National Academies Press: OpenBook
« Previous: Chapter 1 - Introduction
Page 6
Suggested Citation:"Chapter 2 - Cost-Benefit Analysis Overview." National Academies of Sciences, Engineering, and Medicine. 2020. Incorporating the Costs and Benefits of Adaptation Measures in Preparation for Extreme Weather Events and Climate Change—Guidebook. Washington, DC: The National Academies Press. doi: 10.17226/25744.
×
Page 6
Page 7
Suggested Citation:"Chapter 2 - Cost-Benefit Analysis Overview." National Academies of Sciences, Engineering, and Medicine. 2020. Incorporating the Costs and Benefits of Adaptation Measures in Preparation for Extreme Weather Events and Climate Change—Guidebook. Washington, DC: The National Academies Press. doi: 10.17226/25744.
×
Page 7
Page 8
Suggested Citation:"Chapter 2 - Cost-Benefit Analysis Overview." National Academies of Sciences, Engineering, and Medicine. 2020. Incorporating the Costs and Benefits of Adaptation Measures in Preparation for Extreme Weather Events and Climate Change—Guidebook. Washington, DC: The National Academies Press. doi: 10.17226/25744.
×
Page 8
Page 9
Suggested Citation:"Chapter 2 - Cost-Benefit Analysis Overview." National Academies of Sciences, Engineering, and Medicine. 2020. Incorporating the Costs and Benefits of Adaptation Measures in Preparation for Extreme Weather Events and Climate Change—Guidebook. Washington, DC: The National Academies Press. doi: 10.17226/25744.
×
Page 9
Page 10
Suggested Citation:"Chapter 2 - Cost-Benefit Analysis Overview." National Academies of Sciences, Engineering, and Medicine. 2020. Incorporating the Costs and Benefits of Adaptation Measures in Preparation for Extreme Weather Events and Climate Change—Guidebook. Washington, DC: The National Academies Press. doi: 10.17226/25744.
×
Page 10
Page 11
Suggested Citation:"Chapter 2 - Cost-Benefit Analysis Overview." National Academies of Sciences, Engineering, and Medicine. 2020. Incorporating the Costs and Benefits of Adaptation Measures in Preparation for Extreme Weather Events and Climate Change—Guidebook. Washington, DC: The National Academies Press. doi: 10.17226/25744.
×
Page 11
Page 12
Suggested Citation:"Chapter 2 - Cost-Benefit Analysis Overview." National Academies of Sciences, Engineering, and Medicine. 2020. Incorporating the Costs and Benefits of Adaptation Measures in Preparation for Extreme Weather Events and Climate Change—Guidebook. Washington, DC: The National Academies Press. doi: 10.17226/25744.
×
Page 12
Page 13
Suggested Citation:"Chapter 2 - Cost-Benefit Analysis Overview." National Academies of Sciences, Engineering, and Medicine. 2020. Incorporating the Costs and Benefits of Adaptation Measures in Preparation for Extreme Weather Events and Climate Change—Guidebook. Washington, DC: The National Academies Press. doi: 10.17226/25744.
×
Page 13
Page 14
Suggested Citation:"Chapter 2 - Cost-Benefit Analysis Overview." National Academies of Sciences, Engineering, and Medicine. 2020. Incorporating the Costs and Benefits of Adaptation Measures in Preparation for Extreme Weather Events and Climate Change—Guidebook. Washington, DC: The National Academies Press. doi: 10.17226/25744.
×
Page 14
Page 15
Suggested Citation:"Chapter 2 - Cost-Benefit Analysis Overview." National Academies of Sciences, Engineering, and Medicine. 2020. Incorporating the Costs and Benefits of Adaptation Measures in Preparation for Extreme Weather Events and Climate Change—Guidebook. Washington, DC: The National Academies Press. doi: 10.17226/25744.
×
Page 15
Page 16
Suggested Citation:"Chapter 2 - Cost-Benefit Analysis Overview." National Academies of Sciences, Engineering, and Medicine. 2020. Incorporating the Costs and Benefits of Adaptation Measures in Preparation for Extreme Weather Events and Climate Change—Guidebook. Washington, DC: The National Academies Press. doi: 10.17226/25744.
×
Page 16
Page 17
Suggested Citation:"Chapter 2 - Cost-Benefit Analysis Overview." National Academies of Sciences, Engineering, and Medicine. 2020. Incorporating the Costs and Benefits of Adaptation Measures in Preparation for Extreme Weather Events and Climate Change—Guidebook. Washington, DC: The National Academies Press. doi: 10.17226/25744.
×
Page 17
Page 18
Suggested Citation:"Chapter 2 - Cost-Benefit Analysis Overview." National Academies of Sciences, Engineering, and Medicine. 2020. Incorporating the Costs and Benefits of Adaptation Measures in Preparation for Extreme Weather Events and Climate Change—Guidebook. Washington, DC: The National Academies Press. doi: 10.17226/25744.
×
Page 18
Page 19
Suggested Citation:"Chapter 2 - Cost-Benefit Analysis Overview." National Academies of Sciences, Engineering, and Medicine. 2020. Incorporating the Costs and Benefits of Adaptation Measures in Preparation for Extreme Weather Events and Climate Change—Guidebook. Washington, DC: The National Academies Press. doi: 10.17226/25744.
×
Page 19
Page 20
Suggested Citation:"Chapter 2 - Cost-Benefit Analysis Overview." National Academies of Sciences, Engineering, and Medicine. 2020. Incorporating the Costs and Benefits of Adaptation Measures in Preparation for Extreme Weather Events and Climate Change—Guidebook. Washington, DC: The National Academies Press. doi: 10.17226/25744.
×
Page 20

Below is the uncorrected machine-read text of this chapter, intended to provide our own search engines and external engines with highly rich, chapter-representative searchable text of each book. Because it is UNCORRECTED material, please consider the following text as a useful but insufficient proxy for the authoritative book pages.

