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Premium member Presentation Transcript Project Evaluation and Development: Project Evaluation and Development Remaining Steps for Comprehensive PED ProceduresComprehensive PED Procedures: Comprehensive PED Procedures At this stage, we are left with only “big” projects and/or those that are to be funded externally and all of these passed the basic PED. We proceed with the next two stages: – ANALYZE it thoroughly, and then – JUDGE it fairly. 26-28 April 2011 NEDA-ADB PED Refresher Workshop 2Comprehensive PED Procedures: Comprehensive PED Procedures ANALYZE it thoroughly Three key points need to be looked into: Market Situation : Will there be demand for the project’s output up to the design life of the project or up to 10 years in case of the economic life of the project extends to more than a decade? Technical Aspects : Is the choice of project technology and design the most cost-effective? Project Costs and financial sustainability : How much will the project cost – capital + O & M, and will there be sufficient fund cover for these costs. 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 3Comprehensive PED Procedures: Comprehensive PED Procedures Traditional Approach Non-Traditional Approach 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 4Comprehensive PED Procedures: Comprehensive PED Procedures Market Analysis Describing the market situation means describing the demand for and supply of the project’s output over the project’s design life. We can have an idea of the likely demand for the project’s output by observing the existing demand and supply of the same good. If the demand is more than the supply of the good, then clearly, there is a supply gap and this can be filled up by the project’s output . 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 5Comprehensive PED Procedures: Comprehensive PED Procedures Market Analysis The questions that need to be answered are : Is there a demand for the project’s output ? Is there a current supply of a good similar to the project’s output? For how much is the good being sold ? Is there a supply gap? Market Analysis Long queues at hospitals and clinics imply a shortage in the supply of health care facilities. Overcrowded classrooms indicate a shortage in the supply of classrooms (and even teachers ). High incidence of absenteeism during certain school days (say, rainy season) may indicate poor road conditions thus reducing accessibility. 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 6Comprehensive PED Procedures: Comprehensive PED Procedures Market Analysis Identify the potential users of the project’s output 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 7Comprehensive PED Procedures: Comprehensive PED Procedures Market Analysis Estimate the potential number of project users. Be guided by the historical trend, that is the relationship between demand and time . When there is no existing demand, adopt historical demand and supply for comparable sites . In the case of an intermediate good, demand may be estimated from the demand for the final good . Demand for irrigation facilities may be estimated from the demand for rice using irrigation water to rice production ratios. Use an explanatory variable related to the demand for the good like income via the income elasticity, own price via the price elasticity and population. 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 8Comprehensive PED Procedures: Comprehensive PED Procedures Time Series & Forecasting Time Series – a collection of data recorded over a period of time – daily, weekly, monthly, quarterly, semestral , annual. Secular Trend – smooth long-term direction of a time series, Cyclical Variation – rise and fall of a time series ver periods longer than 1 year. Seasonal Variation – patterns of change in a time series within a year Irregular Variation Episodic fluctuations – unpredictable variations in a time series that is due to unusual causes that can be identified like strikes, floods, fire, etc. Residual fluctuations - unpredictable variations in a time series that is due to unusual causes that cannot be identified. 11/18/2009 Introduction to Statistical Modelling 9Comprehensive PED Procedures: Comprehensive PED Procedures Secular Trend Cyclical Variation 11/18/2009 Introduction to Statistical Modelling 10 3 year election cycle Upward trend lineComprehensive PED Procedures: Comprehensive PED Procedures Seasonal Variation Episodic Fluctuation 11/18/2009 Introduction to Statistical Modelling 11 Seasonal 4 th Quarter Jump Asian Financial CrisisComprehensive PED Procedures: Comprehensive PED Procedures Market Analysis The Concept of Elasticity Measurement of the percentage change in one variable (dependent) that results from a 1% change in another variable (explanatory ). Signs of Demand Elasticities Income: + Price: - Size of Demand Elasticities Elasticity > 1, elastic: Growth rate of demand > growth rate of price Elasticity < 1, inelastic: Growth rate of demand< growth rate of price Elasticity = 1, unitary: Growth rate of demand = growth rate of price 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 12Comprehensive PED Procedures: Comprehensive PED Procedures Market Analysis The relevant elasticity may also be estimated by fitting a double logarithmic function on paired time series or cross-section data. In the case of income elasticity, the relevant functional form is LN D = α + β LN Y Where LN D and LN Y are the natural logarithms of demand and income respectively; and β measures the relevant elasticity of demand with respect to income. An analogous form may be use for estimating the price elasticity. 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 13Comprehensive PED Procedures: Comprehensive PED Procedures Market Analysis Ability-to-Pay is a function of Income levels Willingness-to-Pay is a function of Present prices paid or incurred – also known as “coping costs”. Quality of service Issue of Life-line Pricing : The 1 st 10 to 20 liters per capita per day of water consumption is critical to human survival In cases like these, access and the life-line volume may be subsidized but full economic pricing should be applied on consumption above the life-line level. For LGU projects, an additional pricing consideration is the willingness to charge of the LGU officials 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 14Comprehensive PED Procedures: Comprehensive PED Procedures Market Analysis Addressing the WTP Issue T o assess and quantify this willingness to pay at the project level several methods are currently in use: Determine what people are currently paying under similar and existing schemes ( Revealed Preference surveys ) Carry out household surveys, using such methods as Contingent Valuation Method ( CVM) a type of the so-called Stated Preference surveys Carry out focus group discussions on various service and payment options. The whole point of the exercise is to facilitate informed choice on investment options and determine a fair basis for setting tariffs that will ensure sustainable operations. In this context, the key question is: does the established rate cover the real costs of offering the desired level of service , and are consumers willing to pay that amount? 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 15Comprehensive PED Procedures: Comprehensive PED Procedures Technical Analysis Is the project technically feasible? Is it the best alternative to meet project objectives ? E xperts , especially engineers, need to be consulted to identify the technical alternatives to the project . Alternatives need to distinguish: Fixed capital requirements (land, location, resource base ); Production technique; Level and quality of supply; Economic life; Operations and maintenance costs; and Construction periods and other implementation-related lags. Technical Analysis For roads, there are several types to choose from. Concrete roads require higher investment costs and take longer to build but the operations and maintenance (O&M) cost may be lower. F eeder roads require less investment cost and take less time to build but the O&M costs are higher. The duration of usable life of the feeder road, however, is definitely shorter than that of the concrete road. There may also be different choices as to the location of these roads . There are different irrigation technologies such as gravity type, shallow tube well (STW), small water impounding project, and low-lift pumps. Each of these requires different water sources, varying investment and O&M costs, among others. 