OECS ENGINEERING
WORKSHOP
Why Cost Benefits Analysis
CBA Methodology
CBA Exercise
CBA Limitation
Application in the Context of Disaster
Risk Reduction
Why YOU, the Engineer?
 Those who generate solutions are most intimate with
the details and best suited to analyze them financially.
 To be heard, engineers must be able to speak
financially:
 It is generally assumed that the engineering solution will
work -- must justify financially
Engineering
 Engineers provide answers.
 Ability to solve problems or take advantage of
opportunities through the application of science.
 Must meet certain criteria.
 Technical feasibility/efficiency: meet or exceed
specifications.
 Economic feasibility/efficiency: meet budgets and
return.
The Role of engineering
Economic analysis
 Engineering economic analysis is most suitable for
intermediate problems and economic aspects of
complex problem, they have those qualities :
1) the problem is important enough to justify our
giving it serious thought and effort.
2)
careful analysis requires that we recognize the
problem and all various consequences, and this is
just too much to be done all at once.
3)
the problem has economic aspects important
in reaching a decision.
CBA Terms & Concepts
 Interest and equivalence
 Present Value Analysis
 Cash Flow Analysis
 Rate of Return
 Deprecation
 Cost benefit analysis
 Risk, and uncertainly
 Sensitivity analysis
Engineering Economy
 Every technical solution has financial
consequences.
 Engineering economic analysis
determines whether a proposed
solution is financially viable.
 Will it pay?
 Is this the minimum cost solution?
 Will it generate an acceptable return?
Making an Economic Decision
The steps:
1 Problem or opportunity recognition and definition
2 Generation of Solution Alternatives
3 Development of Feasible Solution Alternative Cash
Flows and Information Gathering
4 Evaluation of Solution Alternatives
5 Selection and Implementation of Best Alternative
6 Post-implementation Analysis and Evaluation
Decisions in Design
 The design process is generally embedded in the
second step of the decision-making process.
 Designs = Solution Alternatives
 Design decisions are generally discipline specific.
 But the economics surrounding design decisions are
for all engineers
Engineering Economic
Decision Analysis Difficulty
 Investments carry risk.
 Money spent now for expected savings
or returns in the future.
 As future is uncertain, so are returns or savings.
 Money spent can be lost. If too often, could lead to
bankruptcy.
 While economics are paramount, many
other factors influence decision.
Evaluation Techniques
 Payback Period
 Net Present Value
 Internal Rate of return
 Cost Benefit Ratio
CBA Example
A country is considering installing a water treatment system
in a rural community that is expected to cause
environmental and direct benefits of $ 1,000,000 per year
for its inhabitants. The system would require an investment
of $ 9,000,000 and have operating and maintenance costs
of $ 300,000 per year for an expected life of 20 years, after
which it would have no value.
If money for this type of project costs the county 6%, is the
project justified on an economic basis? Suppose an AID
Agency is willing to pay $ 4,000,000 of the investment.
Now is it justified?
Year Capital Cost O&M
0
Benefit
9,000,000
0
NB
0
(9,000,000)
1
300,000
1,000,000
700,000
2
300,000
1,000,000
700,000
3
300,000
1,000,000
700,000
4
300,000
1,000,000
700,000
5
300,000
1,000,000
700,000
6
300,000
1,000,000
700,000
7
300,000
1,000,000
700,000
8
300,000
1,000,000
700,000
9
300,000
1,000,000
700,000
10
300,000
1,000,000
700,000
11
300,000
1,000,000
700,000
12
300,000
1,000,000
700,000
13
300,000
1,000,000
700,000
14
300,000
1,000,000
700,000
15
300,000
1,000,000
700,000
16
300,000
1,000,000
700,000
17
300,000
1,000,000
700,000
18
300,000
1,000,000
700,000
19
300,000
1,000,000
700,000
20
300,000
1,000,000
700,000
NPV
($916,089.76)
Evaluation based on NPV Method
Net PW = ($ 1,000,000 - $ 300,000)(P/A, 6%, 20) - $ 9,000,000 =
= - $ 971,000 < $ 0
Thus, it is not justified in total.
Based only on benefit and costs to the county
Net PW = ($ 1,000,000 - $ 300,000)(P/A, 6%, 20)
- ($ 9,000,000 - $ 4,000,000) = $ 3,029,000 > $ 0
B
1
I  C'
B > (I + C’’)
B – (I+ C’’) >
0
PW(i) = B – C’ >
0
FOCUS ON THE DIFFERENCES
 Only the differences in expected future outcomes
among the alternatives are relevant to their
comparison and should be considered in the
decision
Summary
 A benefit-cost analysis is commonly used to evaluate public
projects;
 Difficulties involved in public project analysis include the
following:
1) Identifying all the users who can benefit from the project;
2) Identifying all the benefits and disbenefits of the project;
3) Quantifying all benefits and disbenefits in some money unit
of measure;
4) Selecting an appropriate interest rate at which to discount
benefits and costs to a present value;
CBA AND DISASTER RISK
REDUCTION
An important aspect in risk
evaluation is also:
How much do we need to spend
in order to reduce the risk
Risk reduction
Risk reduction strategies