6 Introduction Scientific studies widely show climate is beginning to exacerbate extreme weather. Higher temperatures mean more evaporation and moisture in the atmosphere and stronger storms, droughts, and heat waves. With this in mind and looking at the increases in heavy rainfall, rising heat, and higher storm surges in store, DOTs are preparing for • Increased incidence and magnitude of extreme events common to the region; • Unseasonal or unusual types of extreme weather hazards; • Impacts to vehicles (e.g., tires of trucks, ability of planes to fly) and the transportation system (e.g., road closures and vulnerability to flooding); • Impacts to citizens and travelers and their needs related to the transportation system (e.g., access, evacuation); and • The gradual shifting of climate zones outside the parameters for which infrastructure may have been designed (Meyer et al., 2014), potentially reducing an asset’s life span, including – Higher maximum temperatures (affecting pavement binders, rails, and transportation operations); – Wetter or drier climates, depending on geography; – Changes to expected types of seasonal precipitation; and – Rising sea level. Effective planning for resilience acknowledges that “1-in-100-year events” have been occurring at closer to 5-, 10-, and 15-year intervals in some areas, affecting DOTs around the country. Many more catastrophic events encountered in the last decade, such as the 2013 floods in Colorado, are closer to 1-in-1,000-year events (Minchon, 2013) or 1-in-500-year events, such as the hurricanes and floods in South Carolina in 2015 (Holmes, 2015) or in Texas repeatedly. Tools and frameworks that address cost-effectiveness can help DOTs make informed decisions about how to invest limited funds in the face of changing climate and increased incidence of extreme weather. Cost-benefit analysis (CBA) for climate adaptation helps provide a rigorous foundation for communication and decision making, improving stewardship of limited public monies and overall transportation system resilience. Theoretically, as more comprehensive ranges of impacts can be included along with discount rates that treat all groups equally, CBAs will increase in value for decision making at multiple levels of government. CBAs can help strengthen the case for resilience investments, particularly because peak benefits usually occur later in the infrastructure life cycle (Coley, 2012). In some cases, CBA may also help illustrate both the extent of need and the limits on what is affordable through adaptation, providing feedback to legislatures, councils, and other decision makers on the cost of climate change and what is more or most affordable. Research on disasters C H A P T E R 2 Cost-Benefit Analysis Overview

Cost-Benefit Analysis Overview 7 and recovery has shown that prevention is a worthwhile investment many times over. Several years of TRB workshops on climate change adaptation and CBA concluded that discounting the future and the magnitude of likely costs is a problem, pointing to a need to extend research and work toward prevention and mitigation. Planning and resilience entail recognizing that weather extremes are not as extraordinary as they once were, and DOTs need to incorporate this “new normal” into planning and decisions about what is worthwhile. Transportation agencies need effective CBA methodologies to develop long-term plans with partners and efficiently select between project alternatives, allowing them to prepare, respond, and recover quickly. The following sections provide information about CBA—what it is and different types of CBAs, how CBA is traditionally used, and some economic factors to consider. Cost-Benefit Analysis Definition and Use Cost-benefit analysis (CBA), also known as benefit-cost analysis (BCA), is a formal way of organizing evidence of the good and bad effects of projects and policies. CBA is a process that tries to quantify the benefits and costs of a project or policy using equivalent monetary value, to evaluate if the project or policy meets financial and other criteria for implementation. The objective of a CBA may be to decide whether to proceed with a project, to place value on a project, or to decide which of various possible alternatives would be the most beneficial (Figure 1). The actions DOTs take and the policies they consider or enact in response to extreme weather events and climate change can have significant cost implications. DOTs need to ensure that any adaptation measures they consider implementing will provide long-term cost savings. They need to be able to evaluate the trade-offs between different climate responses and adaptation measures and their effectiveness in terms of cost and other values. CBA provides an overview of options for assets at a specific location, experiencing a particular hazard or set of hazards, over a certain period of time. CBA is usually most effective when incorporated into the planning process (Figure 2). This guidebook assumes that transportation agencies have already completed at least preliminary vulnerability and criticality analyses of transportation assets and corridors to identify those that might benefit from adaptation strategies. FHWA has developed publications on how to evaluate Figure 1. CBA can help transportation agencies evaluate investment alternatives.