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 16Comprehensive PED Procedures: Comprehensive PED Procedures Technical Analysis The recommended technical option must be rated as the most cost-effective in terms of net present worth cost per unit of design project output among all technically feasible options. Thus, the criterion is: Min PV 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 17 Alternative Methods of Providing the Desired OutputComprehensive PED Procedures: Comprehensive PED Procedures Proposed Communal Irrigation System Proposed School Building with 7 Classrooms 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 18Comprehensive PED Procedures: Comprehensive PED Procedures Traditional Non-traditional These questions are addressed at the end-phase of ANALYZING the project How much is needed to operate and maintain the project in usable form? If we can charge user fees, how much should they be? How much more is needed to collect the fees (administrative cost of collecting the fees)? Given the fees, what is the projected number of users? If we do not collect the fees, what is the projected number of users? If the project cannot be expected to pay for itself, will the provincial government be willing to subsidize its operations and maintenance? By how much ? These questions are addressed at the beginning phase of ANALYZING the project and the results serve as basis for the technical design and project costing. At this phase what remains are just refinements and focus is on financing instrument design. 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 19 Project Costs and Financial Sustainability Analysis This phase of the study is similar to financial analysis.Comprehensive PED Procedures: Comprehensive PED Procedures Project Costs and Financial Sustainability Analysis We should conduct cash-flow analysis even for projects that will not generate revenues. I t is still useful to have an estimate of the cash flow. At the very least, it informs us of the timing of the need for subsidies . Forecast the cash inflows like revenues, bond or loan proceeds, etc. Forecast the cash outflows like project costs, operating expenses, etc. Analyze the cash flow. If operating deficits cannot be met by subsidies (LGU support) from the LGU, then the project cannot be undertaken 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 20 Cash Flow Forecasts for a Proposed Public Market funded by a Bond FloatComprehensive PED Procedures: Comprehensive PED Procedures Project Costs and Financial Sustainability Analysis Financial institutions may also look for projected project income statements Only revenues and expenses are recorded. 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 21 Profit and Loss Statement Forecast for a Proposed Public Market funded by a Bond FloatComprehensive PED Analysis: Comprehensive PED Analysis 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 22 Project Costs and Financial Sustainability AnalysisComprehensive PED Analysis: Comprehensive PED Analysis Project Costs and Financial Sustainability Analysis MIRR is calculated as follows: MIRR = - 1 where n is the number of equal periods at the end of which the cash flows occur (not the number of cash flows), PV is present value (at the beginning of the first period), FV is future value (at the end of the last period). The formula adds up the negative cash flows after discounting them to time zero using the external cost of capital, adds up the positive cash flows including the proceeds of reinvestment at the external reinvestment rate to the final period, and then works out what rate of return would cause the magnitude of the discounted negative cash flows at time zero to be equivalent to the future value of the positive cash flows at the final time period. Spreadsheet applications , such as Microsoft Excel , have inbuilt functions to calculate the MIRR. In Microsoft Excel this function is "=MIRR ". 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 23Comprehensive PED Analysis: Comprehensive PED Analysis Project Costs and Financial Sustainability Analysis PV (negative cash flows, 12%) =-4,636.36 FV (positive cash flows, 10% 5,000× )+2,000= 7,600 MIRR = - 1 = 17.91% 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 24 Year Net Cash Flow 0 -1,000 1 -4,000 2 5,000 3 2,000 Assume a finance rate of 10% and a reinvestment of 12%Comprehensive PED Analysis: Comprehensive PED Analysis Project Costs and Financial Sustainability Analysis The Modified Internal rate of Return (MIRR) resolves two of the problems associated with the IRR. First, IRR assumes that interim positive cash flows are reinvested at the same rate of return as that of the project that generated them. This is usually an unrealistic scenario and a more likely situation is that the funds will be reinvested at a rate closer to the firm's cost of capital. The IRR therefore often gives an unduly optimistic picture of the projects under study. Generally for comparing projects more fairly, the weighted average cost of capital should be used for reinvesting the interim cash flows. Second, more than one IRR can be found for projects with alternating positive and negative cash flows, which leads to confusion and ambiguity. MIRR finds only one value. 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 25Comprehensive PED Analysis: Comprehensive PED Analysis Non-DCF Project Viability Measures Payback Period : length of time required to recover the amount of initial investment Payback period = Example: Initial Investment = PhP 18,000 resulting in annual revenues of PhP 3,000 Payback Period = = 6 years Decision Rule : Choose the project with the shorter payback period. The rationale is the shorter the payback period, the less risky the project, and the greater the liquidity Advantages are 1) it is simple to compute and 2) handles investment risk effectively Shortcomings are 1) it does not consider the time value of money and 2) it ignores cash flows after the payback period. 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 26Comprehensive PED Analysis: Comprehensive PED Analysis Non-DCF Project Viability Measures Accounting Rate of Return (ARR): measures profitability by relating the required investment to the future annual income. Example: Initial investment is PhP 6,500, estimated life of 20 years, cash revenues per year of PhP 1,000, and annual depreciation of PhP 325 ARR = = 10.4% Decision Rule : Choose the project with the higher rate of return. Advantages are 1) it is easy to understand and 2) recognizes the profitability factor. Shortcoming is that it fails to recognize the time value of money 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 27Comprehensive PED Analysis: Comprehensive PED Analysis Judge the project fairly How much is the true cost of the good to society True cost of a good to society is referred to as economic cost. The basic premise behind economic pricing is that the market price does not accurately inform us of the true value of the good or service. Rather, the market price is distorted by taxes, subsidies, and transport and handling costs. The economic cost is given by the undistorted price at which suppliers are willing to sell a given quantity of their produce. This means that we need to know the supply price, corrected for distortions such as taxes, subsidies, and transport and handling costs . Example (p): Consider a unit of good that costs PhP220 per bag, inclusive of a 10% value-added tax (VAT). What this means is that only PhP200 is received by the seller of the good, and the PhP20 is remitted to government. Thus, the economic cost of this good, which we implicitly assume as non- tradeable , is PhP200, and not PhP220 . 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 28Comprehensive PED Analysis: Comprehensive PED Analysis Classification of Project Inputs To guide the determination of economic costs, we need to indicate the following for each major project input: If the good is wholly tradeable , partly tradeable , or wholly non- tradeable . Tradeable means that the good is being demanded and/or supplied in the international market. If wholly tradeable , is it an exportable or importable good? If the domestic price of the good is less than the freight on board (FOB) price at the border, then the good must be exportable. On the other hand, if the domestic price of the good is higher than the cost, insurance, and freight (CIF) price at the border , then the good must be importable . If partly tradeable , what proportion of the cost is due to tradeable inputs? For projects to be funded internally, we can skip questions a-c and simply answer: How much is the cost of the good at the project site? Net of taxes? 