Salale University

College of Agriculture and Natural

Resource
Department of Agricultural
Economics
Project Planning and Management
(Fors4123)

Instructor : Nigusu Abera

(MSc)
 Introduction
• Project planning and analysis has a long history
in financial and business analysis.

• Project planning has always been used as a means

of checking the profitability of a particular
investment by private firms.

• The selection criteria have also included economic

criteria on top of financial criteria.

• Projects are now assessed from the economy’s

viewpoint instead of only from the firm’s perspective.

• Thus, projects are the cutting edge of

development.
 Introduction…Cont’d
• Perhaps the most difficult problem confronting
administrators in developing countries is
implementing development programs.

• Much of the failures can be traced to poor project

preparation.

• Especially, from development viewpoint, for most

development activities requires careful
preparation in advance of expenditure.

• The basic characteristics of capital expenditure

(just project), is that it typically involve current
outlay of funds in the expectation of a stream of
benefits extending far into the future.
 What is a Project?
 It can be defined as an investment activity in which
financial resources are expended to create capital
assets that produce benefits over an extended
period of time.

 It is a unique process consisting of a set of

coordinated and controlled activities with start and
finish dates.

 Undertaken to achieve an objective conforming to

specific requirements, including constraints of time,
cost, quality and resources.
 From this definition, we can understand that;
• A Project has a planned set of activities

• A Project has a scope

• A Project has time, cost, quality and resource

constraints
 What is a Project…Cont’d
 It is an economic activity with a well-defined
objective with certain durations and gains to
entrepreneurs.

 It is a scientifically evolved work plan devised

to achieve a specific objective within a specified
period of time.

 It is an individual or collaborative enterprise

that is carefully planned to achieve a particular aim.

 Thus, we generally think of an agricultural project

as an investment activity in which financial
resources are expended to create capital
assets that produce benefits over an
extended period of time.
 What is a Project…Cont’d
 In some projects, however, costs are incurred for
production expenses or maintenance from which
benefits can normally be expected quickly, usually
within about a year.

 Projects are a part of an overall development

strategy and a broader planning process.

 Project analysis tells us something about the effects

of a proposed investment on the participants in the
project, whether they are;
• farmers,
• small firms,
• government enterprises, or

• the society as a whole.

 Characteristics of a
• Objectives :
Project
o A project has a set of objectives or a mission.

o Once the objectives are achieved the project is

treated as completed.

• Life cycle :
o A project has a life cycle.

o The life cycle consists of five stages i.e.

conception stage, definition stage, planning
& organizing stage, implementation stage
and commissioning stage.
 Characteristics of a Project…Cont’d
• Uniqueness :
o Every project is unique and no two projects are
similar.

o Setting up a cement plant and construction of a

highway are two different projects having unique
features.

• Team Work :
o Project is a team work and it normally consists of
diverse areas.

o There will be personnel specialized in their

respective areas and co-ordination among the
diverse areas calls for team work.
 Characteristics of a Project…Cont’d
• Complexity :
o A project is a complex set of activities relating to
diverse areas.

• Risk and uncertainty :

o Risk and uncertainty go hand in hand with
project.

o A risk-free, it only means that the element is not

apparently visible on the surface and it will be
hidden underneath.

• Customer specific nature :

o A project is always customer specific.
 Characteristics of a Project…Cont’d
o It is the customer who decides upon the product
to be produced or services to be offered and
hence it is the responsibility of any organization
to go for projects/services that are suited to
customer needs.
• Change :
o Changes occur through out the life span of a
project as a natural outcome of many
environmental factors.
o The changes may very from minor changes,
which may have very little impact on the project,
to major changes which may have a big impact
or even may change the very nature of the
project.
 Characteristics of a Project…
Cont’d
• Optimality :
o A project is always aimed at optimum utilization of
resources for the overall development of the economy.

• Sub-contracting :
o A high level of work in a project is done through
contractors.

o The more the complexity of the project, the more will be

the extent of contracting.

• Unity in diversity :
o A project is a complex set of thousands of varieties.

o The varieties are in terms of technology, equipment and

materials, machinery and people, work, culture and
others.
 Types of Project
• 1.Short Term Vs. Long Term Projects

• 2.Large, Medium and Small Projects

• 3. Classification of projects by type and area

• 4. Sequential Vs. Parallel Projects

• 5. External Vs. Internal Projects

 Short Term Vs. Long Term Projects
 A project is considered to be short term if it could
be concluded during a year; and long term if it
could take more than a year.

 Examples:
• Short Term;
 Relief Aid to Natural Disaster Areas
 Buying/ selling a Car/ house

• Long Term;
 Construction of Mega
Structures/Dams/bridges/Sky Scrapers/Cities.
 Development of Complex Medicines’
Formulae/ Pharmaceuticals
 Insurance Claim
 Large, Medium and Small

Projects
The Projects are categorized as Large, Medium
and Small on the basis of the following:
• Total financial resources available

• Number of team members involved

• Number and size of deliverables to be

produced

• Complexity of deliverables to be produced

• Time frames involved in delivery

 The main distinguishing features are project

size and complexity.
 Classification of projects by type
and area
 Technical projects:
• Construction of a building or structure;
• Developing of a new product line;
• Software development
 Organizational projects
• Reorganizing or creating a new company;
• Implementation of a new system of management;
• Execution of an international conference or
exhibition.
 Economical projects
• Privatization of the company;
• Introduction of financial planning and budgeting;
• Introduction of a new taxation system
 Classification of projects …Cont’d
 Social projects;
• Reform of welfare;
• Social protection of vulnerable population;
• Overcoming the effects of natural and social
disasters.

 Mixed projects
• Restructuring plan of the company, including;
the introduction of a system of financial
planning and budgeting,

development and implementation of special

software
 Sequential vs. Parallel Projects
 There are two main types according to the workflow
management of the projects.
• Sequential projects: Task should be done in a
specific order.
o Not so much flexible
o Problem in complex design issues
o Every step will be monitored
Example: Building a house
• Parallel projects: Tasks can be done in any order.
o Task management of the staff is important
o Challenges of the project manager
o Critical steps should be defined in depth
Example: Studying for lectures
 Internal Projects vs. External
Projects
 Internal project: Optimization of organizational
processes. To support external projects in general.
• Examples:-
Upgrading the company's IT infrastructure
Essentially any endeavor that will enhance the
day-to-day activity of the company
– Problems associated with internal projects are
never as stable as projects run for external
customers
 External Projects….Cont’d
 External project:
• On behalf of the external clients.
• Usually well-planned, well-thought out, and well-
funded.
• Client oriented projects.

Examples:
Developing accounting software designed
specifically for another company.

Installing a prepaid system for a mobile

carrier.
 Approaches to project
planning
• Several participatory approaches have been
developed to assist in project planning and
implementation.

• The purpose is to create better and sustainable

projects that apply appropriate methods to focus on
real problems especially from the perspectives of
beneficiaries, or right- holders in rights based
projects.