8 Incorporating the Costs and Benefits of Adaptation Measures in Preparation for Extreme Weather Events and Climate Change—Guidebook transportation assets and corridors for vulnerability and criticality, such as the Vulnerability Assessment and Adaptation Framework, 3rd Edition (https://www.fhwa.dot.gov/environment/ sustainability/resilience/adaptation_framework/index.cfm), and Assessing Criticality in Transpor- tation Adaptation Planning (https://www.fhwa.dot.gov/environment/sustainability/resilience/ publications/assessing_criticality/index.cfm). In addition, the Conference of European Directors of Roads (2016) has developed some questions to assist with incorporating climate adaptation into planning: • What challenges do you want to address (e.g., flooding, storm surges, strong winds, increasing heat, sea level rise, rising or falling groundwater level, rockfalls, avalanches, river flooding)? • What is the existing state of the road network? How vulnerable is it? Do you have any experi- ence of former climate- or weather-induced incidents, and where in the organization can you find the knowledge? • How do you want to measure (and talk) about the future? Human fatalities, number of incidents, hours of delay, miles of closed road sections? • What kinds of incidents are covered by the strategy? • Is the strategy for both existing and planned roads? • What data are available (e.g., topographic maps, drainage, risk maps)? • What instruments and tools are available (e.g., risk-identification methods, databases for incident statistics)? • Can you do a CBA on different solutions? Further, the European Commission and the European Environment Agency partnered to form the European Climate Adaptation Platform, also known as Climate-ADAPT. Climate- ADAPT supports adaptation by helping users access and share data and information about expected climate change in Europe, current and future vulnerabilities, strategies and action, and potential adaptation options and tools. ROADAPT is part of Climate-ADAPT and provides guidelines for adaptation of road infrastructures to climate change. While ROADAPT focuses on Europe, some of the processes and strategies are transferable or adaptable to North America (European Commission and European Environment Agency, 2015). Once planners decide which areas, assets, or corridors to evaluate for possible inclusion of adaptation measures in future designs, they can consider performing CBAs to help them evaluate alternatives. Steps in Conducting a Cost-Benefit Analysis CBAs are typically conducted using a logical, structured process. In its Cost-Benefit Analysis Guide, the U.S. Army has defined an eight-step CBA process, as shown in Figure 3 and further explained as follows: 1. Define the problem/opportunity. Develop a problem statement that clearly states the problem to be solved or the opportunity to be addressed. 2. Define scope; develop facts and assumptions. The scope includes what will be covered in the project along with specific information such as duration, location, and so on. The assump- Climate Risk Identification Vulnerability Assessment and Prioritization CBA of Adaptations and Alternatives Adaptation Selection Implementation Figure 2. The transportation sector has begun performing vulnerability assessments, but does not usually have a formal CBA framework to distinguish between adaptations addressing identified vulnerabilities. CBA is a key link between climate vulnerability assessments and adaptation implementation.

Cost-Benefit Analysis Overview 9 tions provide additional information about the conditions being used as the basis for the CBA. When determining assumptions, it is important to establish a baseline, that is, the status quo, against which identified alternatives will be evaluated. 3. Define alternatives. Alternatives are the adaptation strategies that could help address the problem or achieve the objective. One alternative always included in the analysis is the base case, also known as the status quo, in which the existing solution continues to be used. The alternatives under consideration are compared with this base case or default path. 4. Develop cost estimate for each alternative. The cost estimate for each alternative includes all life-cycle costs from pre-construction through decommissioning and salvage (if applicable). It should include other quantifiable costs, whether direct or indirect. 5. Identify quantifiable and non-quantifiable benefits. Each alternative is expected to yield benefits. When planning and designing for natural hazards, benefits are usually quantified in terms of losses avoided, that is, damage or interruptions to service that would normally result if the alternative was not implemented (or the damage did not occur because of prevention). Losses avoided are quantified in dollars. Some benefits are difficult to quantify but contribute positively to the project, for example, improved aesthetics, better health, or business continuity. These benefits are noted in the analysis and included as placeholders when dollar values are not available or have not been estimated. 6. Define selection criteria for alternatives. The agency (and sometimes the public) needs to determine the bases on which the alternatives will be compared and the decision will be made, sometimes adding further consideration of what is at stake. CBA might be the only criterion, or it might be one of many criteria. Further, CBA itself has different metrics that can be used Figure 3. Eight-step process for conducting a cost-benefit analysis (after the U.S. Army Cost Benefit Analysis Guide, 2013).

10 Incorporating the Costs and Benefits of Adaptation Measures in Preparation for Extreme Weather Events and Climate Change—Guidebook to evaluate among alternatives. The CBA metric used for selection will depend on the agency’s priorities or means of doing business (metrics are discussed further in the sections that follow). 7. Compare alternatives. Using the selection criteria established by the agency, each alterna- tive should be evaluated and compared against the others being considered. Common CBA metrics used for comparison include benefit-cost ratio, net present value, and return on investment. At this point, sensitivity analysis may be performed to evaluate how a change in assumptions could affect the CBA. 8. Report results and recommendations. The results of the analysis are summarized and conclusions are presented. The conclusions should tie back to the CBA and any other evalu- ation criteria used to recommend the preferred alternative, any rankings of alternatives, or both. The total quantifiable and non-quantifiable value of the benefits needs to balance or outweigh that of the costs for the project to be considered cost-effective. Cost-Benefit Analysis Metrics To compare different projects or alternatives of the same project in which costs and benefits may occur in different years, discounting is used to convert future benefits and costs to a current- year perspective. One of the most frequently used metrics used when deciding whether a project can be justified is the net present value (NPV). The NPV is the discounted monetized value of expected net benefits (i.e., benefits minus costs). As discussed below, metrics (such as the discount rate, internal rate of return, simple payback period, discounted payback period, net present value, benefit-cost ratio, or return on investment) can be used to summarize CBA results. Discount Rate In our culture, people, agencies, and businesses often prefer to have benefits immediately and delay costs. As a result, people value future benefits less than they do immediate flows of money. To reconcile this when comparing different projects or alternatives of the same project that may have costs and benefits occurring in different years, discounting is used to convert future benefits and costs to a current-year perspective. Discounting involves the use of a discount rate—the annual percentage change in the present value of a future dollar. The formula for calculating the present value (PV) of a future value is given by Equation 1. Equation 1. Present value formula. 1 PV V r t( ) = + where V = is a value (positive or negative) occurring at t, t = a given period of time, and r = is the discount rate (e.g., r = 7% = 0.07) Using this formula shows that the choice of discount rate (r) plays a large role in a CBA; a lower discount rate generates a higher present value to future flows than does a higher discount rate. For example, a $1,000 benefit that occurs in 30 years is equivalent to $231 today at a 5 per- cent discount rate, but only $131 using a 7 percent discount rate. There are two types of discount rate: (1) the financial discount rate and (2) the social dis- count rate. 1. The financial discount rate, also known as the private discount rate, is the interest or borrowing rate, or the weighted average cost of capital for a project. In the United States, a financial