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 29Comprehensive PED Analysis: Comprehensive PED Analysis Computation of Economic Cost . The computation of economic cost depends on whether the good is wholly tradeable (importable or exportable), partly tradeable or non- tradeable . Good is non- tradeable The true cost is a weighted average of the demand and supply prices . where w d is the weight given to demand and w S s is the weight given to supply; P d is the demand price and P S is the supply price. Recall that the demand price is the price that consumers pay for the good while supply price is the price that producers receive for the good . The demand and supply prices differ from the market price by the amount of the tax or subsidy . Example : 10% VAT on lighting bulbs that cost PhP25, net of taxes. Demand price = PhP25 * (1+10%) = PhP27.50 Supply price = PhP25 Example : PhP3 subsidy to producers per kilo of sugar. Market price is PhP30 Demand price = PhP30 Supply price = PhP30 + 3 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 30Comprehensive PED Analysis: Comprehensive PED Analysis Good is non- tradeable Weights choose among the following weights, corresponding to different assumptions on demand and supply elasticities Scheme 1 assumes that price is entirely determined by demand and that supply is inelastic (quantity supplied does not respond to changes in prices). In this case, supply may be very constrained especially in the short-term . At the other extreme (Scheme 5), we have the case where price is entirely determined by supply, meaning that demand is inelastic. There are intermediate states Scheme 2: Demand is more responsive than supply Scheme 3: Demand is just as responsive as supply Scheme 4: Demand is less responsive than supply 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 31Comprehensive PED Analysis: Comprehensive PED Analysis Input good is tradeable In this case, the scarcity of foreign currency also needs to be considered in determining the true cost of the input. This is done by imposing a foreign exchange premium (FEP) on the official exchange rate. The value of the FEP is determined by the NEDA and may change from time to time. The most recent value is 1.2. Input good is importable D omestic supply is not enough to meet domestic demand. Since we are using it up for the project, then we will need to increase imports. In turn, the increased importation will require more foreign exchange. The financial price (FP) of the input is roughly equal to the sum of the following: Cost , insurance, and freight (CIF) price multiplied by the current exchange rate ; Handling cost inclusive of taxes; and Transport cost inclusive of taxes. 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 32Comprehensive PED Analysis: Comprehensive PED Analysis Input good is importable To convert this to economic price, we need to apply the foreign exchange premium (FEP ) to the current exchange rate and then deduct the taxes from the handling and transport costs. The economic price (EP) is equal to the sum of the following: Cost , insurance, and freight (CIF) price multiplied by the current exchange rate multiplied by the FEP; Handling cost less taxes; and Transport cost less taxes. EP = CIF_price × ER × FEP + ( handling_cost less taxes) + ( transport_cost less taxes) where EP is the economic price CIF price is the CIF price of the good at the port ER is the prevailing exchange rate FEP is the foreign exchange premium Handling cost is the cost of handling at the port Transport cost is the cost of transporting the good from port to project site 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 33Comprehensive PED Analysis: Comprehensive PED Analysis Input good is exportable If the input is being exported, then this means that domestic supply exceeds domestic demand and furthermore, there is international demand for our product . The financial price of an exportable input is the same as with an importable input, except that the FOB (freight on board) price is used instead of the CIF (cost, insurance and freight) price. The FP is the sum of the following : FOB price multiplied by the current exchange rate; Handling cost inclusive of taxes; and Transport cost inclusive of taxes . EP = FOB_price *ER*FEP+ ( handling_cost less taxes) - ( transport_cost less taxes ) where EP is the economic price FOB price is the FOB price of the good at the port ER is the prevailing exchange rate FEP is the foreign exchange premium Handling_cost is the cost of handling at the port Transport_cost is the cost of transporting the good from port to project site. 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 34Comprehensive PED AnalySis: Comprehensive PED AnalySis Input good is partly tradeable The good is partly tradeable , or, the good itself may be non- tradeable but the process of producing the good requires tradeable goods . EP= s t × ECF × FP + (1 - s t ) × [ w d × FP d + w s × FP s ] where s t is the proportion that is tradeable , ECF is the conversion factor or the amount used to express financial prices to economic prices and the others are as defined before. Labor Inputs The true cost of labor is equal to the opportunity cost of labor. Skilled labor is more scarce than unskilled labor, but the income of skilled labor is taxable while the income of unskilled labor is non-taxable. In effect, there are negative and positive tradeoff s . In the Philippines, wages of skilled labor are taken to be the true cost of skilled labor while wages of unskilled labor are multiplied by a factor of 0.6 to arrive at the true cost of unskilled labor. 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 35Comprehensive PED AnalySis: Comprehensive PED AnalySis Consider the following example of a rural roads project where the cost of inputs at the project site is known. Most of the inputs that will be used, e.g., gravel and sand are non- tradeable but they make use of some tradeable inputs. Meanwhile, labor is considered tradeable and is valued at the opportunity cost of labor. In Column A, we specify the cost structure of the project in terms of materials, equipment, and labor. This is further broken down in Column B into local and foreign ( tradeable ) component and for labor, into skilled and unskilled . Assume a foreign exchange premium of 1.2. 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 36Comprehensive PED AnalySis: Comprehensive PED AnalySis Negative Externalities Negative effects that may be generated by projects. What is needed is to identify the cost of preventing these externalities and include them as part of project cost. Examples A communal irrigation project promotes the growth of parasites that cause schistosomiasis . The prevention measure takes the form of frequent cleaning of the canals to get rid of snails. The cleaners need to use special equipment for cleaning. This cost as well as the labor component needs to be included as part of the O&M cost . The construction of a solar dryer for palay exposes the neighboring residents to respiratory hazards. This can be mitigated by installing finely-meshed nets around the solar dryer. The cost of the nets as well as the replacement has to be included. 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 37Comprehensive PED AnalySis: Comprehensive PED AnalySis Valuation of the economic benefit of a project’s output Valued at the price that consumers are “willing to pay” for the good . Output good is non- tradeable The same rules as in valuing non- tradeable inputs apply. Output good is importable If the project produces or results in the production of an importable output, then the country’s import bill is reduced . The value of the output at the port is given by the CIF price . To be comparable, the price of the output at the project site should be equal to the CIF price less the handling and transport costs from port to project site. 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 38Comprehensive PED AnalySis: Comprehensive PED AnalySis Output good is importable The EP is given by the following formula: EP = CIF_price × ER × FEP – ( handling_cost less taxes ) – ( transport_cost less taxes) where EP is the economic price CIF_price is the CIF price of the good at the port ER is the prevailing exchange rate FEP is the foreign exchange premium Handling cost is the cost of handling at the port Transport cost is the cost of transporting the good from port to project site Output good is exportable If the project produces or results in the production of an exportable output, then the country’s export bill is increased The value of the output at the port is given by the FOB price. To be comparable, the price of the output at the project site should be equal to the FOB price less the handling and transport costs from port to project site. 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 39Comprehensive PED AnalySis: Comprehensive PED AnalySis Output good is exportable The EP is given by the following formula: EP = FOB_price × ER × FEP – ( handling_cost less taxes) – ( transport_cost less taxes) Where: EP is the economic price FOB_price is the FOB price of the good at the port ER is the prevailing exchange rate FEP is the foreign exchange premium Handling_cost is the cost of handling at the port Transport_cost is the cost of transporting the good from port to project site Output good is partly tradeable The same rules as in valuing “partly tradeable ” inputs apply Labor Inputs The same rules as in valuing labor inputs apply . Public Goods I t is difficult to determine the true willingness-to-pay so that whatever information we can get will clearly underestimate the true value of the benefit to society. Either or both of two things can be done: Find a proxy for willingness-to-pay; and/ or Add to the original variable a fixed amount that will incorporate the true value of the benefit to society . 