1.

1 The project concept

Project planning and evaluation 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. Recent experiences show that
project analysis has attracted the attention of development economists. But the inclusion of project analysis in
development economics did not necessarily amount to a new analytical discovery, rather to a new approach. Projects are
now assed from the economy’s viewpoint instead of only from the firm’s perspective. The selection criteria have also
included economic criteria on top of financial criteria.
•A project is a complex set of activities where resources are used in expectation of return and which lends itself to
planning, financing and implementing as a unit. It is the smallest operational element unit. A project usually has a
specific starting point and a specific ending point, intending to accomplish specific objectives. Projects usually have
well defined sequence of investment and production activities and a specific group of benefits that can be identified,
quantified and valued, either socially or monetarily. Projects are temporal and spatial units each with a financial and
economic value and a social impact that make up the continuum. Projects also have boundaries, which make them
distinguishable from each other. In addition to its time sequence of investment, production and benefits, the project
normally has a specific geographical location with identifiable targets and benefits. Has specific beneficiaries or
clientele group.
characteristics of projects. Projects in general need to be SMART.
S – Specific
 Specific in its objective.
 Specific activities.
 Specific group of benefits.
 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. 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. Though
some secondary costs and benefits may go beyond the boundary, its major area of operation must
be identified. Hence projects are said to be area bounded.
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.
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 and valued and be presented year-by-year
The linkage between projects and programs

Most developing countries in general have some sort of national planning. Of course the degree and complexity of such development plans vary form country to
country and even in a particular country form time to time. For instance in Ethiopia Planning was much most centralized in the 1974-91 periods compared to
either before or after this period. Project formulation is an integral part of amore broadly focused and continuous process of development planning.

Nevertheless, it is necessary to distinguish between projects and programs because there is sometimes a tendency to use them interchangeably. While 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 bound. Examples could be a road development program, a
health improvement program, a nutritional improvement program, a rural electrification program, etc. A development plan is a general statement of economic
policy. National development plans are further disaggregated into a set of sectoral plans.
A development plan or a program is therefore a wider concept than a project. It may include one or several projects at
various times whose specific objectives are linked to the achievement of higher level of common objectives. For
instance, a health program may include a water project as well as a construction of health centers 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). We have to note that projects could be either public or private. Projects can also be understood and an
activity for which more will be spent in expectation of returns and which logically seems to lend itself to planning,
financing, and implementing as a unit. It is the smallest operational element prepared and implemented as a separate
entity in a national plan or program. In general, thus, sound development plans require good and realistic projects for
the latter are the concrete manifestation of the pan as noted above.
[Link] PROJECT CYCLE
A project cycle 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.
According to world ban fives broad phases of project are
1. Identification
2. preparation and analysis (Pre-feasibility Study & Feasibility study)
4. Selection and project design
5. Implementation
6. Ex-post evaluation
1. 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 immanent form government agencies in the context of government development plans. In the
latter case sectoral information (i.e. the direct and indirect demands of sectors) is an import and source of
identification.
In general there are four major sources from which ideas or suggestions for project may come:

1. Project ideas from technical specialists

2. Project ideas from local leaders
3. Project ideas from entrepreneurs
4. Project ideas from government policy and plans
The identification of project ideas is based on several aspects of development.
5. Need - a need assessment survey may show the need for intervention
6. Market demand - domestic or overseas
7. Resource availability - opportunity to make available resources more profitable
8. Technology - to make use of available technology
9. Natural calamity - intervention against natural calamity such as flood or drought
10. Political considerations
[Link] preparation and analysis phase
Once project ideas have been identified the process of project preparation and analysis starts. Project preparation must
cover the full range of technical, institutional, economic, and financial conditions necessary to achieve the project’s
objective. Critical element of project preparation is identifying and comparing technical and institutional alternatives
for achieving the project’s objectives. Different alternatives may be available and therefore, resource endowment (labor
or capital) would have to be considered in the preparation of projects. Preparation thus require feasibility studies that
identify and prepare preliminary designs of technical and institutional alternatives, compare their costs and benefits, and
investigate in more details the more promising alternatives until the most satisfactory solution is finally worked out.
•It involves generally two steps:
1. Pre-feasibility studies
2. Feasibility studies
• i. Pre-feasibility Study: The identification process will give the background information for defining the basic
concept 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. At
the pre-feasibility study stage the analyst obtains approximate valuation of the major components of the
projects costs and benefits. Some of the maincomponents examined during the pre-feasibility study include:
ii. 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 is undertaken. Feasibility study or appraisal provides a comprehensive review of all aspects of the
project and lays the foundation for implementing the project and evaluating it when completed. 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. 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. Appraisal should cover major aspects like technical,
institutional, economic and financial.
•The final product of this stage is a feasibility report. 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
•ASPECTS OF PROJECT PREPARATION AND ANALYSIS

