Lecture Notes

FINA623

ADVANCED CAPITAL BUDETING

Lecture Twelve

STAKEHOLDER IMPACTS
OF
PROJECTS
 Assess Stakeholder Impacts of
Projects

• A Comparison between economic and

financial values tells us who wins and
who loses, i.e., the Stakeholders
ECONOMIC VALUE ECONOMIC

= VALUE

FINANCIAL
VALUE =
+
TAX IMPACT
+
NET BENEFITS TO
NET LABOUR
CONSUMERS FINANCIAL TAX
BENEFITS

+
NET LABOUR
VALUE IMPACT
NET
BENEFITS TO
CONSUMERS
BENEFITS
FOR EACH INPUT AND OUTPUT VARIABLE:
• Economic = Financial + S Stakeholder Impacts

– Example of a non-traded good with a sales tax:

• Economic Value = Financial Value +
Change in Government Tax Revenues +
Increase in Consumer Benefits –
Loss in Profits to other producers

Taken over all variables and time periods of project (using a

common discount rate)
• NPV economic = NPV financial + S PV Stakeholder
Impacts

• Note: Stakeholder Impacts are often called

externalities of project
 General Relationship

NPVECOeco = NPVFINeco + PVEXTeco

 Stakeholder Analysis
is composed of six distinct steps:
1. Identify the externalities
2. Measure the net impact of the externalities
in each market as the real economic
values of resource flows less the real
financial values of resource flows
3. Measure the values of the various
externalities throughout the life of the
project and calculate their present values
by using the economic discount rate
4. Allocate the externalities across the
various stakeholders of the project

5. Summarize the distribution of the project’s

externalities and net benefits according to
the key stakeholders in society

6. Reconcile the economic and financial

resource flow statements with the
distributional impacts
 Financial, Economic and Distributive Effects of Project
to Supply Non-Tradable Goods with No Distortions
P S

S + Project
A
P0
C B
P1 E

D
Q
QS Q0 Qd
Financial Value of Output = QsCBQd or P1 (Qd -Qs)
Economic Value of Output = QsCABQd
Difference (Economic - Financial) = CAB
CAB = P1P0AB -P1P0AC = Gain in Consumer Surplus - Loss in Producer Surplus
Economic Value = Financial Value + Gain in Consumer Surplus - Loss in Producer Surplus
= Financial Value + Distributive Impacts
 Financial, Economic and Distributive Effects of Project to Supply
P
Non-Tradable Goods with Unit Tax
d
(P0+T) = P 0 E S
S + Project
Pd Financial Value of Output =
1 F QsCBQd
s A
P0
Economic Value of Output =
QsCAQ0+ Q0ABQd +AEFB
s
P1 C B
Increase in Government Revenue =
AEFB

D1 D0 Q
QS Q0 Qd

CAB = PS1PS0AB – PS1PS0AC

Since PS1PS0AB = Pd1Pd0EF Therefore, CAB = Pd1Pd0EF – PS1PS0AC
= Gain in Consumer Surplus - Loss in Producer Surplus
Economic Value of Output = Financial Value of Output + Change in Gov. Tax Revenues
+ Increases in Consumer Surplus - Loss in Producer Surplus
 Measuring Distributive Impact from Financial and
Economic Values of Inputs with Tariffs
P
S

B C F
EmPCIF(1+t)=PW(1+t)

A E
EmPCIF=Pw H
G

D + Project
D
Qs Qs Qd Qd Qd Q
0 1 1 0 2

Financial Cost of Importable Goods = Qd1CFQd2

Economic Cost of Importable Goods = Qd1GHQd2*(1+Ee / Em - 1 )
Where (Ee / Em - 1) = Foreign Exchange Premium (FEP)
Financial Cost - Economic Cost = GCFHd1 – Qd1GHQd2*(Ee / Em - 1) =
= Gain in Tariff Revenues to Government – Loss in Government Revenues from
Additional Use of Foreign Exchange in Importing This Input
 Examples:

– Who benefits from worker transportation?

