❓ Hon. Alan Cadby asks the Minister for Planning and Infrastructure to explain the $1.427 billion net present value (NPV) figure cited in the PATREC report on the South West Metropolitan Railway (SWMR). The Minister provides a detailed explanation of NPV calculation and the factors considered.
AnsweredQoN 1850Legislative Council
QuestionView source ↗
I refer to the Planning and Transport Research Centre (PATREC) report that was released in February 2004 on the South West Metropolitan Railway. In that report (Section 4, page 11, Table 4.1) gives an ‘Overview of economic outcomes of SWMR’ and cites a net present value of $1,427 million. Will the Minister please advise -
(1) What does this figure refer to?
(2) How was it determined?
(1) What does this figure refer to?
(2) How was it determined?
AnswerView source ↗
Answered
3 June 2004
Responded by
Parliamentary Secretary representing the Minister for Planning and Infrastructure
Response time
65 days
(1)&(2) The Net Present Value (NPV) of $1,427 million shown in Table 4.1 of the report is the net worth of the project to the community.
NPV is a well recognised measure of benefit used in virtually all benefit cost analyses of infrastructure projects. It is calculated by subtracting the aggregate benefits from the project from the extra costs incurred by building the project, after all benefits and costs have first been converted to ‘present values’ (PV) by discounting. Discounting aims to express the value of future costs and benefits in the present year, which is necessary to reflect the fact that a dollar to be gained or spent in a future year is worth less than a dollar in the hand in the present (this has nothing to do with inflation, and all costs are first presented in ‘constant dollars’). Discounting ensures that the effect of the different timing of costs and benefits is fully reflected in the NPV (initial capital costs are little affected by discounting, but future benefits several years into the future are strongly affected (i.e. reduced) by discounting, so that one dollar of cost spent this year will generally require several dollars of future benefits to produce a positive NPV outcome). The extent of the discounting applied to future benefits and costs depends on the ‘discount rate’ used, which in this case is 7%. Table 4.1 also presents an NPV produced by discounting at 3.5%. The text explains the rationale for these alternative rates.
Calculating the NPV involves identifying the benefits generated by the
Project
, and comparing them with the difference between the cost of a
Base Case
(i.e. the no-rail-project scenario) and the cost of the Project Case, i.e. the extra costs incurred by building the project. This might be better understood by the following simple formula; NPV = [PV of Benefits from the Project] – [[PV of Cost of Project] – [PV of Cost of Base Case]]. Where the present value of the extra costs involved in undertaking the Project are less than the present value of the benefits generated by the project, the NPV will be positive.
The benefits and costs with the railway investment (project case) and without the railway investment (base case) were calculated. The difference is the net present value. In both cases, where appropriate, costs covered were:
· Railway track capital
· Railway rollingstock capital
· Railway operating costs
· Road construction capital costs for buses (freeway lanes, arterial and local roads)
· Bus station and bus storage construction capital.
· Bus rollingstock capital
· Bus operating costs
· Expansion of the road (motor car) network (freeway lanes, arterial and local roads).
The benefits generated from the project taken into account in calculating the NPV were: (a) the reduction in car operating costs as a result of diversion of trips from car to bus and train and as a result of reduced congestion; (b) time savings by existing car and bus users; (c) the value to travellers transferring to rail of the perceived improvement in service, known as ‘consumer surplus’, measured by their willingness to pay for the new service; (d) the value of changes in road maintenance costs resulting from fewer car vehicle-km; (e) the dollar value of changes in the cost of accident trauma, also as a result of fewer car vehicle-km; and (f) the dollar value of changes in environmental effects (air pollution, greenhouse gas emissions, water pollution, and traffic noise). (g) residual value of rollingstock (rail and bus) capital at the end of the period.
The size of these benefits and the methods of valuation used are described and discussed on pages 14-16 of the report.
NPV is a well recognised measure of benefit used in virtually all benefit cost analyses of infrastructure projects. It is calculated by subtracting the aggregate benefits from the project from the extra costs incurred by building the project, after all benefits and costs have first been converted to ‘present values’ (PV) by discounting. Discounting aims to express the value of future costs and benefits in the present year, which is necessary to reflect the fact that a dollar to be gained or spent in a future year is worth less than a dollar in the hand in the present (this has nothing to do with inflation, and all costs are first presented in ‘constant dollars’). Discounting ensures that the effect of the different timing of costs and benefits is fully reflected in the NPV (initial capital costs are little affected by discounting, but future benefits several years into the future are strongly affected (i.e. reduced) by discounting, so that one dollar of cost spent this year will generally require several dollars of future benefits to produce a positive NPV outcome). The extent of the discounting applied to future benefits and costs depends on the ‘discount rate’ used, which in this case is 7%. Table 4.1 also presents an NPV produced by discounting at 3.5%. The text explains the rationale for these alternative rates.
Calculating the NPV involves identifying the benefits generated by the
Project
, and comparing them with the difference between the cost of a
Base Case
(i.e. the no-rail-project scenario) and the cost of the Project Case, i.e. the extra costs incurred by building the project. This might be better understood by the following simple formula; NPV = [PV of Benefits from the Project] – [[PV of Cost of Project] – [PV of Cost of Base Case]]. Where the present value of the extra costs involved in undertaking the Project are less than the present value of the benefits generated by the project, the NPV will be positive.
The benefits and costs with the railway investment (project case) and without the railway investment (base case) were calculated. The difference is the net present value. In both cases, where appropriate, costs covered were:
· Railway track capital
· Railway rollingstock capital
· Railway operating costs
· Road construction capital costs for buses (freeway lanes, arterial and local roads)
· Bus station and bus storage construction capital.
· Bus rollingstock capital
· Bus operating costs
· Expansion of the road (motor car) network (freeway lanes, arterial and local roads).
The benefits generated from the project taken into account in calculating the NPV were: (a) the reduction in car operating costs as a result of diversion of trips from car to bus and train and as a result of reduced congestion; (b) time savings by existing car and bus users; (c) the value to travellers transferring to rail of the perceived improvement in service, known as ‘consumer surplus’, measured by their willingness to pay for the new service; (d) the value of changes in road maintenance costs resulting from fewer car vehicle-km; (e) the dollar value of changes in the cost of accident trauma, also as a result of fewer car vehicle-km; and (f) the dollar value of changes in environmental effects (air pollution, greenhouse gas emissions, water pollution, and traffic noise). (g) residual value of rollingstock (rail and bus) capital at the end of the period.
The size of these benefits and the methods of valuation used are described and discussed on pages 14-16 of the report.
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