International Programme

Sustainable Refurbishment in

Housing

Vilnius, 1st-16th April 2013

“Economic Appraisal of Projects”

Jorge Lopes, Ph.D

Department of Construction and Planning

Polytechnic Institute of Bragança-Portugal

Why Study Building Economics

“We no longer build buildings like we used to

nor do we pay for them in the same way.

Buildings today are no longer only shelter…

when buildings were shelter they lasted longer

than their builder. The average gothic master

mason lived 35 or 40 years. Cathedrals took 3

or 4 hundred years to build…

Today, the client brings builder, contractor,

architect, and facilities manager to account in

their life time…

When OPEC increased oil prices fourfold in

1973 and doubled them again in 1979, building

cost became a serious issue. The cost of energy

did more to improve the basic design and cost

procedures than eclecticism, modern

architecture, post-modern architecture and de-

constructivism combined”

(Rosaline Ruegg and Harold Marshal, 1990)

What is a Project for the purpose of

economic appraisal?

The World Bank Definition:

“a set of interrelated expenditures, actions

and policies designed to achieve a

country’s specific objective for economic

development within a specific time period”

Project Appraisal -Project Evaluation

is the process whereby a public agency or

private enterprise determines whether a

projects meets the country’s economic

and social objectives and whether it

meets these objectives efficiently.

The basic purpose of economic/financial

appraisal is to measure its economic costs

and benefits from the point of view of the

country/private enterprise to determine

whether the net benefits (benefits minus

costs) are at least as great as those

obtainable from other investment

opportunities.

The Time Value of Money

A major difficulty in making the

comparison between benefits and costs is

that merely adding up the costs, adding

up the benefits, and comparing the two

sums would neglect the time element.

An expenditure incurred this year has a higher

economic cost than the same expenditure

incurred five years from now.

It becomes then necessary to bring the

project’s streams of future costs and

benefits to a common denominator.

This is done by discounting the two

streams by an appropriate rate- the

Discount Rate.

The discount rate is also called minimum

acceptable rate of return (MARR)

The process of discounting is simply the

reverse of the known process of

compounding interest.

For example, if the rate of discount is 12

percent, the present value of a cost of

$100 which will be incurred next year or a

benefit of $100 which will not be received

until next year is

(

)

The general formula is

(

)

Where:

P- present value

F- future value

d– discount rate

n- number of periods until F occur

Aspects of Project Evaluation

Appraisal involves the investigation of six

different aspects of a Project (Adler, 1987):

Economic Evaluation has to do with

the identification and measurement of

the economic costs of the project and

the size and distribution of the

benefits.

Technical Evaluation is concerned, for

example, relaciona-se, por exemplo,

with engineering, environmental

matters, and with estimates of capital

and operation costs related to the

construction process and the operation

of the project after it is completed.

Institutional Evaluation deals with the

multitude of management, organizational

and staffing problems involved in the

construction and operation of the project.

Financial Evaluation is used to determine

what funds will be available and whether

the enterprise is likely to be financially

viable -that is, whether it can meet its

financial obligations and produce a

reasonable return on the capital invested.

Financial analysis focuses on the costs

and revenues of the enterprise

responsible for the project and is

usually summarized in the enterprise’s

financial reports.

Commercial Evaluation deals with the procurement of goods and services to implement and operate the project and with the marketing arrangements for the sale of its output.

Social Evaluation addresses the social

objectives of the project, such as the

distribution of income, health and

human variables affecting the project.

Decisions which Affect the Economics of Buildings

Deciding to accept ou reject a project;

Deciding where to locate a buiding;

Choosing between leasing and buying;

Selecting among alternative building and

system designs and sizes (envelope,

mechanical systems, furnishings layout);

Choosing among alternative building

investments;

Establishing operation, maintenance

and repair policies

Choosing a replacement schedule;

Choosing interdependent buiding

projects (design envelope and HVAC

systems, windows and lighting systems, fire

sprinkel systems and fire-resistent buiding

materials);

Steps in the Economic Analysis Process

1- Define the problem and your

objective;

2- Identify feasible alternatives for

accomplishing your objecive, taking

into account any coinstraints;

3- Determine whether an economic

anlysis is necessary, and if so, the level

of the effort which is required;

4- Select a method or methods of

economic evaluation;

5- Select the technique that accounts

for uncertainty and/or risks;

6- Compile data and make assumptions

called for by the economic method and

risk analysis technique;

7- Compute a measure of economic

performance;

8- Compare the economic

consequences of alternatives and make

a decision, taking into account any

nonquantified effectsand the risk

atttitue of the investor.

Methods of Economic Evaluation

Life Cycle Cost (LCC)

DESCRIPTION- Sums of all significant cost relevant to a

given course of action over a study period.

- present value (PV) formula

∑

( )

Where: PV LCC A1 = LCC in present value Euros of a building or system which is

estimated to result if the decision is made to choose a given alternative

A1;

Ct- sum of all relevant costs, including initial and future costs, arising from

a selection of an alternative A1, less any allowable positive cash flows;

d- discount rate used to adjust cash flows;

n- number of years comprising the study period.

