Yardstick International College

Department of business Master of business Administration

(MBA)

Project Analysis and management Assignment Two

(Third Semester online program)

Submitted by-Gezahegn Yenew

ID MAO/1924/13

Submitted to Instructor Zegeye Habtemariam (Ph.D)

October 2022 GC

1
Contents Page
Section One Financial Analysis of a Project..........................................................................................3
1. Introduction...................................................................................................................................3
2. Financial Analysis of a Project......................................................................................................3
a. Introduction...............................................................................................................................3
b. Definition, Scope and Importance of Financial Analysis............................................................3
i. What Is Financial Analysis?..................................................................................................3
ii. Scope of financial Analysis...................................................................................................3
iii. Importance of Financial Analysis......................................................................................5
c. Approaches in Financial Analysis of a project............................................................................6
i. Non-discounting methods......................................................................................................6
ii. Discounting Methods.............................................................................................................7
Differences and Similarities between financial and economic analysis of a project............................10
1. Introduction.....................................................................................................................................12
2. Definition, scope, and Importance of Economic Analysis...............................................................12
2.1. Definition of Economic Analysis................................................................................................12
2.2. Scope of Economic Analysis......................................................................................................12
2.3. Importance of Economic Analysis.............................................................................................13
3. Rationale for Economic Analysis....................................................................................................14
4. Valuation and Shadow Price............................................................................................................14
4.1. Pricing in economic analysis or Shadow pricing........................................................................15
4.2. Sources of Shadow pricing.......................................................................................................15
5. Basic Principles of shadow pricing..................................................................................................16
6. Use of shadow Price........................................................................................................................17
1. in project evaluation................................................................................................................17
2. in public policy........................................................................................................................18
7. Conversion Factor........................................................................................................................18
7. Approaches in Economic Analysis.................................................................................................19
7.1. LM-Approach............................................................................................................................19
7.2. UNIDO Approaches...................................................................................................................19
Reference.............................................................................................................................................21

2
 Section One Financial Analysis of a Project

1. Introduction
Financial analysis refers to an analysis of finance-related projects/activities or a company’s
financial statements, which includes a balance sheet, income statement, and notes to accounts
or financial ratios to evaluate the company’s results, performance, and its trend, which will be
useful for taking significant decisions like investment and planning projects and financing
activities. After assessing the company’s performance using financial data, a person presents
findings to the top management of a company with recommendations about how it can
improve in the future.

2. Financial Analysis of a Project

a. Introduction

Financial analysis is the process of evaluating businesses, projects, budgets, and other
finance-related transactions to determine their performance and suitability. Typically,
financial analysis is used to analyze whether an entity is stable, solvent, liquid, or profitable
enough to warrant a monetary investment.

b. Definition, Scope and Importance of Financial Analysis

i. What Is Financial Analysis?
Financial analysis refers to the process of analyzing a business' various finances to evaluate
its financial stability and future. Financial analysis helps business owners determine any
necessary courses of action they'll need to take to stay afloat, make a profit or avoid
bankruptcy. It also helps investors decide whether they will invest in your business. During
this process, a company's financial statements, such as their income statement and balance
sheet, are analyzed.

ii. Scope of financial Analysis

Within the general scope of financial analysis, there are several types to consider. Here are
seven types of financial analysis:

1. Vertical:- In vertical financial analysis, the relationship between various items on a

financial statement is analyzed. For example, during one accounting period, one item

