Term
| What is the difference between with-without and before-after analysis? Provide a concrete example of a situation when the benefit-cost results would be different using the two approaches. |
|
Definition
| Slides 76-78 (draw graph from slides). Before-after assumes that the present continues into the future. With-without requires that you ask what happens if you do nothing and what happens if you do the project. The difference between with and without are the net benefits of the project. See banana blight problem from homework for concrete example. |
|
|
Term
Name and define the three most widely used measures of project worth (the ones we used in class)?
What are the advantages and disadvantages of each?
Will they always give the same results in terms of project ranking and project acceptance? |
|
Definition
| Slides 26-35, see equations for NPV and IRR. NPV, IRR and Benefit-Cost Ratio. IRR, the rate of interest that that equates NPV to zero. B/C ratio is the ratio of discounted benefits to discounted costs. The problems: NPV has a problem of scale, big projects generate big benefits and the social rate of discount is not known with precision; IRR can give more than one possible solution and it assumes that net benefits are reinvested at the IRR, which might not be possible; B/C has a problem of replicability. IRR doesn’t require use of the social discount rate, NPV provides a concrete dollar value and B/C ratio gives an indication of efficiency and also gets around NPV large project issue. No they will not give the same results for either situation (see slide 34). |
|
|
Term
What are the three major differences between economic and financial analysis? Why are the treatments different in these areas?
What is the major objective of government budget impact analysis? |
|
Definition
| Slide 79. Treatment of taxes and subsidies (which are just transfers of payments), social or economic values versus private values (excluded from financial – like opportunity cost and shadow prices), interest on capital (debt, which is only included in financial). They are different because transfer payments don’t result in a net change for the entire market, while shadow prices correct for market distortions, which a financial analysis will include. |
|
|
Term
What are the three major approaches to handling uncertainty in benefit cost analysis? What are the advantages and disadvantages of each?
Is correlation among variables an issue for any of the three approaches? If so, explain why. |
|
Definition
Slide 117. Sensitivity analysis, switching values for important variables and Monte Carlo simulation using @risk. Sensitivity analysis is aggregate costs and benefits, critical costs and benefit items and the effect of delays. Sensitivity analysis allows for a range of applicability of the model to different situations, testing different values and how the model reacts. The switching value provides a breakeven price and Monte Carlo simulation gives a more realistic distribution of results.
Correlation among the variables is moderately important for the calculation of switching values and is extremely important for Monte Carlo simulation. |
|
|
Term
| What is the difference between revealed preference and stated preference in economic and b/c analysis? Provide an example of each. |
|
Definition
| Revealed preference approaches infer environmental values from observed consumer behavior eg, travel cost method, random utility model, hedonic pricing model. Stated preference approaches estimate environmental values by asking consumers what they are willing to pay for the preservation of environmental assets eg. contingent valuation method and discrete choice modeling. They are used to estimate nonmarket values. |
|
|
Term
Why is correlation among input variables important in Monte Carlo simulation (@Risk)?
If inputs are uncorrelated, but you mistakenly model them as perfectly correlated, would your estimated variance be too high or too low? |
|
Definition
| When here are nonlinear transformations it is likely that the Monte Carlo mean will vary from the deterministic mean. This is because the mean of a linear function is a function of the mean, but the mean of a nonlinear function is not a function of the mean |
|
|
Term
| What is hedonic pricing? Example of how is it used in economic or benefit-cost analysis? 2 steps in the analysis? |
|
Definition
Slide 163. A market valuation for a non-market good. Use econometric regressions using market data to find the hedonic price of a non-market good. It is used in benefit-cost analysis in order to find a price for environmental and non-market goods, eg a view.
(1) Estimate a hedonic price fn by regressing the observed price on a vector of explanatory variables
(2)estimate a demand curve based on the estimated hedonic price generated in the first step |
|
|
Term
Why is contingent valuation analysis used?
Describe the general procedure for contingent valuation analysis.
Also list and describe at least 3 problems encountered in contingent valuation analysis. |
|
Definition
to elicit preferences or willingness to pay for (or protect against) changes in the quantity or quality of goods.