•The major aspects of project preparation and analysis are outlined

bellow:
a) Technical Aspects
 This aspect may include the works of engineers, soil scientists and
agronomists in case of, say, agricultural projects.
 The technical analysis is concerned with the projects inputs (supplies)
and outputs of real goods and services and the technology of
production and processing.
 Technical analysis seeks to determine whether the prerequisites for the
successful commissioning of the project have been considered and
reasonably good choices have been made with respect to location, size,
process, etc.
 This is crucial because the rest of the project analysis cannot be
•In general the technical analysis is primarily concerned with
 Material inputs and utilities
 Manufacturing process and technology
 Product mix
 Plant capacity
 Location and site
 Machines and equipment
 Structure and civil works
 Project charts and layouts
 Work schedule
b)Demand and Market Analysis
 The study of this aspect need to ensure the existence of effective demand at
remunerative price; the size of market which will absorb the output without effect on
price and if it does affect the price by how much.
 Similar arrangements need to be done on the input side too (including procurement of
equipment and intermediate input supplies).
 Market analysis is basically concerned with two questions:
 1. What would be the aggregate demand of the proposed product/service in future?
 2. What would be the market share of the project under appraisal?
•To answer the above two questions the project analyst requires a wide variety of information and
appropriate forecasting methods. The kind of information required is:
1. Consumption trends in the past and the present consumption level
2. Past and present supply positions
3. Production possibilities and constraints
4. Imports and exports
5. Structure and competition
6. Cost structure
7. Elasticity of demand
8. Consumer behavior, intentions, attitudes, preferences, and requirements
9. Distribution channels and marketing policies in use
10. Administrative, technical, and legal constraints
• The market analysis is also concerned with the arrangement for marketing the output to be
produced and the arrangement for the supply of inputs needed to build and operate the
project.
• The key steps in such analysis are as follows.
 Situational analysis and specification of objectives
 Collection of secondary information
 Conduct of market survey
 Characterization of the market
 Demand forecasting
 Market planning
C) Institutional-Organizational-Managerial Aspects
 This basically incorporates the socio-cultural patterns and institutions or the population
that the project is believed to serve.
 To have a chance of being carried out, a project must related properly to the
institutional structure of the country or region where the project is to be carried.
Examples include the land tenure system, use of local institutions such as Idir or
Debbo
 Similarly, managerial issues are critical for successful completion of projects.
 Thus, the project analyst must examine the ability of available staff to identify whether
they have the capacity to carry out the managerial needs of the project.
d) Social Aspects
 Project analysts are expected to examine the broader social implications
of the proposed project.
 This is particularly related to the income distribution implications of the
project, which very much related to employment creation.
 Such social goals might also include issues of balanced regional
development, the displacement impact of the project (the Wonji-Methara
sugar plantations displacement is a good case in point); the gender
implication of the adopted technology; environmental impacts etc.
e) Financial Aspects
 Financial analysis seeks to ascertain whether the proposed project will be financially
viable in the sense of being able to meet the burden of servicing debt and whether the
proposed project will satisfy the return expectations of those who provide the equity
capital.
 Here the project analysts is concerned with the financial effects of the proposed project
on each of its various participants (firms, framers/workers, government etc.).
 By examining the financial implications for these parties the analysts need to identify
the projects financial efficiency, incentive impact to the participants in the project,
creditworthiness and liquidity (say, could firms have enough working capital?).
 For instance projections of receipts of one particular participant may help to identify
the possibility of/or the demand for credit for that participant.
•The aspects which have to be looked into while conducting financial appraisal are:
1. Investment outlay and costs of the project
2. Means of financing
3. Cost of capital
4. Projected profitability
5. Break-even point
6. Cash flows of the project
7. Investment worthwhile ness judged in terms of various criteria of merit
8. Projected financial position
9. Level of financial risk
f) Economic Aspects
 The economic aspect of project preparation is primarily concerned with the
determination of the likelihood of the proposed project, and hence the committing of
scares resources, by justifying the significance of the project from the whole economy
point of view (the society as a whole).
 In such evaluation the focus is on the social costs and benefits of a project,
 which may often be different from its monetary costs, and benefits. The financial
analysis views form the participants (or owners) point of view, while the economic
analysis form the society’s point of view.
•There are three important distinctions between the two types of analyses