- annual value (AV)formula

∑

( )

( )

( )

Net Benefits (NB)

DESCRIPTION- find the difference between time-adjusted benefits and costs of a course of action relative to a mutually exclusive course of action

- present value (PV) formula

∑

( )

Where:

PV NB A1: A2- benefits net of costs in present value Euros

attributed to a given alternative, A1, compared with

those of a mutually exclusive alternative, A2, (which may

be the alternative of doing nothing);

Bt- relevant benefits associated with a given alternative,

A1, less relevant benefits for a mutually exclusive

alternative, A2, in the period t; and

Ct- relevant costs associated with a given alternative, A1,

less relevant costs for a mutually exclusive alternative,

A2, in the period t;

- annual value (AV) formula

∑

( )

( )

( )

Benefit- to- Cost Ratio (BCR)

DESCRIPTION- find the ratio of benefits (less future costs) to investment costs, where all amounts are time-equivalent values.

∑ ( ) ⁄

( ) ⁄

Where:

BCR A1: A2- benefit-to-cost ratio computed from present

value benefits and cost for a given alternative, A1, as

compared with that of a mutually exclusive alternative,

A2, (which may be the alternative of doing nothing);

Bt- relevant benefits associated with a given alternative,

A1, less relevant benefits for a mutually exclusive

alternative, A2, in the period t; and

- relevant costs associated with a given alternative, A1,

less relevant costs for a mutually exclusive alternative,

A2, in the period t, where both exclude all or part of

investment costs, shifted to the denominator of the

BCR ratio;

- that part of investment cost in time t (shifted from

) on which the return is to be maximized.

Internal Rate of Return (IRR) DESCRIPTION- the percentage yield on the portion of

investment funds which remain committed to the project

in various periods.

find the value of d which makes NB = 0

∑

( )

Computation of IRR

- Trial-and- error procedure

- Graphical Display

Pay-Back (PB

DESCRIPTION- DPB measures how long it takes to recover

investment costs with time-adjusted benefits or savings.

SPB- measures how long it takes to recover investment

costs with benefits or savings that are not adjusted

-find the value of Y which makes net benefits equal to the initial Investment- Io

Simple pay- back (SPB)

∑( )

discounted pay- back (DPB)

∑

( )

Where:

Y- the minimum length of time (usually number of years) over which future net cash flows must be accumulated in order to offset investment costs; Bt- relevant benefits associated with a given alternative,

A1, less relevant benefits for a mutually exclusive

alternative, A2, in the period t;

- relevant costs associated with a given alternative,

A1, relevant less relevant costs for a mutually exclusive

alternative, A2, in the period t, and

Io – initial investment costs of a given alternative, A1,

relevant less those of a mutually exclusive alternative, A2,

where the initial outlay comprises total investment costs.

Exercise:

Whether to Retrofit a Computer Facility for Waste-Heat

Recovery, utilizing the LCC Method

Suppose that you are the plant engineer for an office

building owned by the country government. A consultant

proposes waste-hear recovery project to save energy. The

proposal is to install a heat exchanger to recover heat

from waste condenser water from a computer room

chiller and then to use that recovered heat to preheat

domestic water for the building.

Purchased steam is used to heat the domestic water. The

supplier of the steam uses coal to generate the steam.

Data:

-Thousand pounds of steam (Mlb) - 45

-Total installed cost of the heat exchanger- 32,500

- Maintenance cost per year- 1,400

- Repair cost (retubing of the heat exchanger in year 15)-

-Estimated annual amount of equivalent energy to heat the

water from to - 360.3 Mlb

-Discounted rate-d- 10%

- Study period- 25 years

It is expected that with the heat exchanger, the energy

requirements will be two-thirds of the annual amount calculated:

360.3 Mlb x 2/3 = 240.2 Mlb

Calculate the LCC and decide whether to accept or reject

the building system

Single present value (SPV) – the present value of a single

amount

(

)

Uniform present value (UPV)- the present value of a uniform

series of future amounts

[( )

( ) ]

Where:

A – annual amount

Table1: Energy Costs without and with Heat Exchanger

Alternative

(1)

Annual

quantity

steam (Mlb)

(2)

Price per

Mlb Steam

( )

(3)

Cost per

year ( )

(4)= (2)x (3)

UPV

(5)

Present

value

energy

costs ( )

(6)= (4) x (5)

No heat

exchanger

360.3

45.00

16,216

9.07

147,056

Add the

heat

exchanger

240.2

45.00

10,809

9.07

98,038

Table 2: Present Value of Investment, Maintenance, and Repair Costs for

the Heat Exchanger

Type of cost Frequency

of

occurrence

Factor

name

Factor

value

Amount ( ) Present

value ( )

Purchase

and

installation

Once

SPV

1.00

32,500

32,500

Maintenance Yearly UPV 9.08 1,400 12,712

Repair Year 15 SPV 0.24 3,000 720

Table 3: LCC for the Heat Exchanger Present

Value

Costs ( )

Alternative

(1)

Energy

(2)

Maintenance

(3)

Repair

(4)

Purchase and Installation

(5)

LCC

(6) = (2)+(3)+(4)+(5)

NO Heat

Exchanger

147,056

0

0

0

147,056

Add the

Heat

Exchanger

98,038

12,712

720

32,500

143,970

Net Savings for the Heat Exchanger

147,056 - 145,970= 3,086