Cost-Benefit Analysis Overview 11 discount rate of 7 percent has been used for federally financed projects. At one time this was conservative—it meant more public investment or service now. However, when public costs caused by climate change and increasing impacts are inadequately valued and evaluated now, owing to prevalent financial discount rates, 7 percent is neither conservative nor protective of the public interest. A rate of 10 percent or greater might be used for privately funded projects to reflect opportunity cost in private markets. 2. The social discount rate is used in the sustainable net present value (S-NPV) analysis. The social discount rate can be thought of as valuing the present over the future by measuring a time preference for the present over the future and an opportunity cost based on finance and investment; that is, using resources today means that they are not invested to deliver a return elsewhere. The time preference can also be thought of as being composed of a pure time preference and a premium for the uncertainty that benefits and costs will materialize in the future. In the United States, the typical social discount rate is 7 percent, with a sensitivity analysis also run using 3 percent. Economists have extensively debated the discount rate to use for climate change adaptation benefits because of the preference for and valuing of the current generation over future genera- tions and their well-being. Climate change, future concentrations of carbon dioxide (CO2) in the atmosphere, and impacts on average world temperature are highly certain, drawing agreement from over 99 percent of scientists now (and with increasing certainty since the dynamic was discovered in the 1800s). Also factoring into the debate is the idea that future generations will benefit the most from climate policies implemented today, and possibly a hope that the current generation and decision makers could evade associated costs for now. There has been uncertainty around the action that can or needs to be taken and its worth, a question that could be tackled with CBA; however, this has not been undertaken for transpor- tation infrastructure in the United States. Long-term uncertainty and discounting over long time horizons imply lower interest rates, often referred to as intergenerational discounting or discounting future generations. Researchers have generally concluded that discount rates of 1.4 percent to 4.3 percent are likely to be appropriate (Goulder and Williams, 2012). The Office of Management and Budget (OMB) recommends that sensitivity analyses be performed using both 3 percent and 7 percent discount rates. Meanwhile, in 2017 the TRB updated its study on the social cost of carbon; the Interagency Working Group on the Social Cost of Greenhouse Gases recommends conducting sensitivity analysis for carbon emissions using a lower bound of 2.5 percent and an upper bound of 5.0 percent, along with a 3.0 percent central rate to reflect uncertainty associated with climate change and future economic growth, as well as with the long time frames and intergenerational consequences associated with climate change. “The National Academies of Sciences and the U.S. Council of Economic Advisers strongly support a 3 percent or lower discount rate for intergenerational effects. A 7 percent rate based on private capital returns is considered inappropriate because the risk profiles of climate effects differ from private investments” (Revesz et al., 2017). Despite this, the current federal guidance is that CBAs use a 7 percent discount rate for carbon and non-carbon costs and benefits (with a 3 percent rate as a sensitivity analysis). Additional information regarding discount rates is included in Appendix A. Internal Rate of Return Internal rate of return (IRR) is a measure of profitability or investment efficiency. IRR is a discount rate that makes the NPV of all cash flows from a particular project equal to zero. IRR may give better insights than return on investment in capital-constrained situations. However, when comparing mutually exclusive projects, NPV is the appropriate measure.

12 Incorporating the Costs and Benefits of Adaptation Measures in Preparation for Extreme Weather Events and Climate Change—Guidebook Simple Payback Period Simple payback period is the number of years or months until capital is recouped by the flow of benefits or cash flow. The payback period is used to determine timing of the project or the length of time capital is at risk. A shorter payback period means less risk. The simple payback period uses undiscounted benefits or cash flows. In other words, the cash flows from the project are taken at their nominal value to determine the time until the project pays back. For this reason, the simple payback period is usually shorter than the discounted payback period (discussed in the following section). For example, a project to install five 100-square-foot bioswales will cost $10,000. It is antici- pated that installing these green infrastructure drainage improvements would reduce opera- tions and maintenance (O&M) costs for the adjacent parking lot by $2,000 per year. The simple payback period is 5 years, as shown in Table 1. Discounted Payback Period Discounted payback period is the number of years or months until capital is recouped by the flow of benefits or cash flow. The payback period is used to determine timing of the project or the length of time capital is at risk. A shorter payback means less risk. The discounted payback period uses discounted benefits or cash flows. In other words, the cash flows from the project are discounted by the discount rate before the payback period is determined. For this reason, the discounted payback period is usually longer than the simple payback period (discussed previously). For example, assume that the bioswale project, which the owner is considering to be a green infrastructure/environmental project, is discounted at a rate of 3 percent. Calculating the present value interest factors using Equation 1, the discounted payback is between 5 and 6 years, as shown in Table 2. Net Present Value OMB Circular A-94 (1992, 2016) states that CBAs should be prepared on a net present value basis. NPV measures the present-day value of benefits less the present-day value of costs, meaning the present value of benefits gained from the project is compared with the total project cost to evaluate cost-effectiveness. Because the value of money changes over time, it is useful to calculate the monetary values of costs and benefits of a proposed project in today’s dollars (or dollars of a particular date) so that they can be more easily and accurately compared. This is done using a discount rate, which is the rate of return for the project. NPV is calculated by Year 1 2 3 4 5 Reduction in O&M $2,000 $2,000 $2,000 $2,000 $2,000 Cumulative Reduction in O&M $2,000 $4,000 $6,000 $8,000 $10,000 Table 1. Example simple payback period. Year 1 2 3 4 5 6 Reduction in O&M $2,000 $2,000 $2,000 $2,000 $2,000 $2,000 Present Value Interest Factor 0.971 0.943 0.915 0.888 0.863 0.837 Discounted Reduction in O&M $1,942 $1,886 $1,830 $1,776 $1,726 $1,674 Cumulative Reduction in O&M $1,942 $3,828 $5,658 $7,434 $9,160 $10,834 Table 2. Example discounted payback period.

