NATIONAL STRONGER REGIONS FUND Devonport LIVING CITY Cost Benefit Analysis

This document provides a Cost Benefit Analysis (CBA) of the Devonport LIVING CITY project to inform the Devonport

LIVING CITY Stage One National Stronger Regions Fund (NSRF) grant application as recommended by the funding

application guidelines for Assessment Criterion One.

LIVING CITY will transform the Devonport CBD , by opening the heart of the City to the Waterfront. The vision is for

redevelopment of the CBD, with consolidated retail space and multi-purpose development that will provide ongoing

economic benefits to the North West Tasmania region.

This document identifies the direct costs and benefits of the whole project using a discounted cash flow method.

Benefits assessed in the CBA models include industry value add, the terminal value of development, the increased

tourism expenditure outside of the LIVING CITY development, and the indirect impact on the economy measured by

input output multipliers. Direct benefits to the region, using a discount rate of 7% are estimated at:

• Net Present Value (NPV)of $267 million;

• IRR of 14.5%; and

• A Benefit Cost Ratio (BCR)of 1.65.

Once indirect benefits are included the total benefits, including multiplier effects, the benefits are estimated at:

• NPV of $1,360 million;

• IRR of 29%; and

• A BCR of 2.87.

On the basis of these figures, LIVING CITY is expected to deliver significant economic benefits to the North West region

and should be supported by grant funding.

SUMMARY

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TABLE OF CONTENTS

I. Summary………………………………………….…………...………..…....2.

II. CBA Definitions & Approach.…………………….…………….…..…4.

III. CBA Approach – The Scope and Methods.………………….…..5.

IV. CBA Approach – Scenarios & Assumptions..……………….……6.

V. CBA Model – Quantified Costs .………………………..…….….…...7.

VI. CBA Model - Quantified Benefits.………………………...…….……8.

VII. CBA The Model………………………………………………….……....….12.

VIII. CBA Key Findings & Conclusions……………………..…….…..….13.

IX. Appendix A: Limitations...……………………………………….……14.

X. Appendix B: IVA Data Sources…………………………………..…..15.

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A Cost Benefit Analysis (CBA) is a decision making tool based on the evaluation of the

economic performance of different projects and / or stages. For each option it

involves quantifying the incremental (marginal) costs and benefits to all sectors of the

economy through the life of a project and discounting them to a net present value.

CBA is often used as a method for organising information to aid decisions about the

allocation of resources. It is recognised that CBA is useful where developments can

impose costs and benefits on third parties having wider economic and social effects.

As a result, a CBA takes a broader perspective than a site specific financial feasibility

study as it assesses the costs and benefits made to the community as a whole, rather

than on an individual, developer or financial sponsor.

A CBA also differs from an Economic Impact Assessment in that it quantifies both the

external economic, social and environmental costs and benefits (or welfare impacts)

of a project. The CBA converts the benefits and costs that would occur in the future

into present values using the ‘discounting’ technique. This enables a comparison of

the value of costs and benefits at any one point in time.

The CBA uses Net Present Value (NPV) as a measure of economic performance. NPV

relates to the difference between the present value (PV) of total incremental benefits

and the present value of the total incremental costs. Where there is a positive NPV,

it means that the incremental benefits of the scenario in question exceeds the

incremental costs over the evaluation period (or project life).

CBA - DEFINITIONS AND APPROACH

“Where there is a positive

NPV, it means that the

incremental benefits of the

scenario in question

exceeds the incremental

costs over the evaluation

period (or project life)”

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CBA APPROACH: THE SCOPE & METHODS

The CBA assess all of the costs and benefits of LIVING CITY from the point of view of

the “whole of community” or “whole of economy”. In this case we have defined the

‘standing’ or ‘scope’ of the CBA to be the North West region of Tasmania.

LIVING CITY aims to open the heart of the City to the waterfront and create a resilient

and robust economy. Key components of the vision identified in the August 2014

Masterplan include the development of functional conference space within the CBD ,

development of opportunities to showcase the fresh food and beverage produce of

the North West region, and the development of a range of facilities, including a hotel

and associated tourist development on the Waterfront to cater for the expected

growth in visitor numbers.

The CBA provides an estimate of the benefits of LIVING CITY relative to the costs.

Similar to financial appraisals, a CBA utilises the Discounted Cash Flow (DCF) method

for determining the NPV of the scenario. However an economic appraisal differs from

a financial appraisal in that it measures the costs and benefits to the whole of the

community – and not just the financial costs and revenues to the owner, financial

sponsor, developer or proponent.