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 40Comprehensive PED AnalySis: Comprehensive PED AnalySis 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 41Comprehensive PED AnalySis: Comprehensive PED AnalySis 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 42Comprehensive PED AnalySis: Comprehensive PED AnalySis Case of Projects with benefits that cannot be monetized Examples of these are projects that improve health and sanitation, or peace and order, preserve culture, or promote harmony Some studies still venture to estimate consumers’ willingness-to-pay for such goods. However, the application may be so limited to a certain group of people as to be useful in general. The projects can still be evaluated in comparison to same project types in similar settings or with international standards. The procedures is as follows: Identify a measure of effectiveness. Determine the effectiveness level for each type of provision. Determine the economic cost of each type of provision. Compute for the cost-effectiveness ratio, or the ratio of the economic cost to the measure of effectiveness. The same set of procedures may be used alternative types of output provision. 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 43Comprehensive PED AnalySis: Comprehensive PED AnalySis Project’s output produces other benefits . The project’s log frame can help determine if the positive externality is due to the project alone, or in conjunction with other factors. In general, we only consider benefits that are due to the project alone. For instance, road construction may lead to an increase in real estate prices within the vicinity of the road, but only if there are business opportunities in the area . A water supply project will increase the influx of tourists, but only if there will be tourism development in the area. If the benefit is attributable to the project alone, the valuation will follow the same rules. In general, if the economic benefits outweigh the financial benefits, the project is said to generate positive externalities. 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 44Comprehensive PED AnalySis: Comprehensive PED AnalySis Net Impact of the project to society The project’s net benefits take into consideration the incremental benefit of the project, the cost of the project and any externalities (positive or negative) that may result from the project. All of these figures should be expressed in economic values 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 45Comprehensive PED AnalySis: Comprehensive PED AnalySis Economic Viability Indicators The usual economic viability indicators include: Net Present Value (NPV), Economic Internal Rate of Return (EIRR), and Benefit/Cost Ratio (BCR) he recommended indicator of “worth” is the net present value (NPV). This is because of the following advantages: The NPV always exists, unlike the EIRR . The NPV is not sensitive to project scale unlike the EIRR and BCR. The NPV is additive unlike the EIRR, BCR and CER The cost-effectiveness ratio (CER) is used only when the benefits are difficult to quantify and/or monetize. Consideration for differences in economic life The project with the shorter life-span can be adjusted, as if the project will be implemented again in order to make it comparable . Alternatively, we can shorten the benefit stream of the project with the longer life with the proper adjustment also done on the cost side – there will be a residual value of the investment cost at the last year of the period of analysis. The residual value is computed as follows: × Investment Cost Distribution of Benefits In summing up the benefits, the usual principle is “a peso is a peso.” This is devoid of distributional biases. If the province has very strong equity bias then different weights can be assigned to the different types of stakeholders. 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 46Comprehensive PED AnalySis: Comprehensive PED AnalySis PED and Uncertainty In both financial and economic analyses, specific values must be assigned to input variables so that the viability calculations can be performed. However, some uncertainty often exists regarding the value that should be assumed by one or more input variables, especially those that represent future conditions. For example, projections of the cost of raw materials, future interest rates, future numbers of employees, and expected product demand are random variables because their true values are unknown and will be determined in the future. If we cannot say with certainty what value one or more input variables will assume, we also cannot say with certainty what value the viability indicators will assume . This uncertainty associated with the value of the dependent viability indicators introduces an element of risk to the decision-making problem. Specifically , if the bottom-line viability indicator that LGU managers use to make decisions, and its value is uncertain, any decisions made on the basis of this value are based on uncertain (or incomplete) information. When such a decision is made , some chance exists that the decision will not produce the intended results. This chance, or uncertainty , represents an element of risk in the decision-making problem . The term “risk” also implies the potential for loss. 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 47Comprehensive PED AnalySis: Comprehensive PED AnalySis Methods of Risk Analysis Best Case/Worst Case Analysis If we don’t know what value a particular input variable will assume, we could enter a number that we think is the most likely value for the input. If we enter such numbers for all the uncertain inputs, we can easily calculate the most likely value of the viability indicator This is also called the base-case scenario. However, this scenario gives us no information about how far away the actual outcome might be from this expected, or most likely, value. One simple solution to this problem is to calculate the value of the bottom-line performance measure using the best-case , or most optimistic, and worst-case , or most pessimistic, values for the uncertain input values . These additional scenarios show the range of possible values that might be assumed by the bottom-line viability measure . 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 48Comprehensive PED AnalySis: Comprehensive PED AnalySis What If Analysis In what-if analysis , changes in the input values of the uncertain input variables are made to see what happens to the bottom-line viability measure. By making a series of such changes, an LGU manager can gain some insight into how sensitive the performance measure is to changes to the input variables. Watch-out Points Bias in the selection of the range of values to be used in the sensitivity analyses. T he values must be randomly selected from a distribution, or pool, of values that reflects the appropriate range of possible values. Making sense and presenting the results of numerous sensitivity analyses. 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 49Comprehensive PED AnalySis: Comprehensive PED AnalySis Monte Carlo Risk Simulation The objective in simulation is to describe the distribution and characteristics of the possible values of the bottom-line viability measure Y, given the possible values and behavior of the input variables X 1 , X 2 ,…, X n . The idea behind simulation is similar to the notion of playing out many what-if scenarios The difference is that the process of assigning values to the cells in the spreadsheet that represent random variables is automated so that: (1) the values are assigned in a non-biased way, and (2) the spreadsheet user is relieved of the burden of determining these values .. With simulation, we repeatedly and randomly generate sample values for each uncertain input variable (X 1 , X 2 , ..., X k ) in our model and then compute the resulting value of our bottom-line performance measure (Y ). We can then use the sample values of Y to estimate the true distribution and other characteristics of the performance measure Y . For example, we can use the sample observations to construct a frequency distribution of the performance measure, to estimate the range of values over which the performance measure might vary, to estimate its mean and variance , and to estimate the probability that the actual value of the performance measure will be greater than (or less than) a particular value. 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 50 You do not have the permission to view this presentation. In order to view it, please contact the author of the presentation.
