Page 60 - DLIS104_MANAGEMENT OF LIBRARIES AND INFORMATION CENTRES

Unit 8: Library Finance

Valuation Notes

The costs of an intervention are usually financial. The overall benefits of a government intervention
are often evaluated in terms of the public’s willingness to pay for them, minus their willingness to
pay to avoid any adverse effects. The guiding principle of evaluating benefits is to list all parties
affected by an intervention and place a value, usually monetary, on the effect it has on their
welfare as it would be valued by them. Putting actual values on these is often difficult; surveys or
inferences from market behavior are often used.
One source of controversy is placing a monetary value of human life, e.g. when assessing road safety
measures or life-saving medicines. However, this can sometimes be avoided by using the related
technique of cost-utility analysis, in which benefits are expressed in non-monetary units such as
quality-adjusted life years. For example, road safety can be measured in terms of ‘cost per life saved’,
without placing a financial value on the life itself. Another controversy is the value of the environment,
which in the 21st century is sometimes assessed by valuing it as a provider of services to humans,
such as water and pollination. Monetary values may also be assigned to other intangible effects such
as loss of business reputation, market penetration, or long-term enterprise strategy alignments.

Time
CBA usually tries to put all relevant costs and benefits on a common temporal footing using time
value of money formulas. This is often done by converting the future expected streams of costs and
benefits into a present value amount using a suitable discount rate. Empirical studies suggest that
in reality, people do discount the future like this. There is often no consensus on the appropriate
discount rate to use - e.g. whether it should be small or larger. The rate chosen usually makes a
large difference in the assessment of interventions with long-term effects, such as those affecting
climate change, and thus is a source of controversy. One of the issues arising is the equity premium
puzzle, that actual long-term financial returns on equities may be rather higher than they should
be; if so then arguably these rates of return should not be used to determine a discount rate, as
doing so would have the effect of largely ignoring the distant future.

Risk and uncertainty
Risk associated with the outcome of projects is also usually taken into account using probability
theory. This can be factored into the discount rate, but is usually considered separately. Particular
consideration is often given to risk aversion- that is, people usually consider a loss to have a larger
impact than an equal gain, so a simple expected return may not take into account the detrimental
effect of uncertainty. Uncertainty in the CBA parameters is often evaluated using a sensitivity
analysis, which shows how the results are affected by changes in the parameters.

Application and history

The practice of cost benefit analysis differs between countries and between sectors within countries.
Some of the main differences include the types of impacts that are included as costs and benefits
within appraisals, the extent to which impacts are expressed in monetary terms, and differences in
the discount rate between countries. Agencies across the world rely on a basic set of key cost-
benefit indicators, including the following:
NPV (net present value)
PVB (present value of benefits)
PVC (present value of costs)
BCR (benefit cost ratio = PVB / PVC)
Net benefit (= PVB - PVC)
NPV/k (where k is the level of funds available).

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