• Such approaches also help to pay attention to

monitoring and evaluation in the planning stage of a
project.

• Some approaches are explained below.

 Approaches …Cont’d
 Appreciative Inquiry; builds on existing strengths,
resources and accomplishments of a community.

• The goal is to improve the self-esteem and

initiative of the community and its members,
ultimately to enhance the ability to develop
itself further.

• This approach includes four stages:

definition, hypothesis, design and destiny
which are used for a project planning.

 Outcome Mapping; is a participatory

approach developed for planning, monitoring
and evaluation, where the outcome is defined
as the changes of behavior and action of people
 Approaches …Cont’d
• This approach emphasizes learning, for
instance, through monitoring and evaluating both
the progress and selected methods of the project.
 Logical Framework Approach (LFA); The Logical
Framework Approach provides assistance to all
the stages in the project cycle from planning to
evaluation.

• The purpose of LFA is to ensure the planning

and implementation of a functional project and a
useful evaluation process.

• In LFA there are two main phases: analysis

and planning.
 The Links Between Project and
Program
 It is necessary to distinguish between projects and
programs because there is sometimes a tendency to
use them interchangeably.

 A project refers to an investment activity where

resources are used to create capital assets, which
produce benefits over time and has a beginning and an
end with specific objectives,

 A program is an ongoing development effort or plan

which may not necessarily be time bounded.

 Examples: a road development program, a health

improvement program, a nutritional improvement
program, a rural electrification program, etc.
 The links between …Cont’d
 A development plan is a general statement of
economic policy.

 National development plans are further

disaggregated into a set of sectorial plans.

 A development plan or a program is therefore a

wider concept than a project.

 Thus, development plan or program may

include one or several projects at various
times whose specific objectives are linked to the
achievement of higher level of common objectives.
 The links between …Cont’d
 For instance: a health program may include;
 a water project as well as
 a construction of health centers project
• Both aimed at improving the health of a given
community, which previously lacked easy access
to these essential facilities.
• Projects, which are not linked with others to
form a program, are sometimes referred to as
“stand alone” projects.
• Projects in such context are the concrete
manifestations of the development plans in a
specific place and time.
• One can think of projects as subunits and bricks of
programs, which constitute the national plan
(usually the direction is from plans to projects).
 The links between …Cont’d
• We have to note that projects could be either public
or private.

• It is the smallest operational element prepared

and implemented as a separate entity in a national
plan or program.

• From the above discussion it can be seen that the

major difference between a project and a
program is not so much in objectives stated but
lies more in scope, the details and accuracy.

• A project is designed with a high degree of precision

and details as regards its objectives, features,
calculation of returns and implementation plan.
 The links between …Cont’d
 A program by contrast is general, lacks details and
precision and aims at a broader goal often related to a
sectorial policy of a country or departmental policy of an
organization.

 Perhaps the distinction between projects and programs

would be clear if we see the basic characteristics of
projects.

 Projects in general need to be SMART.

• S – Specific
• A project needs to be specific in its objective.

• A project is designed to meet a specific objective

as opposed to a program, which is broad.
 The links between …Cont’d
• A project has also specific activities.

• Projects have well defined sequence of

investment and production activities and a
specific group of benefits.

• A project is also designed to benefit a specific

group of people.

 M - Measurable
• Projects are designed in such a way that investment
and production activities and benefits expected
should be identified and if possible be valued
(expressed in monetary terms) in financial,
economic and if possible social terms.
 The links between …Cont’d
• Though it is sometimes difficult to value especially
secondary costs and benefits of a project,
attempt should be made to measure them.

• Measure costs and benefits must lend

themselves for valuation and general projects are
thought to be measurable.

 A – Area bounded
• As projects have specific and identifiable group of
beneficiaries, so also have to have boundaries.

• In designing a project, its area of operation

must clearly be identified and delineated.
 The links between …Cont’d
• Though some secondary costs and benefits may
go beyond the boundary, its major area of
operation must be identified.

 R – Real
• Planning of a project and its analysis must be
made based on real information.

• Planner must make sure whether the project fits

with real social, economic, political,
technical, etc. situations.

• This requires detail analysis of different aspects

of a project.
 The links between …Cont’d
 T – Time bounded
• A project has a clear starting and ending
point.

• The overall life of the project must be

determined.

• Moreover, investment and production

activities have their own time sequence.

• Every cost and benefit streams must be

identified, quantified or valued and be
presented year-by-year.
 Chapter 2
Project Planning and
Cycle
 The Concept of Project
Planning
• Project planning is a discipline addressing how to
complete a project in a certain timeframe, usually
with defined stages and designated resources.

• One view of project planning divides the

activity into these steps:
 Setting measurable objectives
 Identifying deliverables
 Scheduling
 Planning tasks

• Planning enables project managers to turn an

intangible idea into reality.
 The Concept of Project …
Cont’d
• Supporting plans may encompass
human resources, communication
methods and risk management.

• Enterprises often have an information

technology project planning guide
that identifies the processes used.

• Tools used for the scheduling parts of

a plan include Gantt charts and
PERT charts.
 The Concept of Project …
Cont’d
• Key purposes of planning include the
following:
• facilitate communication and provide a central
source of information for project personnel;
• help the project sponsor and other key stakeholders
know what is required;
• identify who will perform certain tasks, and when
and how those tasks will happen;
• facilitate project management and control as the
project progresses;
• enable effective monitoring and control of a project;
• manage project risk; and
• generate feedback useful for the next project
planning phase.
Project Planning
Process/Steps
 Contents of Project
Master Plan
• A master plan is a long-term dynamic
planning document that provides a conceptual
framework to drive project development and
growth.

• Successful project managers are masters at

creating comprehensive project plans that
define project;
• scope,
• cost,
• planning,
• activities and
• resources.
Contents of Project
Master Plan
 Project Planning
Tools
• Project planning tools help everyone
concerned keep track of project
requirements and deadlines.

• Some of the most popular project

planning tools include the following:

•Gantt Chart
•Network diagram
•Critical Path Method (CPM)
 Gantt Charts
• Gantt charts are an industry standard that helps in
tracking both time and interdependencies
between tasks

• Gantt charts are an essential tool to show

different phases, jobs, and resources involved in
project management
• A network diagram is a graphical representation
of a project and is composed of a series of
connected arrows and boxes to describe the
inter-relationship between the activities
involved in the project.
 Critical Path Method
(CPM)
• Critical Path Method (CPM) is a crucial tool for
determining the progress of the project to ensure
that the project is on schedule.

• CPM helps in determining the essential or critical

path by finding out the longest stretch of
dependent tasks.
 Project Cycle
• It is a sequence of events which a project
follows.

• These events, stages or phases can be

divided into several equally valid ways,
depending on the executing agency or parties
involved.

• Some of these stages may overlap.