In order to compare the likely costs and benefits of the Project, HillPDA prepared a

bespoke Microsoft- Excel based model. The model incorporates the quantified costs

and benefits of the Project for each year of the Project’s life. The resulting costs have

been subtracted from the total benefits to identify the net impacts. These impacts

have then been discounted to the base year (the year of construction) and

summarised as a NPV.

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For further reading:

Cost Benefit Analysis What is cost benefit analysis, and does it have a role in development appraisal? Adrian Hack, Principal HillPDA Read Article in Australian Property Institute News

The CBA model was prepared generally in accordance with the Commonwealth Handbook of Cost Benefit Analysis1.

For the purposes of this assessment two Scenarios have been tested:

Scenario 1: The ‘Do Nothing’ Scenario i.e. no redevelopment occurs; and

Scenario 2: Redevelopment for the mix of land uses as proposed for LIVING CITY.

Scenario 1 ‘Do Nothing’ has a NPV of 0 as it is the status quo. A positive NPV for Scenario 2 therefore implies a net economic

gain over Scenario 1 i.e. the Base Case. A negative NPV would imply economic loss compared to the Base Case.

The scenario with the highest NPV provides the highest net benefit to the National economy (measured in dollar terms). The

HillPDA CBA model also allows for any required sensitivity testing by varying discount rates and other variables.

General Modelling Parameters & Assumptions

The CBA models are based on the following parameters:

The model is in annual rests;

Project life was assumed at 20 years, however a terminal value was included to reflect continuing future net benefits

after the project life;

GST, stamp duties and the majority of other taxes were excluded because they are transfer payments with zero net

benefit to the economy; and

A discount rate of 7% has been adopted. The Office of Best Practice Regulation 2013 cost benefit analysis guidelines2

specify an annual real discount rate of 7% with sensitivity testing at 4% and 10% to be used for CBA modeling.

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CBA APPROACH: SCENARIOS & ASSUMPTIONS

1 Common Wealth of Australia, Handbook of Cost Benefit Analysis, January 2006

For the purpose of the CBA modeling process, we have identified a range of costs and benefits. The identified costs are

described here.

Capital Costs

The capital costs included in the CBA modeling include the fixed expenses incurred in the development Capital costs

include:

Demolition;

Construction;

Design and application fees; and

Project management costs.

Demolition and construction has been assumed to occur in four stages over six years from 2015 to 2020. Pre-construction

design and application fees are assumed at 7.5% of construction and incurred the year before construction for each stage of

works. Construction for each stage spans 2 years. A further 5% professional fees is incurred during construction to meet

project management and supervision costs.

CBA APPROACH: QUANTIFIED COSTS

Opportunity Cost

Opportunity cost refers to the opportunity forgone from redevelopment. It is the benefit of the ‘do nothing’ option. Often in

CBA this is measured as an upfront cost of the land. However in this model we have shown the industry value add from the

existing uses on site from the year of demolition for each respective stage to the project end.

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In addition to the costs incurred during the implementation of LIVING CITY, the CBA also assumes there will be benefits

derived from implementation of the project. For the purpose of our analysis we have identified the four categories of

benefits used as inputs to the CBA model as being:

Industry value add;

Tourism benefits;

Terminal value of development; and

Input Output (I-O) multiplier impacts.

These benefits are described here.

Industry Value Add

Industry value add (IVA) is defined by IBIS World as the “market value of goods and services produced by an industry minus

the cost of goods and services used in the production process, which leaves the gross product of the industry”.

Industry value add is the industry's contribution to gross domestic product (GDP). It is calculated as “the value of output

minus the value of intermediate inputs. That value added is the difference between the costs of production (excluding the

Compensation of Employees, Gross Operating Surplus, Taxes and Imports) and the value of sales turnover. In a national

accounts context, Gross Domestic Product (GDP) consists of the sum of value-added by all industries. Value-added also

pertains to differences between the value of production at various stages of the supply chain.”

In simple terms IVA is the contribution the industry or company makes to gross domestic product. The data sources for IVA

are identified in Appendix B of this document.

CBA MODEL: QUANTIFIED BENEFITS

Tourism Benefits

As estimated in the HillPDA Regional Benefit Analysis (2014), overnight tourists staying in the hotel development proposed as

part of LIVING CITY are expected to spend around $4.3m every year in the region over and above transportation and

accommodation costs. Whilst much of this is likely to be captured on site, some of this expenditure will also be captured by

other businesses in the locality off site. This proportion is difficult to quantify but for the purpose of the assessment we have

assumed 60%. The value add from this amounts to around $1.2m from the time the hotel achieves 65% occupancy.

