4 Project Assessment and Aquaculture

Question 1

Projects in Economics: Definition

Answer 1

A project is a set of interrelated investment activities to attain certain specific objectives by utilizing limited resources within a particular period of time

Question 2

Projects in Economics: Elements

Answer 2

 Investments
 Objectives
 Limited resources
 Time period

Question 3

Projects in Economics: Project examples

Answer 3

 Industrial projects (facilities, factories, etc)

 Road development

 Schools and hospitals

 Projects within a company (software release, new product, etc)

Question 4

Projects in Economics: Water related projects

Answer 4

 Irrigation systems (agriculture)

 Water-intense production

 Water production/supply

 Bridges and Dams

 Construction of a harbor

 Swimming pools and thermal baths

 Aquaculture (e.g. pond systems)

 Water pumps and wells

 …

Question 5

Project cycle

Answer 5

Identification
↓
Preparation
↓
Appraisal (bfr investment decision)
↓
Approval
↓
Implementing & Monitoring
↓
Evaluation
↓
back to identification

Question 6

Cost Benefit (CB) Analysis

Answer 6

 Considers a number of alternatives

 Compares all costs and benefits

 Covers different time periods
- Cash flows over time are not comparable (discounting)

Question 7

4 Performance Indicators of CB Analysis

Answer 7

1. Net Present Value (NPV)
2. Internal Rate of Return (IRR)
3. Benefit Cost Ratio (BCR)
4. Return on Investment (ROI)

Question 8

Net Present Value (NPV)

Remember formula
# Lecture 4 slide 8

Note: Redo the Example on slide 10-12!

Answer 8

 The present value of a project‘s net benefit stream, obtained by discounting the stream of net benefits over its lifetime, back to its value in the chosen base period (usually the present)

 Accept project if NPV > 0

 When comparing projects the one with the higher NPV is preferred

Question 9

The present value (PV) of a future amount

Remember formula
# Lecture 4 slide 9

Answer 9

The maximum amount you would be willing to pay today for the right to receive money in the future

 Suppose a project generates an amount of $1,000,000 in 20 years

• What is the maximum amount you should be willing to pay today?
• You are forgoing (mengabaikan) the interest you could earn on the money loaned

A $1,000,000 payment in 20 years from now is only worth today:
$376,889 if r = 0.05 or $148,644 if r = 0.10

Question 10

NPV Advantages

Answer 10

Accounts for relevant cash flows over the life of a project (timing)

Evaluates profit seeking projects (established in economics)

Based on accounting information which is readily available

Question 11

NPV Disadvantages

Answer 11

 Lengthy and difficult calculation

 Benefits and cost of capital may change over time (not constant)

 Difficult to estimate the economic life of a project

 Determination of the rate of return is critical

Question 12

Internal Rate of Return (IRR)

Remember formula and see graph
# Lecture 4 slide 14, 15

Answer 12

 Rate of interest which is used as the discount rate for a project

Discount rate, r*, at which:

 IRR decision rule:

• Accept: If the project’s IRR > required rate of return (capital cost)
• Ranking: Projects with higher IRRs are ranked higher

 One way to discover the IRR is to calculate the NPV of a project for different interest rates and graph the results
 Cutover point on the interest axis is the IRR

Question 13

Example IRR

Lecture 4 slide 16

Answer 13

NPV for r = 18% is negative

NPV for r = 10% is positive

IRR for a zero NPV is between 10% and 18%

Question 14

IRR Advantages:

Answer 14

Closely related to NPV

Generally yields identical decisions

Easy to understand

Question 15

IRR Disadvantages:

Answer 15

Ignores changes in the discount rate over life of an investment

May lead to incorrect decisions by comparing projects

Question 16

Comparing 2 projects according to their NPV and IRR

Lecture 4 slide 18

Answer 16

 IRR: Project 2
 NPV: Project 1

 NPV gives the correct selection advice

Question 17

Benefit-Cost-Ratio (BCR)

Answer 17

 Calculated as benefits divided by costs (B/C)

 Accept project: BCR ≥ 1

 The higher the BCR, the higher the rank

Question 18

BCR Advantages

Answer 18

 Fast estimation (straightforward)

 Easy to understand

Question 19

BCR Disadvantages

Answer 19

 Value is less meaningful compared to NPV and IRR

 Neglects benefits and costs over time (and discounting)

Question 20

Return on Investment (ROI)

Formula
# Lecture 4 slide 20

Answer 20

 Estimates the return on one unit investment

 Calculates the sum of all revenues/benefits over time and divides by the sum of all cost (initial investment, fix and variable cost)

 Accept project: ROI ≥ 1; the higher the better

Note: variable cost = a cost that varies with the level of output.

Question 21

ROI Advantages

Answer 21

 Considers all revenues and costs (over time)

 Easy and effective interpretation

Question 22

ROI Disadvantages

Answer 22

 Neglects discounting of cash flows

Question 23

Sensitivity Analysis

Answer 23

• Data on prices and discount rates might change due to uncertainty
• Re-calculation in CB Analysis to identify sensitive parameters:
   Scenario1: Labor wage increases annually by 5%; timber price remains unchanged
   Scenario2: Labor wage decreases annually by 10%; timber price increases by 20%
  …

Question 24

Choice of the discount rate

Answer 24

• Discount rate has key role in identifying which project to choose
• The lower the discount rate, the more valuable the back-loaded project
• Less consensus (general agreement) on appropriate discount rate (public vs private sector)
   Rates based on financial sector; Rates based on returns in private sector

Question 25

Limitations of CB Analysis

Answer 25

 Pure economic perspective (cost and benefits)

 Neglects social and environmental impacts of a project

Question 26

Conclusion of CB Analysis

Answer 26

Well-established in economics and project assessment

Mainly economic instruments (often contradicts sustainable development)

Extension possible to consider

• social effects (e.g. equity and fair distribution)
• environmental effects (e.g. externalities, public goods)