Financial & Economic Evaluation of projects

Financial & Economic Evaluation

Presented to:

Prof. Dr. Wagih BadawiPrepared by:

Eng. Amani Mohamed Mustafa

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What is economic analysis?

Why economic analysis?

What is the difference?

Economic analysis procedure

Role of world prices.

Discount rate.

Economic price of labor.

Economic price of land.

Case study

Contents

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BASICS

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What is economic analysis?

It is an analysis which assesses the overall impact of a project on improving the economic welfare of the citizens of the country concerned.

It assesses a project in the context of the national economy, rather than for the project participants or the project entity that implements the project.

It includes an assessment of sustainability of project economical/ financial and environmental effects.

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Why economic analysis

The purpose of the economic analysis of projects is to bring about a better allocation of resources, leading to enhanced incomes for investment or consumption.

Because all resource inputs and outputs have an opportunity cost through which the extent and value of project items are estimated.

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What is the difference?

Financial analysis

Estimates the profit accruing to the project-operating entity or to the project participants.

Includes only project participants.

Uses financial prices.

Economic analysis

Measures the effect of the project on the national economy.

Includes all members of society.

Uses economic prices.

Financial analysis and economic analysis are therefore two sides of the same coin and complementary.

In most cases, it is the level of domestic taxes and subsidies, and trade taxes and controls, that cause financial and economic prices to differ.

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ECONOMIC ANALYSIS PROCEDURE

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Economic analysis procedure

1. Defining project objectives and economic rationale;

2. Forecasting effective demand for project outputs;

3. Choosing the least-cost design for meeting demand or the most cost-effective way of attaining the project objectives;

4. Determining whether economic benefits exceed economic costs;

5. Assessing whether the project net benefits will be sustainable throughout the life of the project;

6. Testing for risks associated with the project;

7. Identifying the distributional effects of the project, particularly on the poor.

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1. Defining

Project proposals should be derived from, and placed in the context of, broader development objectives which may be stated in a government plan document.

This is provided through project framework. Where the project framework provides for the identification, quantification, and valuation of project objectives or targets for inputs, outputs, project effects, and sector impacts.

Projects selected for investment must meet a minimum standard for resource generation and to weed out those projects that do not.

project objectives

&

economic rationale

A statement should be provided of the contribution of the proposed project to meeting sector demands or needs, and any cost reduction or technology innovation it may contribute;

A statement should be provided of the extent of direct government involvement as a supplier and the extent of government subsidy to the sector.

Many investments will work well only if there are complementary investments in related sectors or activities.

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2. Forecasting effective demand for project outputs

Forecasts should be provided of future demands or needs for the type of output to be produced; existing sources of supply, the costs of supply, and intended investments should be outlined.

Demand gap can be met through already existing projects due to their activities expansion without a new project.

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3. Choosing the least-cost design for meeting demand

Least-cost analysis aims at identifying the least-cost project option for supplying output to meet forecast demand.

If differences in output or service quality exist, normalization procedure that takes the foregone incremental benefits of one option relative to another as a cost to the deficient option must be followed to ensure equivalence.

There will be circumstances where project alternatives have more than one outcome.

The alternative with the lowest present value of costs, is the least-cost alternative.

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4. Benefit - cost analysis

There are four basic steps to analyzing the economic viability of a project:

1.Identify the economic costs and benefits;

2.Quantify the costs and benefits, as much as possible;

3.Value the costs and benefits; and

4.Compare the benefits with the costs.

Benefits Costs

1. Identification: The situation without the project should be compared with the

situation with the project. Type of input and output.

2. Quantifying: Time , cost saving, improved health, productivity and welfare and

reduction in prices.

1. Identification: System cost.

Sunk cost.

Contingencies.

Working capital.

Transfer payments.

Depreciation.

Depletion premium.

External costs

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Role of world prices

The extra outputs and demand for inputs created by project will have a direct or indirect effect on international trade.

World prices can be used to measure the value of project inputs and outputs from the national perspective.

World prices are not stable. They fluctuate from year to year so there is also preference for using the domestic price level to conduct economic analysis.

Generally, domestic prices are higher than world prices.

Differences between domestic market prices and border prices of traded goods occur because of net tax and trade controls and the project location.

