker as to whether his or her assessment of the relevant considerations appears to be complete and correct If, in the opinion of the supervisor, the circumstances do not warrant a departure from policy, provide the decision-maker with written advice and guidance as to how the decision might more properly be approached within the current policy framework
Note: Reliance on relevant precedent is a sound basis on which to ground such an opinion. It may also be helpful to seek advice from peers, superiors and/or CASAs Legal Services Division. If, in the opinion of the supervisor, a departure from policy is warranted, the supervisor should ensure the policy sponsor (normally the relevant Executive Manager) is advised of: i. The intention to depart from the otherwise applicable policy ii. The alternative approach the decision-maker will be taking to the matter.
The supervisor should ensure that a full written record of these actions is made and maintained.

Note: In no case may the terms of decision be dictated to a delegate authorised to exercise discretionary decision-making powers. If a decision-makers supervisor or the policy sponsor is not satisfied that the decision the decision-maker intends to make is the correct or preferable decision in all the circumstances, responsibility for that decision should be assumed by, or assigned to, another authorised delegate in accordance with appropriate processes and procedures.
Policy Sponsors Responsibilities If the policy sponsor concurs in the proposed departure from policy, he or she should ensure the decision-maker is advised accordingly as soon as possible. If the policy sponsor does not believe the proposed departure from policy is warranted, he or she should:
Advise the supervisor accordingly Assume responsibility for the decision Ensure that the decision-maker and any person affected by the decision (for which the policy sponsor has assumed responsibility) is advised accordingly Make the decision in a manner consistent with the applicable policy.
The policy sponsor should ensure that a full written record of these actions is made and maintained. Nothing in these processes should be interpreted or applied so as to dictate the terms of the decision to be made by a decision-maker authorised to make discretionary decisions under the civil aviation legislation, or to delay unreasonably the making of such decisions.
Revisions to Policies and Manuals
As a result of experience in applying policies and procedures, users will form views as to accuracy, relevance and applicability of the content. CASA personnel are required to provide recommendations for revisions to policies and processes in this or any other manual should they become aware of shortcomings. In this way the policies and manuals will be continually improved and remain relevant to the tasks being undertaken.
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Each policy and manual has a sponsor and recommendations for amendment are to be forwarded to the relevant individual for consideration. The revision process can be accessed via the link: http://casaconnect/manuals/doc_control/process.htm
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Cost Benefit Analysis Procedures Manual Abbreviations and Glossary

Abbreviations and Glossary
Abbreviations
ACP AERU ALARP ATS ATC ATSB BCR BTRE CAPM CASA CBA CEA DCF DF FAA GAM GDP ICAO IRR MCA NAS NPV NPV/i OAR OB OBPR PSCC PV QRA R&D Airspace Change Proposal Airspace and Environmental Regulatory Unit As Low As Reasonably Practicable Air Traffic Services Air Traffic Control Australian Transport Safety Bureau Benefit Cost Ratio Bureau of Transport and Regional Economics Capital Asset Pricing Model Civil Aviation Safety Authority Cost-Benefit Analysis Cost-Effectiveness Analysis Discounted Cash flow Disproportion Factor Federal Aviation Authority (United States of America) Goals Achievement Matrix Gross Domestic Product International Civil Aviation Organisation Internal Rate of Return Multi-criteria Analysis National Airspace System Net Present Value Net Present Value per dollar invested Office of Airspace Regulation Optimism Bias Office of Best Practice Regulation Project-Specific Cost of Capital Present Value Quantitative Risk Assessment Research and Development
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SEV SOC UK VM VoTT VSL WTP
Standard Economic Values Social Opportunity Cost United Kingdom (of Great Britain and Northern Ireland) Value Management Value of Travel Time Value of a Statistical Life Willingness to pay
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Glossary
Base Case Is a statement of what would have happened in the absence of the project. The base case reflects the realistic circumstances in the absence of the project options and can also be defined as a do nothing scenario or existing condition. Is the year to which all values are discounted when determining a present value. It is usually the evaluation year. Is calculated within the construct of the following formula: Benefits/Cost. Is a term used to indicate an advantage, profit, or gain attained by an individual or organisation. Is a structured decision package for organisational decision-makers. A business case includes an analysis of business process performance and associated needs or problems, proposed alternative solutions, assumptions, constraints, and a risk-adjusted costs-benefit analysis. Is the measure of what has to be given up in order to obtain something. While frequently the same thing, the financial cost of a good is conceptually distinct from its opportunity cost. Cost-Benefit Analysis Is a method of economic evaluation for projects, programmes or policies that measure benefits and costs as far as possible in monetary terms. It differs from a financial appraisal or evaluation in that it considers all gains (benefits) and losses (costs), regardless of to whom they accrue. Compares options in terms of their substantive effectiveness and their cost. Whereas, in cost-benefit analysis, benefits, as well as costs, are as far as possible expressed in monetary units, here benefits are expressed in the appropriate physical unit. Is the estimation of a projects lifecycle costs, time-phased by fiscal year, based on the description of a project or systems technical, programmatic, and operational parameters. Represent valuations in dollar values of the price year under consideration, usually in todays dollar values. Is the rate used to convert current dollar values of cost which occur in a future year to a present value in the base year. The recommended inflation free rate is r. To convert an amount which will be paid n years in the future to a present value, divide the future value by (1+r)n. Discount rates can be reflected in real or nominal terms where real indicates that the effects of general inflation have been removed. The discount rate used depends on the type of dollars to be adjusted:
Base Year BCR (Benefit Cost Ratio) Benefit Business Case
Cost
CostEffectiveness Analysis Cost Estimate
Current Prices Discount Rate
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Discounting translates projected cash flows into present value terms using specified discount factors. As follows, the discount rate (or factor) is equal to 1/(1+ i)n or (1+ i)-n where i is the interest rate and n is the number of years from the date of initiation for the project. Real Discount RatesAdjusted to eliminate the effects of expected inflation and used to discount constant year dollars or real benefits and costs. A real discount rate can be approximated by subtracting expected inflation from a nominal discount rate. Nominal Discount RatesReflect expected inflation and used to discount future year (inflated) dollars or nominal benefits and costs. Double Counting Economic Evaluation Is the analytical error of misidentifying costs or benefits so that they are counted twice instead of once only. Is a method of evaluation that uses a money metric and assess the real value of goods and services to individuals based on economic principles. The term is sometimes used synonymously with cost-benefit analysis but may also include cost-effectiveness analysis.
Evaluation Period Is the time frame over which the costs and benefits of a project are compared. It can also be referred to as the project life. Externalities Are benefits or costs falling on third parties who normally cannot pay or be compensated for it through the market mechanism. An external benefit is often termed a positive externality; an external cost a negative one. Is an assessment of the financial effects of a project or policy from the perspective of some defined agency, which may include the whole of government, gains and losses accruing elsewhere is the economy are not included. Is a key measure of the value of economic production in the economy. GDP is determined in one of three ways: the value of goods and services produced less the cost of production; the sum of incomes generated by production; the sum of final expenditure on goods and services produced plus exports minus imports. An average of the three approaches may be calculated and is also referred to as GDP. Another way of considering GDP is that it as a measurement in dollar terms of aggregate goods and services produced within a particular economy over a year excluding income earned outside the country. GDP is considered one of the main yardsticks of the health and vitality of the particular economy and represents the total income of the economy and its residents. Is a sustained rise in the general price level; the proportionate rate of increase in the general price level per unit of time. The Consumer Price Index (CPI) is a standard measure of the general level of inflation in the economy. The Australian Bureau of Statistics (ABS) also publishes a number of industry/sector-specific measures.
Financial Evaluation
GDP Gross Domestic Product
Inflation
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Intangibles
Are costs and benefits which cannot be valued in monetary terms.
IRR (Internal Rate Is the discount rate that sets the net present value of the program or project to zero. While the internal rate of return does not generally provide an of Return) acceptable decision criterion, it does provide useful information, particularly when budgets are constrained or there is uncertainty about the appropriate discount rate. Lifecycle Costs Are the overall estimated costs for a particular program alternative over the time period corresponding to the life of the program, including direct and indirect initial costs plus any periodic or continuing costs of operation and maintenance. Is any analytical method that is meant to imitate a real-life system, especially when other analyses are too mathematically complex or too difficult to reproduce. Spreadsheet risk analysis uses both a spreadsheet model and simulation to analyse the effect of varying inputs on outputs of the modelled system. One type of spreadsheet simulation, which randomly generates value for uncertain variables over and over to simulate a model. (Monte Carlo simulation was named for Monte Carlo, Monaco, where the primary attractions are casinos containing games of chance.) Analysts identify all key assumptions for which the outcome was uncertain. For the lifecycle, numerous inputs are each assigned one of several probability distributions. The type of distribution selected depended on the conditions surrounding the variable. During simulation, the value used in the cost model is selected randomly from the defined possibilities:
Monte Carlo Simulation
Net Benefits NPV (Net Present Value)
Are benefits less costs. Is defined as the difference between the present value of benefits and the present value of costs. The benefits referred to in this calculation must be quantified in cost of monetary terms in order to be included.
NPV/i (Net Is the ratio of the Net Present Value to the present value of capital costs. Present Value per dollar invested) Opportunity Cost Payback Period Is the value of the best alternatives or other opportunities which have to be forgone in obtaining an item or achieving an objective. Is the time taken for a project to recover the initial investment. Similarly, the discounted payback period is the time taken for the present value of the projects earnings stream to cover the initial investment. Is the equivalent value in the base year of a benefit or cost to be incurred at some other point in time. For example, with a discount rate of 6%, the value today of $100 to be received in one years time is 100/1.06 = $94.34.
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Present Value

Price Year Real Prices Residual Value
Is the year in which the prices prevailing are used in a CBA for the valuation of costs and benefits over the life of the project. It is usually the base year. Are prices that have been adjusted for changes in the purchasing power of money, ie, inflation, between different periods. Is the value of an asset at the end of the evaluation period. It is included in CBA calculations as a negative cost associated with a particular option or project, accruing at the end of the evaluation period. Is a term used to define the class of factors which:

Risk
Have a measurable probability of occurring during an investments life cycle Have an associated cost or affect on the investments output or outcome (typically an adverse affect that jeopardises the success of an investment) Have alternatives from which the organisation may choose.1
Risk Analysis
Is a technique to identify and assess factors that may jeopardise the success of a project or achieving a goal. This technique also helps define preventive measures to reduce the probability of these factors from occurring and identify countermeasures to successfully deal with these constraints when they develop. Are benefits to airspace users or their customers which cannot be determined by reference to aircraft operating costs. Is the analysis of how sensitive outcomes are to changes in the assumptions. The assumptions that deserve the most attention should depend largely on the dominant benefit and cost elements and the areas of greatest uncertainty of the program or process being analysed. Is an approach to setting discount rates for evaluation purposes based on the gross return available from alternative public or private uses of capital. To be distinguished from the rate of time preference approach that is based on individuals preferences for current rather than deferred consumption. Is defined as the value society attaches to present, as opposed to future, consumption. Is a rate used for discounting future benefits and costs, and is based on comparisons of utility across different points in time or different generations. Are standard indicative values or range of values given to data items commonly used in CBAs. Is one that cannot be retrieved by resale in the market. More specifically, a sunk asset is one which, once implemented, has no value in any alternative use.
Secondary Benefits Sensitivity Analysis
Social Opportunity Cost of Capital Social Time Preference Social Time Preference Rate (STPR) Standard Economic Values (SEVs) Sunk Cost
CIO Council, Best Practices Committee (2002) Value Measuring Methodology How-To-Guide, Washington D.C.
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Utility Value of a Statistical Life
is consumer satisfaction, welfare, happiness, or well-being. Economists suggest two primary approaches for defining the value of a statistical life. The first is based on an assessment of the deceaseds productivity (generally in cases of premature death). This approach is referred to as the human capital method as it considers the individual in terms of productive value only, ie, as physical capital (machines, tools, etc.). The method takes into account the individuals total expected income. This was the most frequently used method prior to the early nineties in most industrialised countries. The second approach advocates the use of the willingness to pay (WTP) concept, based on the surplus theory. Instead of being considered only as a link in the production chain, it is now the individual who determines, on the basis of his budget and preferences, what he is willing to pay to reduce the mortality risk. With this approach, non-market elements are factored into the assessment. The method used to determine WTP is that of contingent valuation. This entails the use of a questionnaire to determine how much individuals are willing to pay to reduce the mortality risk, as a measurement of the value of a statistical life. Contingent valuation leaves it up to the individual to assess what premature death means to him, by suggesting a hypothetical scenario: how much would you be willing to pay for the establishment of such and such an infrastructure designed to reduce the likelihood of your death by X%?. In this case, the method is based on stated preferences. It is sometimes thought that methods based on revealed preferences (hedonic method) can also be used to determine individual WTP. Indeed, the hedonic method uses an existing market in able to deduce from an individuals behaviour what he is willing to pay in order to reduce the mortality risk (wage differential between hazardous and non-hazardous jobs, purchase of security goods, etc.). In both instances, the approach is based on the preferences of individuals who arbitrate between their budget and the risk they are subjected to (or think they are).
Willingness-toPay
refers to the valuation placed by an individual on a good or service in terms of money. The valuation is in two parts: market price and consumer surplus, if any. Willingness to accept is the analogous approach of finding out how much people are willing to pay to avoid a loss, or how much they are willing to accept in the way of compensation to put up with the loss.
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Cost Benefit Analysis Procedures Manual References

References
Access Economics Pty Ltd (2004) Economic Benefit-Cost Analysis Comparing Enroute Class E and Class C Airspace, , 30 April 2004, for Airservices Australia. Australia Government (2007) Best Practice Regulation Handbook, Canberra. Australian Government Civil Aviation Authority, (2007) Office of Airspace Regulation Airspace Planning Manual, April 2007, Draft Version 1.2, Canberra (available at: http://www.aeru.com.au/oar/download/OAR_manual.pdf). Australian Transport Council (2006) National Guidelines for Transport System Management in Australia, Australia. Austroads (1999) Benefit Cost Analysis Manual, Sydney, Australia. Austroads (2007) Guide to Project Evaluation Part 4: Project Evaluation Data, 2nd Ed., Sydney. Boardman A., Greenberg D., Vining A., and Weimer D. (2006) Cost-Benefit Analysis: Concepts and Practice, 3rd Ed., Prentice Hall, Toronto. Bureau of Transport and Regional Economics (BTRE) (1999) Facts and Furphies of Benefit-Cost Analysis: Transport, Report 100, Commonwealth of Australia, Canberra. BTRE (2005) Risk in cost-benefit analysis, Report 110, Commonwealth of Australia, Canberra. BTRE (2006) Cost of Aviation Accidents and Incidents, Report 113, Commonwealth of Australia, Canberra. Campbell, H.R. and Brown, R.P.C., (2003) Benefit-Cost Analysis: Financial and Economic Appraisal using Spreadsheets, Cambridge University Press, UK. Department of Finance and Administration (2006) Introduction to Cost-Benefit Analysis and Alternative Evaluation Methodologies, Commonwealth of Australia, Canberra. Department of Finance and Administration (2006) Handbook of Cost-Benefit Analysis, Commonwealth of Australia, Canberra. Department of Infrastructure (2005) Guideline on economic, social and environmental cost-benefit analysis, Melbourne, Victoria. Department for Transport (UK) (2004) Values of Time and Operating Costs, TAG Unit 3.5.6 Transport Appraisal Guidance, June 2004, London. Accessible at www.webtag.org.uk.
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Department of Transport & Regional Services, Department of Defence, Civil Aviation Safety Authority, Airservices Australia (2007), Common Risk Management Framework for New and Changed Operational Requirements within Aviation, Draft 1.3: Consultation draft, Canberra. Federal Chief Information Officer (CIO) Council , Value Measuring Methodology, How-ToGuide, Best Practices Committee , Washington DC, USA, October 2002. HM Treasury (2003) The Green Book: Appraisal and Evaluation in Central Government. London, United Kingdom. International Air Transport Association (2000) Guidelines for the economic appraisal of European Air Traffic Management Program (EATMP) projects the effective use of costbenefit studies, edition 1.3 (Sept. 2000), prepared for Eurocontrol, Brussels, Belgium. Kip Viscusi W and Aldy J.E., (2003) The Value of a Statistical Life: A Critical Review of Market Estimates throughout the World, The Journal of Risk and Uncertainty, 27:1; 576, 2003. Mackie PJ, Jara-Diaz S and Fowkes AS (2001), The Value of Travel Time Savings in Evaluation, Transportation Research 37 E, 91-106. (available at http://www.cec.uchile.cl/~dicidet/sjara/The%20Value%20of.pdf University of Chile, Department of Civil Engineering) Minister for Transport and Regional Services, The Australian Airspace Policy Statement, 28 June 2007, Department of Transport & Regional Services, Canberra. NSW Treasury (2004) Total Asset Management - Value Management Guideline, Sydney, Australia. NSW Treasury (2007) NSW Government Guidelines for Economic Appraisal, Policy & Guidelines Papers, tpp 07-5, July 2007, Sydney, Australia. NSW Treasury (2007) Economic Appraisal Principles and Procedures Simplified, Office of Financial Management, Policy & Guidelines Papers, tpp 07-6, July 2007, Sydney, Australia. Office of Best Practice Regulation (OBPR) (2007) Best Practice Regulation Handbook, Canberra. Queensland Treasury (2006) Cost-Benefit Analysis Guidelines - Achieving Value for Money In Public Infrastructure and Service Delivery, Project Assurance Framework Supplementary Material Cost-Benefit Analysis, version 0.3, 6 July 2006, Brisbane, Australia. Standards Australia / Standards New Zealand (2004) Risk Management AS/NZS 4360:2004, 3rd Edition, Sydney, Australia.
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Standards Australia / Standards New Zealand (2005) Risk Management Guidelines Companion to AS/NZS 4360:2004, Handbook HB 436:2004, Sydney, Australia. Strategic Rail Authority (2002) Appraisal Guidance, London, United Kingdom. State Rail Authority NSW (RailCorp) (1995) Manual for the Evaluation of Capital Projects. Sydney, Australia.
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Cost Benefit Analysis Methodology Procedures Manual 1. Introduction 1.1. Introduction