1. Treatments of taxes and subsidies: these items are treated as transfers in the economic
analysis while in financial analysis taxes are usually treated as cost and subsides re a
return/income.
2. Use of Prices: in the financial analysis we will use actual market prices. In economic analysis
the market prices are adjusted to accurately reflect social and/or economic values. The latter
prices are termed as ‘shadow prices’ or ‘accounting prices’ or ‘economic accounting prices’.
3. Treatment of interest on capital: in economic analysis interest on capital is never separated
and deducted from the gross return since it is part of the return from capital which is available
for the society as a whole. Such interest is deducted from benefit stream in financial analysis
whose point of view is the firm and hence interest is a cost to the firm.
g) Environmental analysis
Ecological analysis should be done particularly for major projects, which
have significant ecological implications like power plants and irrigation
schemes, and environmental polluting industries. The key questions raised
in ecological analysis are:
1. What is the likely damage caused by the project to the environment?
2. What is the cost of restoration measures required to ensure that the
damage to the environment is contained within acceptable limits?
3. Appraisal:
 The feasibility study would enable the project analyst to select the most likely project out of
several alternative projects.
 It addresses the question - is the project worthwhile? A wide range of appraisal criteria have
been developed to judge the worthwhile of a project.
 They are divided into two broad categories, viz., non-discounting criteria and discounting
criteria.
 The principal non-discounting criteria are the payback period and the accounting rate of return.
 The key discounting criteria are the net present value, the internal rate of return, and the benefit
cost ratio.
 After a project has been prepared, it is generally appropriate for a critical review or an
independent appraisal to be conducted.
 This provides an opportunity to re-examine every aspect of the project plan to assess whether
the proposal is appropriate and sound before large sums are committed.
 It is a second look at the project report by a team of professionals, who were not participated in
the preparation of the study but qualified and experienced to evaluate such studies.
 It is or should be an independent assessment of the project to identify the weaknesses and
strengths of the study that have a bearing on the decision to invest and/or to finance the project.
 If the appraisal team concludes that the project plan is sound, the investment may proceed. But if
the appraisal team finds serious flaws, it may be necessary for the analyst to alter the project
plan or to develop a new plan altogether.
4. 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.
 At the project implementation phase tenders are let and contracts signed.
 Project implementation must be flexible since circumstances change frequently. Technical changes are
almost inevitable as the project progresses; price changes may necessitates adjustments to input ad output
prices; political environment may change.
 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.
For expeditious implementation at a reasonable cost, the following are helpful.
1. Adequate formulation of projects. A major reason for the delay is inadequate formulation of projects.
Put differently if necessary homework in terms of preliminary studies and comprehensive and
detailed formulation of projects is not done, many surprises and shocks are likely to spring on the
way. Hence the need for adequate formulation of the project cannot be overemphasized.
2. Use of the principle of responsibility accounting. Assigning specific responsibilities to project
managers for completing the project within the defined time frame and cost limits is helpful in
expeditious execution and cost control.
3. Use of network techniques. For project planning and control two basic techniques are available -
PERT (program evaluation Review Technique) and CPM (Critical Path Method). These techniques
have of late merged and are being referred to by common terminology that is network techniques.
5. Ex-post evaluation:
 the final phase of the project is the evaluation phase. 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.
 A feedback device, it 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. Evaluation is not limited only to completed projects. Ongoing projects
could also be evaluated to rectify problems when the project is in trouble. The evaluation may be
done by the project management, the sponsoring agency, or other bodies.
Chapter 2: Financial Analysis and Appraisal of Projects

Financial analysis of a project amounts to reviewing it from the angle of the entity (private or
public) that will be responsible for its execution.
2.1. When to undertake financial analysis.
 A financial analysis must be undertaken if it is necessary to determine the financial profitability
of a project to the project implementer.
 It will be worthwhile to carry out a financial analysis if the output of the project can be sold in the
market or can be valued using market prices.
 A private firm will primarily be interested in undertaking a financial analysis of any project it is
considering and seldom will it undertake an economic analysis.
 But commercially oriented government authorities that are selling output such as railway,
electricity, telecommunications, etc., will usually undertake a financial and an economic analysis
2.2. Identification and quantification of costs and benefits

