Lecture 2_Basic PED

Project Evaluation and Development: 

Project Evaluation and Development Basic PED Procedures

Basic Principles of Public Investment That Underlie PED: 

Basic Principles of Public Investment That Underlie PED Society will continue functioning even without the public investment. The purpose of public investment is to effect change and catalyze development . Resources available today are more valuable than the promise of benefits to be enjoyed at some time in the future . There is always more than one way to produce an output and even an outcome . Public investments will produce gainers and losers. The benefits to gainers should be so much as to be able to compensate the losers so that the net effect is that nobody was made worse off. 26-28 April 2011 NEDA-ADB PED Refresher Workshop 2

Basic PED Concepts: 

Basic PED Concepts Evaluation : process of examining how well a project meets the objectives for which it has been designed. Timing of evaluation Ex-ante - conducted before a project is implemented. This starts from project identification in the PDPFP, to ranking and matching in the PDPFP to project preparation and appraisal in PED. Ex-post – conducted after a project is implemented. This is part of project implementation and post investment activities. 26-28 April 2011 NEDA-ADB PED Refresher Workshop 3

Basic PED Concepts: 

Basic PED Concepts Focus of Evaluation Basic PED , especially for small projects, embodied in the Project Brief of the PDIP plus the additional information in the Situational Profile – “With” and “Without” Project (See Table 2 Vol. 5 of PLPEM Guidelines) of is essentially focused on impact evaluation - outcome and impact of the project on the intended beneficiaries and on the province as a whole. Comprehensive PED to be done on big and /or externally funded projects goes into a more detailed analyses of project effectiveness and efficiency including a comparison of alternative delivery systems. 26-28 April 2011 NEDA-ADB PED Refresher Workshop 4

Basic PED Concepts: 

Basic PED Concepts Key Definitions Economic Life - refers to the time span over which the project is able to generate benefits (or earnings) and influence development or economic behavior. This is determined by the rate of depreciation subject to operations and maintenance schemes, and obsolescence when new (and better) technologies become available . Discount Rate – interest rate that measures the “ trade-off ” between the present and the future – the so-called time preference rate. Financial : financial rate of return foregone from the “best” alternative use of funds invested in the project. In practice this is measured by what is considered as the “risk-free” financial rate of return” measured by the Treasury bill rate (usually) the 182-day rate + a margin to cover the costs of lending (usually 2 to 3%) Economic : economic rate of return foregone from using a good or resource in its best alternative use or simply the cost of the foregone alternative for the resources invested in the project. In practice this is measured by the so-called “opportunity cost of capital” for public sector projects measured by either the weighted rate of return on public project or the cost of government borrowings. An often used discount rate for government projects is 15%. 26-28 April 2011 NEDA-ADB PED Refresher Workshop 5

Basic PED Concepts: 

Basic PED Concepts Key Definitions Time value of money is a critical consideration in financial and investment decisions . Money has a time value because of the opportunities for investing money at some interest rate. Future value A peso in hand today is worth more than a peso to be received tomorrow because of the interest it could earn from putting it in a savings account or placing it in an investment. Compounding interest means that interest earns interest 26-28 April 2011 NEDA-ADB PED Refresher Workshop 6

Basic PED Concepts: 

Basic PED Concepts Key Definitions Let F n = future value = the amount of money at the end of year n. P = principal i = annual interest rate N = number of years Then: F 1 = the amount of money at the end of year 1 = principal + interest = P+iP =P(1+i). F 2 = the amount of money at the end of year 2 = F 1 (1+i)=P(1+i)(1+i) = P(1+i) 2 26-28 April 2011 NEDA-ADB PED Refresher Workshop 7

Basic PED Concepts: 

Basic PED Concepts Key Definitions Thus: Future value of an investment compounded annually at rate I for n years is F n = P(1+i) n Example: PhP 1,000 placed in a deposit account earning 8% compounded annually will be 1,000(1+0.08) 4 = 1,000(1.3605) = PhP 1,360.50 at the end of 4 years. 26-28 April 2011 NEDA-ADB PED Refresher Workshop 8

Basic PED Concepts: 

Basic PED Concepts Key Definitions Intra-year compounding Interest is often compounded more frequently than once a year – sem -annually, quarterly, monthly, daily an even continuously. If interest is compounded m times a year, then the general formula for solving future value becomes F n = P (1+ i/m) nm The formula reflects more frequent compounding (nm) at a smaller interest rate (i/m) As m → ∞, the term (1+ i/m) nm → e in where e ≈ 2.71828 and F n becomes F n = P ( e in ) The future value increases as m increases Thus, continuous compounding results in the maximum future value at the end of n periods for a given interest rate i . 26-28 April 2011 NEDA-ADB PED Refresher Workshop 9

Basic PED Concepts: 