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Premium member Presentation Transcript Project Evaluation and Development: Project Evaluation and Development Remaining Steps for Comprehensive PED ProceduresComprehensive PED Procedures: Comprehensive PED Procedures At this stage, we are left with only “big” projects and/or those that are to be funded externally and all of these passed the basic PED. We proceed with the next two stages: – ANALYZE it thoroughly, and then – JUDGE it fairly. 26-28 April 2011 NEDA-ADB PED Refresher Workshop 2Comprehensive PED Procedures: Comprehensive PED Procedures ANALYZE it thoroughly Three key points need to be looked into: Market Situation : Will there be demand for the project’s output up to the design life of the project or up to 10 years in case of the economic life of the project extends to more than a decade? Technical Aspects : Is the choice of project technology and design the most cost-effective? Project Costs and financial sustainability : How much will the project cost – capital + O & M, and will there be sufficient fund cover for these costs. 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 3Comprehensive PED Procedures: Comprehensive PED Procedures Traditional Approach Non-Traditional Approach 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 4Comprehensive PED Procedures: Comprehensive PED Procedures Market Analysis Describing the market situation means describing the demand for and supply of the project’s output over the project’s design life. We can have an idea of the likely demand for the project’s output by observing the existing demand and supply of the same good. If the demand is more than the supply of the good, then clearly, there is a supply gap and this can be filled up by the project’s output . 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 5Comprehensive PED Procedures: Comprehensive PED Procedures Market Analysis The questions that need to be answered are : Is there a demand for the project’s output ? Is there a current supply of a good similar to the project’s output? For how much is the good being sold ? Is there a supply gap? Market Analysis Long queues at hospitals and clinics imply a shortage in the supply of health care facilities. Overcrowded classrooms indicate a shortage in the supply of classrooms (and even teachers ). High incidence of absenteeism during certain school days (say, rainy season) may indicate poor road conditions thus reducing accessibility. 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 6Comprehensive PED Procedures: Comprehensive PED Procedures Market Analysis Identify the potential users of the project’s output 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 7Comprehensive PED Procedures: Comprehensive PED Procedures Market Analysis Estimate the potential number of project users. Be guided by the historical trend, that is the relationship between demand and time . When there is no existing demand, adopt historical demand and supply for comparable sites . In the case of an intermediate good, demand may be estimated from the demand for the final good . Demand for irrigation facilities may be estimated from the demand for rice using irrigation water to rice production ratios. Use an explanatory variable related to the demand for the good like income via the income elasticity, own price via the price elasticity and population. 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 8Comprehensive PED Procedures: Comprehensive PED Procedures Time Series & Forecasting Time Series – a collection of data recorded over a period of time – daily, weekly, monthly, quarterly, semestral , annual. Secular Trend – smooth long-term direction of a time series, Cyclical Variation – rise and fall of a time series ver periods longer than 1 year. Seasonal Variation – patterns of change in a time series within a year Irregular Variation Episodic fluctuations – unpredictable variations in a time series that is due to unusual causes that can be identified like strikes, floods, fire, etc. Residual fluctuations - unpredictable variations in a time series that is due to unusual causes that cannot be identified. 11/18/2009 Introduction to Statistical Modelling 9Comprehensive PED Procedures: Comprehensive PED Procedures Secular Trend Cyclical Variation 11/18/2009 Introduction to Statistical Modelling 10 3 year election cycle Upward trend lineComprehensive PED Procedures: Comprehensive PED Procedures Seasonal Variation Episodic Fluctuation 11/18/2009 Introduction to Statistical Modelling 11 Seasonal 4 th Quarter Jump Asian Financial CrisisComprehensive PED Procedures: Comprehensive PED Procedures Market Analysis The Concept of Elasticity Measurement of the percentage change in one variable (dependent) that results from a 1% change in another variable (explanatory ). Signs of Demand Elasticities Income: + Price: - Size of Demand Elasticities Elasticity > 1, elastic: Growth rate of demand > growth rate of price Elasticity < 1, inelastic: Growth rate of demand< growth rate of price Elasticity = 1, unitary: Growth rate of demand = growth rate of price 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 12Comprehensive PED Procedures: Comprehensive PED Procedures Market Analysis The relevant elasticity may also be estimated by fitting a double logarithmic function on paired time series or cross-section data. In the case of income elasticity, the relevant functional form is LN D = α + β LN Y Where LN D and LN Y are the natural logarithms of demand and income respectively; and β measures the relevant elasticity of demand with respect to income. An analogous form may be use for estimating the price elasticity. 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 13Comprehensive PED Procedures: Comprehensive PED Procedures Market Analysis Ability-to-Pay is a function of Income levels Willingness-to-Pay is a function of Present prices paid or incurred – also known as “coping costs”. Quality of service Issue of Life-line Pricing : The 1 st 10 to 20 liters per capita per day of water consumption is critical to human survival In cases like these, access and the life-line volume may be subsidized but full economic pricing should be applied on consumption above the life-line level. For LGU projects, an additional pricing consideration is the willingness to charge of the LGU officials 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 14Comprehensive PED Procedures: Comprehensive PED Procedures Market Analysis Addressing the WTP Issue T o assess and quantify this willingness to pay at the project level several methods are currently in use: Determine what people are currently paying under similar and existing schemes ( Revealed Preference surveys ) Carry out household surveys, using such methods as Contingent Valuation Method ( CVM) a type of the so-called Stated Preference surveys Carry out focus group discussions on various service and payment options. The whole point of the exercise is to facilitate informed choice on investment options and determine a fair basis for setting tariffs that will ensure sustainable operations. In this context, the key question is: does the established rate cover the real costs of offering the desired level of service , and are consumers willing to pay that amount? 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 15Comprehensive PED Procedures: Comprehensive PED Procedures Technical Analysis Is the project technically feasible? Is it the best alternative to meet project objectives ? E xperts , especially engineers, need to be consulted to identify the technical alternatives to the project . Alternatives need to distinguish: Fixed capital requirements (land, location, resource base ); Production technique; Level and quality of supply; Economic life; Operations and maintenance costs; and Construction periods and other implementation-related lags. Technical Analysis For roads, there are several types to choose from. Concrete roads require higher investment costs and take longer to build but the operations and maintenance (O&M) cost may be lower. F eeder roads require less investment cost and take less time to build but the O&M costs are higher. The duration of usable life of the feeder road, however, is definitely shorter than that of the concrete road. There may also be different choices as to the location of these roads . There are different irrigation technologies such as gravity type, shallow tube well (STW), small water impounding project, and low-lift pumps. Each of these requires different water sources, varying investment and O&M costs, among others. 