Cost-Benefit Analysis Overview 13 discounting cash flows over time using the discount rate and summing the discounted values. This metric allows the time value of money to be taken into account because cash flows further into the future become more discounted. Because project benefits accumulate over time, project benefits are calculated on an average annual basis (“annualized”) and then multiplied by a present value coefficient (PVC) to deter- mine the present value of the benefits. As shown in Equation 2, the PVC is a product of the estimated useful life of the project and the discount rate. Equation 2. Present value coefficient (PVC) formula. 1 1 PVC r r T[ ]( )= − + − where PVC = present value coefficient r = discount rate T = project useful life (years) Present value coefficients for several interest rates and time periods are included in Appendix B. NPV is used in go/no go or whether-to-proceed decisions. It is a measure of worth or value. An NPV greater than 0 means the project is economically efficient. Projects or alternatives can be ranked in terms of NPV. Benefit-Cost Ratio Benefit-cost ratio (BCR) is the present value of benefits divided by present value of costs. The BCR is used in go/no go, whether-to-proceed decisions. It indicates dollars of benefit per dollar of cost. A ratio greater than 1 means the project is worthwhile. Return on Investment Return on investment (ROI) is the benefit to the project from the investment of resources (Equation 3). Equation 3. Return on investment calculation. , , ROI Profit Gain or Benefit Investment Cost of Investment Cost of Investment = − As a performance measure, ROI is used to evaluate the efficiency of an investment or invest- ments, or how efficiently the investment is used. Different metrics can allow decision makers to apply their own selection criteria to the data to make a decision. For example, assume a DOT is trying to choose between three alternatives (data in Table 3 are hypothetical and for illustrative purposes only): Alternative Cost Benefit NPV BCR ROI A $100 $130 $30 1.3 0.3 B $250 $500 $250 2.0 1.0 C $500 $800 $300 1.6 0.6 Table 3. Example data for application of selection criteria and CBA metrics.

14 Incorporating the Costs and Benefits of Adaptation Measures in Preparation for Extreme Weather Events and Climate Change—Guidebook The DOT might have different criteria for making its decision about which alternative to pursue: • A budget-constrained agency might want to limit the first cost to accommodate low available capital. In this case, the agency would select Alternative A, as it has the lowest initial cost. • An agency interested in determining the greatest benefit for dollars spent would be most interested in the BCR. In this case, the agency would select Alternative B, as its BCR of 2.0 is higher than the other two alternatives. • An agency interested in maximizing its benefits could select Alternative C, which has the highest NPV of benefits. • Assuming that the periods of the alternatives are the same, an agency interested in maximizing its ROI would select Alternative B. However, if the payback period of Alternative B is 3 years, the average annual return for Alternative B is 1.0/3, or 0.33, in which case Alternative C has a higher average annual ROI and would be selected. Different Types of Cost-Benefit Analysis Project Cost-Benefit Analysis A project CBA evaluates the financial feasibility of a project, focusing on the benefits and costs to the project without considering the impacts to the local, state, or regional economy or the economy as a whole. A financial CBA can be conducted in constant (i.e., present value) or current dollars. This is the most commonly conducted type of CBA. Life-Cycle Cost Analysis Life-cycle cost analysis (LCCA) is a subset of CBA. LCCA compares the total user and agency costs of different options over a period when the alternatives are being compared. This CBA includes the capital costs, operations and maintenance, replacement costs, residual value, and disposal costs of an asset. Typically, LCCA assumes that an asset is maintained proactively according to an established schedule, rather than reactively. LCCA is conducted in constant dollars and quantifies only the financial costs associated with an asset. FHWA has an LCCA primer, which is available from https://www.fhwa.dot.gov/asset/lcca/010621.pdf. Return on Investment Analysis An ROI analysis differs from a CBA in that ROI is calculated using the most tangible costs and benefits, whereas CBA is more detailed than ROI and includes intangibles such as the value of a person’s time or state of health. Triple Bottom-Line Analysis and Triple Bottom-Line Cost-Benefit Analysis Triple bottom-line (TBL) analysis evaluates a project or policy based on its combined financial, environmental, and social impacts. The financial (or profits) impacts are the life-cycle costs associated with the project; LCCA can be used as the financial cost analysis in a TBL analysis. The environmental (or planet) impacts are the effects of a project on the surrounding environment, habitat, or climate. The social (or people) impacts are the effects of a project on the broader community, quality of life, or society. These three values presented together form the TBL evalu- ation and are typically represented as Profits, Planet, and People. They can be used in the context of a CBA by quantifying the monetary values associated with each in constant dollars and adding

