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LECTURE:06 Development Project Appraisal for sustainable development M A Kamal, Ph.D Director General National Academy for Planning and Development Outline: 10 11 12 13 14 Introduction Definition of a Project Types of Project Project Cycle Project Appraisal Objectives of Project Appraisal Scope of Project Appraisal Methods of Calculating Profit Worthiness Exercise Acceptability Criteria The basic difference between Financial Appraisal &Economic Appraisal Types of Project Appraisal Conclusion Farewell Call Introduction: 1.1 Development projects impose a series of costs and benefits on recipient communities or countries 1.2 Those costs and benefits can be social, environmental, or economic in nature, but may often involve all three 1.3 Irrigation projects may facilitate the growing of cash Definition: Project 2.1 A Project is a set of interrelated investment activities to attain certain specific objectives by utilizing limited resources within a particular period of time – Investment Activities – Specific objective – Limited Resources Projects types: Projects are: 3.1 Type ‘x’ : Self financing projects i.e projects which earn revenue through sale of output (goods & services) These are called directly productive projects, i.e Industrial Projects 3.2 Type “y” : In directly productive but non-revenue earning projects, i.e., projects which give rise to tangible output, benefit of which not accrue directly to projects themselves but to other parties Example: Irrigation Projects, Roads, Bridge etc 3.3 Type “z” : Service Sector Projects Projects which not give rise to tangible output but provide service benefits to the society Example: School, College, Hospital, Training Projects Cycle 4.1 There tends to be a natural sequence in the way projects are planned and carried out and this sequence has come to be known as ‘ the Project Cycle’ 4.2 Project Cycle Covers following stages: I II III IV V VI Project Identification Project Preparation & Analysis Project Approval / Negotiation Project Appraisal Project Implementation & Monitoring Project Evaluation & Follow-up Analysis 4.3 A Project generally goes through all these phases sequentially from identification to evaluation & follow-up This sequence has come to be termed or referred to as “Project Cycle” 4.4 Project Cycle Identification Evaluation Preparation Implementation & Monitoring Appraisal Approval Project Appraisal 5.1 5.2 5.3 Project Appraisal involves the comparison of costs and benefits If benefits exceeds costs, the project could be considered for acceptance Otherwise, it is not The basic principle in appraisal / CBA is for potential acceptance of a project Project Appraisal means a pre-investment analysis of a project to determine whether the project should be implemented or not Objectives of Project Appraisal 6.1 Project Appraisal is necessitated because the resources or means are limited as compared to the needs of the society 6.2 As a result, any investment undertaken implies depriving other projects resources 6.3 Hence, it is very important to appraise each project before investment decision so that scarce resources are utilized in the best possible ways 6.4 In other words, before allocation of resources for a particular project, the decision making authority must convince itself that the proposed project is the best and most economical way of achieving the desired objective (in terms of socio-economic benefits) 6.5 For this and for ensuring economic use of resources, we have to appraise each project very minutely from different angles Objectives of Project Appraisal 6.6 6.7 6.8 A Project Appraisal involves detailed preinvestment analysis of market & technical feasibility, financial soundness, economic desirability and, finally, measuring its investment worth The task aims mainly at ensuring that scarce resources are put to most effective use It requires the combined efforts of a team of persons from various disciplines such as engineers, financial analysts, 10 economists, etc working in close co- 7.2 Technical Appraisal a Availability of inputs at reasonable cost b Consistency & soundness of engineering design c Economics of scale in production d Appropriate technology & alternative ways of production e Advantageous location of the project f Maintenance & Repairs g Provision for expansion h Balancing of equipment 13 7.3 Financial Soundness a b c d e f g h Exhaustive & realistic cost estimation Sound capital structure: Fund Source Provision for working capital requirement Generation of sufficient cash flows to cover debtservice liability Generation