• Capital expenditure decision is a complex

decision process, which may be divided into six
broad phases:
Project Cycle…Cont’d
• 1. Identification

• 2. Pre-feasibility Study

• 3. Feasibility (technical, financial, economic)

• 4. Selection and project design (Appraisal)

• 5. Implementation

• 6. Ex-post evaluation
Project Cycle…Cont’d
Identificati
on

Pre-feasibility
Ex-post
Study
evaluation

Feasibility
Implementa
tion Appraisal
 Identification
• The first stage in the project cycle is to find potential
projects.

• Identification of promising investment opportunities

requires imagination, sensitivity to environmental
changes, and a realistic assessment of what the firm
can do.

• This phase may take two forms.

• If the project is largely a private venture in a widely
market economy context, the initiating entity will define
the concept, expectation and objectives of the project.

• On the other hand the project idea can also emanate

form government agencies in the context of
government development plans.
Identification…Cont’d
• In the latter case sectoral information (i.e.
the direct and indirect demands of sectors)
is an important source of identification.

• In market economy context, anticipated

demand for the projects output is important.

• In addition to assessment of appropriate

technology, scale of the project, timing
of the project etc. are important.

• All types of specialists’ input are required

at this stage.
Identification…Cont’d
• The planning phase of a firm’s capital
investment is concerned with the articulation of
its broad investment strategy and the
generation and preliminary screening of project
proposal.

• The investment strategy of the firm

delineates the broad areas or types of
investment the firm plans to undertake.

• This provides the framework, which

shapes, guides, and circumscribes the
identification of individual project opportunities.
Identification…Cont’d
• In general there are four major sources from
which ideas or suggestions for project may come:
• Project ideas from technical specialists
• Project ideas from local leaders
• Project ideas from entrepreneurs
• Project ideas from government policy and plans

• Some of these projects may appear for

reasons nothing to do with the national plan.

• In such circumstances its advantageous to

understand the ‘political history’ of the
project.
 Identification…
Summary
• The identification of project ideas is based on
several aspects of development.
• Need - a need assessment survey may show the
need for intervention
• Market demand - domestic or overseas
• Resource availability - opportunity to make
available resources more profitable
• Technology - to make use of available technology
• Natural calamity - intervention against natural
calamity such as flood or drought
• Political considerations

• Possible alternative project must be

adequately assessed.
 Pre-feasibility Study
• The identification process will give the background
information for defining the basic concept of the
project, which leads to the feasibility study stage.

• Once a project proposal is identified, it needs to be

examined.

• To begin with, a preliminary project analysis is done.

• A prelude to the full blown feasibility study, this exercise is

meant to assess;
• (i) whether the project is prima facie worthwhile to justify a
feasibility study and
• (ii) what aspects of the project are critical to its variability
and hence warrant an in-depth investigation.
 Pre-feasibility Study…
Cont’d
• At the pre-feasibility study stage the analyst obtains
approximate valuation of the major components
of the projects costs and benefits.
• Some of the main components examined during
the pre-feasibility study include:

• Availability of adequate market

• Project growth potential
• Investment costs, operational cost and distribution costs
• Demand and supply factors; and
• Social and environmental considerations

• If the project appear viable form this preliminary

assessment the analysis will be carried to the
feasibly stage.
 Feasibility Study
• The major difference between the pre-feasibility
and feasibility studies is the amount of work
required in order to determine whether a project
is likely to be viable or not.

• If the preliminary screening suggests that the

project is prima facie worthwhile, a detailed an
analysis of the marketing, technical, financial,
economic, and ecological aspects will is
undertaken.

• The focus of this phase of capital budgeting is on

gathering, preparing, and summarizing relevant
information about various project proposals, which are
being considered for inclusion in the capital investment.
 Feasibility Study…Cont’d
• Based on the information developed in this
analysis, the stream of costs and benefits
associated with the project can be defined.

• At this stage a team of specialists

(Scientists, engineers, economists,
sociologists) will need to work together.

• At this stage more accurate data need to be

obtained and if the project is viable it should
proceed to the project design stage.
 Feasibility Study…
Cont’d
• The feasibility report should contain the
following elements:
• 1) Market analysis

• 2) Technical analysis

• 3) Organizational analysis

• 4) Financial analysis

• 5) Economic analysis

• 6) Social analysis, and

• 7) Environmental analysis
 Appraisal
• The feasibility study would enable the project analyst
to select the most likely project out of several
alternative projects.

• Selection follows, and often overlaps, analysis.

• It addresses the question - is the project

worthwhile?

• Wide ranges of appraisal criteria have been developed

to judge the worthwhile of a project.

• They are divided into two broad categories; the

non-discounting criteria versus discounting
criteria.
 Appraisal…Cont’d
• The level of risk pursued influences choice of the
project.

• Despite a wide range of tools and techniques for risk

analysis, risk analysis remains the most
intractable part of the project evaluation
exercise.

• This exercise also involves the undertaking of

detailed;
• engineering design;
• manpower and administration requirement as well
as
• marketing procedures.
 Implementation
• After the project design is prepared negotiations with
the funding organization starts and once source of
finance is secured, implementation follows.

• Implementation is the most important part of

the project cycle.

• The better and more realistic the project plan

is, the more likely it is that the plan can be carried
out and the expected benefits realized.

• Project implementation must be flexible since

circumstances change frequently.
Implementation…Cont’d
• Project analysts generally divide the implementation
phase into three time periods.
• the investment phase, where the major
investments are made. This may extend from three to
five years.
• the development phase, which may also extend
from three to five years.
• the project life

• Translating an investment proposal into a

concrete project is a complex, time consuming and
risk fraught task.

• Delays in implementation, which are common, can

lead to substantial cost overrun.
 Ex-post
Evaluation
• The final phase of the project is the evaluation phase.

• Many usually neglect this stage.

• The project analyst looks carefully at the

successes and failures in the project experience
to learn how better to plan for the future.

• In this stage, it is important to examine the project

plan and what really happened.

• Performance review should be done periodically to

compare actual performance with projected
performance.
 Ex-post Evaluation…
Cont’d
• A feedback device is useful in several ways:
• (i) it throws light on how realistic were the
assumptions underlying the project;
• (ii) it provides a documented log of experience
that is highly valuable in future decision making;
• (iii) it suggests corrective action to be taken in the
light of actual performance;
• (iv) it helps in uncovering judgment biases;
• (v) it induces a desired caution among project
sponsors.

• Weakness and strengths should carefully be

noted so as to serve as important lessons for
future project analysis undertaking.
 CHAPTER 3
Aspects of project preparation and analysis
2.1. Aspects of project preparation
The project analyst must consider several aspects (feature)
when carrying project analysis.
Aspects (feature) : a distinctive attribute of something. a part of
the Project analysis making a significant contribution to its
overall appearance of project.

The major aspects of project preparation and analysis are

outlined bellow …….