Terminal Value

Because the buildings are assumed to have a life beyond 20 years a terminal value was applied to reflect the value of the

assets to the economy. The terminal value was calculated from capitalising the previous year’s net benefit at 14% to reflect

the ongoing value of the assets over the following ten year period.

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CBA MODEL: QUANTIFIED BENEFITS

Input Output Multiplier Impacts

The costs and benefits identified all refer to direct impacts on the economy. Input output (I-O) multiplier impacts refer to

indirect impacts – both production induced and consumption induced. Production induced is comprised of:

First round effects: which are all outputs and employment required to produce the inputs for construction; and

An industrial support effect: which is the induced extra output and employment from all industries to support the

production of the first round effect.

Consumption induced impacts relate to demand for additional goods and services due to increased spending by the wage

and salary earners across all industries arising from employment.

While their ease of use makes I–O multipliers a popular tool for economic impact analysis, they are based on limiting

assumptions that results in multipliers significantly over estimating or underestimating the costs or benefits of a project. The

ABS identifies the following inherent shortcomings and limitations of multipliers for economic appraisals3:

Lack of supply–side constraints: A significant limitation of economic impact analysis using multipliers is the implicit

assumption that the economy has no supply side constraints. That is, it is assumed that extra output can be produced in

one area without taking resources away from other activities, thus overstating economic impacts. The actual impact is

likely to be dependent on the extent to which the economy is operating at or near capacity.

Fixed prices: Constraints on the availability of inputs, such as skilled labour, require prices to act as a rationing device. In

assessments using multipliers, where factors of production are assumed to be limitless, this rationing response is

assumed not to occur. Prices are assumed to be unaffected by policy and any crowding out effects are not captured.

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3 5209.0.55.001 - Australian National Accounts: Input-Output Tables, 2008-09

CBA MODEL: QUANTIFIED BENEFITS

Input Output Multiplier Impacts (continued)

Fixed ratios for intermediate inputs and production: Economic impact analysis using multipliers implicitly assumes that

there is a fixed input structure in each industry and fixed ratios for production. As such, impact analysis using multipliers

can be seen to describe average effects, not marginal effects. For example, increased demand for a product is assumed

to imply an equal increase in production for that product. In reality, however, it may be more efficient to increase

imports or divert some exports to local consumption rather than increasing local production by the full amount;

No allowance for purchasers’ marginal responses to change: Economic impact analysis using multipliers assumes that

households consume goods and services in exact proportions to their initial budget shares. For example, the household

budget share of some goods might increase as household income increases. This equally applies to industrial

consumption of intermediate inputs and factors of production.

Absence of budget constraints: Assessments of economic impacts using multipliers that consider consumption induced

effects (type two multipliers) implicitly assume that household and government consumption is not subject to budget

constraints.

Not applicable for small regions: Multipliers that have been calculated from the national I–O table are not appropriate

for use in economic impact analysis of projects in small regions. For small regions multipliers tend to be smaller than

national multipliers since their inter–industry linkages are normally relatively shallow. Inter–industry linkages tend to be

shallow in small regions since they usually don’t have the capacity to produce the wide range of goods used for inputs

and consumption, instead importing a large proportion of these goods from other regions.

In summary, the true benefit of indirect impacts depends on the level to which resources would be employed elsewhere in

the economy if the project did not proceed. For the purpose of the CBA we have excluded the indirect impacts but have

documented the range of performance indicators with and without their inclusion.

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CBA MODEL: QUANTIFIED BENEFITS

Economic Performance

The table below provides the direct benefits and costs in an equivalent discounted cash flow method. The performance

indicators – NPV, BCR and IRR – for the entire LIVING CITY project are also summarised.

The table below provides the direct benefits and costs in an equivalent discounted cash flow method. The performance

indicators – NPV, BCR and IRR are summarized below it.

CBA: THE MODEL

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Table 1 – Devonport LIVING CITY Cost Benefit Analysis COST BENEFIT MODEL (2014 $,000s)

YEAR NPV 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 2034

COSTS

Capital Cost 264,716 7,222 53,466 88,928 78,558 65,222 22,396 0 0 0 0 0 0 0 0 0 0 0 0 0 0

Opportunity Cost 145,185 10,444 10,549 12,409 12,533 12,658 12,785 12,913 13,042 13,172 13,304 13,437 13,571 13,707 13,844 13,983 14,122 14,264 14,406 14,550 14,696

Multiplier Impacts 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0

TOTAL COSTS 409,900 17,666 64,015 101,337 91,091 77,880 35,180 12,913 13,042 13,172 13,304 13,437 13,571 13,707 13,844 13,983 14,122 14,264 14,406 14,550 14,696