Structural measures:
refer to any physical construction to reduce or avoid possible
impacts of hazards, which include engineering measures and
construction of hazard-resistant and protective structures and
infrastructure

Non-Structural measures:
refer to policies, awareness, knowledge development, public
commitment, and methods and operating practices, including
participatory mechanisms and the provision of information,
which can reduce risk and related impacts.
Tools to evaluate best risk reduction
measures
 Cost Benefit Analysis (CBA) is used to compare costs and benefits of a
one specific measures or a set of alternative measures over a period of
time for a. CBA assesses the measure(s) mainly on the basis of the
efficiency criterion. It requires the monetization of all the effects. The
effects that cannot be expressed in monetary terms will be usually
described in their original unit of measurement.
 Cost Effectiveness Analysis: (CEA) has most of the features of CBA, but
does not require the monetization of either the benefits or the costs
(usually the benefits). CEA does not show whether the benefits
outweigh the costs, but shows which alternative has the lowest costs
(with the same level of benefits). CEA is often applied when the norm
for a certain level of safety has been set. CEA analyzes which types of
solution is the ‘cheapest’ given a certain level of safety standard.
 Multi Criteria Analysis (MCE) is a tool that allows comparing
alternative measures on multiple criteria. In contrast to CBA, MCE
allows the treatment of more than one criterion and does not require
the monetization of all the impacts. MCE results in a ranking of
Alternatives
Which alternative is economically the
most attractive?
•If all alternatives are all as effective in terms of risk reduction 
the cheapest alternative (Cost Effectiveness Analysis, CEA)
•If effectiveness in risk reduction differs  the cheapest alternative
in terms of risk reduced (Cost Benefit Analysis, CBA)
Levees
Flood proofing
relocation.
Cost Benefit Analysis of Risk Reducing
Measures
 Costs for (structural) risk reducing measures are
relatively less difficult to estimate
 Estimating the benefits is a major challenge !
We need to know:
 Avoided damage
 Probability of damage
We need to estimate:
 how often natural hazard events occur (frequency)
 how much damage and losses occur as a result of the
event
Do we include all losses?
Flooding Example
Direct damage
Indirect damage
 buildings
 income forgone
 infrastructure
 interruption of economic and
 crops and livestock
 Machines
 human victims
 landscape/nature
social activities
 extra costs of transportation
due to infrastructure damage
Damage functions
Damage-probability curve
Damage-probability curve
in case of flood protection
against events upto 1:100
years
Basic CBA steps
1.
2.
3.
4.
5.
6.
7.
Define scope of the project
Identify the type of costs and benefits
Put monetary values on costs and benefits
Compare costs and benefits
Calculate profitability indicators/decision criteria
Sensitivity analysis
Make recommendations
Example CBA Flood Reducing Measures
Scenario I (removal)
 removal of housing in the
10-year Return Period
flood zone
 10 year RP flood zone is
converted into green areas
 buildings are demolished,
new terrain to be bought,
and new buildings have to
be constructed in other
hazard free zones
 the set-up of a vigilance
group is required
 The risk in the area that
was formerly threatened by
a 10 year Return Period
flood will be reduced to 0
Scenario II (retention)
 construction of an
upstream storage lake
 engineering works
 flood retention basin and
drainage need
maintenance
 the retention basin will
reduce the flood losses.
 It will retain the discharge
for 2 and 5 years RP and
reduce the risk to 0.
 For the other return
periods the damage will
reduce the losses
Damage without risk reduction, Scenario I and II at
different Return Periods
Flooding
Return
Period
2
5
10
25
50
100
200
Annual
without Scenario 1 Scenario
Probability mitigation
2
0.5
0.2
0.1
0.04
0.02
0.01
0.005
0.0
19.3
34.4
100.0
199.0
510.0
1134.0
0
0
0
65.6
164.6
475.6
1099.6
0.0
0.0
19.3
34.4
100.0
199.0
510.0
Risk reduction

Once you have calculated the annual loss for the existing
situation, you can now evaluate the reduction in total annual
losses for the two scenarios.