62
1. Technical Analysis
This aspect is concerned with
 the projects inputs (supplies) and outputs of real gods and
services and
 the technology of production and processing.
Technical analysis is the prerequisites for the successful
commissioning of the project with respect to location, size, process,
etc.
This because it is from this aspect that all the physical quantity of
input and output will be determined for the estimation of costs and
benefits. 63
• In general the technical analysis is primarily concerned
with
• Material inputs and utilities
• Manufacturing process and technology
• Input – output relationship and product mix
• Plant capacity, Location
• Machines and equipment
• Project design and civil works
• Technical study of a project provides the basis for all other
aspects of a project study, since a technically unfeasible project
cannot be promoted. 64
2. Demand and market Analysis
The study of this aspect need to ensure the existence of effective
demand at remunerative price (input & output).
Market analysis is basically concerned with two questions;
a. what would be the aggregate demand of the proposed product
or service in future.
 Who are the customers, income, taste & preference, substitutability
of the product
b. what would be the market share of the project?
 to do so you have to know what is the level of sales and what is the
sales of others.

65
3. Financial Analysis
It seeks to ascertain whether the proposed project will be
financially viable in servicing debt and in satisfying the return
expectations of these who provide the capital.
The project analyst is concerned with:
identify the financial efficiency, incentive impact to the participants
in the project, creditworthiness and liquidity, establishes the
magnitude of costs and benefits and evaluating the project
profitability by comparing costs versus revenues using realistic
market prices

66
 Factors to be considered in financial analysis include:
 investments outlay and running costs
 means of financing, Cost of capital
 Projected profitability
 cash flow of the project
 Projected financial position
 Level of financial risk
 Time value of money
 Financial analysis must generate future financial statements
and financial ratio analysis so as to ascertain financial
feasibility. 67
4. Economic Analysis
 Economic analysis is primarily concerned with the determination
of the likelihood of the proposed project by justifying the
significance of the project from the whole economy point of view
(the society as a whole).
 Economic analysis views the project form the society’s point of
view.
 Decision makers concerned about the investment of scarce capital
and other resources that will best optimize national objectives.
 Economic analysis uses ‘economic prices’ or ‘shadow prices’ or
‘efficiency prices’ to value inputs and outputs.
68
 Thus economic analysis require adjustment of market prices into
economic prices.
 The questions that must be answered in social cost benefit analysis
are:
 What are the direct economic benefits/costs of the project
measured interims of shadow/efficiency prices (not in terms of
market prices)?
 What would be the impact of the project on the distribution of
income in the society? (Does it lead to equal distribution?)
 What would be the impact of the project on the level of saving and
investment in the society?
 What are the direct and indirect benefits and costs of the project to
the society (external economies and diseconomies?)

69
5. Social Analysis
Project analysts are expected to examine the broader social
implications of the proposed project.
social goals that should be considered might include issues of
 income distribution implications of the project
 employment creation
 balanced regional development,
 the displacement impact of the project,
 the gender implication of the adopted technology, etc.

70
6. Ecological Analysis:
This should be done particularly for those projects which have
significant ecological implications like power plants, irrigation
schemes, chemical plants, leather processing, etc.
The key questions raised in ecological analysis are:
 What are the likely damages caused by the project to the
environment?
 What is the cost of restoration measures required to ensure that
the damage to the environment is contained with in acceptable
limit and who shall bear the cost?

71
7. Institutional-Organizational-Managerial Aspects
 Project analysis must make a detail analysis of project
organization and management. This analysis aims at
answering the following questions:
 Is the organizational set-up of the project adequate?
 Will the project be provided with competent personnel to manage
it?
 Can competent staff be recruited freely, locally or overseas?
 But even if the right staff is available, their success will
depend mostly on the institutional set-up i.e., the relationship
between the implementing agency with related institutions like
subsidiary companies, banks, transport companies and others.

72
 Once the right institutions to facilitate project implementation are
available, the project should be implemented by competent,
responsible and committed managers.
 So, managerial issues are critical for successful completion of
projects.
 Thus the project analyst must examine the ability of the available
staff whether they have the capacity to carry out the managerial
needs of the project.

73
 Chapter 4
Identifying and Describing
Project Costs and Benefits
 What are project
objectives?
• Project objectives are what you plan to
achieve by the end of your project.

• This might include deliverables and

assets, or more intangible objectives
like increasing productivity or motivation.

• Your project objectives should be;

• attainable,
• time-bound,
• specific goals you can measure at the end
of your project.
 What are project …Cont’d
• Project objectives are a critical element of
project management —without them;
o you don’t have a concise way to communicate your goals
before and during the project,

o nor do you have a measurable way to

evaluate your success after the project ends.

• Though some teams may use these

interchangeably, there is a distinct difference
between project goals vs. objectives.

• In general, project goals are higher-level than

project objectives.
 What are project …Cont’d
• Your project goals should outline;
• what happens once your project is
successful, and

• how your project aligns with overall

business objectives.

• Project objectives, on the other hand, are;

• more detailed and

• specific than project goals.

 Project Costs
• The Project Costs are any expenditures;
• made or estimated to be made, or
monetary obligations incurred or

• estimated to be incurred to complete the

project which are listed in a project
baseline.

• Project Cost is the total funds needed to

complete the project or work that consists of
a Direct Cost and Indirect Cost.
 Project Benefits
• A project benefit is an outcome of the
project that is seen as a positive change by
one or more stakeholders.

• The proposed deliverables are linked to

organizational needs and goals so as to produce
desired benefits.

• Realized benefits will provide a return on

investment and contribute to strategic planning
objectives.

• To assess its successful delivery, a project

benefit must be able to be measured.
 Costs of Agricultural
Projects
• In almost all project analyses, costs are
easier to identify (and value) than benefits.

• In every instance of examining costs we will

be asking ourselves if the item reduces;

• the net benefit of a farm or

• the net income of a firm (our objectives in

financial analysis), or

• the national income (our objective in economic

analysis).
 Costs of Agricultural …
Cont’d
1. Physical goods:
• Rarely will physical goods used in an
agricultural project be difficult to identify.

• For such goods as;

o concrete for irrigation canals,

o fertilizer and pesticides for increasing

production, or

o materials for the construction of homes in

land settlement projects,
 Costs of Agricultural …
Cont’d
2. Labor:
• From the highly skilled project
manager to the farmer maintaining his
orchard while it is coming into
production,

• the labor inputs raise less a question of

what than of how much and when.

• Labor may, however, raise special

valuation problems that call for the use
of a shadow price.
 Costs of Agricultural …
Cont’d
3. Land
• By the same reasoning, the land to be used
for an agricultural project will not be
difficult to identify.

• It generally is not difficult to determine

where the land necessary for the project
will be located and how much will be used.

• Yet problems may arise in valuing land

because of the very special kind of market
conditions that exist when land is transferred
from one owner to another.
 Costs of Agricultural …
Cont’d
4. Contingency allowances
• It would clearly be unrealistic to rest project
cost estimates only on these assumptions
of perfect knowledge and complete price
stability.

• Sound project planning requires that

provision be made in advance for possible
adverse changes in physical conditions or prices
that would add to the baseline costs.

• Contingency allowances are thus included as

a regular part of the project cost estimates
 Costs of Agricultural …
Cont’d
5. Taxes
• Recall that the payment of taxes, including duties
and tariffs, is;
• customarily treated as a cost in financial
analysis but

• as a transfer payment in economic analysis

(since such payment does not reduce the
national income).