 The costs and benefits of a project depend on the objectives the project wants to
achieve.
 A cost is anything that reduces an objective, and a benefit is anything that contributes
to an objective.
 For a farmer, a major objective of participating may be to maximize family income.
He may also wish his children to be educated, which reduces the available labor force
for farm work.
 For a private business firm or government corporations a major objective is to
maximize net income
· A society as a whole will have as a major objective increased national income, but it
clearly will have many significant, additional objectives. One of the most important of
these is income distribution. Another may be to increase the number of productive job
opportunities so that unemployment may be reduced - which may be different from the
objective of income distribution itself. Another objective may be to increase the
proportion of saving for future investment.
· Or there may be other broader objectives such as increasing regional integration,
raising the level of education, improve rural health, or safeguard national security. Any
of these may lead to the choice of a project that is not the alternative that would
contribute most to national income narrowly defined.
Quantification:

 Once costs and benefits are enumerated the next step is accurate prediction of the future benefits and costs which
then be quantified in dollars and cents.
 Thus, quantification involves the quantitative assessment of both physical quantities and prices over the life span
of the project.
 The financial analysis of projects is typically based on accurate prediction of market prices, on top of quantity
prediction
 The same principle applies in the case of economic analysis the only difference being the price needs to be
changed to reflect net efficiency benefits to the nations at large.
 One widely accepted ‘’efficiency’ measure is its actual or potential value as an import or export; similarly the
opportunity cost of any input is related to the question of its potential contribution to (or claims on) foreign
exchange.
 In other words world price are considered as efficiency price indicators compared to domestic prices.
 However, to take account of the distribution impact of projects further adjustment of such price is required.
 This lends itself toe the social cost benefit analysis.
2.3. How to value project costs and benefits in financial analysis.

 The financial benefits of a project are just the revenues received and the financial
costs are the expenditures that are actually incurred by the implementing agency as a
result of the project.
 If the project is producing some goods and services for sale the revenue that the
project implementor expects to receive every year from these sales will be the benefits
of the project.
 The costs incurred are the expenditures made to establish and operate the project.
 These include capital costs, the cost of purchasing land, equipment, factory buildings
vehicles, and office machines, working capital as well as its ongoing operating costs;
for labor, raw material, fuel, and utilities.
 In financial analysis all these receipts and expenditures are valued as they appear in the
financial balance sheet of the project, and are therefore, measured in market prices.
 Market prices are just the prices in the local economy, and include all applicable taxes,
tariffs, trade mark-ups and commissions. Since the project implementors will have to
pay market prices for the inputs and will receive market prices for the outputs they
produce, the financial costs and benefits of the project are measured in these market
prices.

 In a freely perfectly competitive market, without taxes or subsidies the market price of
an input will equal its competitive supply price at each level of production.
 This is the price at which producers are just willing to supply that good or service.
 The supply curve will reflect the opportunity cost, or the value in their next best
alternative use, of the resources used to produce that input. In equilibrium the supply
price of an input will equal to its demand price at the market-clearing price for that
input.
2.4. Secondary costs and benefits

 We may distinguish between primary and secondary costs. The former is concerned
with the direct project outputs and inputs.

 The latter, however, exist where the project enables more efficient use of resources to
be made elsewhere or leads to external claims on resources elsewhere.

 Project might lead to benefits created or costs incurred outside the project itself. So
project analyst must also consider the external or secondary costs so that they can be
properly attributed to project costs investment. This is more a problem of economic
analysis and not a concern of financial analysis. The tracing through of secondary
effects is the proper subject of economic analysis.
2.5.1 Tangible costs of a project