Approved by Head, Office of Airspace Regulation
1. Introduction
1.1
Introduction
The methodology set out in this document provides guidance in performing cost-benefit analysis (CBA) which is to be used by CASA for economic evaluations of airspace change proposals (ACPs) and other investment proposals. Although the initial impetus for the preparation of the methodology was ACPs, this document has been drafted in such a way as to make the methodology a suitable framework in which to assess the economic merits of any investment proposal or policy change undertaken by CASA. To ensure that resources are efficiently allocated, some ACPs may require a CBA before gaining approval. This methodology provides a set of practical instructions (as well as background theoretical information) to assist with the preparation of economic evaluations of ACPs submitted to or undertaken by the Office of Airspace Regulation (OAR) within CASA. This Manual has been drafted on the understanding that parties other than CASA may be required to undertake a CBA of an ACP and that CASAs role in such circumstances would include reviewing the economic evaluation (and other material) provided to justify the proposal. This methodology reflects the view that CBA is the best economic evaluation tool available to assess and prioritise airspace change and other investment proposals using quantified costs and benefits. This Manual recognises that there will be some costs and benefits of proposals that cannot be readily quantified in monetary terms. It further recognises that decision-makers need to be informed of such costs and benefits. Some approaches to dealing with such situations are provided in this methodology. The methodology set out here has been drafted to be consistent with current Australian Government CBA guidance material. To this extent, guidelines prepared by Federal departments and agencies were key source documents used in its preparation (see References for source material).
1.2
Purpose of the Manual

The purpose of this Manual is to help CASA staff complete consistent economic evaluation of ACPs The methodology set out in this Manual should be considered in conjunction with the Common Risk Management Framework when considering changes to the aviation safety system and related elements (the Common Framework).1
Department of Transport and Regional Services, Department of Defence, Civil Aviation Safety Authority, Airservices Australia (2007) Common Risk Management Framework for New and Changed Operational Requirements within Aviation, February 2007, Draft 1.3: Consultation draft, Canberra.
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Cost Benefit Analysis Methodology Procedures Manual 1. Introduction 1.3. Background

Approved by Head, Office of Airspace Regulation Version 1.0: November 2007
1.3
Background
The draft Common Framework as set out by the Government includes the following direction: 8.13 Large scale assessments will embrace formal Cost Benefit Analysis which covers all performance dimensions relevant to the subject under review. Rationale for non-inclusion of analysis on particular performance dimensions must be provided. (p.9) The preparation of this Manual is consistent with Government policy in the aviation sector. In June 2007, the Minister for Transport and Regional Services, the Hon Mark Vaile MP, released the Australian Airspace Policy Statement2, which provides guidance to CASA, as airspace regulator, on the administration of airspace as a national resource. Among other things the Statement notes: Australia will take full account of the availability of new technologies, and will also adopt better processes for assessing the implementation of technologies and changes to airspace arrangements. This will be through better analysis including of risks and costs and benefits and enhanced consultation with stakeholders. (p. 5) The key principles of the Government policy addressed by the Statement are:
Safety of passenger Transport operations is the most important consideration; Efficient use of airspace is a benefit to the aviation sector and the Australian economy; Protection of the environment is of concern to all Australians; Access to airspace will be open to all users unless there are justifiable reasons to deny access in terms of safety, efficiency, environmental protection or national security; and Airspace administration will take account of national security. (p. 6)
In relation to the on-going implementation of the National Airspace System (NAS), the Minister also noted in the Statement that: Future stages of the NAS will be implemented subject to the results of an enhanced analytical process, including cost-benefit and the single common risk management framework. (p. 14) With respect to the role of CASA in airspace change, the Statement includes the following: In developing, assessing and promoting significant airspace reform proposals, CASA should adopt best practice risk management and cost: benefit analyses and give attention to the practicalities of implementation. (p. 14)
2
The Australian Airspace Policy Statement, Minister for Transport and Regional Services, the Hon Mark Vaile MP, Australian Government, 28 June 2007, Canberra.
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Cost Benefit Analysis Methodology Procedures Manual 1. Introduction 1.3. Background

The Statement sets out how airspace changes of a major nature are to be made, with a view to the implementation of an international best practice approach. The steps are summarised as follows:
q
Risk management analysis consistent with the Common Framework An assessment of potential costs and benefits Consultation with stakeholders Ensuring consistency with Government policy as expressed in the Statement.
The Statement defines major and minor airspace changes as follows: Major airspace change
A major airspace change seeks to change Australias Airspace Architecture or the way in which Australia currently deploys the ICAO airspace classifications and airspace design standards. A minor airspace change is one which is not major. For example a change to the lateral or vertical boundaries of an existing volume of airspace or a temporary designation of airspace. (p. 23)
Minor airspace change
Where the ICAO refers to the International Civil Aviation Organisation. It is acknowledged that the OAR receives different types of ACPs, typically including one or more of the following characteristics:
q
Changes of airspace classification Changes to the dimensions of Controlled Airspace Changes to Danger Areas, Restricted or Prohibited Airspace Changes to the type of operation within a volume of airspace (including significant changes to aircraft type, patterns and procedures) Changes to the hours of operation of existing airspace Changes to the localised area of regional airspace for a limited period of time to meet the needs of a special event (for example, a major sporting event) or in response to an emergency circumstance (for example, a police emergency) Changes to the airspace Administering Authority.3 (p. 4.1)
However, it may not be necessary for all ACPs to be subject of a CBA.
Australian Government Civil Aviation Authority, (2007) Office of Airspace Regulation Airspace Planning Manual, April 2007, Draft Version 1.2, Canberra (available at: http://www.aeru.com.au/oar/download/OAR_manual.pdf).
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Cost Benefit Analysis Methodology Procedures Manual 1. Introduction 1.4. Target Audience
The methodology set out in this Manual is intended to provide the necessary analytical framework and rigor for the assessment of the costs and benefits of airspace change and other proposals. It should be noted that although the focus of this Manual is on major ACPs, the methodology can be applied to any ACP or investment proposal. In determining whether to use the methodology, the main issue may be the level and depth of analysis appropriate for the particular situation to be evaluated. What is important to recognise is that while the depth and breadth of analysis may vary, the steps followed to assess the proposal or project should be the same. The methodology set out in this Manual has been designed to be consistent with current Australian Government CBA guidance material. While this material has been extremely useful in the preparation of this Manual, CASA has taken the view that, consistent with practice in other aviation jurisdictions (eg, in Europe and the United States of America), it desires a methodology specific to its area of operation and activity, and of direct relevance to the broader aviation community in Australia. In particular, this methodology provides specific references to ACPs and other situations faced in the management of Australias airspace and related systems.
1.4
Target Audience
While the methodology described in this Manual is to be observed in general by all CASA staff, it is to be followed in particular by proponents of ACPs, regulators, senior managers, policy makers and analysts conducting the economic evaluations for ACPs.
1.5
Purpose of Cost-Benefit Analysis

Investment in the aviation industry is required in order to maintain safety and reliability, improve the quality of service and match system capacity with the expected traffic growth. The providers of Air Traffic Services (ATS) and the users of these services (ie, aircraft operators and the supporting organisations) need to know whether ACPs are economically justified and whether the option selected for implementation provides net economic benefits to the community. CBA is an approach to public sector investment appraisal that can provide useful information to decision-makers about the most economically viable option out of a range of alternatives. CBA is particularly important to CASA because of the OARs role in evaluating ACPs. CBA will form part of the analytical process that ACPs will be subjected to in order to be approved. As noted earlier, this process also includes an assessment of risk utilising the Common Risk Management Framework.
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Cost Benefit Analysis Methodology Procedures Manual 1. Introduction 1.6. Purpose of the Methodology
The aim of the CBA methodology described in this Manual is to provide a standardised approach to the economic evaluation of ACPs so that they can be compared and reviewed consistently. The methodology presented covers both theoretical issues underpinning CBA and practical issues associated with application of the techniques involved.
1.6
Purpose of the Methodology

The methodology set out in this Manual provides guidelines for undertaking an economic evaluation of ACPs using a CBA framework. For CBA to be effective in comparing projects it must be applied in a consistent manner. Therefore the adoption of a standard methodology is crucial to ensuring the consistent application of CBA when evaluating ACPs and other relevant investment proposals. This Manual is designed as a guide for analysts, who may be representatives of key stakeholders, as well as for reviewers as a useful checking tool.4 Use of this Manual (ie, application of the methodology) should achieve greater efficiency, consistency and comparability in the analysis of different projects related to Australias airspace architecture. The methodology supports consistency in the way proposals are assessed by different jurisdictions and individual analysts because it:
q
Complements and informs the existing practices in individual jurisdictions Is applicable to all ACPs Provides a framework for strategic planning and for the appraisal of specific proposals by all stakeholders.
The methodology explains the role of CBA in the context of Australian ACPs and provides specific guidance on the conduct of CBA. The methodology also addresses the limitations of CBA. To aid in the consistency of the application of the methodology, a common set of Standard Economic Values (SEVs) has been compiled for use in CBA by and for CASA. The SEV Guidelines is a companion document to this Manual and contains a range of data and analysis input parameters that may be required in preparing a CBA for an ACP and other projects related to Australias airspace architecture. The methodology has been written with non-economists in mind. However, it does expose readers to some relevant economic concepts and has been drafted under the premise that the economic evaluation of ACPs and other investment proposals can only be undertaken in a sensible manner with an adequate understanding of the economic principles involved.
s
4
For example, should a third party propose an ACP and provide CASA with documentation in support of the proposal, it would be anticipated that the OAR would undertake a review of the CBA and associated documentation to ensure that, inter alia, that it was consistent with this report.
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Cost Benefit Analysis Methodology Procedures Manual 1. Introduction 1.7. Format of this Report
1.7
Format of this Report

The remainder of this Manual contains five distinct Chapters. These are:
q
Key Decisions; Principles of Cost-Benefit Analysis
Provides an overview of the conduct of CBA and also introduces a number of topics and issues that may need to be considered when undertaking particular evaluations.
The Cost-Benefit Analysis Checklist
Provides the analyst with a quick-reference tool by posing questions related to the project and points related to the evaluation.
Steps in Cost-Benefit Analysis
Describes the broad aspects of project evaluation and provides a description of the steps involved in conducting CBA.
Data Issues
Provides guidance on what data is required for the analysis and how to go about collecting the data.
A list of abbreviations, references and glossary are provided at the front of this manual.
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Cost Benefit Analysis Methodology Procedures Manual 2. Key Decisions 2.1. Introduction
2. Key Decisions
2.1
Introduction
Economic evaluation and financial evaluation are different but related methods. Financial evaluation is concerned with how to fund a project over its lifespan and measures the adequacy of revenue cash flows to cover the cost of a project. While financial evaluation is important in project management, the economic merit of a project, measured by economic evaluation using CBA is generally unaffected by the financing of a project. CBA considers the changes in costs and benefits that could be caused by potential changes to the base case or do nothing scenario. CBA considers costs and benefits to the wider community, whereas financial evaluation looks at the financial costs and benefits to a particular entity. Table 2.1 compares the major differences between economic and financial evaluations.
Table 2.1: Comparison of Economic and Financial Evaluations ECONOMIC Perspective Australian Economy Using the Australian community's resources efficiently Opportunity costs / market prices Excluded* Included FINANCIAL CASA (or sponsoring agency) Using CASA resources efficiently
Objective
Pricing Income distributional effects Externalities
Market prices Excluded Excluded
* May include qualitative discussion of distributional impacts. Source: Booz Allen Hamilton
2.2
Cost-Benefit Analysis as Opposed to Cost-Effectiveness Analysis

For virtually all ACP evaluations, the appropriate analytical technique of a projects worth will be economic evaluation. The key question to determine whether a cost-benefit or cost-effectiveness analysis (CEA) is used is: Can any of the Major Benefits or Savings of the Proposed Project be quantified? If the answer is yes, then the evaluation should be a CBA. Only when the major benefits or savings of the proposed project cannot be quantified should a CEA be considered. In the case of ACPs, there will be measurable differences in recurrent costs (ie, differences in future cost savings and thus differences in benefits). 2-1
Cost Benefit Analysis Methodology Procedures Manual 2. Key Decisions 2.3. Cost-Benefit Analysis Flowchart
The major difference between CEA and CBA is that in CEA the major benefits cannot be valued in dollar terms but only identified and quantified in physical terms. A CEA essentially compares projects and/or options in terms of their effectiveness and their cost.
2.3
Cost-Benefit Analysis Flowchart

Figure 2.1 provides an overview of the steps involved in the economic evaluation process using a CBA framework and serves as an outline guide in using this Manual. The steps will be discussed in more detail in Chapter 6. A key point is that in many cases, undertaking a CBA requires inputs from supplementary analytical processes such as operations modelling, engineering studies, user surveys, specific risk and/or safety analyses and modelling.1 Outputs from these processes are fed into the CBA framework, typically as quantified costs and benefits (as shown in Figure 2.1).
3 Identify Identify unquantified unquantified costs and costs and benefits benefits
1 Define Define objectives objectives and project and project scope scope
2 Identify Identify project project options options
3 Identify Identify quantified quantified benefits benefits
7 Identify Identify preferred preferred option option
8 Prepare Prepare report report
4 Discount Discount future costs future costs and benefits and benefits
5 Calculate Calculate the decision the decision criteria criteria
6 Undertake Undertake sensitivity sensitivity tests tests
(Inputs into the CBA): (Inputs into the CBA): Operations, Incident, Operations, Incident, Demand Analyses; Demand Analyses; Environmental Impacts; Environmental Impacts; Technology Assessment. Technology Assessment.
3 Identify Identify quantified quantified costs costs
Figure 2-1 Cost-Benefit Analysis Framework Flowchart
For example, it is likely that specific risk modelling will be required in some situations to estimate the probability of particular events (such as a collision pair or a midair collision or Controlled Flight into Terrain CFIT) to determine the likely changes in fatalities per annum.
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Cost Benefit Analysis Methodology Procedures Manual 3. Principles of Cost Benefit Analysis 3.1. Introduction
3. Principles of Cost Benefit Analysis
3.1
Introduction
CBA is a tool used to undertake an economic evaluation of an investment proposal, change in policy or regulatory arrangement. It is specifically concerned with identifying and measuring (where practical), and then discounting future costs and benefits to present values to enable the calculation of the net economic worth of project options. CBA involves an incremental assessment: that is, evaluating a project option(s) against a base case. Defining and clearly articulating the base case (sometimes referred to as the do nothing option) is often one of the more challenging aspects of CBA. In practice, while most costs and benefits can be quantified, the measurement of all the projected costs and benefits can sometimes prove to be elusive. This Chapter presents a discussion on a number of important elements involved in preparing a CBA. The information provided includes both practical guidelines and a discussion on key underpinning principles of the CBA approach to project appraisal.
3.2
Project Identification
The project identification phase represents the first stage in undertaking a CBA, and comprises:
q
Defining the problem Clarifying the problem(s), key issues(s), etc Identifying specific objectives and / or service needs Consulting with stakeholders Scoping the project (eg, timing, relationship to other projects, developmental stage, and indicative cost estimates).
These elements are consistent with established CASA practices as well as those of some of its major stakeholders and industry partners.
3.3
Specification of Project Options

