Video Script: Cost-Benefit Analysis - CGIAR …...Strategic Assessment of Banana Research Priorities...

Strategic Assessment of Banana Research Priorities

Video Script: Cost-Benefit Analysis

Let’s start digging into the methodology for the strategic assessment of banana research priorities. We

are using Cost-Benefit Analysis as an overall framework to evaluate if it is worthwhile to invest in

different banana research options. In general, Cost-Benefit Analysis, or in short CBA, is defined as a

systematic process for calculating and comparing the costs of a project to the estimated benefits it will

create. In the assessment all costs and benefits are expressed in monetary terms (in our case dollars)

and are adjusted for the time when they occur – economists call this discounting.

The results of a CBA can be used in two different ways: first, they help us determine if an investment in a

certain banana research line is financially sound. This means that we need to justify the investment of

scarce research funds by showing that the value of benefits created sufficiently exceeds the costs

incurred. Second, the results of the CBA serve as a basis for comparing two or more different banana

research options to ensure money is invested in the best way. In order to rank different investment

options we need to define the indicators to be used. The two most important indicators produced by a

CBA are the Net Present Value and the Internal Rate of Return. The Net Present Value (or short NPV)

represents today’s value of the net benefit of an investment while the Internal Rate of Return (or short

IRR) is the interest rate earned on the research investment.

The Net Present Value is calculated by deducting the estimated costs from the anticipated benefits for a

certain time into the future – in our case the assessment period is 25 years. The result is a net benefit

stream, which is negative initially since research and extension costs typically occur at the beginning of

the project and before benefits arise. In order to compute the NPV, net benefits are then adjusted for

the time when they occur. That is, in economic terms, they are discounted to a present value and then

added up. If the Net Present Value of a banana research option is positive, it is a financially viable and

profitable investment.

But why is it crucial to adjust costs and benefits for the time when they occur? Time affects economic

values and a dollar available now is more valuable than a dollar available in the future. This is because

we are impatient and will always value having something right now higher than having the same thing

later – assuming it is something with a positive value, like this Minion who is excited about eating a

banana rather sooner than later. The reverse holds true for costs – we would rather delay paying a bill.

Another way to explain this is that we have the option to either spend a $ we have today or “earn”

money through investing it for example by depositing it in a bank account (or loaning it to somebody)

and being compensated by receiving interest. As a result, we will have more than the initial amount

after some time has passed. How much more we will have after for example a year’s time, depends on

the interest rate, the rate that is paid or charged for the use of money. For instance, if we deposit $100

in a bank account today at 5% annual interest - we will have $105 next year (our initial $100 plus $5 of

interest earned). This is why $100 available in the future is less valuable than $100 today. This means

that the further in the future benefits from our banana research arise, the lower their equivalent

present value and the less they are valued in our assessment. These present values of future benefits

are lower the higher the interest rate is.


Let’s explore how this adjustment for time influences the Net Present Value of a project in practice.

Imagine three banana research investments: let’s call them projects A, B, and C. Even though all three

projects incur different absolute amounts of costs and benefits, their Net Present Values are the same.

How can that be? The costs of project A accrue at the beginning of the assessment period while benefits

are only realised far in the future. This is typical for example for investments in banana breeding which

takes a long time. In contrast, project B yields fewer benefits but they occur earlier while costs are the

same and follow the same pattern than for project A. For instance, this could be the case for a project

that focuses on multiplying and disseminating existing improved genetic material. For project C, finally,

costs are equally spread over the entire assessment period while benefits occur at the same time than

those in investment A. This can be a typical pattern for improved crop or pest management research,

which requires on-going investment in extension services to disseminate the knowledge to a large

number of small-scale banana producers to realize benefits. As you can see, the absolute amounts of

costs and benefits of all three projects differ, but the net present values are the same, due to the timing

of costs and benefits. This example illustrates that benefits and costs that occur later in the assessment

period have lower present values and thus carry less weight when computing NPVs than benefits or

costs occurring earlier.

