Project Finance

Economic Framework for

Assessing Development
Impact

Group - 3
Sagar (013) Mayank (020) Rohit (024) Priyanshu (042)
What do big institutions and banks look for before funding
projects ?

 Multilateral institutes (IFC, EBRD etc.) provide support to private projects with a goal of
stimulating growth in developing nations.

 To participate in funding, they need to understand a project's private and social returns

 As a manger in a company seeking funding, needs to understand these returns to better predict
how a project will be received.

 An economic framework for assessing a project’s private and social return, will help in
examining the overall development impact of a project.
Private vs Social Returns
 A profitability of an investment from society’s perspective may differ from the private sector’s
perspective.

 When people are free to decide which transaction they wish to enter into, there are four main reasons
for Private returns differing from Social returns:

 Reason 1: Taxes, Tariffs, Subsidies & government interventions. Due to taxes, there is a difference
between the return the private investor receives and the returns generated by project.

 Reason 2: Transaction costs: It may prevent investor from collecting a fee for services provided,
resulting in an un price benefit to society

 Reason 3: Externalities: Non-market effects (Externalities) are not captured in private returns but can
increase the social returns

 Reason 4: Imperfect Markets: Significant difference in the price paid for a good and the opportunity
cost of providing that good
Proposed Framework for Assessing Development Impact

Overall Development Impact = Estimated net Impact + Individual groups affected by the
project

Groups:

This classification affects both domestic or foreign resident.

Proposed Framework for Assessing Development Impact

 This classification affects both domestic or foreign resident.

 Generally, projects are likely to affect only a few of the possible groups.
 Overall social return may be positive but the effect on any one group may be negative
 Compensation programs warranted to those groups
 Calculating Private returns and Social returns:
 Private returns = Actual Revenue – Actual market cost
 Social returns = Actual Revenue – Opportunity cost
 Reasons for shadow prices differ from market prices:
 Taxes and Subsidies
 Transaction costs
 Externalities
 Imperfect markets
Net Impact

The Project Financiers

 Net private benefits is the annual total free cashflows

 IRR = returns to all capital providers (debt + equity)

Employees
 Key input – Labor to the project company
 Net benefits:
 Increased wages: The wages received are greater than what they would have received from alternative
employment opportunities
 Training:
Company Personal

Higher productivity
Increased skills can be
captured in private
used for other jobs
returns
Net Impact

Customers

 New good or service: Benefit equals the price they are willing to pay and the actual price they paid, the
net benefit is consumer surplus

 Better quality product: Improved good or service sells at same price

 Increased supply leading to a lower price

 Supply of product faces downward sloping of demand

curve
 Market price falls
 Incremental consumer surplus = ½ (P1-P2)(Q1-Q2)
Net Impact

Producers of Complementary Products

 Difficult to quantify the value derived from this effect. But where relevant the effect is positive.

 Incurs indirect benefits

Suppliers
 Enjoy increased demands to goods & services and often high
profits

 Impact on suppliers is an example of backward linkage

Gain to suppliers from increased

demand
Net Impact

Competitors & New Entrants

 Competitors may see reduction in demand and thus a lower price for their products

 Consumers benefit if we see society as overall

 Competitors may benefit from network & demonstration effects

Neighbours

 It refers to the surrounding community that will be impacted by projects

 Impacts may result from environmental externalities, new or improved infrastructure

 Impact on environment maybe positive or negative

 Large firms often contribute to local communing by funding scholarships, building schools
Net Impact

Rest of Society

Under this, one would include the effect of taxes, subsidies, tariffs & other government interventions

 Profit Taxes - A portion of profits goes to taxes. For private return – one calculates free cash flow after
any profit taxes due. For social return, one includes profit taxes as part of overall return.

 Value-Added, Sales, and Excise Taxes – Govt. collection of VAT will rise if overall sales increases

 Subsidies – Included in the FRR. Subtracted from ERR

 Import Tariffs, and Export Taxes – For goods produced by the project, the social revenue stream
should be reduced by the portion of the price that is accounted for by the tariff. For inputs also, the costs
should be adjusted to reflect the existence of tariffs.
Considerations When Applying The Framework

The following list of issues should be considered when applying this framework:

 Information Gap: Not all the costs and benefits generated by a project can be qualified easily or accurately.
For example, there may be no way to calculate the value of demonstration effects. And even when an
estimation procedure is possible, the effort may not be worthwhile. In such cases, a description of the impact
may be sufficient.

 Discount Rate: This note does not discuss the appropriate discount rate for societal cash flows. The concept
of one “social” discount rate may be too simplistic and does not properly weigh the risk associated with
various flows. Yet assigning multiple discount rates to each component of flow can be arbitrary.

 Shadow Foreign Exchange Rates: Traditional social cost/benefit analysis, as developed in the 1960s and
1970s, paid a great deal of attention to the proper determination of shadow foreign exchange rates. The
shadow foreign exchange rate is an estimate of the opportunity cost to society of using or producing foreign
exchange, and differs from the actual rate paid for foreign exchange when foreign exchange markets are
subject to capital controls. Distortions of this kind were far more prevalent during the 1960s and 1970s than
they are today. As a result, the issue is less important now.
Considerations When Applying The Framework

 Efficiency Versus Equity: The ERR calculation focuses on the efficiency of resource allocation, and
treats the returns to each group equally. It does not address the question of whether society should
place a higher value on the net benefits to certain groups (e.g. the poor) than the net benefits going to
others (e.g. the rich).

 Accounting for the Future: Project analysis is generally undertaken prior to the start of a project to
assist in the decision on whether to proceed. It should incorporate any changes that are expected to
take place, such as price changes (including expected changes in the real exchange rate, or in the real
wage rate).
THANK YOU !!!