The range of viable (or technically feasible) options may vary according to the nature of the problem. At the project identification stage, a large range of project options may be generated and assessed at a preliminary level. Viable project options must then be specified accurately for a detailed CBA.
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Cost Benefit Analysis Methodology Procedures Manual 3. Principles of Cost Benefit Analysis 3.4. Defining the Base Case
3.4
Defining the Base Case

Options are evaluated relative to a base case. CBA cannot be conducted without a base case. The base case provides the benchmark against which the proposed project, an ACP, can be measured. The base case is a do nothing option. The do nothing option requires a clear description of what is likely to occur in the absence of a project/policy change. This should not necessarily imply that the base case is a costless option: doing nothing does not necessarily mean spending nothing. In other words, the base case or do nothing option means including only those changes to the existing situation that are for all practical purposes, unavoidable between the present day and the end of the evaluation period. Similarly, maintaining the status quo should be considered as what needs to be done without the project to maintain the current or prescribed levels of service or policy, rather than simply continuing in the existing state. It is important that the base case is defined as the option that will maintain the existing level of service/performance. The base case can therefore be expressed as what would happen without the project if the project objectives were to be met. If an option is viewed as providing an improvement to the status quo, it should be included as a project option. One useful way to consider the base case is as the without project option, which in turn could be a do nothing option (in the strictest sense) or a do minimum option. Quantification of the do nothing option necessitates identification of the incremental costs and benefits from the project. The project options are incremental to the base caseie, Net Project Benefit is Option Benefit minus Base Case Benefit. Costs and benefits must be carefully considered as to whether they are an outcome of the project. Calculating costs and benefits by reference to the situation pre-project is not correct as it overlooks changes to the existing situation that are unavoidable between the present day and the end of the evaluation period.
3.5
The Role of Value Management

There are a range of techniques that can be used to enhance the rigor and effectiveness of a CBA. One approach, Value Management (VM), has proved to be effective as a complimentary tool to CBA.1 VM addresses the technical and functional dimension of a project/proposal as opposed to the resource allocation perspective that is dealt with by CBA.
Whilst the term complimentary is used here, in the practical sense, use of the VM (or similar) approach becomes an integral part of the initial steps of the CBA process as it will assist in successfully completing the first 3 steps as shown in Figure 2.1.
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Cost Benefit Analysis Methodology Procedures Manual 3. Principles of Cost Benefit Analysis 3.6. Role of the Department of Defence
VM is an approach that can encompass strategic objectives and structured analyses of an overall project assessment methodology. When used as an input into the preparation of a CBA, VM typically involves a formalised meeting(s) with key stakeholders (usually including technical/specific subject-matter experts) in a facilitated workshop to provide a forum for issues, risks and areas of uncertainty to be raised. VM outputs can include identifying what benefits are the most highly valued and the best way to divert resources to realise these valued benefits and ensuring that options considered are suitable for the objectives being addressed. The selection of a proposal-specific evaluation period different from the recommended evaluation period, in Section 3.8.4, could be an agenda item for a VM workshop. VM workshops are particularly useful exercises where it may be problematic defining the base case or where the technically feasible options or likely impacts are complex and may present the non-technical analyst (in an airspace sense) with some conceptual and clarity concerns. A VM workshop with some experienced industry stakeholders may prove extremely useful in gaining an understanding of the likely behavioural changes that may follow from the implementation of a particular ACP, for example. The approach is also useful in quickly moving from a long or ill-defined listing of options to a firm short list of well-articulated options (and sub-options) that can be widely understood. The use of VM should be considered a potentially useful initial element of an ACP costbenefit analysis as an aid to an effective evaluation. There are other related techniques, such as the Value Measuring Methodology2, which in effect combine multi-criteria assessment techniques (discussed later in the Manual) with CBA techniques to arrive at an evaluation approach that attempts to quantify both monetary and non-monetary aspects of options under investigation. These techniques are typically adopted where Government policy criteria are major influences on investment decision-making.
3.6
Role of the Department of Defence

The Statement directed CASA and the Department of Defence to work closely in order to administer a civilian/military airspace management regime: Close coordination of civilian and Defence airspace requirements is to be facilitated under a Memorandum of Understanding (MOU) between CASA and Defence, assisted by:
Placement of Defence officers within the Office of Airspace Regulation (OAR) to work as OAR officers, but also holding delegated powers under Defence legislation. This will help ensure that decisions on Defence needs for access to airspace are met through the one regulatory body; and
Value Measuring Methodology, How-To-Guide, Federal Chief Information Officer (CIO) Council, Best Practices Committee , Washington DC, USA, October 2002.
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Cost Benefit Analysis Methodology Procedures Manual 3. Principles of Cost Benefit Analysis 3.7. Valuing Costs and Benefits
Close strategic and policy coordination between the heads of the Aviation agencies.
The working relationship between CASA and Defence will develop according to the following agreed principles:
National airspace needs to be managed as a single entity and Commonwealth agencies involved in airspace management will work together to ensure that safety, national security, environmental protection, efficiency and access objectives are met; and The civil and military airspace design and operation must be integrated at the strategic level, and in the operations of the OAR.3 (p. 18)
Therefore when conducting a CBA for ACPs, outcomes should be considered in close consultation with relevant defence personnel. Defence must be viewed as a key stakeholder agency in any ACP. It may also be the case that for a particular CBA to be completed, Defence will need to supply inputs and information not publicly available. For example, implementation of an ACP could impact upon defence operations in various ways, including (but not limited to) impacting operational requirements; flight training arrangements and effectiveness; crew duty limits and total training times because of delays or increases in sortie time; or an increase in the ratio of transit as opposed to actual training time for a given sortie duration. Therefore, some CBA inputs may not be made publicly available. Publicly available contact information for the various Defence bases relevant to aviation is provided in the SEV Guidelines.
3.7
3.7.1
Valuing Costs and Benefits

Quantitative and Qualitative Costs and Benefits
Costs and benefits that can be directly expressed in economic terms are referred to as quantitative. Costs or benefits that cannot be quantified in economic terms are referred to as qualitative costs and qualitative benefits. It is important here to understand that quantitative in this sense means quantified in monetary terms. Even though something can be expressed numerically, it may not necessarily be able to be quantified in the economic sense by the assignment of a monetary value. Furthermore, there are many variables that are not sold in any market for which it is still possible to estimate values and thereby represent them in monetary terms. A prime example is the concept of value of travel time, where minutes saved can be converted into dollars of estimated savings (refer to Section 3.7.5). The concept of the Value of a Statistical Life (VSL) (refer to Section 3.7.6) falls within this category in the CBA context.
3 Minister for Transport and Regional Services, the Hon Mark Vaile MP, Airspace Act 2007 The Australian Airspace Policy Statement, 28 June 2007, Canberra.
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Only those quantified costs and benefits directly attributable to the project/proposal are subject to the discounted cash flow analysis (discussed in detail in Section 3.8). However, all qualified costs and benefits should be identified and described (including the identification of the affected parties and the nature of the impacts involved) in the CBA report as this could be important information for the decision-maker. There is another class of benefits that can be considered in CBA though not included in the discounted cash flow analysis of benefit streams referred to as enabled benefits (see Section 3.8). As opposed to actual (or delivered) benefits realised from the project/proposal, there may be a number of enabled benefits that only materialise if another project/proposal is carried out; the so-called enabling project. These enabling projects should be clearly identified and described in the CBA as should projects that are dependent on the enabling project. In the same way, as qualitative benefits should be identified and described in the CBA report, so too should enabled benefits be presented separately to the decision-maker.
3.7.2
Valuation in Resource Cost Terms

CBA is concerned with the flow of real resource costs and benefits, and therefore excludes market distorting instruments of policy such as taxes and subsidies. Taxes and subsidies are market imperfections that can cause social costs and benefits to differ from private costs and benefits as measured in the marketplace. They are regarded as transfer payments from one part of the economy to another. CBA is about endeavouring to measure the value of all costs and benefits that are expected to result from the proposal/project. It therefore includes estimating costs and benefits that are unpriced and not the subject of normal market transactions but which nevertheless entail the use of real resources. In economic evaluation, all inputs to the analysis (such as time, fuel, maintenance, etc) are valued in resource cost terms. Generally, resource costs equal market prices plus subsidies less taxes. In order to maintain consistency, the resource cost approach should be used.
3.7.3
The Concepts of Sunk and Opportunity Costs

Sunk costs are costs that have already been incurred and that cannot be recovered to any significant degree. Sunk costs are sometimes contrasted with variable costs, which are the costs that will change due to the proposed course of action. In evaluating a project, only variable costs are relevant to a decision; sunk costs are excluded from the analysis. If the project includes an asset that is owned prior to the project, the asset should not be treated as sunk and of no value if the asset has an alternative use with a positive realisable value. In this example, the cost attributable to the asset is the opportunity cost of the asset if utilised in the project in question i.e. the cost of the asset minus the value of the asset in its alternative use. This is an important aspect as the conceptual basis for valuing costs in CBA is their opportunity cost.
3-5
Implementing a program or policy requires the use of resources (or inputs) that could be utilised elsewhere. The opportunity cost reflects the benefits forgone by society in not using these resources for an alternative purpose. The opportunity cost of a resource is measured by its value in the next best or most valuable alternative use.
3.7.4
Externalities
Externalities are the costs incurred by the wider community (ie, non-users) that are a direct effect of the project. Examples of external costs and benefits are noise pollution, air pollution, greenhouse emissions and other environmental effects. Externalities are often referred to as spill over costs (or benefits) such that other parties receive a benefit for which they do not have to pay or incur a cost for which they are not automatically compensated. An external benefit is often termed a positive externality; an external cost a negative externality. While there are various approaches to the valuation of externalities, such as contingent valuation and the dose-response approach, for the purposes of most CBAs, it will be sufficient to identify the nature and quantum of the effects and then apply default values to elements such as air pollution and noise pollution. These would be on the basis of estimated changes in output of pollutions multiplied by cost values derived from environmental and scientific studies. In most cases, approximations will be the norm as opposed to precise measurements. For example, a cost of noise and air pollution may be applied in the evaluation on the basis of defined units per take-off and landing by aircraft type. The difficulty in including externality costs and benefits in evaluations is common across most transport sectors, not so much because of their relevance but because of theoretical and practical constraints on measurement. Externalities should be included in CBA where the method for measurement (and valuation) has broad professional support and the time and resources needed to establish estimates are available. At the least, an attempt should be made to describe the issues in terms of the sources and nature of the externalities involved.
3.7.5
Value of Travel Time

It is generally accepted that people place a value on time in a range of work and non-work situations. There has been a substantial volume of international research (mostly in the surface public transport domain) dedicated to estimating values of travel time (VoTT) and related savings and the impact this has on demand, in particular. Changes in airspace regulations can impact on the travel times of aircraft users and passengers on commercial and charter flights, for example. These changes (measured typically in minutes per passenger), valued on the basis of dollars per hour for non-working time (for commuting, for example), can be a significant source of benefit in transport CBA and need to be captured in the evaluation. Where available, data that enables some disaggregation of travel time savings by trip purpose (eg, leisure or business or commuting, etc) should be adopted.
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In most transport applications, it is usual to weight time spent waiting (eg, delay) at a level greater than time spent travelling as this time is typically perceived as less desirable. In public transport evaluations, a weight in the range of 1.5 to 2.0 (based on a substantial body of Australian and overseas research) is typically adopted for waiting time relative to time spent actually travelling (i.e. in-vehicle time). It is reasonable to assume that there is a relationship between VoTT and income, albeit at a high level. It is usual to assume therefore that the VoTT changes over time and this is addressed in CBA by applying the following formula: Forecast growth in VoTT = Elasticity of the average VoTT with respect to Gross Domestic Product (GDP) x (Real GDP Growth percentage per annum Population growth percentage per annum), where an elasticity value of 0.8 is recommended for non-working time (e.g. commuting time) and 1.0 for working time. VoTT are provided in the SEV guidelines and should be used as default values. Growth rates for VoTT are also provided.
3.7.6
Value of a Statistical Life

Transport accidents impose a range of impacts on people and organisations. These include casualty related costs such as human costs, loss of output due to injury and medical and healthcare costs. Human costs include pain, grief and suffering to the casualty, relatives and friends. In the case of fatalities it represents the intrinsic loss of enjoyment of life over and above the consumption of goods and services. Loss of output due to injury is typically based on estimations of the present value of expected loss of earnings plus non-wage payments. Medical and healthcare costs are those associated with hospital emergency services, treatment, rehabilitation, etc. Accident related costs can include material damage (to aircraft or facilities), police and fire service costs, disruption costs, insurance costs, legal and court-related costs (but not settlements) and the cost involved in accident investigations. The Common Risk Management Framework4 directs the following: 8.12 Agencies will use Economic Values published by the Bureau of Transport and Regional Economics (BTRE) in relation to the value of a statistical life. (p. 8) The latest BTRE report that provides information that can be utilised in preparing a CBA is: Cost of Aviation Accidents and Incidents, BTRE Report 113 (2006).
Common Risk Management Framework for New and Changed Operational Requirements within Aviation, February 2007, Draft 1.3: Consultation draft.
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The BTRE analysis is based on adoption of the Human Capital approach (as opposed to a willingness-to-pay (WTP) approach which can take more time and cost substantially more money due to the elaborate surveys required) that in effect puts the major value of a persons life as the productive output of that individual over their working life. It therefore assumes that the productive output of the economy will be forgone if a significant input to the production one person were removed. The loss is valued at the income forgone during recuperation for injured persons and over the expected remaining life for fatalities. The BTRE also adds the value of household and volunteer work to this value as well as values for lost quality of life and the costs associated with accidents and incidents as cited previously. The concept of VSL is not without controversy, and alternative approaches to that used by the BTRE in the particular report cited exist and are often championed (including by the BTRE themselves in its Report 113 when discussing the application of its results).5 Importantly, the BTRE notes: Ideally, willingness to pay studies should be used to assess safety improvements on a project by project basis, incorporating the values and tradeoffs of actual people. This would be a context specific approach, allowing users to reveal how much safety they wish to buy. (p. vii Report 113) While this analysis based on the human capital approach is transparent, human capital type analyses are often likely to produce lower bound estimates. Preferably, and in principle, willingness to pay studies of Australians should be used to determine the value of specific safety improvements in Australia. Such studies should be context specific, allowing those who will be affected by certain proposals to express their own views on how much safety they wish to buy. (pp. 27-28 Report 113) There is a view that the Human Capital approach provides a conservative minimum estimate to valuing a statistical life as it does not, among other things, fully address or capture the value of the leisure, health and joy that people experience. Furthermore, the approach, because it is mostly related to forgone earnings, could be argued to value less the lives of children, elder people, volunteers etc. Other concerns relate to the uncertainty about future earnings and life expectancy assumptions as well as discount rates used and the fact that in the Australian context most of the data used relates to General Aviation (GA) activity as opposed to scheduled Regular Public Transport (RPT) services.
The article cited in the references by Kip Viscusi and Joseph Aldy - The Value of a Statistical Life: A Critical Review of Market Estimates Throughout the World, provides useful reading for those wishing to explore and understand the concept and techniques for measurement more.
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In order to address some of the concerns associated with the Human Capital approach and the BTRE data specifically, particular reference to the cost of accidents is contained in the discussion of sensitivity analysis in Section 3.10. In the absence of Australian-specific WTP values, the BTRE data provides a useful (and transparent) starting point for an estimate of VSL until better information is available. Furthermore, in the absence of an Australian- specific VSL based on societal WTP estimates for reductions in small risks of premature death, the BTRE cost of accidents data is a transparent default. Analysts need to be aware that VSL has no application to an identifiable person or to very large reductions in individual risks. It does not suggest that any persons life can be expressed in monetary terms. The concepts sole objective is to assist in valuing the likely benefits of proposals. As in the case of VoTT, it is reasonable to assume that there is a relationship between the VSL and incomes (again, at a high level). Therefore, it is usual to assume that the VSL changes over time and this is addressed in CBA by applying the following formula: Forecasts growth in VSL = Elasticity of the average VSL with respect to GDP x (Real GDP Growth percentage per annum Population growth percentage per annum), where an elasticity value of 1.0 is recommended. Furthermore, it may be necessary to examine the composition of the VSL to determine whether relative cost adjustments are also merited.6 This is particularly so because there is typically a gap of several years between studies used to determine the default values.
3.7.7
Residual Values
The residual value is the value of an asset at the end of the evaluation period. This may be an estimate of its market value (if any) or its remaining value in use. For projects involving the introduction of assets with long lives compared to the evaluation period, a residual value must be included. Another way of considering residual values is that they reflect that the asset will generate future benefits beyond the evaluation period. It is recommended that residual values be treated as negative costs as opposed to benefits in the discounted cash flow analysis, that is, an offset against capital costs incurred in implementing the proposal or project. Readers should note the implications for the calculation of the benefit-cost ratio from this approach. In most cases, it will suffice to estimate the residual value of an asset, in the absence of a market value, by using a straight line depreciation approach based on an agreed economic life of the asset in question. Where asset lives are not readily available, the treatment in the official accounts (eg, Annual Report) should be adopted.
This should not be confused with a re-valuation associated with a rise in real incomes as measured by GDP.
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3.7.8
Decommissioning Costs
It is not uncommon in preparing a CBA to come across situations where existing facilities/assets are made redundant and require dismantling or some other method of disposal. The costs involved in decommissioning facilities resulting from the proposal under review need to be included. This may also include costs of site restoration. If there are salvage values associated with redundant equipment or facilities, these should also be included as appropriate (and not confused with residual values).
3.7.9
Secondary Effects
Secondary effects typically relate to benefits and are effectively benefits that are the consequences of the project or proposal. These can also be referred to as indirect or second round effects and are a common source of double counting in CBA, particularly where distributional/allocative analysis has been undertaken. Where the project/proposal is a catalyst in stimulating other investments in production, businesses or property, it is legitimate to include the benefits of these new activities only if their own incremental costs are also included. The analyst needs to be sure if including secondary benefits, they are not including benefits for effects that are the direct result of benefits that have already been counted. For example, if travel time savings to aircraft passengers has already been counted and these savings are the sole cause of some other benefit / positive effect, it would be a case of double counting to include this latter effect in the evaluation as the estimate of travel time savings would have already captured benefits.
3.7.10
The Rule of Half and the Concept of Consumer Surplus