 In almost all project analyses costs are easier to identify (and value) than benefits. In examining
costs the basic question is whether the item reduces the net benefit of a farm or the net income of a
firm.
 The prices that the project actually pays for inputs are the appropriate prices to use to estimate the
project’s financial costs. These prices may include taxes, tariffs, monopoly or monopsony (seller
monopoly) rents, or be net of subsidies.
 Some of the project costs are tangible and quantifiable while many more are intangible and non
quantifiable. The costs of a project depend on the exact project formulation, location resource
availability, or objective of the project. In general, the cost of a project would be the sum of the
total outlays on the following items.
•The cost of land and site development
•· Land charges
•· Payment for lease
•· Cost of leveling and development
•· Cost of laying approach roads and internal roads
•· Cost of gates
•· Cost of tubes wells
Plant and machinery
· Cost of imported machinery which might include the FOB value, shipping freight and insurance
costs, import duty, clearing, loading, unloading, and transportation costs
· Cost of local or indigenous machinery
· Cost of stores and spares
· Foundation and installation charges
Technical know how and engineering fees
· Consultants (local or external)
Miscellaneous fixed assets
· Expenses related to fixed assets such as furniture, office machines, tools, equipments, vehicles,
laboratory equipments, workshop equipments
Pre-operative expenses
· Establishment expenses,
· Rents, taxes, and rates
· Traveling expenses interest and commitment charges on borrowings
· Insurance charges
· Mortgage expenses interest on differed payments,
· Miscellaneous expenses
Provision for contingencies
The cost of production

For instance, for an project the following may be necessary:

· Material cost which comprises the cost of raw materials, chemicals, components for increasing agricultural production,
concrete for irrigation canal construction, material for the construction of homes etc and consumable stores required for
production.
· Utilities consisting of power, water, and fuel are also important cost components.

· Labor: this is the cost of all manpower employed in the enterprise. it will not be difficult to identify and quantify the
labor required for the production process. From the highly skilled manager to the unskilled factory worker the labor input
can easily be identified. Problems in the case of valuing unskilled labor and family labor might arise in the economic
analysis of projects.
· Factory Overhead: the expense on repairs and maintenance, rent, taxes, insurance on factory assets, etc. are collectively
 Land to be used for the project can also be easily identified and quantified. It will not be difficult to know who much
land is need and about the location. Yet problems might arise in valuing land because of the special kind of market
conditions that exist when land is transferred from one owner to another.
 Contingency allowances are usually included as a regular part of the project cost. In general project costs estimates
are assume that there will be no relative changes in domestic or international prices and no inflation during the
investment period or there will no be any modification in design, no exceptional conditions such as unanticipated
environmental conditions (flood, landslides, or bad weather). It would be unrealistic to base 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 cost
 . Contingency allowances may be divided into those that provide for physical
contingencies and those for price contingencies.
 In turn price contingencies comprises two categories, those for relative cages in price
and those for general inflation.
 Physical contingency allowances and price contingency allowances for relative changes
in price are expected and form part of the cost base when measures of project worth are
calculated.
 To avoid the problem of inflation on the other hand it is advisable to work with constant
prices instead of current prices. This approach assumes that all prices will be affected
equally by any rise in the general price level. So contingency allowances for inflation
will not be included among the costs in project accounts other than the financing plan.
Taxes: payment of taxes including tariffs and duties is treated as a cost to the project
implementor in financial analysis. But they are considered as transfer payments in
economic analysis.
· 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 debt service is treated as a transfer payment within the economy even if the
project will actually be financed by a foreign loan and debt service will be paid abroad.
· Sunk costs: sunk costs are those incurred in the past and upon which the 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 account.
2.5.2. Tangible Benefits
Tangible benefits can arise either from increased production or from reduced costs. The specific forms, in which
tangible benefits appear, however, are not always obvious and valuing them might be difficult. In general the following
benefits can be expected
· Increased production
· Quality improvement
· Changes in time of sale changes in location of sale
· Changes in product form (grading and processing)
· Cost reduction through technological advancement
· Reduced transport costs
· Looses avoided
· Other kinds of tangible benefits
2.6. Intangible costs and benefits

 There may be some costs and benefits that are intangible. These may include the creation of new employment
opportunities, better health and reduced infant mortality as a result of more rural clinics, better nutrition, reduced
incidence of waterborne diseases, national integration, or even national defense. Such intangible benefits, however,
do not readily lend themselves to valuation.
 Although the benefits may be intangible most of the costs are tangible. Construction costs for schools, hospitals,
pipes for rural water supply, etc. are all quantifiable.
 However, cost such as the disruption of family life, the increased pollution as a result of the project, ecological
imbalances as the result of the project, etc. are difficult to capture and quantify. But effort should be made to identify
and quantify wherever possible.
The Treatment of Transfer Payments in Financial Analysis

 Some entries in financial accounts represent shifts in claims to goods and services from one entity in the society to
another and do not reflect changes in national income.
 These payments are called direct transfer payments. These direct transfer payments include taxes, subsidies, loans,
and debt services.
[Link]:
• taxes that are treated as a direct transfer payment are those representing a diversion of net benefit to the society.
• A tax does not represent real resource flow; it represents only the transfer of a claim to real resource flows.
• In financial analysis a tax is clearly a cost.
• But the payment of taxes does not reduce national income .So, in economic analysis taxes will not be treated as a
cost in project account.

