Chapter 4: Market & Private CBA

Question 1

Market cash flow

Answer 1

Cash flow for the overall project at market prices, irrespective of who the gainers and losers are

Question 2

Private cash flow

Answer 2

Cash flow to the individual investor engaged in the project at market prices, after allowing for loan service costs and after payment of profit taxes

Question 3

Deriving private cash flow

Answer 3

Calculate overall market cash flow, then subtract:

• debt/financing inflows and outflows to creditors
• taxes paid to government

Question 4

Cash flow on equity

Answer 4

The private cash flow is the cash flow on the investors own funds or “equity”

• market cash flow minus debt cash flow = cash flow on equity (before tax)
• cash flow on equity is what is left over after servicing debt

Question 5

Deriving market cash flow: concepts to be mindful of

Answer 5

• Inflation: usual to see constant prices with a real discount rate (otherwise, nominal prices with nominal interest rate)
• Incremental rather than total cash flow (“with” vs “without”)
• Depreciation: excluded from cost to avoid double counting. But “scrap value” or “salvage” is added to cash flow in the last year
• Changes in working capital appear under investment costs at beginning and end of project
• Interest on debt excluded from cost to avoid double counting

Question 6

Deriving debt financing cash flow

Answer 6

To derive debt financing flow from the borrower’s perspective, begin with market cash flows, then:

• add all loan receipts in each period
• subtract all interest payments in each period
• subtract all principal repayments in each period

Question 7

Deriving IRR on equity

Answer 7

1. Calculate IRR on market cash flow
2. Calculate IRR on debt financing cash flow
3. Calculate IRR on equity cash flow

Question 8

Gearing and debt: equity ratio (IRR)

Answer 8

IRR on equity + IRR on debt = Market IRR

Question 9

Implications of gearing

Answer 9

If an investor can borrow on concessional terms a “bad” project can appear “good”
If an investor borrows on unfavourable terms a “good” project can appear “bad”

Question 10

Calculating after-tax cash flow

Answer 10

Some items of project cost that do not enter into a project’s cash flow directly, affect the net cash flow indirectly though their effect on the project’s taxable profits:
- depreciation
- interest on debt
These should be added to the operating costs in the market cash flow for the purpose of calculating taxable profits
Taxes are then calculated as some % of taxable profits and are deducted from the private cash flow to derive the after tax private cash flow

Question 11

Using private CBA: why would the project analyst who is concerned with the wider public or social interest be concerned with the return on private equity?

Answer 11

• When the private investor is one of the stakeholders’ whose gains are part of the Referent Group net benefits
• Because the policy maker needs to know what’s in it for the investor: need incentives? tax concessions? etc.

Question 12

Distribution of net benefits

Answer 12

The market net benefits (at market prices) can be disaggregated among three stakeholder groups:

• equity holders (private/public sector)
• lenders
• recipients of taxes (government)