The rule of half is based on the concept of consumer surplus. Consumer surplus is a fundamental aspect of welfare economics of which CBA is an important analytical framework. The use of this concept to value aviation project benefits is illustrated by the following example. Assume that an ACP will reduce the cost of travel due to reductions in travel time and aircraft operating costs. In Figure 3.1, the demand curve for flights is shown by AB: as the cost per flight decreases, the number of flights taken increases. Suppose the existing costs per flight is C1. At that cost, the number of flights undertaken is F1, and the consumer (aircraft passenger) expenditure on the flight is the cost per flight multiplied by the total number of flights (the area C1CF1O). The consumer valuation of F1 flights is the area ACF1O. The consumer surplus is the total valuation of F1 flights by the consumers less the expenditure on the flights (ACF1O less C1CF1O or area ACC1). Assume the ACP will reduce the cost per flight from C1 to C2. For the existing flights F1, the change in consumer surplus is the reduction in cost per flight (C1 C2) multiplied by the number of existing flights F1. It is ACDC2 less ACC1 (area C1CDC2). The cost reduction will also result in additional or generated flights so that the total number of flights will increase from F1 to F2. Valuation of the benefits resulting from the reduction in cost per flight to the consumers is given by the change in the value of consumer surplus.
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Cost ($)
C1
E C2 D
F1
F2
Number of Flights
Figure 3-1 Consumer Surplus and Valuation of Consumer Benefits
The benefits of the additional flights (F2 F1) are given by the summation of the total amount that each new trip maker would be willing to pay to make the flight, less the cost of the flight C2. It is the area CED (shaded). If the change in flight cost is small, then it may be assumed that the demand curve section CE is linear and that CED is a triangle. Therefore, generated benefits = (F2 F1)(C1 - C2).
3.7.11
Option Values
The concept that underlies option values can be explained using the following example. Consider a strategy or plan which includes the re-opening of an abandoned air route linking a number of remote communities/towns to a major town or city that has connections nation-wide. Even if a particular individual living in one of the communities served by the new route does not intend to use the air service with any regularity, they may still value having the option to use the service if they choose. For example, a car-owner may value the ability to use the service when for whatever reason they cannot drive or their car is unavailable. A non-car-owning resident who generally does not travel beyond the community may value the knowledge that, should they need to reach the town or city, the facilities exist for them to do so, at reasonable cost and with a reasonable level of convenience. In addition, those who do intend to use the service on a regular basis may also have an option value, over and above the value of their intended use of the service, since they too may value the options offered for air travel over those already taken account of in their individual plans and expectations.
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Cost Benefit Analysis Methodology Procedures Manual 3. Principles of Cost Benefit Analysis 3.8. The Concept of Present Values and Discounting
From this example, it can be seen that:

q
Option Values are associated with unexpected use of the transport facility/system that is not necessarily built into any existing traffic forecasts, and would otherwise not appear in the appraisal as a benefit Option Values are related to the individual's attitude to uncertainty in practice a range of option values is likely to be found within the population There is a real risk of double counting, particularly when trying to separate individuals' WTP to have the option of using the service from their WTP for their actual use of the service.
The use of option values in project appraisal is not widespread in Australia (if at all). In the United Kingdom (UK), the application to public transport project evaluation is becoming more common, but the paucity of data and agreement on the methods for calculating option values limit use. While there is a general agreement with the concept, it is not suggested that this element be used in preparing CBAs for CASA. However, where issues of option values are likely to arise with ACPs, these should be described and where possible some quantification provided around the likely numbers of persons affected, the nature of the impact and the circumstances involved.
3.8
The Concept of Present Values and Discounting

In most projects, the costs and benefits are going to be spread out over time. Since people are not indifferent with respect to the timing of costs and benefits, it is necessary to calculate the present value of all costs and benefits. It is therefore important that the valuation of costs and benefits takes into account the time at which they occur, since people generally prefer to receive benefits as early as possible and pay for costs as late as possible.7 Discounting is performed for two reasons: 1. Immediate income or benefits are preferable to future income or benefits (social time preference). 2. Capital investment has an opportunity cost: it could earn a rate of return in other sectors of the economy if it were not used for the current project (opportunity cost of capital).
This time preference concept is a fundamental concept of cost-benefit analysis.
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The standard approach to valuing costs and benefits that occur at different times is based on the fact that a dollar today is worth more than a dollar tomorrow. The approach reduces a time stream of costs or benefits to an equivalent amount in the price years dollars. This amount is known as the present value (PV) of the future costs and benefits. The PV is calculated using the method of compound interest and the rate that converts future values into PV (ie, the discount rate). The PV of costs and benefits can be expressed as follows:
PVCosts =
Cn n n = 0 (1 + r ) Bn n n = 0 (1 + r )
costs in year n expressed in constant dollars benefits in year n expressed in constant dollars real discount rate evaluation period in years.
N
PV Benefits =
Where: Cn = Bn = r= n=
In the preparation of a CBA, this process is known as the Discounted Cash Flow (DCF) method and can be readily set up in a standard spreadsheet-modelling environment such as MS Excel.8
3.8.1
Selection of a Discount Rate

The discount rate is used to convert costs and benefits that occur in different time periods to PV so that they can be compared. It is based on the principle that, generally, society prefers to receive goods and services now, rather than later, and to defer costs to future generations this is known as 'social time preference'. The selection of the discount rate has an impact on the magnitude of the reported results. The generally preferred approach is to use a real discount rate, that is, to exclude any inflationary component of market rates. Inflation must be treated consistently across both the applied discount rate and the costs and benefits components of the evaluation. However, it is noted that if costs and benefits are measured in nominal (or current) dollars, then a nominal discount rate should be used.
Advice and tips for analysts on good practice for setting up a DCF model within a spreadsheet environment are provided later in the report.
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A common practice in estimating the social time preference is by using the Australian Governments borrowing rate. The yield on long-term Australian government bonds is generally in the order of six per cent. However, alternative measures of opportunity cost exist, such as the Social Opportunity Cost (SOC) of Capital, which is determined by the equivalent return that may be able to be received by another project, whether in the public or private sectors. This application is problematic in a practical sense due to the limitations associated with project choice. However, it is important to consider that the SOC is generally higher than the Government borrowing rate. A related discount rate is the Project-Specific Cost of Capital (PSCC) rate, which is a market-based assessment of the projects volatility. In the Capital Asset Pricing Model (CAPM), this risk is a measure of the non-systematic (eg, business cycle) risk relationship between the market as a whole and the individual project. Market risk is a premium on the project expected return to compensate investors for the volatility involved in their investment. Recent estimates of Australias market risk premium for equities, which are a typical base for project risk assessment, are around six per cent. Most State government Treasury Departments publish a prescribed real discount rate to apply to economic evaluations. This framework does not prescribe a benchmark real discount rate, since it varies from one year to the next. However, it is noted that use of the cost of capital rate ensures that the true opportunity cost of capital is reflected in project/proposal evaluation and that resources are used efficiently. Currently, the New South Wales Treasury directs use of a seven per cent real discount rate in economic appraisal (CBA)9, the Victorian Government directs use of a six per cent real rate10 and Queensland Treasury provides the following advice: These guidelines suggest the choice of discount rates for specific projects be made by agencies in consultation with the Queensland Treasury Analyst for your portfolio (who will consult with Strategic Asset Management Branch and QTC). This section provides some guidance on the factors influencing the choice of discount rates. As noted in section 2.1.4.1, the choice of discount rate should be consistent with the basis for valuing costs and benefits in the analysis of project options: where the flow of costs and benefits is expressed in real (constant dollar) terms, a real discount rate should be used where the flow of costs and benefits is expressed in nominal (current dollar) terms, a nominal discount rate (including an allowance for inflation) should be used.
NSW Treasury (2007) NSW Government Guidelines for Economic Appraisal, Policy & Guidelines Papers, tpp 07-5, July 2007, Sydney, Australia. Available at: http://www.treasury.nsw.gov.au/pubs/tpp2007/tpp07-5.pdf. NSW Treasury (2007) Economic Appraisal Principles and Procedures Simplified, Office of Financial Management, Policy & Guidelines Papers, tpp 07-6, July 2007, Sydney, Australia. Available at: http://www.treasury.nsw.gov.au/pubs/tpp2007/tpp07-6.pdf. 10 Department of Infrastructure (2005) Guideline on economic, social and environmental cost-benefit analysis, Melbourne, Victoria.
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The following reference points may be used in determining the discount rates for projects:
the interest rate for Government borrowings for a term relevant to the expected duration of the project (for example, for Queensland, this would be the interest rate for 10-year QTC bonds for a project expected to generate most costs and benefits within 10 years). An allowance for inflation can be deducted from this rate if costs and benefits are expressed in real terms the long-term average real economic growth rate, with an additional allowance for major risks and time preference for current consumption1. As this is a real discount rate, an allowance for inflation would need to be added to discount flows of costs and benefits expressed in nominal terms the rate of return on debt and equity for comparable private sector projects (as a public sector project would be competing with other activities for debt and equity capital).
Where any of these methods are used to determine a discount rate, sensitivity testing with higher or lower variations on the chosen rate should be used to allow for a margin for error, and the possibility of the project having unique characteristics which would limit the relevance of rates of return for other projects as a benchmark. (p. 50)11 The Office of Best Practice Regulation (OBPR) in its Best Practice Regulation Handbook suggests use of an annual real discount rate of seven per cent.12 CASA has adopted this discount rate. It is also noted that the OBPR advises that it will publish updates to the suggested discount rate on its website http://www.obpr.gov.au/.
3.8.2
Price Year
The price year in an economic evaluation is the year in which the value of all costs and benefits are expressed. That is, the dollar units represent the same purchasing power.
3.8.3
Selection of the Base Year

The base year is the year to which costs and benefits are discounted to arrive at a PV. The base year affects the magnitude of the reported results, with an earlier base year resulting in lower magnitude of results. When undertaking project evaluations, it is preferable to discount to the base year in which the decision to proceed will actually be made so that PV means just that. The base year is usually the same as the price year. Generally, the base year and the price year should be the year in which the evaluation is conducted. The base year must be common to all alternatives being considered.
11
Queensland Treasury (2006) Cost-Benefit Analysis Guidelines - Achieving Value for Money In Public Infrastructure and Service Delivery, July 2006, Brisbane, Australia. 12 Australia Government (2007), Best Practice Regulation Handbook, Canberra (pp. 120, 121, 130).
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3.8.4
The Evaluation Period and Economic Life

The PV of costs and benefits are measured over a set evaluation period. In comparing projects, it is important to evaluate options over the same time period. For aviation technology projects, typical evaluation periods are likely to range from five to 15 years, depending on the type of project and the economic life of the principle asset. This relatively short evaluation period also reflects the dynamics of aviation technology development where changes can be more rapid, for example, than in other transport sectors. The economic life of a project is the period of time over which the benefits to be gained from the project may reasonably be expected to accrue. Benefits from a project are limited ultimately by its physical life. It is also further limited to its technological life. Future regulatory changes may also affect the economic life of a particular project. Economic life is a key variable and it is important to make the best possible determination. This is clearly an example of an element that could be agreed to at a VM workshop and then tabled when scoping the elements of the CBA. Assets with economic lives shorter than the evaluation period should only occur when considering a range of options with different economic lives. One approach is for the short lived assets to be assigned a replacement or renewal cost and this cost should be included in the analysis for the year in which it is expected to be incurred. The key issue is to ensure that the period chosen is sufficiently long enough to capture all potential costs and benefits of the ACP. It is recommended that a 10-year evaluation period be adopted. Where a different period is selected, the choice must be detailed and a rationale provided in the CBA report.
3.8.5
Treatment of Inflation and Interest Rates

It is important that the effects of inflation do not distort the cost and benefit streams. Inflation causes the costs and benefits that occur later in the evaluation period to appear higher than they should. This causes bias towards projects with later benefits. Inflation does not increase the real value of costs and benefits; it only increases their monetary value. The monetary value of costs and benefits should be expressed in real terms at the general price level prevailing in the year the evaluation is conducted, because inflation simply raises all cash values by a given percentage. Real or constant prices prices net of inflation are thus used in CBA. Interest payments should be excluded from the evaluation because they are implicitly reflected in the discounting process.
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3.8.6
Relative Prices
It is possible (even likely) that the prices of different inputs used in an ACP may not move at the same rate, resulting in relative price changes. The expected relative price change can be accounted for directly. If there is good reason to believe that an input is going to increase at a different rate from others, then the correct rate in period t is imputed by multiplying the input using the following expression: P = (1 + g)t (1 + p) Where: P = relative price g = rate of increase in the nominal price of the input p = general rate of inflation (eg, CPI) t = time interval. If differential rates of inflation are expected for individual cost or benefit items, the difference between the expected value of the costs and benefits needs to be included. Where cost or benefit items are expected to increase at a rate greater than general price inflation (eg, as typically measured by the Consumer Price Index CPI), then they should similarly be adjusted upwards. This may occur with wages or civil construction costs, for example. The advice of the Federal Department of Finance and Administration in its Handbook of Cost-Benefit Analysis (January 2006) should be taken in this regard: "If there are good reasons for thinking that particular cost or benefit streams will not follow general price movements, those changes in relative prices should be built into the analysis. (p. 60) It does need to be recognised that this can introduce a problematic situation, namely trying to estimate an inflator value for the particular cost or benefit stream over a (potentially) long time period. If there is a situation where the analyst has strong evidence to believe that a particular category of costs or benefits is highly likely to grow at a rate over and above general inflation (eg, CPI), there is a risk of underestimation of effects in the economic evaluation. The use of a VM session could be useful here in soliciting the views and/or experience from relevant experts or gaining direction to appropriate statistical or other data. The approach recommended is to increase the particular cost and/or benefit stream(s) by the difference between CPI and the expected rate of change (which may vary over time also) prior to discounting. Obviously, where adjustments are significant, sensitivity testing will become an important consideration. Where this approach is taken for any category of cost or benefits, there should be sufficient supporting documented evidence provided in the CBA report to show the rationale underpinning the approach being adopted.
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Cost Benefit Analysis Methodology Procedures Manual 3. Principles of Cost Benefit Analysis 3.9. Decision Criteria
Projections of costs and benefits expressed in dollar units of different years also need to be standardised, generally using the GDP Implicit Price Deflator or the CPI13, although a more specific price indicator might at times be appropriate to aviation sector costs (if readily available). For example, a proposal conducted in 2007/08 may be relying on some equipment costs estimated in 2005/06 dollars. With other cost and benefit streams in 2007/08 dollars, it is important to bring the equipment costs up to 2007/08 dollars.
3.9
Decision Criteria
There are a number of alternative criteria for the assessment of the economic value (net economic worth to society) of projects. These criteria are outlined in the following sections.14 While there are a number of criteria available, it is recommended that Net Present Value (NPV) be viewed as the preferred decision criteria for CBA and any variation from this rule must be well documented in the CBA report and a clearly articulated rationale provided.
3.9.1
Net Present Value