Calculate the amount of risk reduction, comparing Scenario 1
and Scenario 2 with the original average annual risk.
Risk Annual
reduction
Average
Risk
($'000,000)
25,927
17,165
9,737
Present Situation
Scenario 1
Scenario 2
31
Annual Risk Reduction
($'000,000)
8,762
16,190
Costs
 After calculating the risk reduction (benefit) and the
investment costs of the two flood scenarios we can now
continue to evaluate the cost/benefits. The following
table indicates the costs of the two scenarios.
32
Maintenance and operation costs
 Each of the two scenarios will also require long term
investments.
 Scenario 1 requires the set-up of a municipal
organization that controls the illegal spread of housing
in highly hazardous areas. It will require staff, office and
equipment costs, which will rise over time depending
on the increases of salary and inflation. The annual
costs are estimated to be 250.000. We consider that
these costs will increase with 5 % each year.
 Scenario 2 also requires maintenance and operation
costs. The flood retention basin contains a basin in
which sediments are deposited. Annually the sediments
from this basin have to be removed using heavy
equipment. Also the drainage works needs regular
repair. The costs for maintenance are considered to be
500.000 per year. We consider that these costs will
increase with 5 % each year. See table below.
33
Investment period
 The investments for both scenarios are not done within one single
year. They are spread out over a larger number of years, because
normally not all activities can be carried out in the same year.
 It is quite difficult to remove existing buildings. The municipality
would like to buy the land of private owners, but they will resist,
and there will be many lawsuits that might take a lot of time.
Therefore we consider that the entire relocation of all building
might take as much as 10 years. The investment costs are therefore
spread out over this period.
 The construction of the engineering works for scenario 2 will take
less time. Still it is considered that the costs are spread over a
period of 3 years.
 The benefits will start in the year that the investments are finished.
For scenario 1 this is in year 11 and for scenario 2 it is in year 4.
34
Project lifetime
 The lifetime of the scenario 2 is considered to be 40
year. After that the structure will have deteriorated and
it needs to be rebuilt. For the relocation scenario it is
more difficult to speak about a life time, but we will
also keep the same period of 40 years.
35
Flood mitigation Scenario I
year
incremental benefits NPV_10%
1
-8.333
-7.576
2
-8.333
-6.887
3
-8.333
-6.261
4
15.690
10.716
5
15.690 Until
year
40
9.742
Flood mitigation Scenario II
incremental
benefits
year
NPV_10%
1
-8.333
-7.576
2
-8.333
-6.887
3
-8.333
-6.261
4
15.690
10.716
5
15.690
Until
year
40
9.742
Summary CBA scenario I and II
Flood Risk
Reduction
Scenario
NPV at 5 NPV at 10 NPV at 20
%
% interest % interest
interest
rate
rate
rate
IRR
Scenario I
42.23
-0.38
-14.96 9.91%
203.80
93.69
27.79 42.32%
Scenario II
NPV and IRR
Criterion
Decision rule
accept
reject
NPV
NPV > 0
NPV < 0
IRR
IRR >
interest rate
IRR <
interest rate
Result
 Question:
 Which Mitigation Scenario would you advice the
Municipality?
Elements often overlooked in CBA in Natural
Hazard and Disaster Management
 Indirect economic damage
 Social effects
 Irreplaceable items
 Stress induced by disaster
 Temporary evacuation
 Social disruption
 Environmental effects
 Evaluation of non-structural measures
CBA -strengths
 Systematic way of thinking and analysis
 Focus on use of scarce resources
 Strong methodological basis
 Monetary measurement provides comparison
 Appeal to policy makers
Limitations Cost-Benefit Analysis
 One approach to assess the efficiency of (structural) risk reducing
measures
 Take care of uncertainty of all parameters used
 Estimated values of objects at risk
 Probabilities of the hazard
 Take care of all aspects NOT considered:
 Social effects




Irreplaceable items
Stress induced by disaster
Temporary evacuation
Social disruption
 Environmental effects
 Indirect effects
 Discounting favours present generations
 One single outcome hides assumptions and value judgements
THANK YOU