3
 is measured against another item that's considered the base and the relationship is
expressed as a percentage. Though it only accounts for one time period, it can help
you recognize any changes over time and compare various entities
2. Horizontal:- Horizontal analysis refers to the evaluation of how financial statement
figures change over a period of time. In other words, it compares one item to another
in a different time period. Because of this, it can help analyze a business' finances
from one year to the next. Horizontal analysis is also known as dynamic analysis or
trend analysis, the latter being because this form of analysis can be useful in spotting
trends over time.
3. Liqudity:- Liquidity analysis uses ratios to determine whether or not a company will
be able to pay back any debts or other expenses. This type of analysis is helpful
because if a business isn't able to pay off any liabilities, they're bound to face financial
troubles in the near future. Liquidity analysis is particularly helpful for lenders or
creditors who want some insight into your financial standing before offering you a
loan or credit. Various ratios such as the cash ratio and current ratio are used in a
liquidity analysis
4. Profitability:- In a profitability analysis, a company's rate of return is evaluated. Every
business wants to be profitable, therefore, using the profitability analysis to measure
its cost and revenue in a given period can be highly beneficial for them. If a
company's revenue outweighs its costs, it's considered profitable. Profitability ratios—
margin and return ratios—are used in this type of analysis. These types of ratios
include the following:
 Margin ratios:- Gross profit margin, operating profit margin, net profit margin, ash
flow margin
 Returns Ratio:-Return on invest ( Assets), return of equity, ash returns of asset
5. Scenario and Sensitivity:- During this type of analysis, an investment's value is
measured based on current scenarios and changes. For example, it analyzes how
variable A is affected based on changes and sensitivities in other variables such as
variable B or C. Scenario and sensitivity analysis can even help analysts predict
certain outcomes based on different variables. They do so by studying the various
variable effects based on prior data and then making informed decisions based on
their findings.
6. Variance :-Variance analysis refers to the process of analyzing any differences between a
business's budget and the actual amount it spent. For example, if you budgeted your sales to

4
 be $1,000 but you actually sold $250, the variance analysis would conclude with a difference
of $750.

Once you know this, you can start to determine the cause for the variance and implement strategies
for avoiding any negative variances in the future. Variance analysis encompasses various types of
variances including purchase price variance, labor rate variance, fixed overhead spending variance
and material yield variance.

7. Valuation:-Through the valuation financial analysis, your business's present value is

evaluated. This type of analysis can be utilized for various instances including mergers and
acquisitions or taxable events. There are different types of valuation ratios including
price/earnings and price sales. Once you determine your company's ratios, you can begin to
compare them to your company's past ratios, your competitor's ratios or your particular
industry at large.

iii. Importance of Financial Analysis

Financial analysis helps the company understand its financial condition. It is also useful to
learn the creditworthiness, profitability, and ability to generate wealth. Therefore it gives a
more in-depth look at how well it operates internally. 
The analysis of financial statements is crucial for the following reasons.
1. The shares investment and holding
Shareholders own the company; such investments happen with repeated transfers and shares.
Time and again, they may have to decide on whether to continue based on the price, profit,
and reliability factors. Therefore, a company's analysis of the financial statement is crucial to
making decisions. As it reflects all information that is meaningful to the shareholder's
decision process.
2. Plans, decisions, and management
Financial statement analysis is essential for a company's decisions, planning, and
management. As a result, the company management makes smart and intelligent calls on
investment plans. These are backed by data analytics when planning for a bright future and
maximum profits accrual.
Thus, compared to statements in the recent past, the future goals and predicted performances
are endemic to the decision-making of shareholders, companies, and analysts.
3. Providing credit
Shareholders offer loans to the company as its capital. The decision to provide and extend
capital credit is based on a financial examination. The examination is based on the company's

5
financial statements and performance over time. All capital loans carry an interest rate and
determine the best rate. They are also a part of the decision process in making credit loans to
companies.
4. Decisions on investments
Investors with surplus investable capital always look for opportunities to place their funds as
investments in profitable and profit-potential companies. Before investing such capital funds,
investors look at the past performance and predicted profits
In general the goal of financial analysis is to analyze whether an entity is stable, solvent,
liquid, or profitable enough to warrant a monetary investment. It is used to evaluate
economic trends, set financial policy, build long-term plans for business activity, and
identify projects or companies for investment.

c. Approaches in Financial Analysis of a project

i. Non-discounting methods
The basic capital investment decision methods can be classified into two major categories:
non-discounting methods and discounting methods. Non-discounting methods ignore the time
value of money, whereas discounting methods explicitly consider it. Even though a lot of
accounting theorists criticize the non-discounting methods because they ignore the time value
of money, many firms continue to use these methods in making capital investment decisions.