NPV is perhaps the most straight-forward CBA measure. It is the sum of the discounted project benefits less discounted project costs. It can be expressed as the following formula: NPV =
n =0 N
Bn C n (1 + r ) n
Where: Bn = benefits in year n expressed in constant dollars C n = costs in year n expressed in constant dollars r = real discount rate n = evaluation period in years. Using NPV as a decision rule, a project is potentially worthwhile (or viable) if the NPV is greater than zero; i.e. the total discounted value of benefits is greater than the total discounted costs.
The CPI and the Implicit Price deflator for non-farm GDP for Australia can be sourced from the Parliament of Australia, Parliamentary Library, Monthly Economic and Social Indicators (MESI) produced by the Librarys Statistical Section. It is available in five year time series at http://www.aph.gov.au/library/pubs/mesi/index.htm. 14 As with the DCF method discussed earlier advice on setting up for the calculation of the various decision criteria within an MS Excel spreadsheet environment are provided later in this report.
13
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Approved by Head, Office of Airspace Regulation Table 3-1: Decision Rules with NPV Version 1.0: November 2007
If NPV > 0 NPV < 0 NPV = 0
Meaning The project would be worthwhile The project would not be worthwhile The project neither adds or subtracts value
Action The project should be accepted The project should be rejected The project could be accepted since the required rate of return is being obtained
When comparing mutually exclusive alternatives, the alternative that yields the highest NPV would be chosen. Whilst the NPV rule is generally straight-forward there are a number of issues that can arise with its use. These relate to:
q
The impact of budget constraints Complementarities among projects The interaction of budget constraints and project timing choice Comparison of projects with different lengths of life.
3.9.2
Benefit-Cost Ratio
The Benefit-Cost Ratio (BCR) is the ratio of the present value of benefits to the present value of costs. The BCR can be expressed as follows: BCR = PV Benefits PVCosts Where: PV Benefits = PVCosts Bn n n = 0 (1 + r ) N Cn = n n = 0 (1 + r )
N
A project is potentially worthwhile if the BCR is greater than 1. This means that the PV of benefits exceeds the PV of costs. Under this decision rule, if alternatives are mutually exclusive, the alternative with the highest BCR would be chosen. It is recommended that the BCR is not adopted as the prime decision rule. BCRs can sometimes confuse the choice process when the policies under consideration are of a different scale, yielding misleading results. For example, if proposal A has a PV of benefits of 200 and PV of costs of 100, it has a NPV of 100 and a BCR of 2. If the alternative proposal, B, has a PV of benefits of 600 and costs of 400, it has a smaller BCR (1.5) but a larger NPV (200). It would be more efficient to choose proposal B. 3-19
3.9.3
Internal Rate of Return

The Internal Rate of Return (IRR) is the discount rate at which the NPV of a project is equal to zero, ie, discounted benefits equal discounted costs. In algebraic terms, the IRR is the value of r, which solves the equation:
0=
n =0
Bn C n (1 + r ) n
A project is potentially worthwhile if the IRR is greater than the discount rate applied in the evaluation. If projects are mutually exclusive, this rule suggests that the project with the highest IRR should be chosen. There are a number of potential problems with using the IRR for decision-making15:
q
It may not be unique; that is, there may be more than one discount rate at which the NPV is zero. This problem only arises where annual net benefits change more than once from positive to negative (or vice versa) during the discounting period. IRRs are percentages (ie, ratios), not dollar values. Therefore they should not be used to select one project from a group of mutually exclusive projects that differ in size. This scale problem always arises with the use of ratios, including benefit-cost ratios, cost effectiveness ratios, and IRRs.
Nonetheless, as long as it is unique and scale is not an issue, the IRR conveys useful information to decision-makers who want to know how sensitive the results are to the discount rate.
3.9.4
Net Present Value per Dollar of Investment

Net present value per dollar of investment (NPV/i) contains elements of NPV and BCR criteria. It can be expressed as:
NPV / i = NPV /
K
n= 0
(1 + r ) n Where: K n is the capital cost for year n.
NPV/i can be useful where proportions of the capital costs are funded from other sources. The alternative with the highest NPV/i should be chosen.
15
Boardman et al (2006) Cost-Benefit Analysis: Concepts and Practice, p.155.
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Cost Benefit Analysis Methodology Procedures Manual 3. Principles of Cost Benefit Analysis 3.10. Allowing for Risk and Uncertainty
3.9.5
Payback Period
The projects payback period is determined by counting the number of years it takes before cumulative forecast cash flows equal the initial investment. This criterion requires an agreed rule for a cut-off date for payback and any such rule would be arbitrary as the worth of the project has little to do with such a date.
3.9.6
Recommended Decision Criterion

There is often debate about the most appropriate decision rule. The advice from the Department of Finance and Administration is clear: Other decision rules such as benefit-cost ratio and internal rate of return may be included with caution in the analysis alongside the net present value criterion. However, these rules can be misleading and should not be used in place of the net present value rule.16 (p. 62) For additional discussion on these issues, The Department of Finance and Administrations Handbook (pp. 57-59 and 134-140) and the OBPRs Best Practice Regulation Handbook (pp. 119-128) provide useful advice.17 Also, Boardman et al (2006) Cost-Benefit Analysis: Concepts and Practice.
3.10
Allowing for Risk and Uncertainty

Until now, it has been assumed that single-value estimates of future costs and benefits will be applied in the CBA. This is consistent with the assumption that future costs and benefits are known with a high degree of certainty. In many cases, some of the costs and benefits involved in a project evaluation will be uncertain. It is important to take into account the potential variation surrounding these estimates. Estimates of possible outcomes that affect the economic viability of the projectwhether it be from a financial, safety or environmental perspective - will need to be defined, evaluated and treated. Risks associated with aviation projects are to be evaluated under the Common Risk Management Framework (the Common Framework).18 Risks are subjected to the Common Framework and a CBA for their management, which will contribute towards the overall cost of the project. Realised risksissueswill affect the overall viability of the project and hence coordination of the risk management with the project assessment will optimise the project decision. It will be necessary to conduct the risk management processes to provide the relevant inputs to the project CBA once the scope of the project has been defined.
16
17
Handbook of Cost-Benefit Analysis, Department of Finance and Administration, Canberra, January 2006 Refer to Reference list at the end of this report. 18 Common Risk Management Framework for New and Changed Operational Requirements within Aviation, Department of Transport and Regional Services, Department of Defence, Civil Aviation Safety Authority and Airservices Australia, February 2007 (consultation draft Draft 1.3).
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Risk management and the economic evaluation (the CBA) should use the same set of standard values, SEVs as appropriate.19 The following section discusses internal project risk assessment from an economic perspective and from the perspective of preparation of a CBA.
3.10.1
Sensitivity Analysis
As CBA involves estimating many factors that are subject to uncertainty, it is not appropriate to rely on a single value. Therefore sensitivity analysis should be used to gauge the potential for a decision variable to diverge from its estimated value. Sensitivity analysis is also used to calculate the effect of variation of inputs on the decision criteria, such as NPV and/or BCR. Sensitivity analysis involves defining a range of values for an uncertain variable in the appraisal and assessing the effects on the CBA of assumptions or estimates within the defined range. This will highlight those variables for which a change in the input value has a significant effect on the outcome of the CBA. For the significant factors, the following should be listed:
q
Assumptions and estimates on which the appraisal has been based An upper and lower bound of the range of critical or particularly uncertain estimates and the assumptions on which this range is based The resultant NPV at the upper and lower bound of each estimate.
A useful approacha so-called partial sensitivity analysisis to examine how the NPV changes as one variable varies over a plausible range (holding other variables constant). This approach is particularly important to apply for the most important or uncertain variables. It is important to extend sensitivity analysis to the discount rate that is applied to the project cost and benefit streams. Suppose that a discount rate of six per cent was adopted, sensitivity testing at four per cent and eight per cent can accommodate uncertainty about the level of the opportunity cost of capital during the project period ahead. In this regard, it is noted that the OBPR suggests sensitivity analysis with a real discount rate of seven per cent be at three per cent and 11 per cent.20 Given that the recommendation to CASA is to adopt a 7 per cent real discount rate, sensitivity testing as per the OBPR (ie, at three per cent real and 11 per cent real) is also recommended. In addition, use of more than one test discount rate may assist in focusing on key uncertainties in cases where there are significant differences in the time profile of net benefits of project alternatives.
19 20
The Standard Economic Values report is a companion document to this report. Australia Government (2007), Best Practice Regulation Handbook, Canberra (p. 130).
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As noted earlier, the values included in the CBA are the most likely or best estimates. Sensitivity analysis provides information about the effect of errors (under or over estimates) on the viability of the project; and provides a test of the robustness of the results to changes in the original assumptions. Considerations of key project risks should also be incorporated into the sensitivity analysis. The 'tests' to be applied should also include:
q
Variations to the capital expenditure quantum and spend profiles (eg, timing of expenditure) Variations to the estimates associated with operating costs of alternatives Variations in assumptions about take-up rates and other key assumptions with respect to technology and systems as is appropriate Variations in demand/use profiles and ramp up over time.
The development of scenarios with combinations of changes to assumptions can be a useful approach, particularly in terms of deriving reasonable worse case and base case scenarios. Defining and developing a range of possible sensitivity tests could be a task/element of a VM workshop at the beginning of the evaluation. Given the context of CBA of ACPs, it is recommended that specific sensitivity analysis be incorporated around two important aspects associated with risk. An important input into evaluations is likely to be risk analysis/modelling associated with determining safety aspects such as the probability of (increasing or reducing) accidents and fatalities. It is recommended that specific sensitivity tests are applied to the values for the costs of accidents, in part to counter the degree of debate about appropriate valuations. It is recommended that specific sensitivity tests be adopted that draw upon some of the literature around the use of WTP based estimates of statistical values of human life.21 Furthermore, it is recommended that consideration be given to applying a disproportion factor (DF) specifically to an assessment of the risks associated with fatalities and initiatives being proposed to reduce fatalities. In evaluations where the major rationale underpinning expenditure is a reduction of safety risks (particularly where levels are currently deemed adequate) as opposed to the generation of other benefits (eg, travel time reductions, aircraft operating cost savings etc), it is recommended that DF analysis be undertaken to augment and/or further inform the evaluation. This is discussed in more detail in Section 3.14.
21
As discussed in Economic Benefit-Cost Analysis Comparing Enroute Class E and Class C Airspace, Access Economics Pty Ltd, 30 April 2004, for Airservices Australia or in some of the reports/studies referenced in the BTRE Report 113.
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3.10.2
Risk Assessment
Where the project/proposal under investigation does not require a formal risk assessment separate to but related to the CBA, sensitivity analysis within the CBA should suffice. However, should it be deemed necessary22 to undertake a risk assessment as part of the CBA the following advice is provided. Risk assessment with the CBA will involve reiterations of the economic evaluation where new or updated data is provided. Furthermore, a specific focus on the various risks associated with options can be undertaken. Risk analysis for each of the options can be undertaken and could involve drawing upon material from other elements of the study, for example: information about the range of potential outcomes and the probability of each occurring (ie, the probability distribution). The key source of this information will be, ideally, empirical evidence eg:
q
Observed outcomes for projects with similar characteristics Professional advice from study team engineers Statistical analysis, eg, risks of specific events Time series data of values of key variables (eg, exchange rates) Historical evidence of cost and program delivery overruns.
The compilation of a risk register and risk log which incorporates assigned probabilities and/or an impact exposure matrix will be important in endeavouring to quantify the most significant risks for the risk analysis. The register establishes a list of possible project risks, type of risk descriptions, likelihood (or probability), inter-dependencies with other sources of risk, expected impact counter measures, and risk status etc. Statistical evidence and/or study teams expert judgement about the probability of specified risks occurring will be used to calculate the expected value of costs and benefits. Monte Carlo simulation can be used to provide an indication of the range and distribution of possible outcomes (recognising that the key to this sort of modelling is quantifying data inputs). A key feature of the analysis is the determination of the appropriate level of risk adjustmentwhich will be a function of how much risk can be assumed to have been incorporated into costs and benefits (savings). The probability/impact exposure matrix measures can provide an indication of the extent to which costs or benefits are vulnerable to a given risk and can be used to indicate which risks are most material to the business case.
22
Advice should be sought from the General Manager OAR about the level and detail of risk assessment that would be appropriate.
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Approved by Head, Office of Airspace Regulation Table 3-2: Risk Probability/Impact Severity Matrix Version 1.0: November 2007
Impact Severity Low Risk Probability High Medium Low Medium Low Low Medium High Medium Low High Very High High Medium
Furthermore, it could be decided to undertake a quantitative risk assessment (QRA) in order to adjust the business case which would involve drawing the distinction between planned costs (typically point estimates) and benefits (based on an assumption of all going well) and expected costs and benefits (which would incorporate allowances for difficulties such as cost and time overruns). This would result in calculation of the expected (or risk-adjusted) value, which is the weighted-average of all potential outcomes and associated probability. In developing the QRA, it will be necessary to prepare estimates of realistic ranges within which cost might fall and to attach to this a likelihood of occurrence. This can be done by utilising a 3-point estimate for each risk element (triangular distributions), which would represent 3 possible costs (eg, low, most likely, and high) and expressing these in terms of the relative likelihood (or probability) of alternative outcomes within an overall range as illustrated in Figure 3.2.
100%
p =100%
Uncertainty exists surrounding the exact cost of the item however it is known to be within the range of 10-20 dollars with p=100%
Probability (p) 75%
10
12
20
Cost ($m)
Figure 3-2: Cost Probability Distribution for a Cost Activity
Risk analysis software (eg, @Risk and Crystal Ballwhich incorporates Monte Carlo simulation) could be used to simulate the entire project option by solving (or iterating) it numerous times. This could, for example, involve preparation of 3-point estimates for all risk activities in order to enable evaluation of overall project risk.
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Such a simulation analysis could be used to derive a standard probability (or bell-shaped distribution) that could provide an indication of the probability that the total project costs will not exceed a particular value. From the probability distribution it could then be possible to derive a cumulative probability curve (typically, S-shaped as per Figure 3.3) of expected project out-turn costs at various levels of probability (this process could also be applied to benefit streams as well as costs).
Figure 3-3: Example Cumulative Probability Curve
As noted earlier, the level of risk analysis that is directly included within the CBA or undertaken externally and then utilised in preparing the CBA should be determined prior to undertaking the CBA. The BTREs report, Risk in cost-benefit analysis (Report 110, 2005) provides useful discussion on the treatment in CBA.
3.10.3
Optimism Bias
Experience has shown that project and policy planning has long been afflicted by Optimism Bias (OB). Research has shown that there is a demonstrated, systematic, tendency for project appraisers (and/or sponsors) to be overly optimistic. This suggests that the probability of a project or proposal going wrong can exceed that of the outcome proving better than planned, ie, that risks are biased. To redress this tendency, it is recommended that appraisers make explicit, empirically based adjustments to the estimates of a projects costs, benefits and duration.
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Cost Benefit Analysis Methodology Procedures Manual 3. Principles of Cost Benefit Analysis 3.11. Issues and Limitations of Cost-Benefit Analysis
It is suggested that a specific OB analysis23 be undertaken to ensure a high level of certainty can be attached to capital costs and other key cost element estimates. This would involve adjustments to cost and benefit estimates to reflect the potential to underestimate costs and overestimate benefits that can be inherent in the early planning stages of projects. OB is a generic risk, and adjustment for it should be a routine part of project appraisal. The preferred approach to applying OB to risk adjusted estimates is to move away from the generic percentage increases for capital and operating costs and replace these with OB estimates established for separate project components. For example, in deriving capital costs, OB may be established for various operation cost components, such as labour, access charges, etc. Where this is impractical or not warranted in cost grounds, use of percentage increases can suffice. Determination of the appropriate OB factors could be a task included in a VM workshop. It is noteworthy that the UK Treasury guidelines published a schedule by type of project and technology projects (as opposed to for example, civil engineering works) attract a substantially higher penalty. As with other areas of risk analysis, if there are recent empirical studies or projects to reference, this should be done (with positive as well as less-than flattering examples cited).
3.11
Issues and Limitations of Cost-Benefit Analysis

