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56 the benefits most relevant to various stakeholders and geo- For the purpose of both BCA and EIA, all costs and benefits graphic interests, the Freight Evaluation Framework proceeds are measured over the project lifecycle to capture the timing in two parallel tracks: benefit/cost analysis (BCA) and eco- of costs and benefits. Then the NPV of the costs and benefits nomic impact analysis (EIA). Benefit/cost analysis identifies is calculated using the appropriate discount rate. the benefits of investing (as compared with not investing), and compares these to the project costs. It includes both actual or 4.2 Incorporating Risk out-of-pocket cost savings (e.g., reduced spending on fuel) and the broader social benefits (e.g., reduced vehicle emissions). The incorporation of risk into the Freight Evaluation Frame- Benefits and costs can be analyzed based on geography and to work represents a significant enhancement to the freight whom the benefits and costs accrue. Moreover, the direct travel investment analysis tools, methods, and processes that have efficiencies represent productivity gains that are a net benefit been developed by U.S.DOT, NCHRP, AASHTO, various state to the national economy, making BCA an appropriate analysis DOTs, and universities. Risk in the context of a freight invest- for national or federal investment decisions. In addition, con- ment refers to downside outcomes due to uncertainty. From a ducting parallel benefit/cost analyses based on travel efficiency financial perspective, investors or bond holders may experi- analysis for alternative projects using common metrics allows ence weaker-than-anticipated returns on their investment. for the comparison of investments across modes. Weak returns can be the result of weaker-than-expected Economic impact analysis, in contrast, compares the over- demand for a facility's services, or higher-than-expected capi- all economic growth (e.g., employment, income, and output) tal or operating costs, or a combination of the two. From the in the specified study region with or without investing. public's perspective, the project may not yield its anticipated Because this method focuses on regional economic growth, benefits in the form of congestion mitigation or job creation. certain classes of benefits accounted for in benefit/cost analysis are excluded. Specifically, only those travel changes that affect Risk Factors the actual flow of dollars through the regional economy are considered, thus excluding social benefits and personal travel- Risk assessment has been a critical component of private- time savings. Generally, EIA is useful for local-, regional-, and sector investment decision-making for a long time because state-level analysis because the measures in economic growth sizable losses can be devastating to firms of all types and sizes. often represent a redistribution of economic activity from one Risk management metrics also have a role in customer satis- location to another resulting from increased competitiveness. faction, potential market development, and market access. The Framework addresses both BCA and EIA because utilizing All of the functions in this category can have a direct cost-- both types of analysis provides two sets of metrics for evaluat- insurance, employee safety and retention, financial penalties ing freight investments to meet the needs of various stakehold- and down time, etc. On the public-sector side, risk manage- ers and to reflect local-, regional-, and national-level benefits. ment techniques are typically included in asset management As illustrated in Figure 4.2, there are significant distinctions strategies for pavements, bridges, and other investments. between benefit/cost analysis and economic impact analysis. Rarely are risk management techniques employed as part of First, BCA weighs the costs of a given investment initiative the investment decision-making activities of these agencies, against the benefits it provides to their users. It involves iden- including freight investments. tification and estimation of all private, public, and social costs Although considering risk in the Freight Evaluation Frame- and benefits of an investment to derive a measure of net ben- work does add a degree of complexity, it is warranted. Although efit or a benefit/cost ratio that measures the value of benefits simplicity in analysis is desirable, the research team also sought received per dollar in costs. to avoid analyses that are more simple than necessary in order Another major distinction is that private and public expen- to arrive at a decision. The "correct" level of detail is one that ditures/investments and business output and jobs that result addresses the problem while not overburdening the analysis. from those expenditures are viewed as costs in BCA. This is To provide this balance, the Framework assesses a limited because they consume societal resources that could have alter- number of risk factors that most significantly impact freight native uses. Other possible costs include ongoing operation investment decisions. These include the following: and maintenance costs, as well externalities such as pollution, noise, and reduction of property values. Reduction of these (or Market risks, or those that relate to overall demand on the other) costs is viewed as a benefit, and a reduction of some potential investment. Factors to consider include confidence existing benefits is viewed as a cost. In EIA, the cost of the in forecast growth in population and business activity, investment is often regarded as an injection of construction development of competing facilities and services, applica- spending that gives rise to immediate, short-term increases in tion of new technology, or other external factors (i.e., rela- employment and other economic benefits. tive prices).