A. Ranking by Inspection:- With the same investment, two projects produced the same net
value of incremental production for a period, but one continues to earn longer than the other.
In other instances, for the same investment total net value of incremental production may be
the same, but one project has more of the flow earlier in the time sequence say in the second
year itself than the other in the third year. In many cases projects can indeed be examined or
rejected on the basis of inspection. A clear-cut case may be two alternative investments, one
of which will cost more than the return. Such a choice project analysis must be done before
selecting any projects.
B. Payback Period: Payback period is the length of time from the beginning of the project to
until the net value of the incremental production stream reaches the total amount of the
capital investment. The payback period is a basic and common means of choosing among
investments in business enterprises, especially when the choice entails a high degree of risk.
In fisheries projects, however it is not often used. The two important weaknesses of the
paybackperiodare:-
• It fails to consider earnings after the payback period. Hence payback period is an inadequate

6
criterion for the choice between these two alternatives.
• It does not take into account the timings of the proceeds (time value of money).
C. Proceeds per Unit outlay:- Investments are sometimes ranked by the proceeds per unit out
lay, which is the total net value of incremental production divided by the total amount of the
investment. The criterion for proceeds per unit of outlay fails to consider timing or time value
of money; money to be received in the future weighs as heavily as money in hand today.
D. Average Rate of Return:-Another criterion for investment choice is the average annual
proceeds per unit of outlay, which is obviously related to proceeds per unit outlay. To
calculate this measure, the total of the net value of incremental production is first divided by
the number of years it will be realized and then this average of the annual proceed is divided
by the original outlay for the capital items. This investment criterion has a very serious flaw.
As it fails to take into consideration the length of the time of the benefit stream. It
automatically introduces a serious bias towards short-lived-investment, with high cash
proceeds.

ii. Discounting Methods

Many economic decisions including fish production involve benefits and costs that are
expected to occur at future time period. The construction of ponds race ways and fish tank for
example, requires immediate cash outlay, which with the production and sale of fish, will
result in future cash inflows or returns. In order to determine whether the future cash inflows
justify present initial investment, we must compare money spent today with the money
received in the future. The time value of money influences many production decisions.
Everyone prefers money today to money in the future. Therefore in order to invest a rupee in
fish production today, one must be guaranteed a return in the future that is equal to or greater
than the rupee invested today.

A.Net Present Value: - The basic financial concept of time value money states that the money
you have known is more valuable than the money you collect later on. This is because you
can use it now to earn more money by running a business or buying something now and
selling it later for more, or simply putting it in the bank and earning more interest. The money
received in the future is also less valuable because inflation erodes its purchasing power. But
how do you compare the value of money now with the value of money in the future? This is
where net present value plays an important role. Let us discuss what net present value is.

7
Net Present Value or NPV is the sum of the present value of cash inflows and outflows. In
other words, it is the difference between the present values of cash inflows and the present
value of cash outflows over some time.

NPV is a strong approach to determine if the project is profitable or not. It considers the
interest rate, which is generally equivalent to the inflation rate, Hence, the real value of
money now at each year of operation is considered.

Following are the formulas used to calculate NPV.

In case of even cash flows, the following NPV formula can be used:

NPV=R×1− (1+i) −ni−Initial Investment

Here,

-n is the total life of the project in months, years, etc.

-i is the required rate of return per period.

-R is the estimated periodic net cash flows.

B.Benefit cost ratio:-The benefit cost ratio (or benefit-to-cost ratio) compares the present
value of all benefits with that of the cost and investments of a project or investment. These
benefits and costs are treated as monetary cash flows or their equivalents, e.g. for non-
monetary benefits or company-internal costs. Its meaning depends on the value it is
indicating. For the interpretation, refer to the following 3 generic ranges of BCR values:

Value Range of Benefit Cost Ratio Generic Interpretation

BCR < 1 Investment option generates losses.
BCR = 1 Investment option is neither profitable nor lossy.
BCR > 1 Investment option is profitable

What Does a BCR < 1 Indicate?

The present value of the benefits in a series of cash flows is lower than the present value of
the corresponding costs. The lower the BCR, the higher the excess of discounted costs
compared to the discounted benefits.

In general, pursuing investments with a negative BCR is not recommended. The same holds
basically true for different project options.

8
However, there are certain types of projects that need to be conducted even if they are not
generating sufficient tangible or quantifiable benefits to cover the costs, e.g. the
implementation of regulatory or legal requirements. In these cases, the option with the
highest BCR (yet below 1) may be the least unprofitable implementation scenario.

What Is the Meaning of a BCR = 1?

The present value of benefits of a series of cash flows equals the likewise discounted costs.
This situation is obviously more preferable than options with a BCR lower than 1. However,
if there are alternatives with a benefit-to-cost ratio exceeding 1, they are likely to be favored.

How Is a BCR > 1 Interpreted?

This value range indicates that the discounted benefits exceed the present value of the costs
and investments. The general rule is that the higher the BCR the greater the profit an
investment option or project is expected to generate.