• The amount that would be deducted for taxes in

the financial accounts remains in the economic
accounts as part of the incremental net benefit
and, thus, part of the new income generated by
the project.
 Costs of Agricultural …
Cont’d
6. Debt service
• The same approach applies to debt
service - the payment of interest and
the repayment of capital.

• Both are treated as an outflow in

financial analysis.

• In economic analysis, however, they

are considered transfer payments.
 Costs of Agricultural …
Cont’d
7. Sunk costs
• Are those costs incurred in the past upon which
a proposed new investment will be based.

• Such costs cannot be avoided, however poorly

advised they may have been.

• When we analyze a proposed investment, we

consider only future returns to future costs;
expenditures in the past, or sunk costs, do
not appear in our accounts.

• Examples: Sunk cost include rent and

subscription fees
 Direct and tangible benefits of
agricultural projects
• Tangible benefits of agricultural projects can arise either
from an increased value of production or from
reduced costs.

1. Increased production
• Increased physical production is the most common
benefit of agricultural projects.

• Example:
• An irrigation project permits better water control so that
farmers can obtain higher yields.

• Young trees are planted on cleared jungle land to increase

the area devoted to growing oil palm/coffee prodction.

• The benefit is the increased production from the

farm.
 Direct and tangible benefits …
Cont’d
2. Quality improvement
• In some instances, the benefit from an
agricultural project may take the form of an
improvement in the quality of the product.

• For example, the analysis for the livestock

development project in Ethiopia, which was to
extend loans to producers of beef cattle, assumed
that ranchers would be able not only to increase
their cattle production but also to improve the
quality of their animals.

• As in the examples above, quality improvement

are most often expected in agricultural projects.
 Direct and tangible benefits
…Cont’d
3. Change in time of sale
• In some agricultural projects, benefits will
arise from improved marketing facilities
that allow the product to be sold at a time
when prices are more favorable.

• A grain storage project may make it possible

to hold grain from the harvest period, when the
price is at its seasonal low, until later in the
year when the price has risen.

• The benefit of the storage investment arises

out of this change in "temporal value."
 Direct and tangible benefits …
Cont’d
4. Change in location of sale
• Other projects may include investment in trucks
and other transport equipment to carry products
from the local area where prices are low to
distant markets where prices are higher.

• For example, the Fruit and Vegetable Export

Project in Turkey included provision for trucks
and ferries to transport fresh produce from
southeastern Turkey to outlets in the
European Common Market.

• The benefits of such projects arise from the

change in "locational value."
 Direct and tangible benefits …
Cont’d
5. Changes in product form (grading and
processing)
• Projects involving agricultural processing
industries expect benefits to arise from a change in
the form of the agricultural product.

• In the Himachal Pradesh Apple Marketing

Project in northern India, the value of the apples
farmers produce is increased by sorting; the
best fruit is sold for fresh consumption while fruit of
poorer quality is used to make a soft drink
concentrate.

• In the process, the total value of the apples is

increased.
 Direct and tangible benefits
…Cont’d
6. Cost reduction through mechanization
• The classic example of a benefit arising from
cost reduction in agricultural projects is that
gained by investment in agricultural
machinery to reduce labor costs.

• Examples are tube wells substituting for hand-

drawn or animal-drawn water, pedal threshers
replacing hand threshing, or (that favorite
example) tractors replacing draft animals.

• Total production may not increase, but a benefit

arises because the costs have been trimmed
 Direct and tangible benefits
…Cont’d
7. Reduced transport costs
• Cost reduction is a common source of
benefit wherever transport is a factor.

• Better feeder roads or highways may

reduce the cost of moving produce from
the farm to the consumer.

• The benefit realized may be distributed

among farmers, truckers, and
consumers.
 Direct and tangible benefits
…Cont’d
8. Losses avoided
• Total production will change very little as a result of
the investment, yet both the farmers and the
economy will realize a real benefit because the new
investment prevents loss of income.

• The Lower Egypt Drainage Project involves the

largest single tile drainage system in the world.

• The benefit will arise not from increasing

production in the already highly productive Nile
delta, but from avoiding losses due to the
waterlogging caused by year-round irrigation
from the Aswan High Dam
 Direct and tangible benefits
…Cont’d
9. Other kinds of tangible benefits
• Although we have touched on the most common kinds of
benefits from agricultural projects, those concerned with
agricultural development will find other kinds of
tangible, direct benefits most often in sectors other than
agriculture.

• Benefits may arise not only from cost reduction, as

noted earlier, but also from time savings, accident
reduction, or development activities in areas newly
accessible to markets.

• If new housing for farmers has been included among the

costs of a project, as is often the case in land
settlement and irrigation projects, then among the
benefits will be an allowance for the rental value of
the housing.
 Secondary Costs and
Benefits
• Projects can lead to benefits created or costs
incurred outside the project itself.

• Economic analysis must take account of these

external, or secondary costs and benefits so they
can be properly attributed to the project investment.

• Of course, this applies only in economic analysis;

the problem does not arise in financial analysis.

• Thus, it is necessary to estimate the secondary

costs and benefits and then add them to the direct
costs and benefits. This is a theoretically difficult
process, and one easily subject to abuse.
 Secondary Costs and Benefits…
Cont’d
• Instead of adding on secondary costs and
benefits, one can either adjust the values used in
economic analysis or incorporate the secondary
costs and benefits in the analysis, thereby in effect
converting them to direct costs and benefits.

• Incorporating secondary costs or benefits in

project analysis can be viewed as an analytical device
to account for the value added that arises outside
the project but is a result of the project
investment.

• Every item is valued either at its opportunity cost

or at a value determined by a consumer's willingness
to pay for the item.
 Secondary Costs and Benefits…
Cont’d
• For example;
• it is common to consider the output of irrigation
projects as the increased farm production, since
valuing irrigation water is difficult.

• Another example is found in development roads

built into inaccessible areas.

• Technological spill-over or technological

externalities

• Negative or positive ecological effects in

construction of dam: - it can increase spread of
schistosomiasis and malaria, it can increase/decrease
in fish catches, many down-stream effects, etc.
 Intangible Costs and
Benefits
• Almost every agricultural project has costs and
benefits that are intangible.

• These may include creation of new job

opportunities, better health and reduced infant
mortality as a result of more rural clinics, better
nutrition, reduced incidence of waterborne disease
as a result of improved rural water supplies, national
integration, or even national defense.

• Such intangible benefits are real and reflect true

values.

• They do not, however, lend themselves to

valuation.
 Intangible Costs and
Benefits…Cont’d
• How does one derive a figure for the long-
term value of a child's life saved, or for the
increased comfort of a population spared
preventable from debilitating disease?

• Benefits of this kind may require a modification

of the normal benefit-cost analysis to a least-
cost type of analysis.