Basic PED Concepts Key Definitions Examples: Assume P = PhP 100, I = 12% and n= 3 years. Then for the following compounding periods Annual (m=1) F 3 = 100(1+0.12/1) 3 = 100(1.404) 3 = PhP 140.49 Semi-Annual (m=2) F 3 = 100(1+0.12/2) 3(2) = 100(1.4185) 6 = PhP 141.85 Quarterly (m=4) F 3 = 100(1+0.12/4) 3(4) = 100(1.4257) 12 = PhP 142.57 Monthly (m=12) F 3 = 100(1+0.12/12) 3(12) = 100(1.4307) 36 = PhP 143.07 Continuous ( e in ) F 3 = 100 (e 0.36 ) = 100 (2.71828) 0.36 = 100(1.43333) = PhP 143.33 26-28 April 2011 NEDA-ADB PED Refresher Workshop 10

Basic PED Concepts: 

Basic PED Concepts Key Definitions Present Value (PV) – Discounting PV is the present worth of future sums of money The process of calculating PVs or discounting is the opposite of finding the compounded future value with the interest i called the discount rate . P = PV of PhP 20,000 received 6 years from now at at i=10% P = 20,000 = 20,000 (0.5645) = PhP 11,290 This means that receiving PhP 20,000 6 years from now at 10% annual interest rate is equivalent to receiving PhP 11,290 now . 26-28 April 2011 NEDA-ADB PED Refresher Workshop 11

Basic PED Concepts: 

Basic PED Concepts Key Definitions PV of an Annuity Interest received form bonds, pension funds and insurance obligations involved annuities. The present value of an annuity P n for n years is equal to P n = A = A where A = annual payments, and i = interest rate. PV of a Perpetuity Annuities that go on forever are known as perpetuities (P). P = 26-28 April 2011 NEDA-ADB PED Refresher Workshop 12

Basic PED Concepts: 

Basic PED Concepts Key Definitions Annual Percentage Rate (APR) If an investor wants to compare investments with different compounding periods, he or she needs to put them on a common basis using the annual percentage rate (APR) or effective annual rate (EAR) computed as follows: APR = - 1.0 where r is the stated, nominal or quoted rate and m is the number of compounding periods per year. Example : if the nominal rate is 6%, compounded quarterly, the APR = - 1.0 = 0.0614 = 6.14%. This means that if one bank offers 6 % with quarterly compounding while another offered 6.14% with annual compounding, they would be paying the same effective rate of interest . 26-28 April 2011 NEDA-ADB PED Refresher Workshop 13

Basic PED Concepts: 

Basic PED Concepts Key Definitions Market vs. Economic Prices Market Price - price at which the good or service is being bought and sold at the end-users’ market (as opposed to farm-gate ). This is sometimes refer to this as financial price. Economic Price - reflects the value that society places on the good or service with due consideration for its scarcity and relative importance, in the absence of market distortions . So-called “shadow prices” reflect the “true scarcity” values of resources. NEDA currently estimates the following shadow prices: Shadow (or social) Discount Rate: 15% Shadow Exchange Rate: 1.20 × Official Exchange Rate Shadow Wage Rate for Unskilled Labor: 0.60 × current wage rate 26-28 April 2011 NEDA-ADB PED Refresher Workshop 14

Basic PED Concepts: 

Basic PED Concepts Key Definitions Market vs. Economic Prices Economic Prices Exportables and importables are priced at their so-called “border” prices – FOB for exportables and CIF for importables . Domestically produced inputs are priced at farm-gate or factory prices. Example: The cost of one kilo of fresh tomatoes, when sold in the farm in Bulacan is only PhP 20. When sold in the wet market in Cubao , it is PhP 50. Assuming that the tomatoes come from Bulacan , this means that only PhP 20 will be received by the tomato farmer and the difference goes to the trade and transport cost. The market price in this case in Cubao is PhP 50 but the economic price is only PhP 20 . 26-28 April 2011 NEDA-ADB PED Refresher Workshop 15

Basic PED Concepts: 

Basic PED Concepts Key Definitions Project Feasibility Indicators Net Present Value (NPV) NPV = - Internal Rate of Return (IRR) r at which NPV = 0 Benefit-Cost Ratio (BCR) BCR = Where Bt and Ct are the annual cash inflows and outflows at market prices for the financial analysis and the annual economic benefit and cost streams for the economic analysis. The discount rate r is the financial rate of return in financial analysis and the economic (social) rate of return in economic analysis. The IRR is known as the Financial Rate of Return ( FIRR ) in financial analysis and as the Economic Rate of Return ( EIRR ) in economic analysis. 26-28 April 2011 NEDA-ADB PED Refresher Workshop 16

Basic PED Concepts: 