Apart from the benefit cost ratio, there are other important quantitative and qualitative
considerations though – in reality, a project or investment decision is based on a number of
different criteria rather than relying on the BCR only.

C.Internal Rate of Return:-The internal rate of return (IRR) is a metric used in financial
analysis to estimate the profitability of potential investments. IRR is a discount rate that
makes the net present value (NPV) of all cash flows equal to zero in a discounted cash flow
analysis. IRR calculations rely on the same formula as NPV does. Keep in mind that IRR is
not the actual dollar value of the project. It is the annual return that makes the NPV equal to
zero.

Generally speaking, the higher an internal rate of return, the more desirable an investment is
to undertake. IRR is uniform for investments of varying types and, as such, can be used to
rank multiple prospective investments or projects on a relatively even basis. In general,
when comparing investment options with other similar characteristics, the investment with
the highest IRR probably would be considered the best.

 Modified Internal Rate of Return (MIRR)

The modified internal rate of return (MIRR) assumes that positive cash flows are reinvested
at the firm's cost of capital and that the initial outlays are financed at the firm's financing
cost. By contrast, the traditional internal rate of return (IRR) assumes the cash flows from a
project are reinvested at the IRR itself. The MIRR, therefore, more accurately reflects the
cost and profitability of a project. Meanwhile, the internal rate of return (IRR) is a discount

9
rate that makes the net present value (NPV) of all cash flows from a particular project equal
to zero. Both MIRR and IRR calculations rely on the formula for NPV.

Differences and Similarities between financial and economic analysis of a

project
Financial and Economic analyses are essentially used to determine the costs incurred and the
resulting benefits from investing in a project. They both involve ascertaining the NPV or the
net present value of a project based on its estimated present and future cash flows,
appropriately discounted. (Helfert, et.al, 2001) Both techniques, however, differ in their
implications and hence also in what are defined as a cost and a benefit. Financial and
economic analyses have similar features. Both estimate the net-benefits of a project
investment based on the difference between the with-project and the without-project
situations. In this article we are going to differentiate between economic and financial
analysis.

Below mentioned are some of the key points that helps us understand the difference
between economic and financial analysis.

Financial Analysis– Financial analysis is largely confined to individual organizations or

their units. It involves a fairly quantitative, fund-based approach that directly compares the
expenses and revenues from a venture to determine profitability and hence sustainability.
Such evaluation may often employ the financial statement of an enterprise – the balance
sheet, the income statement and the cash flow statement. For example in an oil drilling
company evaluating an independent project they are setting up a new well. If the present
value of the annual cash flows were to exceed the initial investment and other costs such as
taxes, possible interest payments and operational expenses, the project would be looked upon
favourably. Additionally, the firm might also look at the project’s effect on its financial ratios
to be certain about feasibility.

Economic Analysis– Economic analysis takes a much wider view and entails the impact of a
project on society as a whole. It considers the viewpoints of all stakeholders and how the
results of a project align with the broader economic and social policies as well as the
International scenario. The costs in an economic analysis are a measure of the resources that a

10
society collectively invests for the fulfilment of the project. The benefits, however, need not
be just monetary and often include intangible benefits.

Difference Between economic And Financial Analysis

Financial Analysis

 Financial analysis tends to rely on exact market prices for calculating

costs. (Vanhegan,et.al,2012)
 Taxes are treated as costs and subsidies as returns.

 Interest payments are treated as a cost in financial analysis as they are the additional
amount that the stakeholder has to pay to external bodies along with returning the
borrowed capital.

 A financially feasible project, therefore, might not be economically viable if the

overall impact on society is negative.

 The financial analysis compares benefits and costs to the enterprise.

 financial analysis uses market prices to check the balance of investment and the
sustainability of a project,

Economic Analysis

 The market price is often modified to arrive at what is popularly known as the
‘shadow price’ or ‘economic price’
 Taxes are levied on a project’s returns and are collected by the government itself.

 Interest on capital invested by society is also returned to society as a gain on the

capital, thus again removing the need for any separate computation. (Vogel,2020)

 An economically viable project may not always be financially sustainable. The

government may, however, choose to take up such a project by supplying additional
funds, owing to its positive impact on society.

 The economic analysis compares the benefits and costs to the whole economy.

11
 Economic analysis uses economic prices that are converted from the market price by
excluding tax, profit, subsidy, etc. to measure the legitimacy of using national resources
to certain projects.