• Because intangible benefits are a factor in

project selection, it is important that they be
carefully identified and, where at all possible,
quantified, even though valuation is
impossible.
 Intangible Costs and
Benefits…Cont’d
• For example;
• How many children will enroll in new schools?

• How many homes will benefit from a better

system of water supply?

• How many infants will be saved because of more

rural clinics?

• The projects giving intangible benefits have

many a times tangible costs e.g.,
construction costs for schools, salaries for
nurses in a public health system, pipes for
rural water supplies, and the like
 Intangible Costs and
Benefits…Cont’d
• Intangible costs, however, do exist in projects.

• Such costs might be incurred;

• if new projects disrupt traditional patterns
of family life,

• if development leads to increased pollution,

• if the ecological balance is upset, or if

scenic/attractive values are lost.
 Intangible Costs and
Benefits…Cont’d
• Again, although valuation is impossible,
intangible costs should be carefully identified and
if possible quantified.

• In the end, every project decision will have to

take intangible factors into account through a
subjective evaluation because;

• intangible costs can be significant and

• intangible benefits can make an important

contribution to many of the objectives of
rural development.
 Chapter 5

Financial Analysis

105
 Financial Analysis
• Financial analysis answers the question “is
the project financially profitable to a given
individual, group or business? Is the project
financially sustainable?”
• In financial analysis costs and benefits
are valued at market prices

106
 5.1 Objectives of financial Analysis

• Assessment of financial impact on participants:

Farmers
Firms
Government
Other financers
• Judgment of efficient resource use-investment
and ratio analysis.
• Assessment of incentives - related with returns.
• Provision of sound financial plan-provide base
for (activities and corresponding budget).

107
 Important Variables in Financial
Analysis

• Revenues and cost items

• Sources of financing

• Financial viability

Kassa T (PhD) 108

 5.2 Financial Ratios
• Financial ratios will base on financial
statements:
• Balance sheet (Asset-current and fixed assets;
Liabilities-current and long-term liabilities;
Capital- owners equity).
• Income statement (Revenues and Expenses).
• Cash flow [source and use of fund] statement
(cash inflows = benefits; cash outflows =
costs, net cash balance or net benefit).
 i. Efficiency ratio:

• Inventory turnover (ITO) = Cost of

goods sold (CGS) / Inventory
• Operating ratio = Operating
Expenses/ Revenue.
 ii. Income (Profitability) ratio

• Return on sales = Net Income / Revenue

• Return on Equity = Net Income After Tax /
Equity
• Return on Investment = average net income/
total investment
• Return on Assets = Operating Income / Assets
 iii. Creditworthiness ratio

• Current ratio = Current Assets / Current

Liability
• Debt-equity ratio: Long-term Liability /
Equity
• Debt-Service Coverage ratio = Net Income
+ Depreciation + Interest / Interest Paid +
Long-term Loan Repayment.
5.3 PROJECT SELECTION CRITERIA
• The most common project evaluation
criteria are classified into two categories
1. Non-discounting (traditional) criteria
a)Payback Period (PBP)
b)Accounting Rate of Return (ARR)
2. Discounted Cash Flows (DCF) criteria
a)Net Present Value (NPV)
b)Internal Rate of Return (IRR)
c)Profitability Index (Benefit-cost ratio) 113
 Payback Period
• The payback period is the length of time
required to recover the initial investment.
• According to the payback criterion, the
shorter the payback period, the more
desirable the project is.
• If the net cash inflow is uniform each year,
then,

IntialInvestment
Payback Period 
AnnualUniformCashInflow
114
 Example
• A project requires an initial investment of
Br. 24,000 and annual after tax cash flows of
Br. 6000 for five years. How long it takes the
company to recover its initial investment?
PBP = 24,000/6000
= 4 years
• It is expected to take the company four years
to recover the project’s initial investment of
115
Br. 24,000
• If the cash flows of a project are not uniform,
the payback period is calculated by
accumulating a series of cash flows until the
amount reaches the initial investment.
 PBP= Years before full recovery + Un recovered cost
• Cash flow during the next year

• EX
Year 0 1 2 3 4 5

Cash flow -30000 5,000 12,000 12,000 6,000 8,000

The payback period = 3 years + 1000 * 12 = 3 yrs and 2 months

6000

116
 Con’t
Advantages of payback period
• It is simple to apply
• It is helpful in weeding out risky projects.
• It helps to assess the firm’s ability to meet its
financial obligations
Disadvantages of payback period
• It ignores the time value of money.
• It overlooks cash flows beyond the payback period.
• It may divert attention from profitability

117
Average Rate of Return

118
Discounted measures of project
worth
Time value of money
•Present values are better than the same
values in the future and earlier returns
are better than later. This shows that
money has time value. Thus, to include
the time dimension in our project
evaluation, we have to use discounting
methods.

119
• Discounting is essentially a technique
that ‘reduces’ future benefits and costs
to their ‘present worth’. The rate used
for discounting is called discount rate.
• As compounding asks “what is the
future worth of a known present
amount”? discounting asks “what is the
present worth of a known future
amount”?

120
• The factor used to discount future costs
and benefits is called the discount
rate (r) and is usually expressed as a
percentage.
• The discount rate is usually determined
by the central authorities (national
Bank).

121
• Suppose a bank lends 1567.05 Birr for
a project at 5% interest rate. The
project owner is supposed to repay the
principal & interest rate after 5 years.
How much the owner will have to pay
at the end of year 5?
At = P(1 + r) t
At = total amount after t years
r = interest rate
t = time
A5 = 1567.05 (1 + 0.05)5
= 2000 Birr 122
 a) The Net Present Value (NPV)
• The net present value of project is the
difference between the present value of net
cash inflows and present value of initial
investment. In formula,
n
Ct
NPV =   I0
i 1 1  r 
t

• NPV = Net present value, Ct = Net cash flows at the

end of year t(Ct=Bt-Ct)
• n = Life of the project r = Discount rate I0 =
Initial investment

• NPV = PV of NCF – I0 123

Con’t…
The net present value formula if t starts from zero is:

( Bt  Ct )
n
NPV  t
t 0 (1  r )

Where:
Bt stands for the project benefits in period t
Ct stands for the project costs in period t
r, stands for the appropriate financial or economic
discount rate
n, stands for the number of years for which the
project will operate, i.e. the economic life of the
project 124
 Decision Rule:
• If the NPV is positive, accept the
project.
• If the NPV is zero, be indifferent
• If the NPV is negative, reject the
project.
• If we compare two or more projects, the
higher the NPV, the better the project is.