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 16Comprehensive PED Procedures: Comprehensive PED Procedures Technical Analysis The recommended technical option must be rated as the most cost-effective in terms of net present worth cost per unit of design project output among all technically feasible options. Thus, the criterion is: Min PV 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 17 Alternative Methods of Providing the Desired OutputComprehensive PED Procedures: Comprehensive PED Procedures Proposed Communal Irrigation System Proposed School Building with 7 Classrooms 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 18Comprehensive PED Procedures: Comprehensive PED Procedures Traditional Non-traditional These questions are addressed at the end-phase of ANALYZING the project How much is needed to operate and maintain the project in usable form? If we can charge user fees, how much should they be? How much more is needed to collect the fees (administrative cost of collecting the fees)? Given the fees, what is the projected number of users? If we do not collect the fees, what is the projected number of users? If the project cannot be expected to pay for itself, will the provincial government be willing to subsidize its operations and maintenance? By how much ? These questions are addressed at the beginning phase of ANALYZING the project and the results serve as basis for the technical design and project costing. At this phase what remains are just refinements and focus is on financing instrument design. 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 19 Project Costs and Financial Sustainability Analysis This phase of the study is similar to financial analysis.Comprehensive PED Procedures: Comprehensive PED Procedures Project Costs and Financial Sustainability Analysis We should conduct cash-flow analysis even for projects that will not generate revenues. I t is still useful to have an estimate of the cash flow. At the very least, it informs us of the timing of the need for subsidies . Forecast the cash inflows like revenues, bond or loan proceeds, etc. Forecast the cash outflows like project costs, operating expenses, etc. Analyze the cash flow. If operating deficits cannot be met by subsidies (LGU support) from the LGU, then the project cannot be undertaken 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 20 Cash Flow Forecasts for a Proposed Public Market funded by a Bond FloatComprehensive PED Procedures: Comprehensive PED Procedures Project Costs and Financial Sustainability Analysis Financial institutions may also look for projected project income statements Only revenues and expenses are recorded. 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 21 Profit and Loss Statement Forecast for a Proposed Public Market funded by a Bond FloatComprehensive PED Analysis: Comprehensive PED Analysis 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 22 Project Costs and Financial Sustainability AnalysisComprehensive PED Analysis: Comprehensive PED Analysis Project Costs and Financial Sustainability Analysis MIRR is calculated as follows: MIRR = - 1 where n is the number of equal periods at the end of which the cash flows occur (not the number of cash flows), PV is present value (at the beginning of the first period), FV is future value (at the end of the last period). The formula adds up the negative cash flows after discounting them to time zero using the external cost of capital, adds up the positive cash flows including the proceeds of reinvestment at the external reinvestment rate to the final period, and then works out what rate of return would cause the magnitude of the discounted negative cash flows at time zero to be equivalent to the future value of the positive cash flows at the final time period. Spreadsheet applications , such as Microsoft Excel , have inbuilt functions to calculate the MIRR. In Microsoft Excel this function is "=MIRR ". 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 23Comprehensive PED Analysis: Comprehensive PED Analysis Project Costs and Financial Sustainability Analysis PV (negative cash flows, 12%) =-4,636.36 FV (positive cash flows, 10% 5,000× )+2,000= 7,600 MIRR = - 1 = 17.91% 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 24 Year Net Cash Flow 0 -1,000 1 -4,000 2 5,000 3 2,000 Assume a finance rate of 10% and a reinvestment of 12%Comprehensive PED Analysis: Comprehensive PED Analysis Project Costs and Financial Sustainability Analysis The Modified Internal rate of Return (MIRR) resolves two of the problems associated with the IRR. First, IRR assumes that interim positive cash flows are reinvested at the same rate of return as that of the project that generated them. This is usually an unrealistic scenario and a more likely situation is that the funds will be reinvested at a rate closer to the firm's cost of capital. The IRR therefore often gives an unduly optimistic picture of the projects under study. Generally for comparing projects more fairly, the weighted average cost of capital should be used for reinvesting the interim cash flows. Second, more than one IRR can be found for projects with alternating positive and negative cash flows, which leads to confusion and ambiguity. MIRR finds only one value. 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 25Comprehensive PED Analysis: Comprehensive PED Analysis Non-DCF Project Viability Measures Payback Period : length of time required to recover the amount of initial investment Payback period = Example: Initial Investment = PhP 18,000 resulting in annual revenues of PhP 3,000 Payback Period = = 6 years Decision Rule : Choose the project with the shorter payback period. The rationale is the shorter the payback period, the less risky the project, and the greater the liquidity Advantages are 1) it is simple to compute and 2) handles investment risk effectively Shortcomings are 1) it does not consider the time value of money and 2) it ignores cash flows after the payback period. 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 26Comprehensive PED Analysis: Comprehensive PED Analysis Non-DCF Project Viability Measures Accounting Rate of Return (ARR): measures profitability by relating the required investment to the future annual income. Example: Initial investment is PhP 6,500, estimated life of 20 years, cash revenues per year of PhP 1,000, and annual depreciation of PhP 325 ARR = = 10.4% Decision Rule : Choose the project with the higher rate of return. Advantages are 1) it is easy to understand and 2) recognizes the profitability factor. Shortcoming is that it fails to recognize the time value of money 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 27Comprehensive PED Analysis: Comprehensive PED Analysis Judge the project fairly How much is the true cost of the good to society True cost of a good to society is referred to as economic cost. The basic premise behind economic pricing is that the market price does not accurately inform us of the true value of the good or service. Rather, the market price is distorted by taxes, subsidies, and transport and handling costs. The economic cost is given by the undistorted price at which suppliers are willing to sell a given quantity of their produce. This means that we need to know the supply price, corrected for distortions such as taxes, subsidies, and transport and handling costs . Example (p): Consider a unit of good that costs PhP220 per bag, inclusive of a 10% value-added tax (VAT). What this means is that only PhP200 is received by the seller of the good, and the PhP20 is remitted to government. Thus, the economic cost of this good, which we implicitly assume as non- tradeable , is PhP200, and not PhP220 . 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 28Comprehensive PED Analysis: Comprehensive PED Analysis Classification of Project Inputs To guide the determination of economic costs, we need to indicate the following for each major project input: If the good is wholly tradeable , partly tradeable , or wholly non- tradeable . Tradeable means that the good is being demanded and/or supplied in the international market. If wholly tradeable , is it an exportable or importable good? If the domestic price of the good is less than the freight on board (FOB) price at the border, then the good must be exportable. On the other hand, if the domestic price of the good is higher than the cost, insurance, and freight (CIF) price at the border , then the good must be importable . If partly tradeable , what proportion of the cost is due to tradeable inputs? For projects to be funded internally, we can skip questions a-c and simply answer: How much is the cost of the good at the project site? Net of taxes? 