EXTENDED BENEFIT COST ANALYSIS OF INVESTMENT PROJECTS

INTERNATIONAL CONFERENCE ECONOMIC INCENTIVES AND WATER DEMAND MANAGEMENTSultan Qaboos University, Oman18-22 March 2006

Meaning of Development

Maximize social welfare/ satisfaction 1950: Material development 1960: Equitable development 1970: Qualitative development 1980: Righteous development 1990: Sustainable development 2000: Participatory development

PROJECTS, PROGRAMS AND DEVELOPMENT

A project is the building block of development. Several projects make up a sectoral investment

program. Sectoral programs together make up a national

program of development, such as 5 year plan. Hence the best projects (that contributes to

development) should be selected. Benefit-cost analysis is analytical tool that facilitates

selection of efficient projects.

REVIEW OF CONVENTIONAL PROJECT ANALYSIS

What is a project ? Project cycle Identification of project benefits and costs Valuation of benefits and costs Discounting Decision (selection) making criteria

WHAT IS A PROJECT?

A complex set of activities Undertaken over time With use of resources (cost) To achieve development objectives.

What is project analysis ?

Comparison of benefits with costs of projects. Benefits relate to development objectives of

a nation.

Why analyze a project?

Projects uses resources Resources are scares Resources have alternative uses Therefore decisions must be made on best use of

resources in projects Economic analysis of projects provides:

“Comparable objective (quantitative) indicators of projects capability to contribute to development objectives”

Guidance to take objective DECISIONS on choice of projects.

HOW TO ANALYZE PROJECTS?

Project Cycle

Identification

Check list / IEE

Analysis

EIA

Appraisal

Implementation

Monitoring

Evaluation

MODULES OF PROJECT ANALYSIS

Technical analysis (assessment of technical feasibility) Institutional – organizational – managerial analysis Social analysis (income distribution, employment generation ,

effect of different regions, ethnic groups, impact on gender, social participation)

Commercial / Market analysis : out put and input markets Financial analysis Economic analysis Environmental analysis

MODULES OF PROJECT ANALYSIS

Approach Requires multi disciplinary approach

Method Initially, analyze each discipline separately in

modules and integrate at the final stage

On site Off site

Market Included Not Included

Non Market May be included Ignored

1. IDENTIFICATION OF PROJECT BENEFITS/COSTS : PYHSICAL QUANTIFICATION

PRINCIPLE OF IDENTIFYING C & B

Identification of cost and benefits should be in terms of – how much and – when – (Quantity and time)

PRINCIPLE OF IDENTIFYING C & B

The incremental c/b due to the project should be identified

“With and without project” principle

Benefit (farm income)

With out project

With project

Before project

Incremental benefit

Time

Before 2006

2006 2010

After

2. VALUATION

What is valuation? Converting physical different quantities to single comparable denominator (money ).

Why value ? Enable summing of physical different ( cement ) cost and

benefits ( paddy ) To incorporate social preference to decision making

PRINCIPLES OF VALUING

Valuation would differ depending on whether the analysis is financial (individual) or economic (society).

For financial analysis market price is used. Perfect markets prices reflects social values.

However markets are not perfect. – Hence in economic analysis shadow prices are used.

FINANCIAL ANALYSIS

Market prices used for valuation Assessment of financial (private) profitability Assessment of incentive requirement Provides a financial plan

ECONOMIC ANALYSIS

An analysis of benefit to the society as a whole Thus social valuation stand is considered Financial analysis is used with modifications

because market prices may not reflect social values. Shadow prices are used not market prices Taxes, subsidies and loans are treated as transfer

payments. Sunk cost : Only future costs and returns are

considered

TRANSFER PAYMENTS

Payments (expenses) that does not represent use of resources but represents a shift on the right to use resources form one entity to another.

Taxes and Subsidies Loans Debt services

•Thus transfer payments are ignored in economic

SHADOW PRICE

Out put OR.

Shadow Price

MVP of labor Demand

Real Wage 70

Supply of labor

“Market price” (Min wage) 100

Labor.

• Conversion factor = Shadow price / Market Price0.7 = 70 / 100

• Therefore to convert to shadow price value multiply financial value by conversion factor• Conversion factors could be obtained from national planning departments

VALUE OF TIME:PRINCIPLES OF DISCOUNTING

Why discount ?– Project benefits and cost are spread over time

Money received at different points in time are not comparable

– Productivity of capital– Social time preference

OR 100 hundred at present > OR. 100 in 10 year in future

Therefore cost and benefits received at different points is time must brought to a common comparable scale in time ( Present )

PRINCIPLES OF DISCOUNTING

Year 1 2 3

Cost (Rs.) 100 50 0

Benefits (Rs.) 0 50 200

Present Value

Discounting

Discount Formulae

1PV = --------------------------- FV

(1 + i) t

PV = Present ValueFV = Future Valuet = Time periodi = Interest rate

i % is the rate of return to capital / social time preference

t*

MEASURES PROJECT WORTH

B/C Ratio = PV Benefits / PV Cost

Accept project if B/C > 1

NPV = PV Benefits – PV Costs

Accept project if NPV > 0

IRR = Discount rate that makes NPV = 0

Accept project if IRR > i% (Market or Social)

RATIONALE FOR EXTENDED BENEFIT COST ANALYSIS

Why do extended benefit cost analysis? Environmental impacts are offsite and non marketed. Conventional benefit cost analysis does not incorporate values of environmental impacts

LocationOnsite Offsite

Usually May be included

Seldom Included Usually ignored

M

A

R

K

E

T

A

BI

LITY

Marketed

Non Marketed

STEPS IN EXTENDED BENEFIT COST ANALYSIS

1. Environmental Impact Asessment (identification and quantification of environmental impacts)

2. Valuation of environmental impacts

3. Integrating environmental valuation to conventional benefit cost analysis

Environmental Impacts of Irrigation Projects

Principle of valuation

Environmental valuation methods