Technique for calculating NPV/IRR is same for both (their similarity)

Part II Economic Analysis of a Project

1. Introduction
Economic Analysis takes a much wider view and entails the impact of a project on society as
a whole. It considers the viewpoints of all stakeholders and how the results of a project
aligned with the broader economic and social policies as well as the international scenario.
The costs in economic analysis are a measure of the resources that society collectively invests
for the fulfilment of the project. The benefits, however, need not be just monetary and often
include intangible benefits.
Economic analysis is very important as it allows organizations and their donors to compare
the impact of social intervention to the cost of implementing it. These comparisons aid in
determining the most effective resource allocation. 
 Economic analysis is a type of assessment that helps answer the question "is it worth it?" in
addition to the question "does it work?" that other impact evaluations address. Economic
analysis has been more prominent in the impact measurement practices of charities and
donors in recent years, as the sector has been under increasing pressure to give estimates of
what value is created for every pound invested.

2. Definition, scope, and Importance of Economic Analysis

2.1. Definition of Economic Analysis

Economic analysis involves assessing or examining topics or issues from an economist’s

perspective. Economic analysis is the study of economic systems. It may also be a study of a
production process or an industry. The analysis aims to determine how effectively the
economy or something within it is operating. For example, an economic analysis of a
company focuses mainly on how much profit it is making.

2.2. Scope of Economic Analysis

12
The following are some of the scopes of economic analysis
 Cost Effectiveness Analysis
 Cost Utility Analysis
 Cost Benefit Analysis
 Cost Analysis
 Effectiveness Analysis
 Cost and outcome description
 Cost description
 Outcome description

2.3. Importance of Economic Analysis

The following are the importance of economic analysis.

1. Dealing with a shortage of raw materials: - Economics provides a mechanism for
looking at possible consequences as we run short of raw materials such as gas and oil.
2. How to distribute resources in society:-To what extent should we redistribute income in
society? Is inequality necessary to create economic incentives or does inequality creating
unnecessary economic and social problems?
3. To what extent should the government intervene in the economy? :-A critical divide in
economics is the extent to which the government should intervene in the economy.
4. The principle of opportunity cost: - Politicians win elections by promising more
spending and cutting taxes. This is because lower taxes and more spending is what voters
want to hear. However, an economist will be aware that everything has an opportunity cost.
5. Social efficiency.-The free market leads to countless examples of market failure. I feel one
of the best uses of economics is to provide solutions to overcoming market failure. For
example, driving into the centre of town creates negative externalities such as pollution and
congestion. There is overconsumption. An economist can suggest a tax on driving into towns
to internalise the externality. Of course, new taxes are not popular, but, it might provide a
better solution for society. You may not want to pay £10 a week to drive into a city centre.
But, if it saved you two hours of sitting in a jam, then maybe you would be much happier to
pay it.
6. Knowledge and understanding: - One of the principal jobs for economists is to
understand what is happening in the economy and investigate reasons for poverty,
unemployment and low economic growth. Economic studies can try and evaluate the costs

13
and benefits of free movement of labour. Economic studies can try to examine the economic
effects of immigration. This can help people make a decision about political issues.
7. Forecasts: - Economic forecasts are more difficult than understanding the current
situation. However, although forecasts are not always reliable, they can help give decision-
makers an idea of possible outcomes.

3. Rationale for Economic Analysis

The overall analysis was conducted in four steps:

1) Technical assessment;
2) Performance assessment;
3) Evaluation of intervention strategies; and
4) Economic analysis (business case, life cycle costing).
The economic challenge is to align Functional Life with Technical Life, both at the level
of the object and at the network level. The quest is for an economic optimum between
intervention for replacement and/or rehabilitation on the one hand, and performance on
the other. The optimisation principle is to minimise the combined costs associated with
asset operation. These are the costs of life extension and the costs of expected (residual)
disruptions in service and/or function. Investments are made until the cost of the last
investment (i.e. the marginal cost) no longer outweighs the further improvements in
safety of the asset (i.e., the marginal benefits). At this point – where marginal costs equal
marginal benefits – the total costs are minimal, and the extended life of the asset is safe
and economically optimal. Both higher and lower levels of safety than the economically
optimal one lead to higher total economic costs.
The economic analysis can be made more realistic by means of dynamic optimisation,
allowing such factors as economic growth, climate change and changing demands for
infrastructure services to be taken into account (Figure 3). This enables the analyst to
address the ‘when’, ‘how much’ and ‘when again’ questions associated with rehabilitation
and replacement for safe life extension.