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57 Cost risks, or those that relate to cost overruns associated The risk assessment component of the Framework is shown with scope creep, cost overruns associated with price in Figure 4.3. This process conducts an initial screen for increases of raw materials or labor availability, or unantic- potential Case 2 failure to identify these potential catastrophic ipated delay costs. failures early in the process. The analysis of Case 1 risk is an Methodological risks, or those that significantly affect additional dimension to the evaluation and the go/no-go bot- the conclusions of an analysis, such as approximation tom line analytic metrics for each stakeholder group and is introduced by the level of aggregation or level of detail expressed as risk analysis results (i.e., a range of results with an included in the analysis (e.g., assumptions about "peak- associated probability for attaining a particular result). ing," spatial resolution of geography); value judgments and policy variables (e.g., prices assigned to emissions or Risk Case Scenarios and Stakeholder Impacts the value of life); or uncertainties about technical, eco- nomic, and political quantities (e.g., future vehicle fuel Case 1 risk analysis screening involves assessing different burn and emission rates, future inflation rates, potential project alternatives for downside risk using different scenarios. impacts of new regulations). The scenarios correspond to specific future outlooks in which Moral hazard risks, or those related to an individual or orga- a combination of unanticipated negative events, or risk cases, nization's inadequate incentive to guard against a risk when there is protection against it. For instance, in a public- Identify Soft private partnership where the government funds the invest- Factors and Weak ment and the private partner manages and operates it, there Assumptions in Analysis is some likelihood that the private partner will not ade- quately represent the public sector's interests. It is crucial that the selection of the private partner and the public- private partnership contract ensure that the public's inter- Assess Probability of Case 2 Failure ests are not compromised. One of the problems inherent in public-private partnerships is that the pre-decision analysis will typically assume that an identity of interests exists among the partners. However, this will only be the case in Is Less Than Lower Reject Project practice if contracts and incentives are structured in a way Acceptable yes Threshold? that supports this goal. no Accounting for Risk Apply Risk The following two cases of risky outcomes are incorporated Analysis within the Freight Evaluation Framework: Scenarios Case 1: The project is operational, but disappoints at least one stakeholder and fails to realize the hurdle rate that was Find Probability established in the planning stage and upon which the deci- Distributions of all Key Outcomes sion to proceed was based. (Hurdle rate refers to a breakeven threshold--in the case of benefit/cost analysis, NPV=0 is the hurdle rate that a project is expected to exceed. A private entity will typically seek a rate of return in excess of some Confidence Accept Project value equal to the entity's opportunity cost of capital.) yes Alternative Acceptable? Case 2: The project fails overwhelmingly so that it is either abandoned or bailed out with unanticipated public fund- no ing to keep it operating. Refine Alternative The process for assessing risk in the Framework screens and and Seek to rejects grand failures of the Case 2 type. Projects that pass the Mitigate Risks first level of screening will be subject to additional scrutiny and risk analysis, permitting informed decisions on the level of risk Figure 4.3. Freight Evaluation Framework and its acceptability to the project stakeholders. risk assessment component.

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58 Table 4.2. Risk scenarios and stakeholder impacts. Stakeholders and Impacts of Downside Risk Other Asset Service End Impacted Risk Case Scenario Example Provider Provider User Party Case 1 Weak demand due to economic conditions or competing modes Operational, but Falls Short of and facilities Expectations Price shocks Case 2 Demand dramatically less than forecast Fails Overwhelmingly Projected local componennt of demand fails to materialize Region fails to proceed with complementary projects that were critical success components Minimal Impact Slight Impact Severe Impact occur with adverse impacts on the project. Evaluating different cover its prospective losses in the event of facility underutiliza- scenarios also allows for an assessment of how different risk tion.) These examples show that the asset provider (who builds cases impact different stakeholder types. This is critically and operates the new facility) has the most at stake. In the event important because downside risk may not be borne equally of a catastrophic failure with little or no return on its invest- among different stakeholders and the decision-making process ment, the asset provider's financial loss could be very large. At will need to ensure that the opportunities for each party and the other end of the spectrum, prospective facility users may the risks assumed by each are acceptable. have little at stake should a project fail because there may be Table 4.2 describes sample alternative scenarios for a freight existing alternatives or the users may be able to shift their activ- transportation investment being funded by the private sector ity so that the impact is minimal. Because the different toler- and the severity of the downside risk on various parties. (The ances for risk across different project and stakeholder types indicators of severity are illustrative. In principle, contractual factor significantly into eventual decisions, such risk scenario arrangements could shift risk across parties. For instance, an assessments are a critical component of the overall implemen- infrastructure provider could have contractual guarantees that tation of the Framework.