Project Management

Financial and economic analysis

of investment projects

Ghent University – Department Agricultural Economics

 Essential questions

• Firm’s ability to meet its obligations

• Evaluate the return generated by the
investment
 Balance sheet
• Balance sheet describes on the one
hand the property of a firm (assets)
and on the other hand the way in
which these assets are financed
(liabilities)
• Assets are always equal to liabilities
• Balance sheet is important for the
need of financial needs (financing)
 Balance sheet

• Assets
– Fixed assets: investments in land,
buildings, machinery, …
– Current assets: stocks, accounts
receivable, cash, short term deposits, ...
 Balance sheet
• Liabilities: How assets have been financed
– Share capital and reserves
– Long term liabilities (>1 year): loans
– Short term liabilities (<1 year): loans, suppliers
credit, taxes, subsidies
 Financial ratios

• Financial, solvency, profitability

• Based on the balance sheet or profit
and loss account
 Liquidity
• Current ratio: current assets/current liabilities
0.8-2.0; >2=poor cash management
 Solvency
• Equity/total liabilities
• Long term liabilities/equity
• Cash flow/debt service
 Profitability
• Operating profit/turnover
• Profit before interest and taxes/fixed
assets
 Economic analysis

• Why a socio-economic analysis?

– Tax instruments weak
– Income distribution distorted
=> Much broader approach compared to a
financial analysis (individual organisation)
 Economic analysis

• 5 phases:
1) Financial analysis
2) Shadow prices to obtain net benefits
3) Project effects on savings and investments
4) Project impact on income distribution
5) Social value/analysis of products used/produced
 Economic analysis
• Social cost of a resource = total cost of the use
 Private cost (market cost)
 External cost (loss of welfare)
• Social benefits: value of benefits for society of
using the resources
• Social cost-benefit analysis of different options:
comparing opportunity costs or the willingness-
to-pay for the project
 Shadow prices
• Shadow prices = real value for society as a whole
= after adjusting for distortions
= opportunity cost
= value of its best alternative
• Examples: labour, fuel, milk…
 Problem: distorted markets
• In principle market prices reflect opportunity costs
of resources or WTP
• But: markets are distorted because of
– interventions by public authorities (e.g. currency value =>
use of shadow prices)
– project may influence market (corrected prices)
– externalities (welfare effects)
• Financial analysis needs to be corrected for these
distortions
 Why market distortions?
• Inflation
• Overvalueing currencies
• Labour market
• Imperfect capital markets
• Large scale projects
• Inelasticity of demand for export products
• Protectionism: import levies & export subsidies
• Lack of savings or public income
• Unbalanced distribution of income
• Externalities such as environmental impact
 Principles in calculating SP’s?
• World price approach:
- free trade on international markets
- but currencies artificial level, labour, …
• Opportunity cost approach:
- for inputs: withdrawing resources
- for outputs: benefit of alternative project, WTP
• Combining approaches:
- international oriented projects -> world market
- locally oriented projects -> opportunity costs
 Steps in determining SP’s?
1. Identify tangible and intangible goods
2. Eliminate all direct transfer payments
3. Value traded items
4. Value non-traded items
 Traded items
• Border prices such as CIF, FOB increased with
transportation and marketing costs (at project border)
• Parity prices: shadow price = alternative on
international markets
• 4 situations:
- inputs are imported = CIF + local costs
- inputs are exported without project = FOB
- outputs are exported = FOB
- outputs are substitute imports = CIF + local costs
 Non-traded items (1)
• CIF-price > local production cost > FOB because of
public intervention
• Use of market prices: project production is relatively
small; locally produced input from industry working at
full capacity
• New price => benefit for old users & correct price for
new users => (new + old price)/2
• Output substitution => resources saved in the other
market
 Non-traded items (2)
• Input from industry with overcapacity => opportunity
cost = marginal variable cost (not fixed cost)
• Combination of traded and non-traded goods
• Non-produced items such as labour and land
 Shadow exchange rate
• When governments intervene in financial
markets, the prices expressed in local currency
may not reflect the real value of input or output
• Example: custom duties of 20%
• Use of parity prices
 Negative externalities

• Cause a loss of welfare to (a group of)

individuals
• Are not compensated
• The size of the problem depends on:
– The number of individuals affected
– The scarcity of the resource
– The capacity of regeneration
 Internalisation of costs
• Problem: private individuals only look at private
costs and benefits
•  necessary to internalize the external cost
• Internalisation of cost can be:
– Endogeneous (scarcity)
– Exogeneous (command- and control measures like
standards or norms)
 Social benefits
Social benefits = Total Economic Value (TEV)

TEV = UV + EV + OV + QOV
With UV = use value
EV = existence value
OV = option value
QOV = quasi option value
Measuring non-market values
• The same principle as in case of distorted markets
can also be applied in case there is no market
(externalities): Measuring the WTP (for good
impacts) or WTA (willingness-to-accept) for bad
impacts
• Possible methods:
– hedonic prices (e.g. house price related to landscape)
– travel cost method
– contingent valuation