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Discount rate

The common is to use a rate of 10 or 12 percent to calculate the net present value of project for economic analysis.

However, economic rates of return differ considerably between sectors and countries.

From time to time, an appropriate discount rate for economic analysis should be calculated for each country to compare with the existing practice.

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Economic price of labor

Two types of labor:

Scarce.

Surplus.

For foreign labor, the economic cost to the economy will include the cost of its local consumption at economic prices, plus any remittances from the country of employment, plus the cost of any additional benefits or facilities such as health or education provision that has to be made.

New projects affect other sectors through labor displacement from other sectors.

Hiring young female labor affects household industries leading to import increase.

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Economic price of land

The value of land is best determined through its opportunity cost what it would have been used to produce without the project.

Its price differs from project to another.

The economic costs of resettlement should be included in the cost of land, if such costs are not included already in the project costs.

Cost of alternative must be considered when the natural resources in the land are exhausted.

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5. Project effects sustainability

Financial sustainability

The availability of adequate funds to finance project expenditures,

The recovery of some of the project costs from the project beneficiaries,

And the financial incentives.

Environmental sustainability

Those who enjoy the fruits of economic development today may be making future generations worse-off by excessively degrading the earth resources and polluting the earth environment.

Current generations should meet their needs without compromising the ability of future generations to do the same.

Environmental risks associated with different jobs affect labor markets, and wage levels.

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6. Uncertainty & sensitivity analysis

Sensitivity analysis is a simple technique to assess the effects of adverse changes on project.

It involves changing the value of one or more selected variables and calculating the resulting change in the NPV or IRR.

Sensitivity analysis should be applied to project items that are numerically large or for which there is considerable uncertainty.

Where the project is shown to be sensitive to the value of a variable that is uncertain, mitigating actions should be considered.

Specific project

The whole sector

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7. Project effects distribution

Six groups can be considered:

1.The owners of project.

2.Those working in the project.

3.The government.

4.The consumers of project outputs.

5.Those providing material inputs to the project.

6.Lenders to the project.

A particular focus on net benefits going to the poor is pertinent to many agricultural, social sector, urban development and public utility projects.

For some types of project, a distribution analysis can be undertaken on a gender basis, to identify the additional costs and benefits to women in particular.

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A HEALTH PROJECT IN CAMBODIACASE STUDY:

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Objective, rationale & alternatives

Health and physical well being are essential to the formation and maintenance of human capital and are key components for economic growth and sustained poverty reduction.

Since resources are scarce, developing countries like Cambodia have to ensure that the right investment decisions are made from an economic point of view.

An analysis of public expenditures is critical for determining the sustainability of the project in terms of its role in the health sector, in the overall budget process, and in terms of current and future priorities.

Cambodia’s health indicators are among the worst in the Asian and Pacific region.

Infant mortality is estimated to be 95 per 1,000 per live births.

The alternatives are: full governmental contribution, partial contribution or using contractors.

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Economic analysis

Least cost analysis

It was found that the contracting approach was the most cost effective and that significant improvement in health care services in the contracting areas over the government provided ones was achievable. Thus, this was the basis for using the contracting approach in providing primary health care in the districts covered by the Project.

Benefit – cost analysis

Improving the health status of the population will lead to fewer days lost due to illness and fewer days needed to take care of ill relatives than without the health interventions introduced by the Project.

The Project will require additional resources to cover operating and maintenance costs (purchase of new drugs and supplies, training & salaries).

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Sustainability

Cambodia is still in the process of reconstructing its economy and its health care system and, as a result, the amount of resources available for all sectors (including health) is quite limited.

It is estimated that a basic package of publicly provided services costs between $12 to $24.

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Results

It was found that the Project covered more than 5 million people (about 40 percent of the total population of Cambodia). The poor made up 36 percent of the project area population and the near poor made up about another 40 percent.

It was estimated that about 92 percent of the beneficiaries (4.2 million people) will come from the rural areas.

the project is expected to improve access to quality health service for 2.5 million women, or about half of the women in the project area.

In the third year, 20 percent of the target population benefits from the project, increasing to 40 percent in the fourth year, 60 percent in the fifth year, and 80 percent in all subsequent years.

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Thank You