– Why was the Makar Port built?
– Why was the Paphos hotel not built?
 Workers Transportation Case
Basic Facts
• Factory currently employs 20 workers.
• Workers currently use taxis at a cost of $1.00 per day.
• Factory wants to employ 40 workers, but can not recruit any additional
worker without either subsidizing transportation or paying higher wages.
• The proposal is to buy a bus for $25,000.
• Used Bus valued at $10,000 in year 5.
• The bus will operate for 250 days per year.
• It will be necessary to employ a driver to operate and maintain the bus
at a wage of $10.00 per day.
• The economic opportunity cost of employing the driver is equal to
approximately 80% of his wage.
• The charge per person/day on the bus will be 40 cents.
 Workers Transportation Case
• The cost of oil and gas will be $2.00 per day. The conversion factor
for oil and gas is estimated to be 0.60 because of the high taxes
imposed on their purchase price.
• The spare parts bill is expected to be $100 per year. Spare parts
have a tariff and taxes on them that are equal to 25 percent of their
c.i.f price.Thus, the spare parts conversion factor is equal to 0.80.
• The ratio of the economic exchange rate to the market exchange
rate is equal to 1.
• No income taxes are levied on the income of public enterprise.
• The financial discount rate is equal to 6%, and the economic
discount rate is equal to 10%
 Workers Transportation Case
TABLE 1: FINANCIAL APPRAISAL

PV @10% 0 1 2 3 4 5
CASH INFLOWS
Receipts $16,679 4,000 4,000 4,000 4,000 4,000 0
Final in use values $6,209 0 0 0 0 0 10,000
TOTAL INFLOWS 4,000 4,000 4,000 4,000 4,000 10,000

CASH OUTFLOWS
Expenditures
Bus purchase 20,000 20,000
Tariff on Bus 5,000 5,000
Operating Expenses
Labor 10,425 2,500 2,500 2,500 2,500 2,500 0
Fuel 2,085 500 500 500 500 500 0
Spare parts 417 100 100 100 100 100 0
TotalOutflow 37,927 28,100 3,100 3,100 3,100 3,100 0

Net Cash Flow -15,038 -24,100 900 900 900 900 10,000
NPV Financial at 6% -13,509
NPV Financial at10% -15,038
 Measurement of Economic Benefits
$/day

Demand for workers’

1.0 transportation
Net Benefit
to workers
Net Benefit
to workers
0.40

20 40 # of workers

Financial Revenue/person/day = $0.40

Economic Benefits/person/day = $0.85
[(20*$1.0+20*($1+$0.40)/2]/40 = $0.85
 Workers Transportation Case
TABLE 2: ECONOMIC APPRAISAL

Conversion Factor PV at 10% 0 1 2 3 4 5

CASH INFLOWS
Receipts 2.125 35,444 8,500 8,500 8,500 8,500 8,500 0
Final in use values 0.8 4,967 0 0 0 0 0 8000
TOTAL INFLOWS 40,411 8,500 8,500 8,500 8,500 8,500 8,000

CASH OUTFLOWS
Expenditures
Bus purchase 1 20000 20000
Tariff on Bus 0 0 0
Operating Expenses
Labor 0.8 8,340 2000 2000 2000 2000 2000 0
Fuel 0.6 1,251 300 300 300 300 300 0
Spare parts 0.8 334 80 80 80 80 80 0
TotalOutflow 29,924 22,380 2,380 2,380 2,380 2,380 -

Net Cash Flow 10,487 (13,880) 6,120 6,120 6,120 6,120 8,000
NPV Economic at 10% 10,487
 Workers Transportation Case
TABLE 3: DISTRIBUTION OF NET BENEFITS OF THE
EXTERNALITIES TO STAKEHOLDERS

PV EXTERNALITIES
@10% Government Workers Driver
Receipts 18,764 18,764
Final in use values (1,242) -1,242
TOTAL INFLOWS

CASH OUTFLOWS
Expenditures
Bus purchase 0
Tariff on Bus (5,000) 5,000
Operating Expenses
Driver (2,085) 2,085
Fuel (834) 834
Spare parts (83) 83
Total Distribution 25,525 4,676 18,764 2,085

Economic value = Financial Value + Sum of Stakeholder Externalities

RECONCILIATION OF FINANCIAL, ECONOMIC, AND DISTRIBUTIVE ANALYSIS

NPV Economics = NPV Financial + SUM of PV of externalities

at economic discount rate at economic discount rate at economic discount rate

10,487 -15,038 25,525

 Port Rehabilitation and Expansion:
The Makar Project
Basic Facts:
• Makar Port, located in General Santos City at the northern side of
Sarangani Bay, a well-protected bay in Mindanao, lies along the
main north-south trading axis which skirts Mindanao on its western
shore.
• The objectives of the project are to increase the capacity and
improve the efficiency of cargo handling facilities at the port to
accommodate future flows.
• The project will cost approximately 635 million pesos1.
• Seventy-five percent of the total project cost will be provided as a
grant by the US Agency for International Development (USAID) and
the other 25% will be provided from counterpart contribution by the
Philippine government.
 Port Rehabilitation and Expansion:
The Makar Project
Project Outcome