Basic PED Concepts Key Definitions Decision Rules Accept all projects meeting the following financial (or economic) feasibility criteria. NPV ≥ zero IRR ≥ r BCR ≥ 1 If a project the benefits and costs of which are expressed in market prices meets these feasibility criteria then the project is said to be financially viable. If a project the benefits and costs of which are expressed in economic prices meets these feasibility criteria then the project is said to be economically viable. 26-28 April 2011 NEDA-ADB PED Refresher Workshop 17

Basic PED Concepts: 

Basic PED Concepts Key Definitions Issue of several viable projects producing the same development outcomes in the face of LGU fund scarcity Evaluate all “acceptable options” relative to one another on the basis of either: Allocative Efficiency : selecting the option that yields the highest amount of excess benefits or the maximum NPV per PhP of investment cost. Cost-Effectiveness : selecting the least cost option that achieves a pre-established objective, e.g., least cost per patient treated, least cost per child meeting nutrition level standards, etc. Before the cost comparison is made, all options that do not achieve the requisite benefit level are eliminated . 26-28 April 2011 NEDA-ADB PED Refresher Workshop 18

Basic PED Concepts: 

Basic PED Concepts Key Definitions Issue of in-kind benefits and services that need to have a value imputed . This problem can be approached in 2 ways : 1 st : Assess the amount individuals would be willing to pay for a particular service either by : a) identifying the preferences revealed by their behavior; or b) using surveys to determine the contingent valuation of services. 2 nd : Deduce the value of the benefit from other market-type information in order to derive a surrogate price. Examples: a) EDUCATION - Benefits are measured by the discounted rate of return from the stream of higher earnings enjoyed by individuals because of schooling, b) HEALTH - the cost of death or ill health to an individual is measured by forgone earnings or productivity . 26-28 April 2011 NEDA-ADB PED Refresher Workshop 19

Basic PED Procedures: 

Basic PED Procedures Know the Project Identify the OUTPUT (goods and/or services) of the project. Characterize the OUTPUT. Private, Public, or Mixed Good If I consume the good, does it mean that others cannot consume it? Is the project’s output divisible? Can consumption be measured? Can I limit consumption only to those who paid for the good ? Is it feasible to collect fees from the consumers ? If the answers to the above questions are all YES, then the good is strictly a private good. Note that if the answer to a ) is NO, then the answer to b ) is also a NO, then the good is a public good. But it does not necessarily follow that the answers to c ) and d ) are No. If the answers to c ) and d ) are YES, then the good is mixed . If the answer to e ) is NO, then the good qualifies as a public good . If the answers to all the questions are NO, then the good is strictly a public good 26-28 April 2011 NEDA-ADB PED Refresher Workshop 20

Basic PED Procedures: 

Basic PED Procedures Know the Project Tradeable , Non- tradeable , or of Limited Tradeability Is the good being traded in the international market? If it is, then the good is TRADEABLE If it is not, then the good is NON-TRADEABLE From the Philippine point of view, do we import a good of similar type? If we do, then the good is IMPORTABLE From the Philippine point of view, do we export a good of similar type? If we do, then the good is EXPORTABLE Are there restrictions governing the import and export of this good? If the answer to d ) is YES, then the good is NON-TRADEABLE , even if the answer to a ) is YES . 26-28 April 2011 NEDA-ADB PED Refresher Workshop 21

Basic PED Procedures: 

Basic PED Procedures Know the Project Cost Recovery Aspects If the good possesses the characteristics of a private good , then users can be charged a fee for cost recovery purposes If the good is public good , then it is either not possible or administratively infeasible to charge a user’s fee . Cost recovery will have to come from taxes . Existing tax collection levels. Tax revenue anticipating measures, e.g., higher RPT from future revaluation of property values, additional business taxes, etc. Special levies 26-28 April 2011 NEDA-ADB PED Refresher Workshop 22

Basic PED Procedures: 

Basic PED Procedures Understand the project insufficient detail to: Validate whether the project outcome is indeed consistent with PDPFP-PDIP goals and objectives; Decide whether the LGU undertake the project; and Formulate enhancements to ensure that the project outcomes will be achieved. 26-28 April 2011 NEDA-ADB PED Refresher Workshop 23

Basic PED Procedures: 

B asic PED Procedures 26-28 April 2011 NEDA-ADB PED Refresher Workshop 24

Basic PED Procedures: 

Basic PED Procedures Understand the project The starting point for understanding the nature of the project is the PDIP Investment S chedule and the PDIP Project Brief. From the investment schedule and the project brief, determine whether the project is: ( S) Stand-alone – meaning that it can produce output on its own . ( R) Required – meaning that it provides the enabling mechanism for other projects to produce output. The project can be analyzed as a stand-alone or as component of a package of projects. ( N) Needs-a-companion project – meaning that its ability to produce output depends on the success of another project. The project needs to be packaged with the other project that provides the enabling mechanism. 26-28 April 2011 NEDA-ADB PED Refresher Workshop 25

