Purpose of CBA
Cost-benefit analysis(CBA) usually accompanies a feasibility study of the project itself and it constitutes the final synthesis. In CBA externalities and observed price distortions are also considered. In this way market imperfections are explicitly considered, which are reflected neither in
procedures.
monetising them, wherever possible, using conventional techniques for monetising the economic effects.
2. Financial analysis It provides all the necessary data regarding input, output, their relative prices and how they are distributed over time. It serves to:
formulate the tables for the analysis of the cashflows (selection of the important cost and revenue items) evaluate the financial feasibility (verification of sustainability) evaluate the financial benefit by calculating the return from the private investor's (financial return of the project and the capital) point of view.
Fiscal effects can be found in subsidies, in welfare contributions considered in the cost of labour and the effects of duties on the prices of inputs and outputs. In this step two types or corrections are carried out:
all fiscal items (taxes, subsidies) are eliminated; market prices are modified whenever they reflect effects of a fiscal nature, such as duty, VAT and other indirect taxes
4. Calculation of the positive and negative externalities The externalities are social costs or benefits that manifest themselves beyond the realms of the project and influence the welfare of third parties without any monetary compensation. As such they are not captured by market mechanisms and are not monetised, since their effects are transmitted through real variables that influence the welfare of individuals and not through price mechanisms. Such effects, which influence the welfare of the social group involved, must be quantified and then monetised in order to be included in the analysis as a true item of input or output.
5. From market prices to shadow prices The last correction is made through the calculation of opportune conversion factors which, multiplied by the market price, give the value of the shadow prices. This correction is necessary because the markets are imperfect and market prices don't always reflect the opportunity cost of a good. If prices are distorted they are not a suitable indicator of welfare
6. Calculation of the economic return of the project. Having made the three corrections we have built a table of the economic analysis that combines the items contained in the first and second initial tables duly corrected with the elimination of the fiscal effects, and the addition of the external effects and the correction of the prices using discount coefficients. In order to measure the economic convenience, after having time-discounted with a social discount rate (generally different from the financial one), it is now necessary to calculate the net present value and the economic internal rate of return, following the methodology already adopted for the financial analysis
Strengths of CBA enables us to express an opinion on the economic-social convenience of a project; enables us to create rankings among projects; encourages the practice of identifying the economic benefits and costs, even of they are not immediately monetisable. Limitations of CBA does not take redistributive effects into consideration (for these one can use a multicriteria analysis); does not consider the effect on the economic return of non-monetisable benefits or costs; sometimes uses discretional criteria for the monetisation of the costs and benefits for which no market exists.