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 29Comprehensive PED Analysis: Comprehensive PED Analysis Computation of Economic Cost . The computation of economic cost depends on whether the good is wholly tradeable (importable or exportable), partly tradeable or non- tradeable . Good is non- tradeable The true cost is a weighted average of the demand and supply prices . where w d is the weight given to demand and w S s is the weight given to supply; P d is the demand price and P S is the supply price. Recall that the demand price is the price that consumers pay for the good while supply price is the price that producers receive for the good . The demand and supply prices differ from the market price by the amount of the tax or subsidy . Example : 10% VAT on lighting bulbs that cost PhP25, net of taxes. Demand price = PhP25 * (1+10%) = PhP27.50 Supply price = PhP25 Example : PhP3 subsidy to producers per kilo of sugar. Market price is PhP30 Demand price = PhP30 Supply price = PhP30 + 3 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 30Comprehensive PED Analysis: Comprehensive PED Analysis Good is non- tradeable Weights choose among the following weights, corresponding to different assumptions on demand and supply elasticities Scheme 1 assumes that price is entirely determined by demand and that supply is inelastic (quantity supplied does not respond to changes in prices). In this case, supply may be very constrained especially in the short-term . At the other extreme (Scheme 5), we have the case where price is entirely determined by supply, meaning that demand is inelastic. There are intermediate states Scheme 2: Demand is more responsive than supply Scheme 3: Demand is just as responsive as supply Scheme 4: Demand is less responsive than supply 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 31Comprehensive PED Analysis: Comprehensive PED Analysis Input good is tradeable In this case, the scarcity of foreign currency also needs to be considered in determining the true cost of the input. This is done by imposing a foreign exchange premium (FEP) on the official exchange rate. The value of the FEP is determined by the NEDA and may change from time to time. The most recent value is 1.2. Input good is importable D omestic supply is not enough to meet domestic demand. Since we are using it up for the project, then we will need to increase imports. In turn, the increased importation will require more foreign exchange. The financial price (FP) of the input is roughly equal to the sum of the following: Cost , insurance, and freight (CIF) price multiplied by the current exchange rate ; Handling cost inclusive of taxes; and Transport cost inclusive of taxes. 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 32Comprehensive PED Analysis: Comprehensive PED Analysis Input good is importable To convert this to economic price, we need to apply the foreign exchange premium (FEP ) to the current exchange rate and then deduct the taxes from the handling and transport costs. The economic price (EP) is equal to the sum of the following: Cost , insurance, and freight (CIF) price multiplied by the current exchange rate multiplied by the FEP; Handling cost less taxes; and Transport cost less taxes. EP = CIF_price × ER × FEP + ( handling_cost less taxes) + ( transport_cost less taxes) where EP is the economic price CIF price is the CIF price of the good at the port ER is the prevailing exchange rate FEP is the foreign exchange premium Handling cost is the cost of handling at the port Transport cost is the cost of transporting the good from port to project site 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 33Comprehensive PED Analysis: Comprehensive PED Analysis Input good is exportable If the input is being exported, then this means that domestic supply exceeds domestic demand and furthermore, there is international demand for our product . The financial price of an exportable input is the same as with an importable input, except that the FOB (freight on board) price is used instead of the CIF (cost, insurance and freight) price. The FP is the sum of the following : FOB price multiplied by the current exchange rate; Handling cost inclusive of taxes; and Transport cost inclusive of taxes . EP = FOB_price *ER*FEP+ ( handling_cost less taxes) - ( transport_cost less taxes ) where EP is the economic price FOB price is the FOB price of the good at the port ER is the prevailing exchange rate FEP is the foreign exchange premium Handling_cost is the cost of handling at the port Transport_cost is the cost of transporting the good from port to project site. 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 34Comprehensive PED AnalySis: Comprehensive PED AnalySis Input good is partly tradeable The good is partly tradeable , or, the good itself may be non- tradeable but the process of producing the good requires tradeable goods . EP= s t × ECF × FP + (1 - s t ) × [ w d × FP d + w s × FP s ] where s t is the proportion that is tradeable , ECF is the conversion factor or the amount used to express financial prices to economic prices and the others are as defined before. Labor Inputs The true cost of labor is equal to the opportunity cost of labor. Skilled labor is more scarce than unskilled labor, but the income of skilled labor is taxable while the income of unskilled labor is non-taxable. In effect, there are negative and positive tradeoff s . In the Philippines, wages of skilled labor are taken to be the true cost of skilled labor while wages of unskilled labor are multiplied by a factor of 0.6 to arrive at the true cost of unskilled labor. 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 35Comprehensive PED AnalySis: Comprehensive PED AnalySis Consider the following example of a rural roads project where the cost of inputs at the project site is known. Most of the inputs that will be used, e.g., gravel and sand are non- tradeable but they make use of some tradeable inputs. Meanwhile, labor is considered tradeable and is valued at the opportunity cost of labor. In Column A, we specify the cost structure of the project in terms of materials, equipment, and labor. This is further broken down in Column B into local and foreign ( tradeable ) component and for labor, into skilled and unskilled . Assume a foreign exchange premium of 1.2. 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 36Comprehensive PED AnalySis: Comprehensive PED AnalySis Negative Externalities Negative effects that may be generated by projects. What is needed is to identify the cost of preventing these externalities and include them as part of project cost. Examples A communal irrigation project promotes the growth of parasites that cause schistosomiasis . The prevention measure takes the form of frequent cleaning of the canals to get rid of snails. The cleaners need to use special equipment for cleaning. This cost as well as the labor component needs to be included as part of the O&M cost . The construction of a solar dryer for palay exposes the neighboring residents to respiratory hazards. This can be mitigated by installing finely-meshed nets around the solar dryer. The cost of the nets as well as the replacement has to be included. 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 37Comprehensive PED AnalySis: Comprehensive PED AnalySis Valuation of the economic benefit of a project’s output Valued at the price that consumers are “willing to pay” for the good . Output good is non- tradeable The same rules as in valuing non- tradeable inputs apply. Output good is importable If the project produces or results in the production of an importable output, then the country’s import bill is reduced . The value of the output at the port is given by the CIF price . To be comparable, the price of the output at the project site should be equal to the CIF price less the handling and transport costs from port to project site. 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 38Comprehensive PED AnalySis: Comprehensive PED AnalySis Output good is importable The EP is given by the following formula: EP = CIF_price × ER × FEP – ( handling_cost less taxes ) – ( transport_cost less taxes) where EP is the economic price CIF_price is the CIF price of the good at the port ER is the prevailing exchange rate FEP is the foreign exchange premium Handling cost is the cost of handling at the port Transport cost is the cost of transporting the good from port to project site Output good is exportable If the project produces or results in the production of an exportable output, then the country’s export bill is increased The value of the output at the port is given by the FOB price. To be comparable, the price of the output at the project site should be equal to the FOB price less the handling and transport costs from port to project site. 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 39Comprehensive PED AnalySis: Comprehensive PED AnalySis Output good is exportable The EP is given by the following formula: EP = FOB_price × ER × FEP – ( handling_cost less taxes) – ( transport_cost less taxes) Where: EP is the economic price FOB_price is the FOB price of the good at the port ER is the prevailing exchange rate FEP is the foreign exchange premium Handling_cost is the cost of handling at the port Transport_cost is the cost of transporting the good from port to project site Output good is partly tradeable The same rules as in valuing “partly tradeable ” inputs apply Labor Inputs The same rules as in valuing labor inputs apply . Public Goods I t is difficult to determine the true willingness-to-pay so that whatever information we can get will clearly underestimate the true value of the benefit to society. Either or both of two things can be done: Find a proxy for willingness-to-pay; and/ or Add to the original variable a fixed amount that will incorporate the true value of the benefit to society . 