As with any analytical technique, there can be some inherent areas of possible deficiency. In undertaking CBA, analysts and reviewers need to be aware of some key criticisms that can, and have, been levelled at the method.24 These can be associated with:
q
The use of monetary values for costs and benefits including non-monetary items such as values for a statistical life, value of travel time savings and values for other intangibles.
Defined in Handbook of Cost-benefit Analysis (Dept. of Finance and Administration, Canberra, 2006) as when the favourable estimates are presented as the most likely or mean estimates. Suggested remedies are sensitivity analysis, loading of the discount rate and the clear enunciation of assumptions and their supporting rationale. In the UK, a formal approach to Optimism Bias has been introduced to capital works appraisal. In the UK Treasurys Green Book (Appraisal and Evaluation in Central Government, 2003) and the Dept. for Transports Transport Analysis Guidance (2003) specific values for OB are set out be applied to appraisals depending upon the type of capital works involved. For example, on capital expenditure a range of 10% to 200% is recommended for Equipment and or Development projects where these are defined as projects that are concerned with the provision of equipment and/or development of software and systems (ie, manufactured equipment, Information and Communications Technology (ICT) development projects) or leading edge projects. This formal process was put in place based on the findings, inter alia, of two important reports: Underestimating Costs in Public Works Projects Error or Lie , Flyvbjerg, APA Journal (2002) and Review of Large Public Procurement in the UK, Mott MacDonald (2002). The 3 key areas (accounting for over half the bias estimate from a range of 26 specific items under review) of bias identified by Mott MacDonald were associated with: Degree of Innovation involved, Inadequacy of the Business Case and the Technology involved.
23 24
In many cases, criticisms have more to do with the behaviour of analysts undertaking CBAs and not necessarily the method itself.
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Cost Benefit Analysis Methodology Procedures Manual 3. Principles of Cost Benefit Analysis 3.11. Issues and Limitations of Cost-Benefit Analysis
Bias in assumptions in order to make a proposal look good. Concerns that the process of preparing a CBA can be complex and onerous on analytical resources and information requirements. The view that CBA is an inequitable process as all beneficiaries are treated equal irrespective of the identity of the beneficiaries (eg, no reflection of socio-economic circumstances in weighting costs and benefits to members of society affected by proposals).
The following sets out some points useful to consider by way of refuting many of the criticisms levelled at CBA:
q
Bias in assumptions in order to make a proposal look good is a criticism of the analyst carrying out the CBA rather than of CBA as a policy/investment evaluation method. As noted below, a clear articulation of assumptions and transparent analysis can address this criticism. Application of monetary values to human life this criticism is misdirected. Lives are not being valued; the values are for reductions in the risks of premature death. Hence the use of the term, the value of statistical life (VSL). Proposals are not designed to protect identifiable individuals from certain death but rather to protect large populations from collective mortality risks. VSL is the relevant concept for judging such proposals. Concerns that the process of preparing a CBA can be complex and onerous on analytical resources and information requirements it is not uncommon for analysts tasked with preparing a CBA to face time pressure and resource constraints. The decision to quantify, and with what degree of effort, should reflect the value of the increased precision that can be obtained and the costs of obtaining it. Moreover, CBA is not necessarily complex and onerous. The analysis should be commensurate with the magnitude of the problem and the size of the potential impacts. Using a CBA framework can be quite simple for less significant issues and of modest cost. The view that CBA is an inequitable process it is often argued that CBA takes the existing distribution of income as given and does not consider the equity implications of the policies that it seeks to evaluate. In other words, unweighted WTP measures virtually assures proposals that are slanted in favour of the preferences of high-income individuals. This criticism is directed at the way net benefits of individuals are aggregated to obtain estimates of the communitys net benefit. This criticism is legitimate as far as it goes. CBA does not take equity into account. However, that need not be the case. Analysts can weight in any number of ways the impacts on lowincome and high-income individuals, the problem is that someone must state explicitly what the weights should be and from where correct weights should be sourced. No unique set of equity weights have been determined through the political process, and as a consequence no weighting has become the default in CBA. In part this is where using an MCA approach as supplementary to the CBA can aid decision-making. As discussed earlier, even with no weighting, more disaggregated CBA can provide important information about the impacts on particular groups of people.
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Cost Benefit Analysis Methodology Procedures Manual 3. Principles of Cost Benefit Analysis 3.12. Role of Multi-Criteria Analysis
With these potential limitations or concerns in mind, the best advice is to clearly articulate all assumptions and ensure that all analyses involved in the evaluation are verbally and numerically explicit about the assumptions on which they are based and the reason for those assumptions. Where possible, effort should be made to describe impacts and effects in qualitative as well as quantitative terms and describe any unique features and/or issues. The aim should be to provide decision-makers with as much supplementary contextual information as is both reasonable and practical.
3.12
Role of Multi-Criteria Analysis

In many policy decision-making settings there is a requirement (and practicality) to prepare supplementary assessments that are either stand-alone or used in conjunction with CBA. This is particularly the case where hard-to-quantify factors need to captured as part of the advice to policy makers.25 In order to overcome the view (put forward by some commentators and academics, for example) that CBA relies heavily on monetary valuations26 and the alleged omission of factors for which money valuations are difficult or impossible, the use of multi-criteria analysis (MCA) as supplementary (as opposed to an alternative) is often adopted.27 The MCA approach is often used as a supplementary measure to CBA to examine qualitative values when assessing significant change proposals or investment decisions. There would not be any real necessity to contemplate using MCA where it is obvious that the vast majority of costs and benefits of a proposal have been satisfactorily identified, quantified and monetised. As noted previously, the Australian Airspace Policy Statement has specified a number of key general principles for airspace administration that CASA must take into account, namely:
q
Safety the Government expects the safe operation of Passenger Transport operations to be the first priority in airspace administration Efficient use of airspace is a benefit to the aviation sector and the Australian economy Protection of the environment from the effects of, and associated with, the operation and use of aircraft Access to airspace will be open to all users unless there are justifiable reasons to deny access in terms of safety, efficiency, environmental protection or national security
For example, the Value Measurement Methodology mentioned earlier is one such approach used in the USA for Federal Government-sponsored e-commerce projects of national significance. 26 This should not necessarily viewed as a weakness, but is arguably a critical strength of CBA. 27 It is worth noting that exactly what constitutes multi-criteria analysis is hard to say and variations on the theme are common. There is in practice no established theoretical framework or uniform set of principles (unlike that that exists for CBA). Terminology also varies.
25
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Airspace administration will take account of national securityNational security refers to Australias defence, security, international relations or law, coupled with the need to protect the Air Traffic Management system. 28
Adoption of an MCA technique can provide a means for CASA (and/or third parties preparing proposal submissions) to assess these principles (or criteria) for each major ACP. The form of MCA discussed in this section is known as the Goals Achievement Matrix (GAM) method. The primary focus of the GAM method is on selected socio-economic or other objectives as opposed to the effects on particular community groups.29 The approach does not seek specifically to focus on sectoral interests, and does not require effects to be expressed in monetary values. Objectives can be weighted to reflect their relative importance to the analyst or decision-maker. Whereas CBA employs a wellestablished methodology in specifying and estimating various effects or impacts, the choice of impacts in MCA is typically more arbitrary and usually derived via a consultative approach. Typically, MCA includes the determination of factors/criteria for inclusion and then a scoring system (with or without weighting) to reflect the relative importance of each in the overall assessment. The attainment of a single number score for options under the MCA can be developed. This typically involves adoption of a uniform scale. Scoring is usually undertaken using a scale, such as a scoring scale that runs from 0 to 5, for example: Negative effect/Inconsistent, Remotely meets/Weakly Consistent Partially Meets/Moderately Consistent, Substantially Meets/Strongly Consistent and Best Meets/Fully Consistent. Symmetrical scales are also widely used. Whilst the scaling approach (like all scaling approaches) is subject to debate, it does have the benefit in that it converts all impacts to a common range of values and also preserves relativities for each effect under the different options when scores and scales are combined. Figure 3.4 provides an example of a MCA that could be adopted to supplement the CBA approach outlined in this report.
Minister for Transport and Regional Services, Mark Vaile, Airspace Act 2007 The Australian Airspace Policy Statement, 28 June 2007, Canberra. 29 These objectives could also be referred to as 'impacts', 'goals', 'attributes', 'criteria' or 'effects' when discussing multi-criteria analysis.
28
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Principles / Criteria Consistent with the enhancement of safety of passenger transport operations
Option 1 4
Option 2 4
Option 3 4
Delivers a more efficient airspace use and aids the aviation sector
Reduces environmental impacts of current aviation activity in Australia Supports increased accessibility for users of airspace
4 4
2 3
3 2
Does not negatively impact on national security
Negative Effect / Inconsistent
Remotely Meets / Weakly Consistent
Partially Meets / Moderately Consistent
Substantially Meets / Strongly Consistent
Best Meets / Fully Consistent
Figure 3-4: Multi-Criteria Analysis Framework
Furthermore, it may be worth considering widening the scope of the performance criteria under which to assess proposals to capture performance parameters for Air Traffic Management as provided by the ICAO. It is noted that use of the ICAO supported criteria would:
q
Align with the global industry bodys positioning Allow for an even wider range of issues for consideration by decision-makers.
The ICAO parameters are divided into three groups and are presented in the table below.
Table 3-3: ICAO Air Traffic Management Performance Parameters
Societal Safety Security Environmental Sustainability
Operational Performance Cost effectiveness Capacity Efficiency Flexibility Predictability
Performance Enablers Access and Equity Participation Interoperability
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Cost Benefit Analysis Methodology Procedures Manual 3. Principles of Cost Benefit Analysis 3.13. Ex-post Evaluation
A similar scoring framework to that presented in Figure 3.4 could be developed for the factors in the table above. Importantly, when undertaking MCA, it is crucial to recognise that in an ideal situation the first-best approach to assigning values to the effects of proposals/options is to estimate monetary values, as in CBA. For this reason, inter alia, MCA should only be viewed as a supplementary tool to CBA. Furthermore, it is recognised that the Achilles heel of the MCA approach is the weighting/scoring values ascribed to criteria/impacts as well as the potential to double count impacts where they are captured directly within the CBA and then also included in a supplementary MCA. Best practice in MCA usually involves agreeing scoring and weighting frameworks with the decision-making agency and/or key stakeholders (typically experts in particular subject matters of relevance to the evaluation at hand) and then providing a rationale as to why each criteria received a particular score/weight relative to other criteria. It is not uncommon to arrive at a near consensus position via the use of VM workshops, where a selection of key players agree to the scoring systems/weightings to be adopted. The aim is for this process to be as transparent as possible to avoid subsequent 'concerns' about the relative scores and/or weightings applied. In developing the approach, a comparative summary of the proposal and alternatives is useful where the broad achievement against each criteria (or goal) is set out in one table. The varying proportional shading of the Harvey balls (as seen previously in Figure 3.4) will visually indicate the options that perform best overall. As noted earlier, this summary can be taken one step further with scores attached to each level of achievement. Furthermore, scores can be weighted differently for each criteria/goal.
3.13
Ex-post Evaluation
Often a major short-coming with public sector project appraisal is the absence of ex-post evaluations. That is, asking the question: how good was the evaluation undertaken on project X? This process involves re-visiting the original evaluation one or two years after project implementation and re-running the discounted cash flow analysis with new updated values for key inputs including capital costs and other key inputs. This process can also aid in building-up a database of lessons learnt and other useful aids for future proposal evaluation. It is recommended that CASA adopt a formal process for ex-post evaluation of ACPs and other project appraisals with a view to initially, reviewing all CBAs and other projects and some time later, reviewing a sample on a regular basis.
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Cost Benefit Analysis Methodology Procedures Manual 3. Principles of Cost Benefit Analysis 3.14. ALARP, Issues of Disproportionality and Cost-Benefit Analysis
3.14
ALARP, Issues of Disproportionality and Cost-Benefit Analysis

The Common Framework is premised, inter alia, on the concept of As Low As Reasonably Practicable (ALARP), which in the risk management context involves weighing a risk against the trouble, time and money needed to control it. The Guidelines to the Australian and New Zealand Standards on Risk Management30 notes that risks in the ALARP region are also in what it refers to as the Tolerable Region. In CBA, as far as is possible, costs and risk reductions (benefits) are converted to a common set of unitsmoneyin order to undertake comparisons and discounted cash flow analysis of future streams of benefits and costs. In CBA, when the NPV is greater than zero 31, a proposal/project is deemed economically justifiable as society is better off in aggregate terms. However, under the ALARP approach, the rule is basically to adopt a proposal unless the costs of doing so are grossly disproportionate to the risk. Importantly, the Australian and New Zealand Standards on Risk Management provides the advice: Selecting the most appropriate option involves balancing each option against the benefits derived from it.32 (p. 21) It may be that there are cases where the costs could outweigh the benefits and the initiative could still be reasonably practicable to implement. However, the key qualifier in this regard is the concept of intolerable risks whatever the benefits. The Guidelines to the Australian and New Zealand Standard on Risk Management sets out three levels (bands) of risk: an upper band where adverse risks are intolerable; a middle band (or grey area) where there is a need to balance the costs and benefits, and a lower band where positive or negative risks are negligible, or so small that no risk treatment measures are needed. Importantly, the Guidelines include the following statement, which is of relevance in the broader CBA context: When risk is close to the intolerable level the expectation is that risk will be reduced unless the cost of reducing the risk is grossly disproportionate to the benefits gained. Where risks are close to the negligible level then action may only be taken to reduce risk where benefits exceed the costs of reduction.33 (p. 65) This should be the key governing principle in this regard. In terms of considering by how much costs can outweigh benefits before being judged grossly disproportionate, this depends on factors such as how big the risk is to begin with (where, typically, the larger the risk, the greater can be the disproportion between the cost and the risk).
Standards Australia/Standards New Zealand (2005) Risk Management Guidelines Companion to AS/NZS 4360:2004, Handbook HB 436:2004, Sydney, Australia. pp.65-66. 31 The present value of benefits > present value of costs. 32 Standards Australia/Standards New Zealand (2004) Risk Management AS/NZS 4360:2004, 3rd Edition, Sydney, Australia.
30 33
Standards Australia / Standards New Zealand (2005) Risk Management Guidelines Companion to AS/NZS 4360:2004, Handbook HB 436:2004, Sydney, Australia.
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Cost Benefit Analysis Methodology Procedures Manual 3. Principles of Cost Benefit Analysis 3.15. Use of Spreadsheets
From an ALARP perspective, CBA:

q
On its own, does constitute an ALARP case Should not be used to argue against the implementation of relevant good practice, unless an alternative measure(s) can be demonstrated unequivocally to be at least as effective Enables the use of sensitivity analysis to support conclusions suggesting that costs are disproportionate to the benefits of implementing a proposal Should not be used to argue against statutory duties Should not be used to justify risks that are intolerable (supported by appropriate analysis) or justify what is evidently poor engineering.
A specific sensitivity analysis to indicate the relative importance of risk mitigation measures (where these are far and away the key rationale underpinning the proposal) should be provided, which illustrates the ratio of costs over benefits relative to 1 x DF where DF is the disproportion factor. Where costs over benefits is greater than 1 x DF the proposal would be regarded as not justified for the risk reduction achieved. DFs that may be considered gross vary from upwards of 1 depending on a number of factors including the magnitude of the consequences and the frequency of realising those consequences, i.e. the greater the risk, the greater the DF. Factors of 3 or more (with an extreme value of 10) are deemed appropriate for sensitivity analyses. As with a number of aspects in risk management, the issue of a gross proportionality factors is one of debate and active consideration in the Australian aviation sector and caution must be exercised in any application. This area of analysis would be supplementary to the main CBA and only appropriate where risk mitigation and reduction are the over-riding objectives of the proposal (i.e. the expected source of the majority of benefits). This analysis should be undertaken by specialist risk modellers in a way consistent with the previously cited Australian / New Zealand Standards, and elements incorporated into the CBA only as appropriate.
3.15
Use of Spreadsheets
CBA can necessitate a substantial amount of numerical analysis. This includes estimation of the PVs of future cost and benefit streams as well as calculation of various decision criteria e.g. NPV and BCR. Use of a spreadsheet can also be beneficial for undertaking a range of supporting calculations (e.g. determining user benefits or changes in aircraft operating costs associated with a change proposal) which are used in the DCF analysis (which is central to CBA). It is envisaged that a spreadsheet developed model will be required to undertake a CBA.
3-34
In developing a model for undertaking the various calculations required in undertaking a CBA it is not unreasonable to expect that such as model within a spreadsheet environment to contain a range of 'sheets' such as some setting out:
q
Details of the model structure (ie, a control sheet)34 Details of parameter values to be used in the evaluation such as discount rate, the evaluation period (years), value of passenger travel time, average aircraft operating cost per hour by aircraft type, etc Details of sensitivity analysis and risk analysis (as appropriate) Calculations ie, one or more sheets where the analyst may undertake a range of supporting calculations associated with determining specific costs and benefits to be included in the DCF analysis (eg, reductions in average flying times between particular airports, aircraft operating cost savings etc) - including data sources / references etc35 The main DCF table where costs and benefits in monetary terms are converted from undiscounted to discounted values and from future values to present values as well as a range of selection criteria are calculated such as NPV, BCR and IRR.
Where possible inputs should be parameterised, that is, the number of calculations that involve hard-wired inputs (numbers) should be minimised and the use of formulas encouraged that pick-up data from a parameters and / or calculations sheet(s). This is particularly useful where the values of particular inputs may change after review and additional validation etc. Good practice typically means that the 'template' of the main DCF table would enable someone reviewing the work to readily identify the various cost and benefit streams (by category) 'captured' in the evaluation eg:
q
Capital costs (ie, major capital items such as equipment, land, construction items, etc)36; Maintenance costs (ie, annual/recurrent costs of asset maintenance) Other recurrent costs (eg, consumables, energy costs, etc) Training costs37 Decommissioning costs (eg, redundant equipment)
34
35
36
37
A simple flowchart can be a useful tool in a control sheet where the flowchart illustrates the linkages between the various sheets of the spreadsheet and sets out the function (i.e. what is done there) and inter-relationships etc. Depending on the amount of supporting analysis to be undertaken, it may be prudent to have separate sheets for particular issues, e.g. a sheet for use in estimating passenger travel time savings; a separate sheet for estimating operating cost savings to the various aircraft operators etc. Capital costs should not be confused with financial costs of raising capital for investing in assets (of various classes). Capital costs are the resources (i.e. exclusive of taxes etc) costs of the asset acquired. It can be useful to separately show in the DCF tables ad hoc (or once-off) costs that are specific to implementing a change or investment initiative. This is particularly the case with items such as change proposal-specific training, production of new maps, charts and educational and user information material, for example.
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Residual values User benefits (may be presented for various 'classes' eg, aircraft operators (operating cost savings), commercial airline passengers (travel time savings), GA operators, etc; Accident cost savings including estimated reductions and increases in fatalities (as determined by supplementary risk/safety modelling).
This listing will vary from case-to-case and in practice it should be determined by discussions between the analyst and more senior management of their agency as to the level of disaggregation to be provided. It is recommended that the aim should be to provide sufficient disaggregation in the discounted cashflow tables to enable ready review and reasonable scrutiny (obviously the key costs and benefits items should be clearly identified as should those where there is particular 'sensitivity' and / or uncertainty about them). There is no 'single one template' but a number of key elements of 'good practice' as noted above. The Queensland Treasury guidelines38 provide some useful advice on CBA and related analytical techniques vis--vis formats, and the reference Benefit-Cost Analysis: Financial and Economic Appraisal using Spreadsheets39 also provides some good practical advice and examples. It is recommended that summary information from the CBA calculations is presented in the report, whereever practical, in tabular and graphic formats (albeit with more detailed tables contained in attachments and appendices to the main report). For example, the groupings of the various benefit streams could be presented in a pie chart or histogram to readily illustrate where the major benefits come from, e.g. travel time savings to RPT passengers and operating cost savings to RPT aircraft operators etc. Sensitivity analysis also lends itself to summary presentations of results in graphic format where the base result can be compared with the outcomes (eg, NPVs) under the various sensitivity tests and scenarios. The illustration overleaf provides a possible way to present summary results of a CBA showing the NPV, benefits and costs as well as distribution of benefits and results of sensitivity tests.
38
39
Queensland Treasury (2006) Cost-Benefit Analysis Guidelines - Achieving Value for Money In Public Infrastructure and Service Delivery, Project Assurance Framework Supplementary Material Cost-Benefit Analysis, version 0.3, 6 July 2006, Brisbane, Australia. Campbell, H.R. and Brown, R.P.C., (2003) Benefit-Cost Analysis: Financial and Economic Appraisal using Spreadsheets, Cambridge University Press, UK
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Upper Bound
Cost / Benefit ($M)
NPV = Net Present Value (Present Value Benefits less Present Value of Costs)
Reduction in Externalities
Lower Bound
NPV
Benefits to Diverted Traffic Benefits to existing customers Operating Cost Savings for existing operators
Ill
us tra tiv e
Discounted Realisation Costs
Discounted Benefits
Sensitivity Test
The sensitivity tests conducted are: 4% and 8% discount rates; capital costs +/- 20%; benefits streams +/- 20%
Figure 3.5: Illustration of a possible way to present CBA results
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Cost Benefit Analysis Methodology Procedures Manual 4. The Cost-Benefit Analysis Checklist 4.1. Introduction
4. The Cost-Benefit Analysis Checklist
4.1
Introduction
This Chapter provides an overview of the preliminary work that should be completed before launching into a full CBA to determine the net economic worth of a proposal/project. This Chapter also provides a Cost-Benefit Analysis Checklist (as shown in Table 4.1) of questions to assist in preparing a CBA. The detail in the checklist is elaborated upon in Chapter 5. This checklist provides a useful tool to the analyst, which ensures all aspects of the evaluation have been completed. It is also a useful tool for person reviewing a completed CBA report in order to assess the thoroughness of the work that has been completed. The use of this Checklist will assist in defining the scope and thoroughness required for the evaluation. However, it should be borne in mind that CBA is required for all major change proposals to and from CASA. It is recommended that all change proposals are subject to assessment with a CBA framework and that the level of detail and depth of analysis varies between proposals of differing complexity and scale.
4.2
Cost-Benefit Analysis Checklist

Table 4-1: Cost-Benefit Analysis Checklist
Step
Step 1: Define objectives and project scope
Key Questions
Why is the proposal/project proposed? What are the objectives? Are the objectives consistent with other CASA objectives? What type of proposal is it? Temporary or Permanent? What is the scope of the proposal? Is it a new proposal? Has it been evaluated previously or been subject to other forms of analysis eg, risk analysis or value management? Is it part of a larger program or strategy? What major stakeholders are likely to be impacted commercial RPT operators, GA, military, airport operators, aviation service providers etc? What consultation was undertaken and how was it done? Was a VM workshop(s) part of a formal consultation process or purely a technical exercise specific to the design of the CBA process in this particular case?
q q
q q q q q
q q
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Cost Benefit Analysis Methodology Procedures Manual 4. The Cost-Benefit Analysis Checklist 4.2. Cost-Benefit Analysis Checklist
Step
Step 2: Identify the Options
Key Questions
What are the options to achieve the objectives? What is the base case? (What would happen without the project/proposal?) Are there with project/with proposal options? What information was sourced from consultation with key industry stakeholders in answering these questions and what attempts were made to engage industry in this process? Was a VM workshop(s) used in answering questions regarding the likely impacts, the feasible alternatives, the likely behavioural responses of users/groups of users etc?
q q
q q
Step 3: (i) Identify Quantitative Costs
What are the capital (equipment, facilities, structures, project management, construction, decommissioning etc) costs? What is the time frame for capital costs? Will there need to be refurbishment or system upgrade costs considered? What are the recurrent costs? labour (incl. additional training), maintenance, utilities etc Will the change necessitate implementation of new training and new documentation? What are the operating parameters involved? Are there prescribed levels of service, hours of operation/availability, expectations of growth in use/demand etc. What statistics may be required to be accessed? For example, aircraft movements data, passenger traffic data, IFR and VFR activity by location etc. What savings are there from improved safety and risk reduction? Does the change hold implications for security and a need to alter practices and/or make additional investments? What are the user costs? Do these include impacts on passenger travel times or flight times for a class of airspace user eg, GA, military? Are there likely to be impacts on the performance of military training sorties and its requirements in terms of capabilities? Are there implications associated with access to any class of user? Is there likely to be any restrictions on access to one or more classes of user? Can they be identified and quantified?
q q
q q
4-2
Step
(ii) Identify Quantitative Benefits
q q q
Key Questions
Avoidable capital and recurring costs ie, savings in future costs Any proceeds from sale of assets? Residual values years in evaluation period, years of economic life of asset, alternative use of asset etc Incremental Net revenue are there likely to be changes to charges/prices for services? User benefits (eg, travel time savings to passengers, benefits to Defence aviation operations, etc) Cost savings (safety and risk, efficiency, economies of scale, etc) Are user comfort and convenience issues a factor? Are there any quality of service issues? How will safety/risk issues be dealt with? Are there significant option values to consider? How will these costs and benefits be presented and what level of quantification is practical? What are the external costs and benefits?

(iii) Identify Qualitative Costs & Benefits (Difficult to quantify costs and benefits)
q q q q
Environmental considerations Air pollution/emissions Noise Visual effects
Step 4: Discount the future costs and benefits and calculate the decision criteria
q q
q q q
What is the price year? Are the values of all costs and benefits expressed in terms of the price year? Have the values of costs and benefits been adjusted for real price variations over time? What discount rates have been chosen? What is the base year? (Year 0 in the discounted cash flow analysis)? What is the length of the evaluation period? (over how many years will the discounted cash flow analysis be undertaken) What is the length of the principal asset's economic life? Does the evaluation period need to be considered on some other basis other than an asset life basis? Is the evaluation period based on the economic life of the principal asset?
4-3
Step
q
Key Questions
What decision criteria are to be calculated?

Net Present Value (NPV) Net Present Value per dollar of capital invested (NPV/i) Benefit-Cost Ratio (BCR) Internal Rate of Return (IRR) Payback period
Step 5: Sensitivity Analysis
q q
q q
What happens when discount rates are varied? What are the major areas of uncertainty and risk in the project? How have these been dealt with ie, specific analyses? Which assumptions need to be tested? What are the ranges of values which are appropriate for testing? Is there are need for sensitivity analysis based on optimistic and pessimistic estimates of costs and benefits? How are the results affected if different estimates and assumptions are used? What are the plausible upper and lower limits of cost/benefit items subject to uncertainty?
Step 6: Identify Preferred Option
What is the ranking based on initial results? What is the ranking based on sensitivity testing? What is the preferred option when the initial evaluation, sensitivity test and all qualitative factors are taken into account? Does the risk analysis impact on the outcomes significantly?
q q
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Step
Step 7: Prepare Report
Key Questions
What does the report need to include: q Executive Summary? q Recommendations concerning the preferred option? q A description of the background to the proposal/project? q The objectives of the proposal/project? q A description of the evaluation framework? q A description of the options and how they were derived? q Details of underlying assumptions and sources of key input data and parameter values? q A description of all the costs and benefits? q A list detailing cost and benefit streams (tables extracted from the spreadsheet model)? q The assumptions underpinning the evaluation? q Details of the assumptions about the timing of costs and benefits? q The evaluation results and measures of economic worth (NPVs etc)? q The results of sensitivity analysis (in tabular and graphic formats)? q A discussion on qualitative items? q Details of any supplementary analysis eg, multi-criteria analysis? q Comparison of preferred option with other options? q Details of consultation undertaken during the course of the evaluation?
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Cost Benefit Analysis Methodology Procedures Manual 5. Cost Benefit Analysis Procedure 5.1. Introduction
5. Cost Benefit Analysis Procedure
5.1
Introduction
This Chapter details, step-by-step, the activities outlined in the framework for conducting economic evaluation using CBA.
5.2
Cost Benefit Analysis Steps

Conducting a cost-benefit study should include the following, as indicated in Figure 2.1:
q
Defining the objectives and scope of the proposal/project Clarifying the proposal options Identifying the costs and benefits, both quantitative and qualitative Discounting the future costs and benefits Calculating the decision criteria Performing sensitivity analysis and addressing issues of risk and uncertainty Identifying the preferred option Preparing the report.
5.3
5.3.1
Step 1: Define Objectives and Project Scope

The Importance of Objectives
Project identification and specification should be linked to CASA strategic objectiveseg, as indicated in ministerial policy statements, annual reports and other relevant documents. Consistency with stated Government policy vis--vis airspace management is an important consideration, as well as how this fits with Australias international obligations and agreed standards.
5.3.2
Proposal/Project Specification
q
How will it meet objectives? Will it involve new capital works/equipment acquisition? Will there be a need to replace existing facilities/assets? Will there be a need to upgrade or enhance existing facilities? What are the constraints? Who is likely to be effected and how might impacts manifest?
5-1
Cost Benefit Analysis Methodology Procedures Manual 5. Cost Benefit Analysis Procedure 5.4. Step 2: Identify Project Options
It will be necessary to determine the level of detail required for the CBA as well as to identify the beneficiaries of the project and how they are related to the stakeholders. It is important that the proposal/project defined is not so broad that it is actually a program of discrete proposals/projects. Conversely, the project defined should not itself be a component of a discrete project. It must constitute a stand alone investment. Poor specification of the project can lead to inappropriate assumptions and incorrect results. It is recommended that at this initial stage of the CBA process, consideration is given to the development of a consultation plan for industry stakeholders. This plan should include the consideration of the need for/benefits to the process of having one or more formal (structured) VM workshops as part of the process particularly in terms of answering a number of the questions posed above (and in the following section) as well as those identified in Chapter 4 section 4.2 (Steps 1 and 2).
5.4
5.4.1
Step 2: Identify Project Options

Range of Options
Options are prepared to fulfil project objectives. Are there other ways to achieve the same outcome? could be an important question to address. The range of feasible options will vary with the nature of the problem. Tasks set at the strategic level may generate a wide range of options. It will be necessary to determine the feasible options. It will be important to determine whether there are there variations on one basic identified option eg, variations in the design and operational concepts. When describing the options, the analyst should include:
q
A schedule for the project/proposal phase comprising a planning and development schedule The expected operational date of the option plus an operational schedule (eg, airspace organisation and structure, route structure, etc) and a replacement schedule (for individual system components) Type of equipment required if there are different levels of service to be considered Economic life of the key assets involved A transition schedule (if appropriate) Identification of who will be investing in the project (as well as to whom the case needs to be justified to).
The key question initially will be: What is the base case? Proposal options are evaluated relative to a base case. CBA cannot be conducted without a base case. The base case provides the benchmark against which the proposed project can be measured.
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Cost Benefit Analysis Methodology Procedures Manual 5. Cost Benefit Analysis Procedure 5.5. Step 3: Identify Costs and Benefits
Agreeing and defining the base case can be problematic and may benefit from use of a VM workshop (as well as some internal discussion with technical experts within the organisation proposing the change proposal/project).
5.5
Step 3: Identify Costs and Benefits

All relevant costs and benefits must be included in the evaluation. Quantitative costs and benefits are to be included in the discounted cash flow analysis, whilst qualitative costs and benefits must be described and discussed as appropriate. It needs to be recognised that these can accrue to a wide range of parties and, given the particular situation, could include some or all of the following: operators of commercial and GA aircraft, the military (as an operator of aircraft and as a significant user of airspace for training purposes), passengers on commercial and other aircraft, and operators of air traffic and related services. Identification of the likely impacted parties and the probable nature of such impacts is a typical example of the sort of questions dealt with well in a VM workshop at an early stage of the evaluation process.
5.5.1
Identify Quantitative Costs