BENEFITS

Industry Value Add 535,954 0 0 0 19,641 35,039 41,314 70,414 71,119 71,830 72,548 73,273 74,006 74,746 75,494 76,249 77,011 77,781 78,559 79,345 80,138

Add Tourism Benefits 10,072 0 0 0 1,006 1,058 1,110 1,162 1,174 1,185 1,197 1,209 1,221 1,233 1,246 1,258 1,271 1,283 1,296 1,309 1,322

Multiplier Impacts 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0

Terminal Value 130,558 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 472,168

TOTAL BENEFITS 676,584 0 0 0 20,647 36,097 42,424 71,576 72,292 73,015 73,745 74,483 75,227 75,980 76,739 77,507 78,282 79,065 79,855 80,654 553,629

NET BENEFIT 266,684 -17,666 -64,015 -101,337 -70,444 -41,784 7,244 58,664 59,250 59,843 60,441 61,046 61,656 62,273 62,895 63,524 64,159 64,801 65,449 66,104 538,933

Discount Rate NPV (2014 $,000s) BCR

4.0% 499,178 2.07

7.0% 266,684 1.65

10.0% 122,845 1.34

14.5% 0 1.00

In Table 1, the key figures are identified for LIVING CITY:

The NPV at a 7% discount rate is $267m:

The IRR is 14.5% which is considered a strong return on investment: and

The benefit cost ratio is 1.65.

There is considerable further improvement to the performance indicators when indirect benefits are included in the above

DCF model. Table 3 provides a summary of the NPVs when indirect impacts are added to the benefits and to the cost sides of

the model. If all indirect impacts are added, including consumption induced impacts, then the benefits can be summarised as:

An increase in NPV to nearly $1,360m;

An IRR of 29%; and

A BCR of 2.87.

On the basis of the benefits accruing from the entire LIVING CITY project identified in this analysis and the supporting

infrastructure and development that will be provided through Stage One of LIVING CITY, LIVING CITY has a positive economic

contribution to the North West region economy and the first stage of the project should be supported with funding.

Direct Net Benefits (2014

$,000s)

Direct + First Round

Production Induced (2014

$,000s)

Direct + First & Second

Round Production

Induced (2014 $,000s)

Direct + Production &

Consumption Induced

(2014 $,000s)

NPV at 4% 499,178 852,116 1,178,233 2,114,000

NPV at 7% 266,684 505,454 726,244 1,359,046

NPV at 10% 122,845 288,569 441,978 880,783

IRR 14.5% 19.0% 22.3% 28.6%

CBA: KEY FINDINGS & CONCLUSION

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Table 3 – Devonport LIVING CITY Cost Benefit Analysis: Summary Indicators

Appendix A: LIMITATIONS

The Department of Finance and Administration 2006 Handbook of Cost Benefit Analysis3 identifies that the effective use of

CBA requires an appreciation of its limitations as well as its merits. Accordingly, some of the project specific and more

commonly identified limitations associated with CBA analysis in general are identified here. These limitations have been

recognised in the assessment process and the associated risks minimised where possible.

Potential limitations associated with CBA include:

The need for reliable evidence to quantify costs. This can be a challenge in practice where technical studies have not

been undertaken or costs are difficult to value (such as environmental impacts);

A CBA can compare scenarios with one or more scenarios identifying what may / may not have happened in the

absence of the project. This can create a higher level of uncertainty or margin for error;

Not all costs and benefits can be quantified in dollar terms and therefore some costs or benefits may be overlooked or

underestimated. It is therefore important to give due consideration to costs and benefits that are qualitative;

A CBA may have an inherent bias against members of the community with a lower ability to pay; and

A CBA may have a degree of obscurity when the focus is on the project’s ‘bottom line’.

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3 Common Wealth of Australia, Handbook of Cost Benefit Analysis, January 2006

Appendix B: IVA DATA SOURCES

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Industry Value Add

The sources of data for IVA are various IBIS World reports including the following:

H5731 Cafes and Restaurants in Australia Industry Report;

G5329 Automotive Maintenance and Servicing in Australia Industry Report;

N8432 Technical and Further Education in Australia Industry Report;

P9220 Art Galleries & Museums in Australia Industry Report;

P9239 Recreational Parks and Gardens in Australia Industry Report;

L7800 Business Services in Australia Industry Report;

L7841 Legal Services in Australia Industry Report;

AUM8113 Local Government;

G5000 Consumer Goods Retail in Australia Industry Report;

G5111 Supermarkets and Other Grocery Stores in Australia Industry Report;

O8600 Health Services in Australia Industry Report; and

Various other reports.