Basic PED Procedures: 

Basic PED Procedures Understand the Project Establish the “rationale” of the project by: Preparing the log-frame for the project specifying PDPFP-PDIP-defined g oal of the project; The purpose or expected outcome of the project that will contribute to meeting this goal ; The project’s outputs that will result in the expected outcome ; The project’s activities to mobilize inputs (financial, human, technical and material resources) that are needed to produce the output ; Important assumptions ; A list of verifiable indicators of success ; and The proposed strategy to measure accomplishment. 26-28 April 2011 NEDA-ADB PED Refresher Workshop 26

Basic PED Procedures: 

26-28 April 2011 NEDA-ADB PED Refresher Workshop 27 Basic PED Procedures Sample Log-Frame for a Communal Irrigation Project

Basic PED Procedures: 

Basic PED Procedures Understand the Project Determine the likely trend of the outcome if the project is not implemented. Based on the 1 st principle of public investment – society will continue functioning even without the project . The proponent needs to adequately describe the “without project” scenario and contrast this against the “with project” scenario based on the information in the Project Brief, Log-Frame, and Situational Profile 26-28 April 2011 NEDA-ADB PED Refresher Workshop 28

Basic PED Procedures: 

Basic PED Procedures Understand the Project To forecast the “without project” scenario: Start with the outcome, describe the current situation. Forecast what will be the outcome going into the future if the project will not be undertaken. Remember the following: The “without project” scenario should consider future developments. It is not always correct to assume that over time, the “without project” scenario will simply be the value of the outcome at the “initial year ”. The “initial year” should not coincide with extraordinary events, like an El Niño, or an earthquake, unless these are normal occurrences . 26-28 April 2011 NEDA-ADB PED Refresher Workshop 29

Basic PED Procedures: 

Basic PED Procedures Understand the Project The forecast of the “without project” scenario generally requires time series analysis to establish trends. Whenever time series data is not available, the “without project” scenario may be generated via recall and prognoses questions administered on key informants like long-time residents, long time farmers, barangay captains, etc. who have sufficient knowledge of the project area. 26-28 April 2011 NEDA-ADB PED Refresher Workshop 30

Basic PED Procedures: 

Basic PED Procedures Consider the following possible time series indicating volume of rice production . Four possible scenarios – A, B, C and D – are plotted. The actual time series is given by the solid line . The forecast trend is given by the broken line. S cenarios B and C are cases where the status quo may lead to desirable outcomes, even without the project. Scenario A warrants a project to change the situation into a desirable one . In Scenario D, the project may be more interested in sustaining desirable outcomes. Understand the Project 26-28 April 2011 NEDA-ADB PED Refresher Workshop 31

Basic PED Procedures: 

Basic PED Procedures Understand the Project If the “without project” scenario will already result in desirable outcomes, the LGU need not undertake the project . Consider also the alternative strategy of instituting the proper policy and regulatory framework in order to produce the same outcomes, instead of undertaking the project. Consider the following: If the interest is to produce irrigation services, an obvious alternative is for individual farmers to put up their own shallow tube wells. If government updates the hydrological map of the province, will this be enough to encourage farmers to undertake the investment? 26-28 April 2011 NEDA-ADB PED Refresher Workshop 32

Basic PED Procedures: 

Basic PED Procedures Understand the Project The private sector is also engaged in providing education. However, this means that they will charge tuition fees. Can the families of the potential students afford the fees? Will this discourage school participation ? The province plans to showcase its scenic spots by hosting a national event. However, there are not enough lodging places to house the prospective delegates. Should the LGU construct lodging facilities? Or can the private sector be encouraged to construct the facility? What will it take? Suppose the LGU constructs a conference facility and present plans to encourage tourism and use of the conference facility. Will this be sufficient come-on for the private sector ? In highly urbanized areas, the private sector may be enticed to build and operate the public market. But they will want to be assured that the LGU will not allow sidewalk vendors to operate in close proximity to the strategic site identified. 26-28 April 2011 NEDA-ADB PED Refresher Workshop 33

Basic PED Procedures: 

Basic PED Procedures Formulating project enhancements to ensure that project outcomes will be achieved Identified Risks/Assumptions in the Project Log-Frame whenever possible should be addressed. Success-enhancement components should be included in the project. 26-28 April 2011 NEDA-ADB PED Refresher Workshop 34

Basic PED Procedures: 

Basic PED Procedures To ensure better success, the sample communal irrigation system (CIS) may consider the following additional project components: Watershed management systems and procedures; Operations and maintenance (O & M) manual for the CIS; Field school for farmers; Post-harvest facilities; and Organization of farmers into a marketing/trading cooperative. 26-28 April 2011 NEDA-ADB PED Refresher Workshop 35