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 40Comprehensive PED AnalySis: Comprehensive PED AnalySis 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 41Comprehensive PED AnalySis: Comprehensive PED AnalySis 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 42Comprehensive PED AnalySis: Comprehensive PED AnalySis Case of Projects with benefits that cannot be monetized Examples of these are projects that improve health and sanitation, or peace and order, preserve culture, or promote harmony Some studies still venture to estimate consumers’ willingness-to-pay for such goods. However, the application may be so limited to a certain group of people as to be useful in general. The projects can still be evaluated in comparison to same project types in similar settings or with international standards. The procedures is as follows: Identify a measure of effectiveness. Determine the effectiveness level for each type of provision. Determine the economic cost of each type of provision. Compute for the cost-effectiveness ratio, or the ratio of the economic cost to the measure of effectiveness. The same set of procedures may be used alternative types of output provision. 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 43Comprehensive PED AnalySis: Comprehensive PED AnalySis Project’s output produces other benefits . The project’s log frame can help determine if the positive externality is due to the project alone, or in conjunction with other factors. In general, we only consider benefits that are due to the project alone. For instance, road construction may lead to an increase in real estate prices within the vicinity of the road, but only if there are business opportunities in the area . A water supply project will increase the influx of tourists, but only if there will be tourism development in the area. If the benefit is attributable to the project alone, the valuation will follow the same rules. In general, if the economic benefits outweigh the financial benefits, the project is said to generate positive externalities. 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 44Comprehensive PED AnalySis: Comprehensive PED AnalySis Net Impact of the project to society The project’s net benefits take into consideration the incremental benefit of the project, the cost of the project and any externalities (positive or negative) that may result from the project. All of these figures should be expressed in economic values 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 45Comprehensive PED AnalySis: Comprehensive PED AnalySis Economic Viability Indicators The usual economic viability indicators include: Net Present Value (NPV), Economic Internal Rate of Return (EIRR), and Benefit/Cost Ratio (BCR) he recommended indicator of “worth” is the net present value (NPV). This is because of the following advantages: The NPV always exists, unlike the EIRR . The NPV is not sensitive to project scale unlike the EIRR and BCR. The NPV is additive unlike the EIRR, BCR and CER The cost-effectiveness ratio (CER) is used only when the benefits are difficult to quantify and/or monetize. Consideration for differences in economic life The project with the shorter life-span can be adjusted, as if the project will be implemented again in order to make it comparable . Alternatively, we can shorten the benefit stream of the project with the longer life with the proper adjustment also done on the cost side – there will be a residual value of the investment cost at the last year of the period of analysis. The residual value is computed as follows: × Investment Cost Distribution of Benefits In summing up the benefits, the usual principle is “a peso is a peso.” This is devoid of distributional biases. If the province has very strong equity bias then different weights can be assigned to the different types of stakeholders. 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 46Comprehensive PED AnalySis: Comprehensive PED AnalySis PED and Uncertainty In both financial and economic analyses, specific values must be assigned to input variables so that the viability calculations can be performed. However, some uncertainty often exists regarding the value that should be assumed by one or more input variables, especially those that represent future conditions. For example, projections of the cost of raw materials, future interest rates, future numbers of employees, and expected product demand are random variables because their true values are unknown and will be determined in the future. If we cannot say with certainty what value one or more input variables will assume, we also cannot say with certainty what value the viability indicators will assume . This uncertainty associated with the value of the dependent viability indicators introduces an element of risk to the decision-making problem. Specifically , if the bottom-line viability indicator that LGU managers use to make decisions, and its value is uncertain, any decisions made on the basis of this value are based on uncertain (or incomplete) information. When such a decision is made , some chance exists that the decision will not produce the intended results. This chance, or uncertainty , represents an element of risk in the decision-making problem . The term “risk” also implies the potential for loss. 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 47Comprehensive PED AnalySis: Comprehensive PED AnalySis Methods of Risk Analysis Best Case/Worst Case Analysis If we don’t know what value a particular input variable will assume, we could enter a number that we think is the most likely value for the input. If we enter such numbers for all the uncertain inputs, we can easily calculate the most likely value of the viability indicator This is also called the base-case scenario. However, this scenario gives us no information about how far away the actual outcome might be from this expected, or most likely, value. One simple solution to this problem is to calculate the value of the bottom-line performance measure using the best-case , or most optimistic, and worst-case , or most pessimistic, values for the uncertain input values . These additional scenarios show the range of possible values that might be assumed by the bottom-line viability measure . 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 48Comprehensive PED AnalySis: Comprehensive PED AnalySis What If Analysis In what-if analysis , changes in the input values of the uncertain input variables are made to see what happens to the bottom-line viability measure. By making a series of such changes, an LGU manager can gain some insight into how sensitive the performance measure is to changes to the input variables. Watch-out Points Bias in the selection of the range of values to be used in the sensitivity analyses. T he values must be randomly selected from a distribution, or pool, of values that reflects the appropriate range of possible values. Making sense and presenting the results of numerous sensitivity analyses. 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 49Comprehensive PED AnalySis: Comprehensive PED AnalySis Monte Carlo Risk Simulation The objective in simulation is to describe the distribution and characteristics of the possible values of the bottom-line viability measure Y, given the possible values and behavior of the input variables X 1 , X 2 ,…, X n . The idea behind simulation is similar to the notion of playing out many what-if scenarios The difference is that the process of assigning values to the cells in the spreadsheet that represent random variables is automated so that: (1) the values are assigned in a non-biased way, and (2) the spreadsheet user is relieved of the burden of determining these values .. With simulation, we repeatedly and randomly generate sample values for each uncertain input variable (X 1 , X 2 , ..., X k ) in our model and then compute the resulting value of our bottom-line performance measure (Y ). We can then use the sample values of Y to estimate the true distribution and other characteristics of the performance measure Y . For example, we can use the sample observations to construct a frequency distribution of the performance measure, to estimate the range of values over which the performance measure might vary, to estimate its mean and variance , and to estimate the probability that the actual value of the performance measure will be greater than (or less than) a particular value. 26-28 Feb 2011 NEDA-ADB PED Refresher Workshop 50