Cost-Benefit Analysis Overview 15 them up to measure the TBL in dollars. Multiple interest rates might be used to reflect the different time frames associated with economic, social, and environmental benefits (see Appendix A for more detailed information about interest rate selection). Sustainable Return on Investment Sustainable return on investment (S-ROI) is an enhanced form of CBA that includes proba- bilistic assessment and stakeholder engagement. This framework takes into account the entire scope of risk-adjusted costs and benefits related to sustainable design, including traditional internal cash impacts such as savings on energy or water costs, as well as all other appropriate internal and external non-cash impacts such as the dollar value of environmental savings from reduced potable water use or air emissions. The analysis results in at least two sets of output metrics in terms of probabilities, one from the perspective of the organization on a cash flow basis and the other from the perspective of society, which would include the value of exter- nalities such as health and safety benefits expressed in dollars. Finally, the analysis needs to allow for transparency and incorporate a process for expert and stakeholder opinion on the model structure and inputs. S-ROI is a form of TBL-CBA. Economic Impact Analysis Economic impact analysis (EIA) considers the effects that an action, policy, or project has on the economic development of a community or region. Direct (from project expenditures), indirect (from project suppliers’ expenditures), and induced (from those affected spending their wages) impacts can be estimated from input-output tables of the economy and used to evaluate the impacts on economic variables such as employment, tax revenue, and property values. The indirect effects considered in an EIA are not part of a traditional CBA. Funding Sources and Their Impact on Analysis Capital Budget The capital budget is derived from public funds—paid for by the public in the form of taxes. The capital budget is built through a combination of federal transfers, state taxes and fees, and other revenues. Transportation spending represents 8.1 percent of total state spending; by comparison, 29.0 percent of state funds are dedicated to Medicaid, and 19.4 percent to K–12 education (NASBO, 2017). Spending in transportation from states’ own funds grew 8.8 percent and 6.7 percent in FY 2015 and FY 2016, respectively. Table 4 shows the breakout of revenue sources for U.S. transportation projects in FY 2016. Public entities care about the welfare of future generations; essentially, decisions have to serve current as well as future generations. Public agencies guard public welfare and steward common Revenue Source Portion of Total Transportation Spending State gasoline taxes, etc. (earmarked revenue sources) 58.7% %2.92sdnuflaredeF Bonds 8.0% %1.4sdnuflareneG Table 4. State expenditure for transportation by fund source in FY 2016 (NASBO, 2017).

16 Incorporating the Costs and Benefits of Adaptation Measures in Preparation for Extreme Weather Events and Climate Change—Guidebook resources and long-term public infrastructure. Public right-of-way, road bases, and so on are also long-term public investments. Consequently, projects funded as part of a transportation agency’s capital budget tend to have longer time horizons for planning and implementation, sometimes lasting centuries. They also usually have a lower discount rate to reflect their long- term outlook (i.e., the social discount rate). Using a lower discount rate means that future costs and benefits are given a higher present value (more equal with achievement of the same benefits for those here today) than if they were discounted using a higher rate (in which case they may be discounted massively to the extent they are not counted at all). Because the projects are funded from the available (and future) budget, no loans are being used to finance them, which means there are no monthly or annual debt payments. This lowers the annual costs, which helps to make projects more favorable in a CBA than projects that use other financing mechanisms, if such considerations are taken into account. Because government agencies have a social obliga- tion to fulfill, they aim to evaluate projects based on their value to the public without discrimi- nating against some people, such as those of different times or those who are unable to vote, and considering both positive and negative externalities. Loans, Grants, and Other Financing Issuing debt is common practice among states to fill funding gaps in infrastructure spending. In a recent survey, 36 of the 42 states that responded (86 percent) report having outstanding debt obligations for transportation purposes, and 95 percent of states report the authority to issue debt for such purposes (Henkin and DeMoore, 2017). State debt issuance takes many forms, such as general obligation bonds, revenue bonds, project finance such as toll revenue bonds, and a variety of other federal and state debt mechanisms. Each form of debt has a different credit profile and thus a potentially different debt management approach. For example, project finance debt such as toll revenue bonds can be nonrecourse or limited recourse to other resources of the issuing entity. In such financings, the debt is repaid from the cash flow generated by the project. With general obligation or tax-backed bonds, the success of the project may not be tied to the ability to repay the debt. (Henkin and DeMoore, 2017) Bonds Bonds are a common way to issue debt. For reference, a bond is a way for an entity to raise money to finance projects. Instead of borrowing from a bank, an entity can issue bonds that investors “buy” for a defined period (defined by the bond’s maturity date) with a fixed interest rate (“coupon”). Each year, the borrower pays interest, and at the maturity date pays back the loaned funds (principal) (Investopedia, 2003). The city, county, or state is the borrower for tax-exempt municipal bonds, or “muni bonds.” As these bonds are tax exempt, they are an attractive, low-risk investment. They come in two forms: (1) tax-backed, also known as general obligation bonds, and (2) revenue-backed, which dictate how the municipality pays back the interest and principal. A tax-backed bond is backed by the taxing power of the issuing city, county, or state, and is paid back using property (and other applicable) taxes. An example of a revenue-backed bond is issuing a bond to improve a water treatment plant then using revenue from customer water bills to operate and maintain the system, as well as pay back the bond (Edward Jones, 2017). Green bonds may be a way to fill the funding gap while still fulfilling environmental goals. A green bond is a tax-exempt bond earmarked toward funding projects that generate positive environmental or climate impacts, such as energy efficiency, sustainable agriculture, clean trans- portation, and sustainable water management. Because of their tax-exempt status, green bonds offer a financial advantage over traditional bonds, providing an incentive to tackle sustainability issues. In 2012, green bond issuance accounted for $2.6 billion but rose to $157 billion in 2019

