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Decision to invest
A cost effectiveness analysis (CEA)
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Presentation outline
1. CBA versus CEA
2. CEA: average cost effectiveness
3. CEA: incremental cost effectiveness
4. Conclusion
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Outline CBA versus outline
CEA
1. Project definition (CBA = CEA)
- Boundary definitions
- Alternative projects Communicate clearly
Is the investment worth its cost?Which alternative to choose?
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Outline CBA versus outline
CEA
2. Classification of impacts (CBA = CEA)
- Timing of impacts
- Irrelevant impacts
e.g. Fuel consumption, maintenance, avoided CO2emission,
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Outline CBA versus outline
CEA
3. Conversion into monetary terms (CEA CBA)
- CBA: all impacts- CEA: only the cost impacts, benefits are
measured in an effectiveness term (e.g. human lifes saved,Mton emission avoided, )
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Outline CBA versus outline
CEA
4. Discounting (CBA CEA)
- The value of consumption in the future- Time preference (uncertainty, impatience)
CBA: cost and benefits are discountedCEA: only costs are discounted
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Outline CBA versus outline
CEA
0
50
100
1 11 21 31 41 51 61 71 81 91 101
r=3% r=5% r=8%
4. Discounting
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Outline CBA versus outline
CEA
5. Project assessment (CBA CEA)
- CBA: Net present value (NPV) NPV = Investment sum of discounted net cash flows
Net cash flow = annual benefit annual cost
- CEA: cost effectiveness ratios
Average cost effectiveness ratio
Incremental cost effectiveness ratio
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Outline CBA versus outline
CEA
6. Sensitivity analysis (CBA = CEA)
How do variations in parameter values affectthe economic result, the decision?
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Cost effecteveness analysis
A cost effectiveness analysis (CEA):
- The effects/benefits are not monetized
- Comparison of mutually exclusive alternatives
- A ratio of cost and effectiveness measure
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Cost effectiveness ratios
Average cost effectiveness ratio (ACER)
- C/E for each alternative- Overall efficiency
- The alternative with the lowest cost
effectiveness ratio should be selected
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Cost effectiveness ratios
Example ACER
Cost and effectiveness Alternative A Alternative B
Cost measure (M)
Effectiveness measure (Mton
CO2 emission reduction)
CE ratio (/Mton)
1
4
250 000 500 000
200
100
Comment?
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Comment
Scale issue
What if 1 Mton CO2 reduction is worth
1M?
Applying cost benefit analysis, one woulddecide to adopt alternative 2
Net benefit of alternative 1:4 Mton * 1M/Mton 1M = 3M
Net benefit of alternative 2:
200 Mton * 1M/Mton 100M = 100M
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Cost effectiveness ratios
Incremental cost effectiveness ratio (ICER)
- Alternative strategies versus one referencestrategy
- Ratio of a change in cost to a change in effect
- C/ E
- Decision rule: CE-plane
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Positive Incremental Cost
Negative Incremental Effect Positive Incremental Effect
Negative Incremental Cost
ICER1
ICER2
E1,2
C1
C2
E1,2
NB1>0
NB2
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Cost effectiveness ratios
Example ICER
Cost and effectiveness Alternative A Alternative B
Cost measure (M) 1 100
Effectiveness measure (MtonCO2 emission reduction)
4 200
(Reference)
C (M)
E (Mton CO2 emission reduction)
C/E (M/Mton)
99
196
0.505102
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Cost effectiveness plane
-200
-150
-100
-50
0
50
100
150
200
-150 -100 -50 0 50 100 150 200 250
Incremental
effect (Mton)
Incremental cost (M)
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Cost effectiveness plane:
= 0.505102 M/Mton
Net benefit alternative B = E * - C
Indifference between reference A andalternative B
196 Mton* 0.5 M/Mton - 99 M = 0
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Cost effectiveness plane:
= 0.505102 M/Mton
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Cost effectiveness plane:
= 0.6 M/Mton
Net benefit alternative B = E * - C
Alternative B
196 Mton* 0.6 M/Mton - 99 M = 18.6 M
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Cost effectiveness plane:
= 0.6 M/Mton
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Cost effectiveness plane:
= 0.3 M/Mton
Net benefit alternative B = E * - C
Reference A
196 Mton* 0.3 M/Mton - 99 M = - 40.2 M
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Cost effectiveness plane:
= 0.3 M/Mton
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Conclusion
Average cost effectiveness ratioNo burden of monetizing effects/benefits
But issue of scale
Incremental cost effectiveness ratio
Step towards CBA
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