The nature of the particular proposal being evaluated may be such that there may be a number of project phases to consider. The stages of development and the years in which costs are to be incurred needs to be specified. There may be costs incurred during a planning phase (eg, R&D, testing of various technologies and equipment applications, user community consultation) as well as in the implementation and operating phases of the change proposal or other initiative. There may be a number of capital and other cost components incurred over time that need to be included in the evaluation such as:
q
Capital (or investment) items (eg, equipment or software) typically one-off expenditures necessary for the project/proposal Land acquisition and land restitution costs (including demolition, land clearance, site preparation, removal of redundant equipment/facilities, etc) Construction costs (incl. professional fees) Upgrade or refurbishment costs Project management costs Decommissioning costs Transition costs eg, parts of the existing/current system need to operated and maintained during the transition period to a new system. While not part of the base case, these are costs associated with a new investment/change proposal
5-3
Recurrent costs: Operating, repairs and maintenance costs associated with the new system which can accrue to civil and/or military users and can be within CASA or external to CASA Materials, supplies, utilities and other services Overheads administration, personnel and training, for example User costs: Travel time Flying training time for military purposes Delays or increases in training sortie time for military operations Restrictions on access to facilities to one or more classes of user Accident costs New training and related implementation costs (eg, new documentation and stakeholder consultation and communications) Safety and risk costs.
In quantifying user benefits, the analyst must determine who the users are and how many users there are. There are likely to be multiple user groups involved, for example, one or more classes of aircraft operators, passengers, air traffic control, military aircraft operators, etc. In projects where there are likely to be significant improvements to safety or reductions in risk, then some attempt should be made to quantify these in monetary terms. There may also be security implications that, where practical, also need to be quantified (at a minimum, addressed in qualitative terms). Otherwise, the extent to which safety and risk will be affected should be described qualitatively under the category of unquantified costs and benefits and in a way that captures any analysis undertaken under the Common Framework that can be used in the CBA either in a quantitative or qualitative way. Quantification of safety and risk factors is not easy, but there are various approaches that may be used which can be important considerations in project evaluation. In such a case, it is better to quantify the intangibles in monetary terms so that assumptions can at least be subjected to sensitivity tests. In any event, such items should be identified, a qualitative description included and, where possible they should be given a subjective weighting.
5-4
5.5.2
Identify Quantitative Benefits

There may be a range of benefits to be estimated and, where possible, quantified such as:
q
Cost savings between options (eg, differences in operating and maintenance costs of equipment and aircraft). Savings in operating costs such as reductions in fuel and oil costs and flight time related operating costs (primarily crew and parts of maintenance costs) are treated as benefits in CBA. These may also include cost savings for aircraft operators due to a reduction in delays and reduced investment, operating and maintenance costs associated with new technologies. Reductions in fuel and simpler (more predictable) crew scheduling could result from a reduction in delays and these will accrue benefits to aircraft operators. Asset disposal. Residual values (should be included in the DCF analysis as a negative cost item). User benefits such as travel timesavings for passengers that could accrue due to accommodating the optimum flight profile as desired by the operator, ie, optimum routing, altitude and speed. Travel time benefits can also come from a reduction in aircraft delays. Improvements to the ratio of transit time to training time for military operations (training sorties). Incremental net revenue from changes in costs and charges.
5.5.3
External Costs and Benefits

As noted earlier, an externality is defined as any production or consumption process which spills over such that other parties (apart from CASA and airspace users) receive a benefit for which they do not have to pay or incur a cost for which they are not automatically charged. Examples to be considered in an ACP cost-benefit analysis could include:
q
Environmental considerations (in particular air quality/pollution/aircraft emissions). Reductions in fuel burn, for example, will have obvious positive implications for aircraft emissions benefits Noise (in particular aircraft take off and landing effects) Aesthetic/visual considerations (towers or other physical structures) Regional impacts (eg, tourism, industry development, etc).
It is possible to attempt to quantify some of these costs in monetary terms (eg, the SEV has data on costs associated with air pollution/emissions and other externalities). Where the analyst cannot attach monetary values to such effects, they should seek to ascertain who are the winners and losers and the impact of the gain or loss on the economy. 5-5
Cost Benefit Analysis Methodology Procedures Manual 5. Cost Benefit Analysis Procedure 5.6. Step 4: Discount Future Costs and Benefits
5.5.4
Equity and Broader Distributional Considerations

The CBA procedure involves aggregating costs and benefits across individuals without taking into account the distribution of those costs and benefits between individuals. Total economic worth will increase so long as total benefits are in excess of the total costs for a project. CBA is focused on determining whether a particular proposal delivers a net economic gain (measured in monetary terms) to society as a whole, as opposed to what parties or individuals receive benefits or pay the costs. For any particular project/proposal, some individuals (or groups in the community) may be made better off and others made worse off. For example, people who stand to lose their peace and quiet or local view due to increased airport capacity and those who gain greater accessibility and improved air travel frequency will rarely compensate infrastructure. Whilst CBA cannot resolve equity issues, it is important to draw attention to them by qualifying the impacts of proposed policy changes on different parties. Equity and distributional concerns should be considered and should be included in the overall evaluation if they are likely to be significant. Where information is available, the winners and losers and the magnitude of their gains and losses should be identified and discussed in the CBA report. This is to ensure that decision makers are aware of who may gain and who may lose as a result of the project. The size and/or the nature of the project and/or the significance of likely equity issues will influence the level of effort made to assess the magnitude of the distribution of gains and losses between different groups. The recommendation is that, at a minimum, impacted parties and the nature of these impacts are identified.
5.5.5
Presenting Incremental Costs and Benefits

Economic evaluations should be based on costs and benefits, with project options incremental to the base case. The most effective way of evaluating a project is to include all the absolute costs and benefits associated with the options, and then compare the options to calculate the costs and benefits of the project option(s) incremental to the base case. This method facilitates data checking, interpretation of results and any subsequent modifications.
5.6
5.6.1
Step 4: Discount Future Costs and Benefits

DCF Analysis
Discounting what is it and why do it? As noted earlier, discounting is the reverse of adding (or compounding) interest. It reduces the monetary value of future costs and benefits back to a common time dimension the base year/date. Discounting satisfies the view that people prefer immediate benefits over future benefits (social time preference) and it also enables the opportunity cost to be reflected (opportunity cost of capital).
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Cost Benefit Analysis Methodology Procedures Manual 5. Cost Benefit Analysis Procedure 5.7. Step 5: Calculate the Decision Criteria
5.6.2
Discounting Parameters
The analyst needs to determine the following when preparing to undertake the DCF aspects of CBA:
q
The appropriate price year for cost estimates and the level of prevailing inflation Whether analysis of relative prices is necessary for some cost items (eg, labour costs) What the base year (or discount year) is to be What is to be the base/initial evaluation discount rate The evaluation period (or project period).
5.7
Step 5: Calculate the Decision Criteria

As noted previously, all costs and benefits over the evaluation period are discounted to a present value to enable comparison between overall costs and benefits. This enables the economic worth of the options to be determined relative to the base case. It recommended that at a minimum the NPV is calculated and that this should be the key decision criteria as this is considered to provide a better measure of societys wealth maximisation than, for example, the internal rate of return of benefit-cost ratio. In other words, in an unconstrained market, the option with the highest NPV provides the best economic return. Where there is a budget constraint however, the NPV/i ratio facilitates capital rationing and indicates the highest return per dollar invested. It is therefore possible that an option may well result in a lower NPV but a higher NPV/i ratio than another option. While the other measures can be readily calculated eg, IRR, BCR and payback period, they should be utilised only as supplementary indicators.
5.8
Step 6: Sensitivity Analysis

Sensitivity analysis should be undertaken to test the robustness of results under different scenarios, using different assumptions for various variables. It is a necessary part of any investment appraisal as it can:
q
Test the impact of using different discount rates (the agreed rate should be used with sensitivity analysis two or three per cent points above and below the agreed rate) Assess the possible impact of uncertainty Illustrate what would happen if the assumptions made about some variables proved to be wrong and show how changes in the values of various factors affect the overall costs or benefit of a given project Indicate the critical elements on which the positive outcome of the project depends. 5-7
Cost Benefit Analysis Methodology Procedures Manual 5. Cost Benefit Analysis Procedure 5.9. Step 7: Identify Preferred Option
As noted earlier, the development of one or more scenarios should be undertaken, with a particular focus on a credible worse case scenario where a number of assumptions /variables are assessed in a pessimistic (but realistic) light. In general, if the proposal/project can be justified under very adverse scenarios, then the analyst can be confident that the project is robust. The incorporation of any specific relevant risk analysis should be incorporated at this stage.
5.9
Step 7: Identify Preferred Option

All relevant results and issues must be considered when identifying the preferred option. In summary, the identification of the preferred option requires: 1. The ranking of options by NPV and NPV/i and possibly BCR and IRR and other criteria (eg, payback period) in the initial base evaluation. 2. The ranking of options by NPV and NPV/i in the subsequent sensitivity tests. 3. The weighting of costs and benefits which have only been quantified in physical units or described in qualitative terms (intangibles) between options, even though this is inevitably subjective and somewhat arbitrary. 4. The overall ranking of options based on steps (1) to (3). It is recommended to use NPV and NPVi for decision-making. Where a project is robust, the ranking of options in the sensitivity tests will usually reflect the ranking of the initial evaluation. However, the ranking of options in the sensitivity tests may vary in comparison to the initial evaluation ranking in the case of less robust proposals/projects. When the unquantified and external costs and benefits are broadly similar in nature, ranking given by the cost-benefit criteria are usually sufficient and undisputed. However, when there are significant differences in intangibles between options, a judgement between competing options will need to be made. This may require an assessment of whether the net intangible benefits of the second ranked options can be valued at the difference in NPV between it and the first ranked option.
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Cost Benefit Analysis Methodology Procedures Manual 5. Cost Benefit Analysis Procedure 5.10. Step 8: Prepare Report
5.10
5.10.1
Step 8: Prepare Report

Full Evaluation Report
The final step of the CBA process is producing the report with the appraisal findings and recommendations. This detailed report should include:
q q
An Executive Summary of the evaluation, including the results and recommendations The background to the evaluation, including Reasons underpinning the proposal A statement of why the initiative needs to be implemented immediately Implications of deferring implementation of the proposal/project The proposals/projects classification The objectives of the project/proposal Evaluation considerations Strategic issues particular to this proposal which will influence both the choice of the options and the identification of appropriate costs and benefits A description of the options, including the base case The identification of all costs and benefits, including the key assumptions and inputs sourced from technical analysis undertaken to inform the CBA The annual cost and benefit streams The results of the evaluation, including NPV, NVP/i and possibly BCR and IRR The results of any sensitivity tests including specific risk modelling/analyses A discussion of qualitative factors (costs and benefits) The identification of the preferred option and how it compares against the other options.
q q
q q
q q q q q
5.10.2
Summary Reporting
Summary reporting should contain at least:
q q q q
The objectives of the proposal/project and the program goal A brief description of the options, in order of preference, including the base case The annual cost and benefit streams, including the key assumptions Details of any specific technical analysis undertaken to inform the CBA eg, risk modelling or operations modelling The results of the evaluation, including NPV and NPVi A discussion of qualitative factors including risk and issues of uncertainty Details of any supplementary analysis.
q q q
s
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Cost Benefit Analysis Methodology Procedures Manual 5. Cost Benefit Analysis Procedure 5.10. Step 8: Prepare Report
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Cost Benefit Analysis Methodology Procedures Manual 6. Data Issues 6.1. Introduction
6. Data Issues
6.1
Introduction
This Chapter presents a discussion on some of the issues of data and the Standard Economic Values (SEV) for use in CBA. The data needs required for particular CBAs will vary according to the specific proposal under investigation. However, certain broad data types are essential and these have been discussed previously quantified costs and benefits; recurrent costs; user costs; safety and risk savings; accident costs; and parameter values (eg, discount rate, base year, evaluation period etc).
6.2
Standard Economic Values Guidelines

The SEV Guidelines are available through the CASA website. The SEV Guidelines provide a range of economic values for use in CBA for CASA. The SEV data and references can be used to conduct CBA (and other evaluations), and include a number of default values. Others could also use them in preparing CBA for other investments. In general, the application of these values to their corresponding physical quantities permits valuation of the physical quantities in dollar terms. Conceptually they can be thought of as measures of the dollar sacrifice associated with each physical quantity outcome avoided fatality, aircraft damage, travel time saved, etc resulting from a potential investment or regulatory change. Values presented in the SEV Guidelines fall into a number of general groups, of which the two major ones are arguably: passenger-related values and aircraft-related values. Passenger-related values consist of the value of passenger time and the value of an avoided fatality or injury or VSL. Aircraft-related values include aircraft capacity and utilisation factors and aircraft operating costs. There are also other values such as those associated with the cost of service provision (ie, labour related costs). These can include those costs associated with the provision of different levels of service to the various user groups in the aviation industry by airspace management agencies and others. Other costs of service provision can relate to the assets deployed to deliver services such as communications, navigation and surveillance equipment/systems, as well as infrastructure items, such as control towers and buildings necessary to enable safe and effective aviation activity. The values in the SEV Guidelines have been drawn from a wide range of sources including Airservices Australia, CASA and the Department of Transport and Regional Services (incl. BTRE and the Australian Transport Safety Bureau) as well as from international jurisdictions including EUROCONTROL and the US Federal Aviation Administration (FAA).
6-1
Cost Benefit Analysis Methodology Procedures Manual 6. Data Issues 6.2. Standard Economic Values Guidelines
Notwithstanding the data and other information provided in the SEV Guidelines (including references), there will invariably be the need to collect some original data (primary or secondary) which may be location and/or proposal specific in nature This may be by way of surveys/interviews and/or investigations of databases and manual files/records. Should this be the case, the analyst should discuss the requirement with an appropriate supervisor before proceeding. It may also be the case that some specific supplementary analyses are required in order to facilitate completion of the CBA. This could include safety and risk modelling, analysis of aircraft activity and forecasts of growth, for example.
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Cost Benefit Analysis Procedures Manual Revision History

7.
Revision History
Note: The Revision History shows the most recent amendment first. Scroll down the table to view details of previous amendment information. Version Date Chap/Section Details
Version 1.1 Nov 2010 Table of Contents Added Preface. Version 1.0 Nov 2007 Complete Manual First issue of the Manual.
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Cost Benefit Analysis Procedures Manual Revision History

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Cost Benefit Analysis Procedures Manual Table of Contents

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2. Key Decisions ...................................................................................................................2-1

3. Principles of Cost Benefit Analysis .................................................................................3-1

Cost Benefit Analysis Procedures Manual Table of Contents

4. The Cost-Benefit Analysis Checklist ...............................................................................4-1

5. Cost Benefit Analysis Procedure.....................................................................................5-1

Cost Benefit Analysis Procedures Manual Table of Contents

5.7 5.8 5.9

6. Data Issues ........................................................................................................................6-1

Revision History .................................................................................................................. RH-1

Cost Benefit Analysis Procedures Manual Table of Contents

Cost Benefit Analysis Procedures Manual List of Effective Pages

Version 1.1: November 2010

Cost Benefit Analysis Procedures Manual List of Effective Pages

Cost Benefit Analysis Procedures Manual Preface

John F. McCormick Director of Aviation Safety

Cost Benefit Analysis Procedures Manual Preface

Cost Benefit Analysis Procedures Manual Preface

Departure from Authorised Policy

Cost Benefit Analysis Procedures Manual Preface

Supervisors Responsibilities In considering a consultative referral, the decision-makers supervisor should:

Cost Benefit Analysis Procedures Manual Preface

Cost Benefit Analysis Procedures Manual Preface

Cost Benefit Analysis Procedures Manual Abbreviations and Glossary

Version 1.1: November 2010

Cost Benefit Analysis Procedures Manual Abbreviations and Glossary

SEV SOC UK VM VoTT VSL WTP

Cost Benefit Analysis Procedures Manual Abbreviations and Glossary

Base Year BCR (Benefit Cost Ratio) Benefit Business Case

CostEffectiveness Analysis Cost Estimate

Current Prices Discount Rate

Cost Benefit Analysis Procedures Manual Abbreviations and Glossary

GDP Gross Domestic Product

Cost Benefit Analysis Procedures Manual Abbreviations and Glossary

Are costs and benefits which cannot be valued in monetary terms.

Monte Carlo Simulation

Net Benefits NPV (Net Present Value)

Cost Benefit Analysis Procedures Manual Abbreviations and Glossary

Price Year Real Prices Residual Value

Secondary Benefits Sensitivity Analysis

Cost Benefit Analysis Procedures Manual Abbreviations and Glossary

Utility Value of a Statistical Life

Cost Benefit Analysis Procedures Manual References

Cost Benefit Analysis Procedures Manual References

Cost Benefit Analysis Procedures Manual References

Cost Benefit Analysis Methodology Procedures Manual 1. Introduction 1.1. Introduction

Version 1.0: November 2007

Purpose of the Manual

Cost Benefit Analysis Methodology Procedures Manual 1. Introduction 1.3. Background

Cost Benefit Analysis Methodology Procedures Manual 1. Introduction 1.3. Background

Minor airspace change

However, it may not be necessary for all ACPs to be subject of a CBA.

Purpose of Cost-Benefit Analysis

Purpose of the Methodology

Format of this Report

Key Decisions; Principles of Cost-Benefit Analysis

The Cost-Benefit Analysis Checklist

Steps in Cost-Benefit Analysis

Version 1.0: November 2007