Shortfalls in profitability: Internal Rate of Return re-estimation based on ex-ante indicators and ex-post deviations

Cost-Benefit Analysis (CBA) is one of the main tools that public administrations have at their disposal to analyze the socio-economic convenience of infrastructure projects. However, the application of this methodology is often problematic due to the uncertainty surrounding the main variables and the optimistic bias of evaluators, which translates into ex-post deviations and the appearance of the so-called “white elephants” (i.e., projects with negative social profitability). Considering the internal rate of return (IRR) as a decision criterion to accept or reject a project, the contribution of this paper to the academic literature is the redefinition of the IRR in order to include an ex-ante indicator and ex-post deviations. The main advantages of this instrument are its simplicity, transparency, and comparability of results when detailed ex-ante data are not available, and applications span from policy to research. Firstly, it facilitates systematic ex-post reviews by administrations, providing a reasonably accurate estimate in a low-cost and transparent manner. Secondly, it enables the empirical testing of profitability in large samples of projects, which could extend our understanding of the overall validity of CBA and best practices for project appraisal.