The second important CBA outcome variable is the Internal Rate of Return, or IRR. It is defined as the

discount rate at which the Net Present Value equals zero meaning that the present value of costs of our

research would exactly equal the present value of the resulting research benefits. Thus, it is the discount

rate at which the research investment breaks even that is to say all costs are covered. How can we use

the IRR as an indicator to assess projects? Basically, the IRR is the interest rate earned on the research

investment and can be compared to other interest rates such as the returns earned in other investments

or the interest earned when depositing money in a bank account. Hence, the research project is a good

investment if the IRR exceeds these other interest rates. In general, the higher the Internal Rate of

Return of a banana research project, the more desirable it is to undertake this project.

Now that we have described the methodological framework for assessing banana research priorities,

let’s continue with a more detailed look at the steps we carried out to estimate benefits and costs of

each of the banana research options included in our assessment.


Cost-Benefit Analysis

1

Cost-Benefit Analysis

2

Cost-Benefit Analysis (CBA)

Costs Benefits

3

Benefits

Cost-Benefit Analysis (CBA)

Costs

$“discounting”

4

Is the investment financially sound?

5

Costs

Benefits

6


Research

option (1)

Research

option (2)

7

1

23

Investment C

Investment A

Investment B

8

Net Present Value

Internal Rate of Return

Investment C

1

23

Investment A

Investment B

9

Net Present Value (NPV)

Internal Rate of Return

Today’s

$

Investment C

1

23

Investment A

Investment B

10

Net Present Value

Internal Rate of Return (IRR)

Investment C

1

23

Investment A

Investment B

%interest

earned

11

0 5 10 15 20 25 30

benefits

costs

-years


12


0 5 10 15 20 25 30years


$ $

$

$$

$ $ $

$ $ $

$

$ $

$

$

$

$

$

$

$

$

$

$

$

$

$ $

$

$

$

$

$

$

$

$$

benefits

costs

-

$ $

13

0 5 10 15 20 25 30years


$ $

$

$$

$ $ $

$ $ $

$

$ $

$

$

$

$

$

$

$

$

$

$

$

$

$ $

$

$

$

$

$

$

$

$$

benefits

costs

-

$ $

14

$ $

$

$$

$ $ $

$ $ $

$

$ $

$

0 5 10 15 20 25 30

$

$

$

$

$

$

$

$

$

$

years

+

-


$ $

15

$ $

$

$$

$ $ $

$ $ $

$

$ $

$

0 5 10 15 20 25 30

$

$

$

$

$

$

$

$

$

$

years

+

-


Net benefit stream

$ $

16

$ $

$

$$

$ $ $

$ $ $

$

$ $

$

0 5 10 15 20 25 30

$

$

$

$

$

$

$

$

$

$

years

Net benefit stream

+

-

$ $

17

$ $

$

$$

$ $ $

$ $ $

$

$ $

$

0 5 10 15 20 25 30

$

$

$

$

$

$

$

$

$

$

years

Net benefit stream

+

-

‘discounted to a present value’

$ $

18


$ $

$

$$

$ $ $

$ $ $

$

$ $

$

0 5 10 15 20 25 30

$

$

$

$

$

$

$

$

$

$

years

Discounted

net benefit stream

+

-

‘discounted to a present value’

19

$ $

$

$$

$

$

$

0 5 10 15 20 25 30

$

$

$years

+ + + + + + + + +

$ $

$ $

$ $

$

$

$

$

$

$

$

$

Discounted

net benefit stream

20

$ $

$

$$

$

$

$

0 5 10 15 20 25 30

$

$

$years

+ + + + + + + + += $ $ $

NPV

$ $

$ $

$ $

$

$

$

$

$

$

$

$

Discounted

net benefit stream

21

$ $

$

$$

$ $ $

$ $ $

$

$ $

$

0 5 10 15 20 25 30

$

$

$

$

$

$

$

$

$

$

years

+ + + + + + + + +

Discounted

net benefit stream

= $ $ $

NPV

22

benefits

costs

23

benefits

costs

24


benefits

costs

nowfuture

25

>NOW later

26

>NOW later

27 28

29

$ + $

= $ $ $

%

30


$ $ + ?