4. Valuation and Shadow Price

A valuation is an estimate of how much a business, property, antique or any asset is worth. If
you have a business and seek funding from investors, they will need to know how much your

14
enterprise is worth. This is achieved through a valuation – an estimate of the company’s
overall worth.

There are many reasons why somebody may decide to have a business valued:

 to improve the business’ real or perceived value

 to choose a good time to buy or sell the commercial enterprise

 to negotiate a better price – either as a seller or buyer

 to complete the purchase of the business more rapidly

 to raise equity capital

 to create an internal market for shares

 To motivate management – regular valuations can provide a measurement and

inventive for management performance and help management to focus on important
issues.

4.1. Pricing in economic analysis or Shadow pricing

Shadow pricing is defined as allotting a monetary value to a current intangible item that does

not yet have a market of its own to derive an actual price. It is also defined as the maximum
amount that an organization is agreeable to pay for one extra unit of a resource.

This relates to the supposed advantage the company can derive from that extra unit.
Shadow pricing is often considered a limited concept as it can be applied to particular
situations during financial analysis.

It is estimated to be the assumed price of services, products, activities, and tasks that have no
market price. It can also be called an opportunity cost or a proxy value. Shadow pricing
means the highest price that someone is willing to pay for one extra unit of something.

It is used in calculating cost-benefit analysis where some products cannot be quantified by

referring it to a market cost. It is the artificial price that is given to an accounting entry or a
non-priced asset. It is subjective to assumptions as there is a lack of dependable data to fall
back on.

15
4.2. Sources of Shadow pricing

The need for shadow prices arises as a result of “externalities” and the presence of
distortionary market instruments. An externality is defined as a cost or benefit incurred by a
third party as a result of production or consumption of a good or services. Where the external
effect is not being accounted for in the final cost-benefit analysis of its production. These
inaccuracies and skewed results produce an imperfect market mechanism which inefficiently
allocates resources.

5. Basic Principles of shadow pricing

The following are the basic principles of shadow pricing

a. Efficiency and Social Shadow Prices

Two basic types of shadow prices exist, depending on how sensitive society is to income
distribution considerations. Consider the national goal of maximizing the present value of
aggregate consumption over a long period. If the consumption of different individuals is
added directly regardless of their income levels, then the resulting shadow prices are
efficiency prices because they reflect the pure efficiency of resource allocation. Alternatively,
if consumption of low-income groups needs to be raised, shadow prices may be adjusted by
income group to give greater weight to the poor in aggregate consumption. Such prices are
called social prices. In practice, such formal weighting schemes are seldom used in project
evaluation. Instead, distributional and other social issues are addressed by direct targeting of
beneficiaries and similar ad hoc methods. In brief, efficiency shadow prices try to establish
the economic values of inputs and outputs, while social shadow prices take account of the
fact that the income distribution between different societal groups or regions may be distorted
in terms of overall national objectives. Our analysis will place primary emphasis on
efficiency shadow pricing.

b. Common Property Resources and Externalities

Non-priced inputs and outputs like common property resources and externalities (especially
those arising from environmental impacts) must be shadow priced to reflect their economic
opportunity costs.

16
Access to common property resources is unrestricted, and thus exploitation tends to occur on
a first come, first served basis, often resulting in (unsustainable) overuse. Public goods are
environmental resources (e.g., scenic view) that are freely accessible and indivisible (i.e.,
enjoyment by one individual does not preclude enjoyment by others). These properties lead to
―free riding – a situation in which one user, (either knowingly or unknowingly), uses the
resource at a price less than the it‘s efficient cost, and thereby takes advantage of greater
contributions by others.

Externalities are defined as beneficial or adverse effects imposed on others for which the
originator of these effects cannot charge or be charged. If a (damaging) externality can be
economically valued or shadow priced, then a charge or tax may be levied on the perpetrator,
to compensate for and limit the damage. This is the so called ―Pigouvian or ―price control‖
approach to environmental regulation. The basic concepts and techniques for economic
valuation of environmental impacts underlying this approach are discussed later.
Unfortunately, many externalities are difficult to measure not only in physical terms but also
in monetary equivalents (i.e., willingness to pay). Quite often therefore, the ―quantity
control‖ approach is taken, by imposing regulations and standards, expressed in physical
measurements only that try to eliminate the perceived external damages (e.g., safe minimum
standards for pollution). Especially when environmental pollution is severe and obvious,
setting standards could serve as a useful first step to raise consciousness and limit excessive
environmental damage, until more accurate valuation studies can be carried out. In such
cases, the initial emphasis is on cost effectiveness (i.e., achieving pollution targets at the
lowest cost), rather than valuing the benefits of control measures.