Slides 176- 181. Set up a market, get bids, estimate WTP/WTA, estimate bid curves, aggregate data, evaluate area under the curves for welfare. Sample bias, non-response bias – if it is random, not a problem, but if non-random, adjustments need to be made, interviewer bias – need good training, hypotheticality- meaning and context problems, neutrality – see page 385 for illustration. See slides for complete definitions. |
|
|
Term
| Describe the travel cost method of calculating benefits. Include the major steps in doing the analysis. For what purposes is it used in benefit-cost analysis? What are some problems or limitations of the method? |
|
Definition
The travel cost benefit method is a way of valuing the recreational benefits of a given location by measuring the total costs incurred by individuals in traveling to visit them. It considers the monetary costs incurred in traveling and gaining admission to the location and the opportunity cost of time absorbed in travel. Rationale behind its usage in BCA is that the benefits of an activity >= total cost of going there.
The major steps involved in undertaking travel cost analysis are:
(1) Estimate the total number of visitors to a particular location.
(2) Calculate average distance traveled per visitor.
(3)Calculate the opportunity cost of time (multiply travel by wage rate).
(4) Compute total travel cost (sum time costs and travel costs). Then aggregate these over the total number of visits per year.
Some problems with the travel cost method:
(1) Choice of dependent variable.
(2) Some trips are merely "legs" of a multipurpose trip. |
|
|
Term
Based on the following data, calculate the barley prices to use for the economic and financial analysis assuming the processing plant uses both domestic and imported barley and there is no quality difference between domestic and imported barley.
World ref FOB barley price $140
Dom transport farm2processPlant LC25
ocean ship cost barley $20
Import tariff barley 20%
Port charges LC20
Transport port2process plant LC15
Foreign exchange shadow price 1.1 |
|
Definition
Economic Analysis
Imported and Domestic barley price = ((($140+$20)*1.1)*8)+20+15-25
Financial Analysis
Imported = (($140+$20)+(160*.2))*8)+20+15-25
Domestic = ((140+20)*8)+20+15-25 |
|
|
Term
Based on the following data, calculate the barley prices to use for the economic and financial analysis assuming the processing plant uses both domestic and imported barley and there is no quality difference between domestic and imported barley.
World ref FOB barley price $140
Dom transport farm2process LC 30
Ocean shipping cost barley $20
Import tariff on barley 20%
Port charges LC20
Transport port2processing plant LC25
Foreign exchange shadow price 1.1
Exchange rate 8LC/$ |
|
Definition
Economic price (import parity price):
[(FOB+freight)*spfx]*exrate+ptchgs+ptm-ftm
Financial price:
[(FOB+freight)*(1+tariff)]*exrate+ptchgs+ptm-ftm |
|
|
Term
| Explain why depreciation and interest should not be included as costs in the economic analysis. |
|
Definition
| Interest and depreciation are excluded from the economic analysis to avoid double-counting. The economic analysis is only concerned with actual resource flows. When capital investments are made, there is a distinct resource flow for the investment. Depreciation is merely a bookkeeing convention used to expense the decline in the value of capital (i.e. to debit the depreciation expense account and credit the accumulated depreciation account). In benefit-cost analysis, depreciation is only included for the purposes of calculating taxes. Similarly, when funds are borrowed for the purposes of investment, these expenditures are recorded in the year in which the investment is made. Interest is merely a transfer from one agent to another representing the cost of borrowed funds, not a true resource flow. |
|
|
Term
| Why do we do both financial (private) and economic (social) analysis for public sector projects? Shouldn't we be interested only in the economic analysis outcomes? |
|
Definition
| We need to know both the incentive for the private investor and we also need to know the overall welfare benefits. The financial analysis is important for assessing the marketability of a project to private investors that would fund the project, or those participating in the project, like farmers in developing countries. |
|
|
Term
| Why is correlation among ionput variables important in Monte carlo simulation (@Risk)? Would correlated annual values or uncorrelated annual values result in higher variance in NPV? Why? |
|
Definition
| When here are nonlinear transformations it is likely that the Monte Carlo mean will vary from the deterministic mean. This is because the mean of a linear function is a function of the mean, but the mean of a nonlinear function is not a function of the mean |
|
|
Term
| For what purpose is cost allocation (such as in the SCRB method) used in project analysis? Does the cost allocation analysis change the results of the economic analysis? |
|
Definition
| Cost allocation is used in circumstances in which the benefits of a project are shared among multiple beneficiaries. No impact on economic analysis. |
|
|
Term
Based on the following data, calculate the barley prices to use for the economic and financial analysis assuming the processing plant uses both domestic and imported barley and there is no quality difference between domestic and imported barley.