• Deterministic case appeared good with partial financial

analysis:

NPV Financial (with Project) = 10,760,000 million pesos

• Full analysis shows project provide a negative economic

performance

• Project was implemented

 Port Rehabilitation and Expansion:
The Makar Project

Incremental Financial-Economic Analysis

Without Project With Project Incremental
(000s of Pesos) (000s of Pesos) (000s of Pesos)

NPV (Total Investment Point of View) 19,453 10,760 (8,693)

NPV (Economic Point of View) 25,683 (105,576) (131,259)

• Incorrect analysis was done initially that looked at only

financial outcome with project. Should have looked at both
financial and economic outcomes on an incremental basis.

Note: Peso is the Philippine currency and in Year 1 is equal to 0.037 US dollar (1994).
 FINANCIAL ANALYSIS
Incremental Financial Cash Flow Statement (Real)
(in thousands Peso)

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 10 Year 15 Year 16

RECEIPTS
Port Revenues - local - - - - 1,359 2,276 6,895 8,120 -
Port Revenues - foreign - - - - 216 243 425 452 -
Total port revenues - - - - 1,576 2,519 7,319 8,572 -
Rental income from Container Yard I - 3,000 3,000 3,000 3,000 3,000 3,000 3,000 -
Rental income from Container Yard II - - - - 1,000 2,000 6,000 9,000 -
Other Income 69 69 69 69 69 69 69 69 -
USAID Grant and Gov. Contribution 22,148 155,088 219,215 79,719 - - - - -
Liquidation Values: - - - - - - - - 340,810
Total Cash Receipts 22,217 158,157 222,284 82,788 5,645 7,588 16,388 20,641 340,810
EXPENDITURES
Investment cost-non tradable 22,631 103,995 153,285 49,006 - - - - -
Investment cost-tradable 2,758 93,124 139,002 57,285 - - - - -
Operating Cost: - - - - 9,017 9,017 9,017 9,017 -
Loss of rental income from term. shed 1,100 1,100 1,100 1,100 1,100 1,100 1,100 1,100 -
Change in Cash balance - - - - 79 54 64 19 (390)
Change in Accounts Receivable - - - - 158 109 128 38 (779)
Change in Accounts Payable - - - - (1,353) (123) (123) (123) 1,230
Total Expenditures 26,489 198,219 293,386 107,392 9,001 10,157 10,186 10,051 61
NET CASH FLOW (4,272) (40,063) (71,103) (24,604) (3,356) (2,569) 6,202 10,589 340,750
NET PRESENT VALUE (at 9%) (8,693)
.
Economic Benefits Makar Port Project

Financial Analysis
• Additional port revenue from expansion in
traffic including foreign exchange premium.
• Additional rental income from containers yards.
Stakeholder Impacts
• Reduction in waiting time of ships.
• Reduction in animal weight loss from waiting on
ship.
 Economic Cost of Makar Port
Project
• All investment and operating costs of port,
even if subsidized.
 ECONOMIC ANALYSIS
Incremental Economic Net Benefit Flow Statement
(in thousands Peso)
Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 10 Year 15 Year 16
RECEIPTS:
Port revenues - local - - - - 1,359 2,276 6,895 8,120 -
Port revenues - foreign - - - - 249 280 488 520 -
Total Port Revenues - - - - 1,608 2,556 7,383 8,639 -
Benefit to ship owners due to
reduction in ships' waiting time - - - 25,484 31,264 33,539 35,444 36,491 -
Benefit to shippers due to reduction
in animal weight loss - - - - 13,331 13,906 16,204 19,715 -
Rental income from Container Yard I - 3,000 3,000 3,000 3,000 3,000 3,000 3,000 -
Rental income from Container Yard II - 0 0 0 1,000 2,000 6,000 9,000 -
Other Income 69 69 69 69 69 69 69 69 -
USAID Grant and Gov. Contribution - - - - - - - - -
Liquidation Values: - - - - - - - - 316,916
Total Cash Receipts 69 3,069 3,069 28,553 50,272 55,070 68,100 76,914 316,916
EXPENDITURES:
Investment cost-non tradable 21,818 96,550 141,822 45,422 - - - - -
Investment cost-tradable 2,596 87,515 130,373 54,059 - - - - -
Operating Cost: - - - - 9,044 9,044 9,044 9,044 -
Loss of rental income from term. shed 1,100 1,100 1,100 1,100 1,100 1,100 1,100 1,100 -
Change in Cash balance - - - - 80 55 65 20 (397)
Change in Accounts Receivable - - - - 160 111 130 39 (793)
Change in Accounts Payable - - - - (1,329) (121) (121) (121) 1,208
Total Expenditures 25,514 185,165 273,295 100,581 9,056 10,190 10,219 10,082 19
NET CASH FLOW (25,445) (182,096) (270,226) (72,028) 41,216 44,880 57,881 66,832 316,898
NET PRESENT VALUE (at 10.3%) (131,259)
INTERNAL RATE OF RETURN 5.88%
 STAKEHOLDER ANALYSIS