In practice, it is often prudent to use a variable mix of both price and quantity controls to
protect the environment. A mixed system allows the various policy instruments to be flexibly
adjusted depending on marginal cleanup costs. In this way, an optimal outcome can be
approached even without full information concerning control costs

6. Use of shadow Price

The following will be the use of shadow pricing.

17
1. in project evaluation

It is a great tool for evaluating the effects of a task or a project on the national income of a
country. It is prepared based on cost-benefit analysis or profitability criterion where you can
calculate benefits and cots at accounting prices. It is vital to remember that even if you get a
rough estimate via shadow pricing, it can prove a great help.

2. in public policy

It is impossible to take on the development plans of the public sector unless you have

estimate prices of foreign exchange, capital, and labor as per the shadow pricing. The success
of planning is heavily dependent on intrinsic prices gained through shadow pricing. At most
times, these are rough estimates, but it is the responsibility of the country to bring the market
pricing near the projected shadow prices via monetary and fiscal changes.

3. in programming

Shadow prices have much importance in programming. In the context of developing

countries, programming means the optimum use of investment whereby there is no difficulty
in the production process. But, in reality, the difficulties of supplies of factors, rise in market
prices and the scarcity of foreign exchange are found in such economies. All such problems
are overcome with the help of shadow prices.

The use of fiscal, monetary and other policies by the state help in bringing the market prices
of products, factors and foreign exchange in conformity with their shadow prices and thus
make investment programming a success. Thus shadow prices are a useful and important
devise for the success of project evaluation, public policy and investment programming.

There are numerous advantages of shadow pricing, and some of them are described below-

 it is a useful tool that is used to know the advantages associated with the cost of extra
use of a resource
 It comes in handy when you have to convert resources into social costs

 Can convert assumed impacts into social benefits

 It is a device that is used for the optimal allocation of resources

 Shadow pricing avoids under-pricing

18
  The best part is that it takes into account the economic opportunity cost.

7. Conversion Factor
The conversion factor is a key element in hedge calculations and, more generally, in the
analysis of all market operations including bonds and futures.
When a futures contract is held until maturity, the delivery price of a bond for physical
settlement of the future is obtained by multiplying the bond's price with its conversion factor.
CF = EP/FP (EP=economic price, FP= financial price)

• Labor unskilled- is an outdated term, once used to describe a segment of the workforce
associated with a limited skill set or minimal economic value for the work performed. The
correct term is low-wage labor.

• Labor skilled- refers to highly trained, educated, or experienced segments of the workforce
that can complete more complex mental or physical tasks on the job. Skilled labor is often
specialized and may require a prolonged period of training and experience.

• Composite CFs e.g., Construction based on breakdown

• For other commodities, remove transfers (taxes, subsidies), other distortions

• For imports, adjust for transport, distribution costs

The following are Usual Conversion Factors Used

• Standard conversion factor (SCF), Shadow exchange rate factor (SERF) ,Shadow wage rate
factor (SWRF) and CF for labor,

4. Unskilled labor typically 0 to 0.75 in labor surplus economies

5. Implies output lost elsewhere is 0% to 75% of wage; opportunity cost of unskilled

labor
6. SWRF= opportunity cost/ wage rate

7. Skilled labor: SWRF = 1.0

7. Approaches in Economic Analysis

7.1. LM-Approach

19
Little-Mirrlees Approach (I.M.D.):- Little and James A. Mirrlees have developed an approach
to SCBA which is famously known as L-M approach. The core of this approach is that the
social cost of using a resource in developing countries differs widely from the price paid for
it. Hence, it requires Shadow Prices to denote the real value of a resource to society.

7.2. UNIDO Approaches

UNIDO approach measures cost and benefits in terms of consumption. The UNIDO approach focuses
on efficiency, savings and redistribution aspects in different stages. UNIDO Approach consumption
cost and benefits. The UNIDO approach focuses on savings, redistribution and efficiency in different
stages.