World ref FOB barley price $130
Dom transport farm2processPlant LC 30
Ocean shipping cost for barley $15
Import tariff on barley 20%
Port charges LC15
Transport port2processinPlant LC25
Foreign exchange shadow price 1.1 |
|
Definition
Economic price (import parity price):
[(FOB+freight)*spfx]*exrate+ptchgs+ptm-ftm
Financial price:
[(FOB+freight)*(1+tariff)]*exrate+ptchgs+ptm-ftm |
|
|
Term
| Suppose your analysis done in nominal terms results in an IRR of 50%, and the same analysis done in real terms results in an IRR of 25%. What is the rate of inflation for your analysis? |
|
Definition
| (1+nominal IRR)/(1+ real IRR) -1 = inflation |
|
|
Term
| Why is correlation among input variables important in Monte Carlo simulation (@Risk)? If inputs are in reality uncorrelated, but you mistakenly model them as perfectly correlated, would your variance be too high or too low? |
|
Definition
| Slides 125-128. Failure to account for correlation can affect both the mean and variance of output distributions. The variance will be too low, since either a high or low draw in one period will carry through each successive period. |
|
|
Term
| Describe the general procedure for contingent valuation analysis. also, list and describe at least 3 problems encountered in contingent valuation analysis. |
|
Definition
(1) Identify a sample of respondents from the population
(2) ask respondents questions about their valuations of a good
(3) from these responses, analysts can estimate a willingness-to-pay for the good
(4) these results are then extrapolated to the entire population
(1) Sample bias: sample is not randomly generated.
(2)Non-response bias: some systematic cause behind non-responses
(3) Hypothetical: Some respondents might not fully understand the good in question, or the policy that is being evaluated, or the hypothetical market may not be credible
(4)Neutrality: Questionnaires lead responses in a certain direction |
|
|
Term
| Explain why depreciation and interest should not be included as costs in the economic analysis but counted as deductions for calculating taxable income. |
|
Definition
| Depreciation and interest are included in calculating a private cash flow from the private investment view. They are both ways of calculating the time value of money for investors. If it was included in economic analysis it would be double counting the investment. |
|
|
Term
| Debt calculations are done originally in nominal terms using a nominal interest rate? Why? What is the formula for converting between nominal and real interest rates? Suppose you have calculated in your analysis a nominal and a real IRR. How can you verify that they are equivalent? |
|
Definition
| Debt is nominal because that is the way debt is denominated in the real world, must be done in nominal terms because that is the way the institutions work. Working capital, real is the only way to get consistent answers, it assumes that we don’t anticipate inflation. The purpose of working capital is money that you use early in project (an advance on time) pre-pay lots of operating costs at end of project horizon you get it all back, an advance on operating costs. |
|
|
Term
| In Monte Carlo simulation (@Risk), under what circumstances is it more likely that the Monte Carlo mean will differ from the non-stochastic results? Why? How does correlation among variables affect the variance? |
|
Definition
| When here are nonlinear transformations it is likely that the Monte Carlo mean will vary from the deterministic mean. This is because the mean of a linear function is a function of the mean, but the mean of a nonlinear function is not a function of the mean |
|
|
Term
| What is a shadow price (as the term is used in benefit-cost analysis)? How are shadow prices used in project evaluation? Why are they used? |
|
Definition
| Slides 109-112. A shadow price is the weighted average of the ratios of market clearing to official ClF prices, the weights reflecting the content of marginal import bill. Shadow prices are used either in SER and SCF. SER apply shadow exchange rate to all border prices of traded goods while using domestic shadow prices for non-traded goods. SCF apply shadow conversion factor to the shadow priced values of non-traded goods while applying the official exchange rate to border prices of traded goods. They are also used to correct for market distortions in import and export prices as well as distortions in foreign labor markets. |
|
|
Term
| Define the purpose of working capital? |
|
Definition
| Working capital is done in real to make nominal and real terms consistent. Working capital corrects for the fact that firms incur costs before they earn any revenues. |
|
|
Term
| What is an import parity price? |
|
Definition
| What captures the opportunity cost to the nation of a particular good |
|
|
Term
| We converted 2 main forms of debt repayment. What are they and how do they differ? Be sure to explain what is constant in nominal terms and what varies in each for of debt repayment. |
|
Definition
(1) Equal principal payments: The same nominal amnt is deducted from the principal (loan) balance. The total payment will be decreasing each year, as the amount of interest charged on the declining principal balance will be also deceasing
(2) Each year, the same total payment is paid in nominal terms. The portions of the total payment attributable to principal and interest vary from year to year. at the beginning of the loan repayment period, there may be a substantial portion of the total payment that is attributable to interest (as is the case with mortgage loans) while near the end of the repayment period, most of the payment should be principal payments |
|
|