Cost-Benefit Analysis Overview 17 (Investopedia, 2020). Green bonds are also attractive to issuers, as they offer liquidity and access to funding that was previously not possible. The Transportation Infrastructure Finance and Innovation Act The Transportation Infrastructure Finance and Innovation Act (TIFIA) is another way for DOTs to fill the funding gap. This federal program administered by the U.S. DOT provides credit assistance in the form of loans, loan guarantees, and standby credit lines for qualified large-scale surface transportation projects (U.S. DOT, 2014). In so doing, U.S. DOT helps attract private and non-federal co-investments for state and local governments unable to obtain financing at reasonable rates. Loans and Grants and Cost-Benefit Analysis In the case of most transportation projects, loans taken on by public entities provide funding for infrastructure. Unlike with the capital budget, instead of using current available funds, governments borrow to fund projects. Depending on the financial stability of the public entity in question, governments can typically secure long-term loans at favorable rates because the loan is guaranteed by the state. Grants issued by federal agencies also provide funds for infrastructure, and thus are using public funds to finance transportation projects. One of the most well-known annual grant programs was the Transportation Investment Generating Economic Recovery (TIGER) program, which was active through FY 2017. It was replaced in FY 2018 by the Better Utilizing Investments to Leverage Development (BUILD) transportation discretionary grants program. FHWA Emergency Relief and FEMA Recovery Grants Transportation agencies can often access post-disaster programs such as FHWA’s Emergency Relief (ER) program after severe storms or impacts. This program provides 80 to 90 percent of funds required to repair disaster-damaged federal aid roads. Typically, FHWA ER funds are used to restore the damaged facility to its pre-disaster condition; however, some “betterments” may be allowable if they will reduce the risk of future damage; the FHWA division office must determine that doing so would be cost-effective. Cost-effectiveness analysis of betterments under the ER program differs from typical CBA in that it does not include factors such as traffic delay costs, added user costs, motorist safety, and so on; it includes only the cost of the protective features or changes that modify the function or character of the facility before the disaster or catastrophic failure. After a federally declared disaster, FEMA may provide funding for roads ineligible for FHWA ER funding. FEMA funding typically ranges from 75 to 90 percent of the funds required to repair damaged facilities. FEMA-funded projects may be eligible for betterments, called 406 mitiga- tion measures, as part of the Public Assistance program, provided the measures meet FEMA CBA requirements. Regardless of whether the project is being funded entirely by loans or partially with grants supplemented by loans, the funding for recovery from extreme weather events or climate impacts is still provided by the public. Thus, the discount rate will be low, emphasizing the more equitable intergenerational value of money, as well as the public sector’s lower opportunity cost of capital. Given that a loan is essentially substituting future expenditure for current expenditure, there is still an implied bias toward present consumption. Public-Private Partnerships Governments often partner with private entities to help design, deliver, and operate trans- portation projects. Whereas governments have a social contract, companies have an obliga- tion to optimize their bottom line. Public-private partnerships (P3s) are contracts between public

18 Incorporating the Costs and Benefits of Adaptation Measures in Preparation for Extreme Weather Events and Climate Change—Guidebook agencies and private entities that enable greater private sector responsibility for a transportation project, including in design, delivery, financing, operation, and maintenance, beyond traditional design–bid–build procurements (Parsons Brinckerhoff et al., 2015). The degree to which the private sector assumes responsibility, including financial risk, differs from project to project. There are numerous P3 agreements, such as design–build, design–build–finance, design– build–finance–operate, and design–build–finance–operate–maintain (Parsons Brinckerhoff et al., 2015). DOTs are increasingly looking to P3s as a means of financing projects; as of February 2018, 28 U.S. highway P3s will have achieved financial close, with 20 occurring in the last 10 years (FHWA, 2017). Despite more research showing the financial benefits of socially focused business, firms have a mandate to maximize profits. As a result, their priorities are not the same as the public sector and its long-term asset management, including the welfare of future generations. Private firms reinvest profit to make more money now, rather than holding these long-term social welfare responsibilities. Thus, their work and estimates use a higher discount rate than govern- ments, as use of NPV can wipe out the value of future generations, their needs, or longer-term stewardship of public assets. Although a public entity is involved in a project, private involvement adds upward pressure to the discount rate, which DOTs then have to cope with. Some DOTs have dealt with this in creative ways, such as the Hooksett Rest Stop project in New Hampshire (Box 1). Private Funding Private sources of funding, such as from pension funds or sovereign wealth funds, have grown in importance in the last decade. Public infrastructure is now seen as an attractive, low-risk invest- ment for private funds simply because people need to travel (Podkul, 2011). Transportation agencies borrowing against or liquidating transportation infrastructure to pay for maintenance or operations needs is akin to selling a house to cover home expenses not met by income (in this case, taxes). Jean-Paul Rodrigue (2017) raises arguments that have been used to pressure public officials to consider privatizing transport infrastructure: 1. Fiscal burden. Governments can no longer afford transportation infrastructure maintenance and upgrades as other budget demands take priority. 2. High operating costs. With their orientation to maximize profits for shareholders, private interests better control technical and financial risks. 3. Cross subsidies. Much of state transportation spending is cross-subsidized through fuel taxes and so on. If private finances can be tapped to purchase public assets and operate the system, this frees up state revenue to be spent elsewhere or to reduce taxes. 4. Equalization. With public funds, people want their fair share of the benefits. If a project is built in one region, another region expects similar levels of funding, even if it is not efficient or would not maximize public benefit according to certain standards, thus increasing the cost of public provision. Privately financed infrastructure does not face the burden of public accountability or expectations. Three forms of privately funded infrastructure are described briefly as follows: 1. Sale or concession agreement. Owing to budgetary limitations, a government may be forced to sell or lease its assets. For a concession agreement, this commonly takes the form of a long-term lease requiring that the concessionaire maintain, upgrade, and build infrastructure and equipment to certain minimum levels. 2. Concessions for new projects. By offering tax breaks for new projects, governments ensure that existing assets remain untouched, and managerial expertise and technical know-how are employed. 3. Management contract. While ownership remains public, management is given to a private operator, commonly through a bidding process.