Conclusion

To conclude it can be said that financial analysis is largely confined to individual

organizations or their units. It involves a fairly quantitative, fund-based approach that directly
compares the expenses and revenues from a venture to determine profitability and hence
sustainability. On the other hand Economic analysis takes a much wider view and entails the
impact of a project on society as a whole. It considers the viewpoints of all stakeholders and
how the results of a project align with the broader economic and social policies as well as the
International scenario. The costs in an economic analysis are a measure of the resources that
a society collectively invests for the fulfilment of the project. Both are essentially used to
determine the costs incurred and the resulting benefits from investing in a project. They both
involve ascertaining the NPV or the net present value of a project based on its estimated
present and future cash flows, appropriately discounted. Financial analysis tends to rely on
exact market prices for calculating costs. On the other hand the market price is often modified
to arrive at what is popularly known as the ‘shadow price’ or ‘economic price’.  A financially
feasible project, therefore, might not be economically viable if the overall impact on society
is negative. Similarly an economically viable project may not always be financially
sustainable. The government may, however, choose to take up such a project by supplying
additional funds, owing to its positive impact on society.

20
Reference
 Helfert, E. A., & Helfert, E. A. (2001). Financial analysis: tools and techniques: a
guide for managers (pp. 221-296). New York: McGraw-Hill.

21
 Peterson, P. P., & Fabozzi, F. J. (1994). Financial management and analysis. New
York,, USA: McGraw-Hill.

 Vogel, H. L. (2020). Entertainment industry economics: A guide for financial

analysis. Cambridge University Press.

 Cooter, R. D., & Rubinfeld, D. L. (1989). Economic analysis of legal disputes and
their resolution. Journal of economic literature, 27(3), 1067-1097.

 Vanhegan, I. S., Malik, A. K., Jayakumar, P., Ul Islam, S., & Haddad, F. S. (2012). A
financial analysis of revision hip arthroplasty: the economic burden in relation to the
national tariff. The Journal of bone and joint surgery. British volume, 94(5), 619-623.

 Orlewska, E., & Mierzejewski, P. (2004). Proposal of Polish guidelines for

conducting financial analysis and their comparison to existing guidance on budget
impact in other countries. Value in Health, 7(1), 1-10.

 Halpern, P., Trebilcock, M., & Turnbull, S. (1980). An economic analysis of limited
liability in corporation law. The University of Toronto Law Journal, 30(2), 117-150.

 Fromlet, H. (2001). Behavioral finance-theory and practical application: Systematic

analysis of departures from the homo oeconomicus paradigm are essential for realistic
financial research and analysis. Business economics, 63-69.

 Bacchetta, M. D., Girardi, L. N., Southard, E. J., Mack, C. A., Ko, W., Tortolani, A.
J., … & Lee, L. Y. (2005). Comparison of open versus bedside percutaneous
dilatational tracheostomy in the cardiothoracic surgical patient: outcomes and
financial analysis. The Annals of thoracic surgery, 79(6), 1879-1885.

 https://www.investopedia.com/terms/m/mirr.asp

 https://blog.imarticus.org/what-is-importance-of-financial-analysis/

 https://www.investopedia.com/terms/i/irr.asp

 https://corporatefinanceinstitute.com/resources/knowledge/finance/discounting/

 http://ecoursesonline.iasri.res.in/mod/page/view.php?id=146334#:~:text=%EE
%80%80Ranking%20by%20inspection%EE%80%81%20With%20the%20same
%20investment,%20two,the%20flow%20earlier%20in%20the%20time%20sequence
%20

22
https://omanessay.com/differences-between-economic-analysis-and-financial-analysis/

 https://www.investopedia.com/terms/s/skilled-labor.asp#:~:text=Skilled%20labor
%20refers%20to%20highly%20trained,%20educated,%20or,require%20a
%20prolonged%20period%20of%20training%20and%20experience.
 https://www.adb.org/sites/default/files/page/149401/conversion-economic-prices-
2014.pdf
 https://marketbusinessnews.com/financial-glossary/valuation-definition-meaning/
#:~:text=A%20valuation%20is%20an%20estimate%20of%20how%20much,an
%20estimate%20of%20the%20your%20company%E2%80%99s%20overall
%20worth.
 https://www.coursehero.com/file/124072201/PPT4ppt/
 https://www.researchgate.net/figure/Rationale-for-economic-
analysis_fig1_320979306

23
24