2015 2016

Interest

rate

Bank

$ 100

Interest rate: 5 %

Today

$ 105

Next year

31

$ 100

Today

$ 100

Future

32

FUTURE

33

FUTURE

34

FUTURE

35

Project A Project B Project C

36


NPV = NPV = NPV =$ $ $

Project A Project B Project C

37

0 12.5 25years

Annual

benefits

Annual

costs

Project A

38

0 12.5 25years

Annual

benefits

Annual

costs

$ $

$$$

$

$

Project A

39

0 12.5 25years

Annual

benefits

Annual

costs

$ $

$$$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$ $ $

$ $

Project A

40

0 12.5 25years

Annual

benefits

Annual

costs

$ $

$$$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$ $ $

$ $

Project A

NPV = $

41

Project A

42


years

Annual

benefits

Annual

costs

Project B

$

$

$

$

$

$

$

$

$

$

$

$

$ $ $

$ $

$ $

$$$

$

$0 12.5 25

43

years

Annual

benefits

Annual

costs

$

$

$

$

$

$

$ $ $

$ $

Project B

$ $

$$$

$

$0 12.5 25

44

years

Annual

benefits

Annual

costs

$

$

$

$

$

$

$ $ $

$ $

$ $

$$$

$

$

Project B

0 12.5 25

45

years

Annual

benefits

Annual

costs

$

$

$

$

$

$

$ $ $

$ $

$ $

$$$

$

$

Project B

NPV = $

0 12.5 25

46

Project B

47

Project C

years

Annual

benefits

Annual

costs

$

$

$

$

$

$

$ $ $

$ $

$ $

$$$

$

$0 12.5 25

48


0 12.5 25years

Annual

benefits

Annual

costs

$ $ $ $$$ $ $$ $

Project C

$

$

$

$

$

$

$ $ $

$ $

49

0 12.5 25years

Annual

benefits

Annual

costs

$ $ $ $$$ $ $$ $

$

$

$

$

$

$

$

$

$

$

$

$

$ $ $

$ $

Project C

50

0 12.5 25years

Annual

benefits

Annual

costs

$ $ $ $$$ $ $$ $

$

$

$

$

$

$

$

$

$

$

$

$

$ $ $

$ $

Project C

NPV = $

51

Project C

52

years

Annual

benefits

Annual

costs

$ $

$$$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$ $ $

$ $

NPV = $

Project A

0 12.5 25

53

years

Annual

benefits

Annual

costs

$

$

$

$

$

$

$ $ $

$ $

$ $

$$$

$

$

NPV = $

Project B

0 12.5 25

54


0 12.5 25years

Annual

benefits

Annual

costs

$ $ $ $$$ $ $$ $

$

$

$

$

$

$

$

$

$

$

$

$

$ $ $

$ $

NPV = $

Project C

55

0 12.5 25years

Annual

benefits

Annual

costs

$ $ $ $$$ $ $$ $

$

$

$

$

$

$

$

$

$

$

$

$

$ $ $

$ $

56

0 12.5 25years

Annual

benefits

Annual

costs

$ $ $ $$$ $ $$ $

$

$

$

$

$

$

$

$

$

$

$

$

$ $ $

$ $

Lower

present values

57


‘Discount rate at which the Net Present Value equals zero’

Present value

of banana research

costs

Present value

of banana research

benefits=

‘Discount rate at which all costs are covered’

58

Project “Banana”


IRR = Interest rate earned

on the research investment

%

Bank

Interest rate: 10%

>

59

How to estimate costs and benefits

of potential RTB banana research

Production and Narration (November 2016):

Diemuth Pemsl, Lars Scheerer, Veronica Mulligan, Charles Staver

Picture attributions

Bioversity International (N. Roux, A. Molina, C. Zanzanaini; P. Lepoint); Cirad; Pixabay (all images released under Creative Commons CC0 Public Domain)

M. Batte, Courtesy of Musarama, www.musarama.org

60


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Video Script: Cost-Benefit Analysis - CGIAR …...Strategic Assessment of Banana Research Priorities...

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