125
 Undiscounted Discounted
1 2 3 4 5
Year(t) Costs Benefit Net benefits Discount factors Discounted Net Benefits (Net
(Cash flow) (10%)= 1/(1+0.10)-t Cash Flow) (3)*(4)
(2) – (1)
0 20 0 -20 1/(1+0.10)0 = 1.000 -20(1.000) = -20.00
1 10 14 4 1/(1+0.10)1 = 0.909 4(0.909) = 3.64
2 10 14 4 1/(1+ 0.10)2 = 0.826 4(0.826) = 3.30
3 10 14 4 1/(1+0.10)3 = 0.751 4(0.751) = 3.00
4 10 14 4 1/(1+0.10)4 = 0. 683 =2.73
5 10 14 4 =0.621 =2.48
6 10 14 4 =0.564 =2.26
7 10 14 4 =0.513 =2.05
8 10 14 4 =0.467 =1.87
9 10 14 4 =0.424 =1.70
10 10 14 4 1/(1+0.10)10 = 0.386 4(0.386) = 1.54
Total 120 140 20.00 1/(1+0.10)t = 6.144 NPV = 4.57
126
Advantages of NPV
• The time value of money is taken into account
• The cash flows from the beginning to the end of the
project are considered
• It focuses on the profitability of the project
• It is useful for the comparison of mutually exclusive
projects
• Since the NPV is expressed in Dollar or Birr, the
managers can understand it more easily than percentages.

Disadvantages of NPV
• The NPV method can be employed in selecting from
mutually exclusive projects only when the projects are of
the same size.
• The NPV method assumes that funds are reinvested at the
cost of capital
• The cost of capital is assumed to remain constant
throughout the life of the project.

127
 Internal Rate of Return
• The IRR is the rate of discount, which
makes the present value of the benefits
exactly equal to the present value of the
costs.

t
Pt t
( Bt  C t )
NPV P0  0 
t 0 1  R t
t 0 1  R t

128
Calculation of IRR
If the positive and negative NPVs are close to zero,
a precise and less time consuming way to arrive at
the IRR is using the following interpolation
formula.
PV ( I 2  I1 )
IRR  I1 
PV  NV

Where: I1 = the lower discount rate

I2= the upper discount rate
PV = NPV (positive) at the low discount rate of I1
NV = NPV (negative) at the high discount rate of I2
Note: I1 and I2 should not differ by more than one or two
129
percent.
 Decision Rule for IRR is
• Accept :if IRR is greater than discount rate
 Reject: if IRR is less than the discount
rate
 Indifferent: if IRR is equal to the discount
rate
 If we are comparing two or more projects,
the higher the IRR, the better the project
is.
130
 Example:

• Find the IRR of a project with 20,000

initial investments, the cost of capital
of 12 % and with the following table
of cash flows.

Year 1 2 3 4
Cash flow 6000 6000 8000 9000

131
Try to compute the NPV with 12% discount
rate.

 6000 6000 8000 9000 

  2
 3
   20000 5357  4800  5714  5732  20000 1603
4 
 1. 12 (1 . 12 ) (1 . 12 ) (1 . 12 ) 

Since the NPV is still positive, (1603), try

again with a higher discount rate: 15%

 6000 6000 8000 9000 

  2
 = 1673
   20000
4 
 1.15 (1.15) (1.15) (1.15) 

132
Still the NPV is positive. Try
again with a higher discount
rate i.e. 16%.
 6000 6000 8000 9000 

 1.16      20000

 (1.16) 2 (1.16) 3 (1.16) 4 

= -344
• Thus, it can be concluded that
the IRR is between 15% and
16%

133
However, the exact percentage can be
computed using interpolation techniques
as:
• Present value at 15% = 20167
• Present value at 16% = 19656
Difference = 511
The difference between the target present
value 20000, and the PV of 20167
(discounted at 15%) is 167.
Therefore, we get the percentage difference
of:
• Adding this number to 15%, we get the IRR
approximately 15.33%. 134
Advantages of IRR
• It gives due consideration for the time value of
money
• It recognizes the total cash flows during the project
life
• It conveys the direct message about the yield on the
project.
Disadvantages of IRR
• It involves tedious work through trial and error and
interpolation
• The IRR does not reflect the scale, or dollar size
• It assumes that all proceeds are reinvested at the
particular IRR, whereas the NPV approach assumes
reinvestment at the cost of capital.
135
 Benefit Cost Ratio (BCR)

• The BCR is defined as the ratio of the sum

of the project’s discounted benefits to the
sum of its discounted investment and
operating costs.
n
Bt
• This is given as,  (1  r ) t
t 0
BCR  n
Ct
 (1  r ) t
t 0

136
Con’t

137
 Decision rules:

• When BCR > 1, accept the project

• When BCR < 1, reject the project
• When BCR = 1, be indifferent

• If we compare two or more projects,

the higher the BCR, the better the
project is

138
Advantages of BCR
•BCR indicates a relative and not absolute measure
of profits i.e. the benefit per dollar (Birr) of
investment.

Disadvantages of BCR
•This method cannot be employed when a package
of smaller projects is to be considered in relation
to a large project.

139
 Discounted Payback Period
• To overcome the limitations of the
payback period, the discounted
payback period method has been
suggested

• The decision is similar with

payback period. The difference is
multiplying each cash flow by
discount factor.
140
Exercise

Year Cash Flow

1 5000
2 6000
3 8000
4 7000
5 6000
Initial investment 10,000
Discount rate 10%
Calculate the discounted payback period of the
project ?
141
 Exercise
Project Year Cash In flow PV of $1 PV of cash inflow Cumulative cash
at 10% savings

0 -10000 1.000 -10000 -10000

1 5000 0.909 4545 -5455

2 6000 0.826 4956 -499

3 8000 0.751 6008 5509

4 7000 0.683 4781 10290
5 6000 0.621 3726 14016

Payback Pd = 2 Yrs +  499 

 
 6008 
= 2 Yrs + .083 Yr = 2.083 Yrs or 2 yrs and
one month

142
 Chapter 6

Economic and Social

Analysis
 Contents
• Why economic analysis
• Valuation of economic costs and
benefits
• Approaches to economic cost-benefit
analysis
• UNIDO Approach
• Little and Mirrlees Approach

144
Social Cost Benefit Analysis / Economic Analysis

145
Commercial Cost Benefit Analysis (CBA)

Total cost of the Expected future

project benefit from the
project
• Benefit > Cost is desirable here.
• So it is nothing but a profitability analysis.
• But what will be the costs and/or the
benefits that a society may have to bear
and/or get from the proposed project are
not considered here.
For example:
Suppose, a manufacturer produces cigarettes
and sell it Birr.40 a packet, and another
manufacturer produces soaps and sell it Birr.20 a
bar.
Now, if we think about the impact of soaps &
cigarettes on the society, the questions may be –
▫ Does the price of cigarettes take account of the
smokers’ higher probability of heart disease or
cancer?
▫ Does the price of soap take note of the benefits
from the use of soap, e.g., reduced risk of spread
diseases?
Obviously, a commercial entrepreneur can’t
give well answer to these questions.
What is social cost benefit analysis ?
So, to reflect the real value of a project to
society, we must consider the impact of the
project on society.
Impact