• Key Question:
– Why was this BAD project implemented?
 STAKEHOLDER ANALYSIS
(in thousands Peso)

(A) (B) (C) (D) (E)

PV Financial at PV Economic at PV of Allocation of Externalities
Economic Discount Economic Discount Externalities Ship owners/
ITEM Rate of 10.3% Rate of 10.3% (B - A) Government Shippers
RECEIPTS:
Total Port Revenues 25,677 25,928 250 250 -
Benefit to ship owners/shippers due to
reduction in ships' waiting time - 187,684 187,684 - 187,684
Benefit to livestock shippers due to
reduction in animal wt. loss - 77,025 77,025 - 77,025
Rental income from Container Yard I 22,100 22,100 - - -
Rental income from Container Yard II 23,895 23,895 - - -
Other Income 577 577 - - -
USAID Grant 404,200 - (404,200) (404,200) -
Liquidation Values: 81,587 75,867 (5,720) (5,720) -
Total Cash Receipts 558,037 413,076 (144,961) (409,670) 264,709
EXPENDITURES:
Investment cost-nontradable 280,673 260,925 (19,749) (19,749) -
Investment cost-tradable 245,332 230,517 (14,815) (14,815) -
Operating Cost: 44,000 44,135 135 135 -
Loss of rental income from term. shed 9,203 9,203 - - -
Change in Cash balance 223 227 4 4 -
Change in Accounts Receivable 446 454 8 8 -
Change in Accounts Payable (1,145) (1,126) 20 20 -
Total Expenditures 578,732 544,335 (34,397) (34,397) -
NET CASH FLOW (20,695) (131,259) (110,564) (375,272) 264,709
 CONCLUSION

• Philippines wasted 131,259,000 pesos in

order to transfer income to a few ship-
owners/shippers.
 CONTRACTS CANNOT FIX SOME PROBLEMS
Example: The Paphos Holiday Complex
Basic Facts:
• The Paphos Holiday Complex was a major tourism project sponsored by
the Cyprus Development Bank (CDB), which was interested in formulating
and implementing an up-market tourist project that was both financially and
economically viable and one that took into account environmental costs
and benefits.
• The Paphos Holiday Complex targeted the upper class segment of the
Western European Tourism market
• Emphasized recreational activities that made Cyprus attractive in off-
season
• It would have consisted of a main hotel building of 350 room capacity and
another 200 rooms in a bungalow type accommodation
Project Outcome:
• Deterministic case was good
• Riskiness was low
• Project was not undertaken
Deterministic Analysis
NPV (Equity point of view), Discount Rate = 11.4% 1.75 Million CPs
NPV (Economic point of view), Discount Rate = 9.5% 6.90 Million CPs
CP = Cypriot Pounds
 Distribution Analysis: Paphos Holiday Complex
Distribution of Externalities Real Values (CP 000’s)
Total Govt Electr. Other Other
From Guest Expenditure Auth. Hotels Groups
Outside of Hotel 1176 1176
From Taxes 1648 1648
From Hotel Operations -1107 5037 -6144
Service Charge -197 174 -371

In use Values:
•Land
•Buildings
•Electromechanical
0
-100
26
3
26
-103 Paphos
•Furnishings & Equipment 7 7

Holiday
Investments:
•Land 0
•Buildings 374 -12 386
•Electromechanical -199 -199
•Furnishings & Equipment -75 -75
•Preliminary 193 193

Operating Expenses:
•Food Cost
•Beverage Cost 190
188
162
-38
29
226
Complex
•Payroll 0

never
•Departmental -223 -223
•Electricity 283 -67 350
•Fuel -156 -36 -120
•Water -577 -577
•Repairs -34 -34

built.
•Admin. & Marketing 107 107
Corporate Taxation 3301 3301
Staff Service Charge 0

Working Capital:
•Accounts Receivable -64 -64
•Accounts Payable 27 27
•Cash Balance 0
•Reserve Stock 0

Total Externalities 4788 11085 350 -6515 -132