of adequate profit Safety margin Break- Even Point Pay back period Pay back period: Pay back period is a measure of Project’s Capital recovery It is defined as the length of time it takes to recover the initial investment of a Project 14 7.4 Managerial Soundness a Experience of the top managerial personnel in the line b Expertise and ability of supervisory staff c Balance between supervisory staff and workers d Clarity of job description, responsibility and accountability 15 7.5 Environmental Aspects The environmental include – impacts a Ecological : Fisheries, Tree Plantation, Wet Land / Wet Land Habitats, Forests b Physico- Chemical : Flood Control & Drainage Erosion, Drainage, Congestion / Water Logging, Obstruction to waste water Flow, Soil Fertility, Early Flooding c Human Interest : Areas of Settlements, Agricultural Lands, Navigation / Boat Communication, irrigation Facilities, Landscape, 16 Land values 7.6 Measurement of Investment Worthiness a What benefit does the project promise for its sponsors or owners? b What benefit does the project promise for the national economy? c The satisfactory answers to these questions provide the 17 Methods of Calculating Profit Worthiness 8.1 Net Present Value = NPV 8.2 Benefit Cost Ratio = B/C Ratio 8.3 Internal Rate of Return = IRR 18 8.1 Formula for: i) NPV = Discounted Total Benefits – Discounted Total costs 2.2 Formula: ii) B/C Ratio = Discounted Total Benefits Discounted Total costs 19 8.3 Formula for IRR: NPV iii) IRR = LRD + LRD NPV LRD x ( HRD – LRD ) - NPV HRD Where, LRD = HRD = NPV = LRD NPV = HRD Lower Rate of Discount at which NPV is positive; Higher Rate of Discount at which NPV is negative; Net Present value at the Lower Rate of Discount; Net Present value at the Higher Rate of Discount What is IRR? IRR = Internal Rate of Return is that rate of discount that makes/ reduces the Net Present Value (NPV) of a project is to Zero 20 Exercise: Year Cost Benefi t Discount Factor at 15% Discounted Cost Discounted Benefit D.F at 25% Discounted Cost Discounted Benefit 200 - 1.00 200 - 1.00 200 - 60 160 870 52.2 139.2 800 48.00 128.00 60 160 756 45.36 120.96 640 38.40 102.4 60 160 658 39.48 105.28 512 30.72 81.92 337.04 365.44 317.12 312.32 NPV = DTB – DTC NPV at 15% = 365.44 – 337.04 = 28.40 B/C at 15% = 365.44 337.04 = 1.08 NPV at 25% = 312.32 – 317.12 = - 4.8 IRR = 15 + 28.4 × (25 -15) 28.4 – (- 4.8) = 15 + 28.4 × 10 28.4 + 4.8 = 15 + 28.4× 10 33.2 = 15 + 8.55 = 23.55 IRR = 23.55% 21 10 Acceptability Criteria 10.1 NPV (Net Present Value) if if if NPV > NPV < NPV = ACCEPT REJECT AMBIGUOUS 10.2 BCR (Benefit Cost Ratio) if if if BCR > I BCR < I BCR = I ACCEPT REJECT AMBIGUOUS IRR > r IRR < r IRR = r ACCEPT REJECT AMBIGUOUS\ 10.3 IRR (Internal Rate of Return) if if if r = MARKET RATE OF INTEREST 22 11 The basic difference between Financial Appraisal &Economic Appraisal 23 12 Types of Project Appraisal 12.1 12.2 12.3 12.4 Financial / Commercial Appraisal Economic Appraisal Technical Appraisal Social Appraisal 24 13 Conclusion: 13.1 It involves comparison of costs and benefits 13.2 Objectives of a project Appraisal are needed because of limited resources, allocation of resources, investment analysis, etc 13.3 It involves Market, Technical, Financial, Management, Economic and Environment Feasibilities 13.4 It entails measurement of investment worthiness 13.5 Methods of calculation of profit worthiness is highly essential 13.6 Acceptability criteria are needed 13.7 Differences between Financial Analysis's and required 13.8 Finally, a project is appraised for investment and Economic 25 14 Farewell Call: 14.1 There is a widespread concern that adverse environmental effects of economic activities will seriously affect both the present and the future welfare of people in less developed countries, and that the present project appraisal practices not adequately address the issues 14.2 It is necessary to use the idea of sustainable development in project appraisal with the help of cost-benefit analysis methodology 26 27 ... 10 11 12 13 14 Introduction Definition of a Project Types of Project Project Cycle Project Appraisal Objectives of Project Appraisal Scope of Project Appraisal Methods of Calculating Profit Worthiness... VI Project Identification Project Preparation & Analysis Project Approval / Negotiation Project Appraisal Project Implementation & Monitoring Project Evaluation & Follow-up Analysis 4.3 A Project. .. between Financial Appraisal &Economic Appraisal 23 12 Types of Project Appraisal 12.1 12.2 12.3 12.4 Financial / Commercial Appraisal Economic Appraisal Technical Appraisal Social Appraisal 24 13