Positive Negative
(Social Benefit) (Social Cost)
Thus ,when we evaluate a project from the view
point of the society (or economy) as a whole, it
is called Social Cost Benefit Analysis
(SCBA)/Economic Cost Benefit Analysis.
Core differences between CBA &
SCBA
Scope of SCBA
• SCBA can be applied to both Public & private
investments –
• Public Investment:
SCBA is important specially for the
developing countries where govt. plays a
significant role in the economic development.
• Private Investment:
Here, SCBA is also important as the private
investments are to be approved by various
governmental & quasi-governmental agencies.
Purposes of Economic Analysis

• Project selection that most benefits a

nation;
• To identify gainers and losers and take
the externalities in to account.
• Fiscal impact - Beneficiaries (owners &
financers) & Government.
• To assess environmental impact, etc
Objectives of SCBA
The main focus of Social Cost Benefit Analysis is
to determine:
1. Economic benefits of the project in terms of
shadow prices;
2 The impact of the project on the level of
savings and investments in the society;
3. The impact of the project on the distribution of
income in the society;
4. The contribution of the project towards the
fulfillment of certain merit wants (self-
sufficiency, employment, etc.).
Significances of SCBA
• CBA is unable to reflect social values. Hence
SCBA has been emerged with some interesting
significances. These significances also make the
SCBA different from the CBA.
 Market Imperfections
 Externalities
 Taxes & Subsidies
 Concern for Savings
 Concern for Redistribution
 Merit Wants
• Market Imperfections:
Market prices, the basis for CBA, do not reflect
the social values under imperfect market
competition.
• Externalities:
A project may have beneficial or harmful
external effects that are considered in SCBA,
not in CBA.
• Taxes & Subsidies:
From the social point of view, taxes & subsidies
are nothing but transfer payments. But in CBA,
taxes & subsidies are treated as monetary costs
and benefits respectively.
Concern for Savings:
In SCBA, the division between benefits &
consumption is relevant wherein higher
valuation is placed on savings. But in CBA
such division is irrelevant.
Concern for Redistribution:
In SCBA, the distribution of benefits is very
much concerning issue where commercial
private firm does not bother about it.
Merit Wants:
Merit wants are important from the social point of
view and therefore, SCBA considers these
wants.
Approaches to SCBA
• There are two principal approaches for Social
Cost Benefit Analysis:
A. UNIDO Approach, and
B. L-M Approach.
A. UNIDO Approach:
This approach is mainly based on the publication of
UNIDO named “Guide to Practical Project
Appraisal” in 1978.
B. L-M Approach:
Little & Mirrlees have developed this approach for
analysis of Social Cost-Benefit in Manual of
Industrial Project Analysis in Developing
Countries.
 A. UNIDO Approach
The UNIDO approach of SCBA involves five stages:
• Calculation of financial profitability of the project
measured at market prices.
• Obtaining the net benefit of the project at shadow
(efficiency) prices.
• Adjustment for the impact of the project on
Savings & Investment.
• Adjustment for the impact of the project on
Income Distribution.
• Adjustment for the impact of the project on Merit
and Demerit Goods whose social values differ
from their economic values.
Numeraire :
• A unit of account in which the values of inputs
and outputs are to be expressed.
• Numeraire is determined at-
• Domestic currency rather than border price
(international price).
• Present value rather than future value.
Because, “a bird in the hand is worth two in the
bush.”
• Constant price rather than current price.
B. L-M Approach

• Little and 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.
Features of L-M Approach
• L-M methods opts for savings as the
yardstick of their entire approach. Present
savings is more valuable to them than
present consumption since the savings can be
converted into investment for future.

• L-M approach rejects the ‘consumption’

numeraire of UNIDO approach since the
authors (L & M) feel that the consumption of
all level is valuable.
• This approach measures the cost and
benefits in terms of international or
border prices.

Why Border prices?

Because the border prices represent the
correct social opportunity costs or
benefits of using or producing a traded
goods.
Social Cost-Benefit Analysis (SCBA)
The resources – inputs & outputs – of a project are
classified into mainly:
 Labor
 Traded Goods
 Non-traded Goods
Therefore, to find out the real value of these
resources, we should calculate –
a) Shadow wage rate (SWR)
b) Shadow price of Traded Goods
c) Shadow price of Non-traded Goods
Dissimilarities between Two
Approaches
UNIDO Approach L-M Approach

• Domestic currency is • International Price is used

used as Numeraire as Numeraire
• Consumption is the • Uncommitted Social
measurement base Income is the
measurement base
• SCBA objectives are met • At one place all SCBA
through stage by stage objectives are fulfilled
Similarities between Two Approaches

• Calculation of Shadow Prices to reflect

social value
• Usage of Discounted Cash Flow
Techniques
• Taking into account about the effect of a
project on savings, investment and
income of a society
 EXAMPLE
1.Assuming that a project uses two indigenous
equipment's costing Birr 500,000.

•These equipment's can be exported at $30,000. The

shadow foreign rate of $ 1.00 is equivalent to Birr
20.86.(Private angle, market price=500

•Therefore, shadow price of these equipment's (inputs)

are ($30,000 × Birr 20.86) = Birr 620,400.This is from
social point of view.
165
2. Two million man days of unskilled labor for
which the project committee decided to pay a
daily wage of Br. 100.
(Additional Information: The shadow price of
unskilled labor is 80 Br. Per day)
Cost Type Nature Private Social
Angle Angle
(Market (Shadow
price) Price)

Unskilled One-Shot 200 ml 160 ml

Labor
3. Operating & Maintenance cost of the
project will be Br. 75 ml annually.
(However, the operating cost should be Br. 65
ml from social view point)

Cost Type Nature Private Social

Angle Angle
(Market (Shadow
Operating Annual price)
75 ml Price)
65 ml
Cost

167
4. 100 million units of electricity will be generated for
domestic use. The electricity tariff will be
charged at Br. 1 per unit.
(Additional Information: The consumers are
willing to pay Br. 1.5 for per unit of electricity).

Benefit Nature Private Social

Type Angle Angle
(Market (Shadow
price) Price)
Electricity Annual 100 ml 150 ml
5. Flood damages can be saved by Br. 20 ml
annually. However, the Government will
not able to collect anything for this.

Benefit Nature Private Social

Type Angle Angle
(Market (Shadow
price) Price)
Flood Annual - 20 ml
Relief
A Comparative Illustration of UNIDO & L-M
Approach
COSTS:
6. Power equipment costing Br. 300 million. This
equipment can be exported at $15.15 million. The shadow
price of per dollar is Br. 20.8.

Cost Type Nature UNIDO L-M

Approach Approach

Power One-Shot Br. 315 $ 15.15

Equipmen million million
t
 7. Construction materials ( sand, bricks, steel etc.)
cost 200 million. These materials comes from additional
production, production cost of which is 150 million.

Cost Type Nature UNIDO L-M

Approach Approach

Other One-Shot Br. 150 million $ 7.2 million

Materials

4. Two million man days of unskilled labor for which the

project committee decided to pay a daily wage of Br. 100.
The shadow price of unskilled labor is 80 Br. Per day.
Cost Type Nature UNIDO L-M
Approach Approach
Unskilled One-Shot Br. 160 million $ 7.69 million
Labor
Thank You!!

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