Presentation Module 3c Cost-Benefit-Analysis (CBA) Country, Date, Presenter

Objective The objective of this module is to: understand the concept behind cost-benefit analysis, understand the specific approach of the cost-benefit analysis as it is used in the Climate Expert be sensitised on the short-comings of cost-benefit analysis in the context of climate change adaptation assessments 17/11/2018 Title

Background on Cost-Benefit Analysis Outline / Agenda Background on Cost-Benefit Analysis Cost-Benefit Analysis in the Climate Expert 17/11/2018 Title

I. Background on Cost-Benefit Analysis 17/11/2018 Title

I. Overview on Cost-Benefit Analysis – Relevance of quantification for businesses are particularly relevant for business operations help to compare and prioritize measures support the identification of the most suitable, effective and efficient adaptation measures  Support for informed decision making! 17/11/2018 Title

I. Overview on Cost-Benefit Analysis – Challenges of quantification Climate change and associated negatives effects that companies incur from it are uncertain  costs and, particularly, benefits are not easy to quantify Not all data/information necessary for the assessment is readily available to allow for an accurate and comprehensive assessment 17/11/2018 Title

I. Overview on Cost-Benefit Analysis – What CBA is about CBA = Systematic process for calculating and comparing absolute costs and benefits of one or more adaptation measures Two purposes: Determining whether the project is feasible in absolute terms (Do benefits outweigh its costs?) Comparing different measures with each other (Which project achieves greater benefits? Which is most cost-effective?) 17/11/2018 Title

I. Overview on Cost-Benefit Analysis – What CBA is about Costs and benefits are expressed in concrete monetary terms Costs and benefits occurring at different points in time are made comparable through discounting In a business context, discounting is usually done using the market interest rate (expressing the time value of money) BUT: when it comes to climate change, the social discount rate should be used to express the inter-generational value of adaptation 17/11/2018 Title

I. Overview on Cost-Benefit Analysis – Limits of the CBA Structured approaches to quantify adaptation measures’ costs and benefits offer a factual basis to deal with an uncertain future. Besides the process of quantification the interpretation and use of results is of equal importance. It needs to be kept in mind that results of CBA … Offer support for decision making but are by far not the only information to consider – no single number can decide about whether or not to implement a complex measure Are only approximations of reality – they need to be used carefully Assess cost-effectiveness – other criteria, such as social considerations, might be equally important to a company Overall, experience with conducting quantitative assessment and with interpreting results is necessary 17/11/2018 Title

I. Overview on Cost-Benefit Analysis – the Net Present Value (NPV) The Net Present Value (NPV) is the difference between discounted costs and discounted benefits of a measure over its entire lifetime. It is calculated by subtracting the discounted costs from the discounted benefits. By using discounted costs and benefits the NPV accounts for the fact that costs and benefits accruing in the future are worth less today. If the result of the NPV is positive, the adaptation measure is economically feasible in absolute terms. Through the NPV, different adaptation measures can be ranked – the higher the NPV, the higher the net benefits of this measure. 17/11/2018 Title

I. Overview on Cost-Benefit Analysis – Cost-Benefit Ratio The Cost-Benefit Ratio (CBR) is the ratio of discounted costs of the measure over the discounted benefits of the measure for its entire lifetime. It expresses how much money has to be spent in order to create one unit (in monetary terms) of benefit. The adaptation measure is cost-effective if the CBR < 1, meaning that costs are smaller than benefits. 17/11/2018 Title

I. Overview on Cost-Benefit Analysis – Internal Rate of Return (IRR) The Internal Rate of Return (IRR) is a figure to measure and compare the profitability of investments. It is the discount rate which will cause the NPV of the risk mitigation measure to equal zero (if NPV=benefits - costs=0, then r=IRR), i.e. where the present value of total (discounted) costs equals the present value of total (discounted) benefits. Calculating the IRR follows the same logic as calculating the NPV. The main difference is that, rather than deciding on a discount rate depending upon the risk of the measure, calculating the IRR relies on an iterative solution to determine what discount rate will cause the NPV of the project to equal zero. The IRR can be calculated by trial and error by varying the discount rate in the NPV formula until the NPV is equal to 0. If this is the case the discount rate used is the IRR. The IRR can be used to compare different adaptation options with each other. The higher the IRR, the greater the returns of the investment. 17/11/2018 Title

I. Overview on Cost-Benefit Analysis – Return on Investment (RoI) The Return on Investment (RoI) is the money saved with the investment measured in percentage of the total invested sum (investment costs and operating costs). A 60% RoI means that the cost of the project and another 60 percent of these costs have been recovered. The RoI thereby puts the gains of an investment (the NPV) in relation to the costs of the investment. It is calculated by dividing the NPV by the discounted costs over the entire lifetime of the investment. The higher the RoI, the higher the returns of the project in relation to the invested sum. The RoI is therefore always dependent on the invested sum. A higher RoI does not necessarily mean that a measure generates more absolute savings than another measure with a lower RoI. 17/11/2018 Title

I. Overview on Cost-Benefit Analysis – Payback time The payback time is the time it will take for the undiscounted annual benefits to equal the initial investment costs. In other words, after how many years the company will realise net benefits. Note that you should subtract low benefits from high costs and vice versa to get the respective minimum and maximum figures 17/11/2018 Title

II. Cost-Benefit Analysis in the Climate Expert 17/11/2018 Title

II. Cost-Benefit Analysis in the Climate Expert – The climate change dimension of the CBA Please note: Only relevant negative effects on the business (not relevant for opportunities) Impacts are cummulative (the figure of thesevere climate change scenario needs to be higher than that of the baseline scenario -> 1; 2(1+1); 3(2+1) 17/11/2018 Title

II. Cost-Benefit Analysis in the Climate Expert – The climate change dimension of the CBA What is the difference between the two scenarios? Which one is more likely? What are the implications regarding climate change adaptation? 17/11/2018 Title

II. Cost-Benefit Analysis in the Climate Expert – Results How would you interpret these results? 17/11/2018 Title

Experience from practice – Examples of Climate Expert implementation 17/11/2018 Title

Discussion – Cost-Benefit Analysis Do you have experiences with Cost-Benefit Analysis? What are general challenges in implementing CBA? To what extent should you rely on the results of CBA for investment decisions? What is your view on the climate change dimension of the CBA – is it practical and does it have added value for your analysis? 17/11/2018 Title

Thank you for your attention! GIZ Germany Ms Janina Wohlgemuth +49 (0) 6196 - 79 – 1245 janina.wohlgemuth@giz.de www.giz.de adelphi Germany Mr Frederik Eisinger +49 (0) 30 - 89 000 68 – 69 eisinger@adelphi.de www.adelphi.de 17/11/2018 Title