Cost-Benefit Analysis Overview 19 Box 1. Hooksett Rest Stop: A Successful Public-Private Partnership in New Hampshire Interstate 93 in New Hampshire serves as a main thoroughfare between Boston, the White Mountains, and Lake Winnipesaukee, where many visitors enjoy the natural beauty and outdoor activities of the area. The town of Hooksett, located between Manchester and Concord, is the mid-point between Boston, the mountains, and the lake. Through a public-private partnership, the Hooksett rest area, first constructed in 1977, was transformed from its original state into a vibrant destination in itself (Figure 4). The northbound and southbound rest areas feature not only fuel stations and restrooms, but also an information center, a general store with camping supplies, a League of New Hampshire Craftsmen store, a bank (northbound location only), and a Common Man food court that includes a 1950s-style diner, an Italian restau- rant, a country deli, and a bakery/coffee shop. A liquor and wine outlet operated by the State Liquor Commission is also at each rest stop. A private developer worked with the state DOT to create the New Hampshire– centric rest areas; the developer incurred the costs of the project and agreed to a cost share of the revenues with the state. Sales have been much higher than forecasted during the first year of operation, bringing in tens of millions of dollars and prompting the New Hampshire DOT to consider a similar approach for several other projects. Figure 4. Architectural rendering of the Hooksett Rest Area (courtesy of New Hampshire DOT and used with permission). Unlike in a P3, if there is no public entity to dilute the upward pressure on the discount rate, the privately funded project will have the highest discount rate out of all the options and future costs and benefits will not be given much or any weight in a present value calculation. There is more of an incentive to reduce costs now to maximize short-term benefits, rather than focusing on reducing costs that are unaccounted for or externalized in most financial transactions, or increasing benefits to future generations since externalities typically do not affect the bottom

20 Incorporating the Costs and Benefits of Adaptation Measures in Preparation for Extreme Weather Events and Climate Change—Guidebook line (unless externalities such as pollution are internalized by giving them a market price or tax). Even though private investment derives from sources such as pension funds and other entities that have long-term financial strategies, the time horizon for project planning and implementa- tion is likely to be shorter than for government-financed projects. Consequently, the focus is on projects that have smaller up-front costs or projects that generate benefits immediately, enabling investors to recoup the initial investment quickly. Overall Impact of Financing on Cost-Benefit Analysis Figure 5 offers a quick overview of how each financing option treats the characteristics on which impact on the CBA is based. Green indicates a favorable impact on an overall value for money analysis—that is, a full CBA—whereas red indicates a potentially less-favorable impact. Update to the Scenario Virginia DOT leadership has determined that cost-benefit analysis will be one of the criteria used to determine if climate and extreme weather adaptation measures should be incorporated into the design for the replacement culvert. Net present value and benefit-cost ratio will be used to do the initial evaluation of adaptation alternatives once they are identified. If one alternative has a greater NPV while another has a higher benefit-cost ratio, the alternative with the higher NPV will be selected as the recommended alternative. For federal funding purposes, one of the rates calculated will be the OMB A-94 prescribed discount rate of 7 percent for most costs. A sensitivity analysis of the project will be performed using a 3 percent discount rate in place of the 7 percent rate for comparison purposes. Data needed at this stage include • Discount rates to be used in the analysis and • Source of funding for the project (optional—needed if including cost of capital in analysis). Figure 5. Impacts of different financing types on CBA. Green indicates more favorable and red is less favorable.

Next: Chapter 3 - Climate Considerations »
Incorporating the Costs and Benefits of Adaptation Measures in Preparation for Extreme Weather Events and Climate Change—Guidebook Get This Book
×
MyNAP members save 10% online.
Login or Register to save!
Download Free PDF

Extreme weather events and a changing climate increasingly boost costs to transportation agencies and to the traveling public. While Departments of Transportation (DOTs) are taking into account changing climate and extreme weather when making infrastructure decisions, they typically are not using a formal set of tools or cost-benefit analyses (CBAs) to address climate resilience because they may be too time-consuming and expensive to conduct routinely.

The TRB National Cooperative Highway Research Program's NCHRP Research Report 938: Incorporating the Costs and Benefits of Adaptation Measures in Preparation for Extreme Weather Events and Climate Change—Guidebook was developed to try to fill the gaps identified by DOTs. It is intended to provide a consolidated resource for transportation practitioners to be able to more readily consider CBAs as a tool in their investment-decision making processes when considering different climate and extreme weather adaptation alternatives.

This report has additional resources, including a web-only document NCHRP Web-Only Document 271: Guidelines to Incorporate the Costs andBenefits of Adaptation Measures in Preparation for Extreme Weather Events and Climate Change, a Power Point presentation that describes the research and the results, a spreadsheet tool that provides an approximate test to see if it would be cost-effective to upgrade assets to the future conditions posed by climate change, and a spreadsheet tool that uses existing conditions without climate change only to calculate the new return period for future conditions with climate change.

  1. ×

    Welcome to OpenBook!

    You're looking at OpenBook, NAP.edu's online reading room since 1999. Based on feedback from you, our users, we've made some improvements that make it easier than ever to read thousands of publications on our website.

    Do you want to take a quick tour of the OpenBook's features?

    No Thanks Take a Tour »
  2. ×

    Show this book's table of contents, where you can jump to any chapter by name.

    « Back Next »
  3. ×

    ...or use these buttons to go back to the previous chapter or skip to the next one.

    « Back Next »
  4. ×

    Jump up to the previous page or down to the next one. Also, you can type in a page number and press Enter to go directly to that page in the book.

    « Back Next »
  5. ×

    To search the entire text of this book, type in your search term here and press Enter.

    « Back Next »
  6. ×

    Share a link to this book page on your preferred social network or via email.

    « Back Next »
  7. ×

    View our suggested citation for this chapter.

    « Back Next »
  8. ×

    Ready to take your reading offline? Click here to buy this book in print or download it as a free PDF, if available.

    « Back Next »
Stay Connected!