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LECTURE:06Development Project Appraisal

for sustainable development

M. A. Kamal, Ph.DDirector General

National Academy for Planning and Development

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Outline:1. Introduction2. Definition of a Project3. Types of Project4. Project Cycle5. Project Appraisal6. Objectives of Project Appraisal7. Scope of Project Appraisal8. Methods of Calculating Profit Worthiness9. Exercise10. Acceptability Criteria11. The basic difference between Financial Appraisal

&Economic Appraisal12. Types of Project Appraisal 13. Conclusion14. Farewell Call

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1. 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 crops in one locality, but cause water shortages, and hence economic, social and environmental pressures in another locality.

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2. Definition: Project2.1 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– A particular Period of time

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3. 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 do 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 do not give rise to tangible output but provide service benefits to the society.Example: School, College, Hospital, Training Institute.

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4. 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. Project Identification.II. Project Preparation & AnalysisIII. Project Approval / Negotiation IV. Project AppraisalV. Project Implementation & MonitoringVI. 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”

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4.4 Project Cycle

Identification

Evaluation Preparation

Implementation & Monitoring Appraisal

Approval

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5. Project Appraisal 5.1 Project Appraisal involves the comparison of

costs and benefits. If benefits exceeds costs, the project could be considered for acceptance Otherwise, it is not.

5.2 The basic principle in appraisal / CBA is for potential acceptance of a project.

5.3 Project Appraisal means a pre-investment analysis of a project to determine whether the project should be implemented or not.

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6. Objectives of Project Appraisal6.1 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.

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6. Objectives of Project Appraisal

6.6 A Project Appraisal involves detailed pre-investment analysis of market & technical feasibility, financial soundness, economic desirability and, finally, measuring its investment worth.

6.7 The task aims mainly at ensuring that scarce resources are put to most effective use.

6.8 It requires the combined efforts of a team of persons from various disciplines such as engineers, financial analysts, economists, etc. working in close co-ordination.

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7. Scope of Project Appraisal

7.1 Market Feasibility study.7.2 Technical Feasibility / viability.7.3 Financial Soundness.7.4 Management and Organizational

Aspects / Managerial Soundness.

7.5 Economic viability / Appraisal.7.6 Environmental Appraisal /

Viability.

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7.1 Market Feasibility

a) Whether does a sufficient demand exist?

b) In case of import substitution, whether the domestic cost of production is less than the cost of import.

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7.2 Technical Appraisala. 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

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7.3 Financial Soundnessa. Exhaustive & realistic cost estimationb. Sound capital structure: Fund Sourcec. Provision for working capital requirementd. Generation of sufficient cash flows to cover debt-

service liability. e. Generation of adequate profit.f. Safety margin.g. Break- Even Pointh. 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.

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7.4 Managerial Soundnessa. Experience of the top managerial

personnel in the line.b. Expertise and ability of supervisory

staff.c. Balance between supervisory staff

and workersd. Clarity of job description,

responsibility and accountability.

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7.5 Environmental AspectsThe environmental impacts include –

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, Land values.

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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 prime test of a project’s acceptability.

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8. Methods of Calculating Profit Worthiness.

8.1 Net Present Value = NPV8.2 Benefit Cost Ratio = B/C Ratio8.3 Internal Rate of Return = IRR

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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

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8.3 Formula for IRR: NPV

iii) IRR = LRD + LRD x ( HRD – LRD ) NPV - NPV

LRD HRDWhere,

LRD = Lower Rate of Discount at which NPV is positive;HRD = Higher Rate of Discount at which NPV is negative;NPV = Net Present value at the Lower Rate of Discount; LRDNPV = Net Present value at the Higher Rate of Discount. HRD

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.

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Year Cost Benefit Discount Factor at

15%

Discounted Cost

DiscountedBenefit

D.F at 25%

Discounted Cost

Discounted Benefit

0 200 - 1.00 200 - 1.00 200 -1 60 160 .870 52.2 139.2 .800 48.00 128.002 60 160 .756 45.36 120.96 .640 38.40 102.43 60 160 .658 39.48 105.28 .512 30.72 81.92

337.04 365.44 317.12 312.32

NPV = DTB – DTCNPV 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%

9. Exercise:

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10. Acceptability Criteria

10.1 NPV (Net Present Value) if NPV > 0 ACCEPT if NPV < 0 REJECT if NPV = 0 AMBIGUOUS

10.2 BCR (Benefit Cost Ratio) if BCR > I ACCEPT if BCR < I REJECT if BCR = I AMBIGUOUS

10.3 IRR (Internal Rate of Return) if IRR > r ACCEPT if IRR < r REJECT if IRR = r AMBIGUOUS\

r = MARKET RATE OF INTEREST

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11. The basic difference between Financial Appraisal &Economic Appraisal

Financial Appraisal Economic Appraisal a. Profitability or worthiness of any

project is determined or judged from the point of view of an individual/ Entrepreneur.

a. Profitability/ viability or worthiness of any project is determined or judged from the point of view of the society or nation as a whole.

b. Only direct cost and direct benefits are considered while determining the profitability of the project.

b. Include both direct and indirect cost and benefits.

c. Cost and benefit are evaluated at market prices.

c. Costs and benefits are evaluated at shadow price/ Accounting price.

d. Use Market Rate of Discount d. Use Social Rate of Discount.

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12. Types of Project Appraisal

12.1 Financial / Commercial Appraisal

12.2 Economic Appraisal12.3 Technical Appraisal12.4 Social Appraisal.

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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 and Economic Analysis's and required.

13.8 Finally, a project is appraised for investment.

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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 do 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.

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