[Link]:
• are simply direct transfer payments that flow in the opposite direction from taxes.
• If the subsidy is granted on the output side i.e., increase the revenue of the project; we
should deduct the amount of the subsidy from the revenue that includes subsidy.
• If a firm is able to purchase an input at a subsidized price that will reduce his costs and
thereby increase his net benefit, but the cost of the input in the use of the society’s real
resources remains the same.
[Link] Transactions:
• A loan represents the transfer of a claim to real resources from the lender
to the borrower. From the standpoint of the producer, receipt of a loan
increases the production resources he has available; payment of interest
and repayment of principle reduces them.
• But from the standpoint of the national economy loans do not reduce the
national income available. The loan transaction from one enterprise to
another would not reduce the national income; it is rather, a direct transfer
payment. Repayment of a loan is also a direct transfer payment.
2.5. Investment Profitability Analysis
2.5.1. Non-Discounted Measures of Project Worth

• 1. Ranking by Inspection
• It is possible, in certain cases, to determine by mere inspection which of two or more
investment projects is more desirable. There are two cases under which this might be
true.
(i) two investments have identical cash flows each year up to the final year of the
short-lived investment, but one continues to earn cash proceeds (financial results or
profits) in subsequent years. The investment with the longer life would be more
desirable. Accordingly project B is better than investment A, since all things are equal
except that B continues to earn proceeds after A has been retired.
(ii) Two investments have the same initial outlay (the total net value of incremental
production may be the same), the same earning life and earn the same total
proceeds (profits), but one project has more of the flow earlier in the time sequence,
we choose the one for which the total proceeds is greater than the total proceeds for
the other investment earlier. Thus investment D is more profitable than investment
C, since D earns 2000 more in year 1 than investment C, which does not make up
the difference until year 2.
Investment (project) Initial cost Net cash proceeds per year

Year I Year II

A 10,000 10,000 ---

B 10,000 10,000 1,100

C 10,000 3,762 7,762

D 10,000 5,762 5,762

2. The Payback Period
• The payback period is defined as the length of time required for the stream of cash
proceeds produced by the investment (project) to be equal to the original cash outlay
required by the investment (capital investment).
•It is defined as the number of years it is expected to take from the beginning of the
project until the sum of its net earnings (receipts minus operating costs) equals the cost of
the projects initial capital investment.
• Example: if a project requires an original outlay of Birr 300 and is expected to produce a
stream of cash proceeds of Birr 100 per year for 5 years, the payback period would be
• 300/100 = 3 years.
Example: consider project C. 10000 - 3762 = 6238. then 6238/7762 = 0.8 so 1.80 years.
Investment A and B are both ranked as 1, since they both have shorter payback periods than any of the other investments, namely 1
year. But investment B which has the same rank as A will not only earn 10,000 Birr in the first year but also 1,100 Birr a year later.
Thus investment B is superior to A.

Investment Payback period Ranking

A 1 1
B 1 1
C 1.8 4
D 1.7 3

But a ranking procedure such as the payback period fails to disclose this fact. Thus it has two important limitations:

(i) it fails to give any considerations to cash proceeds earned after the payback date. It simply emphasizes quick financial
returns.
3. Proceeds per Unit of Outlay

Under this method, investment are ranked according to their total proceeds divided by the amount of the corresponding
investments.
Example: consider the following hypothetical example

Investment Total Investment Proceeds per Ranking

proceeds outlay unit of outlay

A 10,000 10,000 1.00 4

B 11,100 10,000 1.11 3
C 11,524 10,000 1.15 1
D 11,524 10,000 1.15 1
Accordingly project C and D must be implemented. However, both projects are given the
same rank.
Although we know by inspection that project D is superior because D generates Birr 2000
of proceeds in year 1.

This method is again deficient because it still fails to consider the timing of proceeds. In
other words, the method considers that 1 Birr or proceeds received in year 2 is equal to 1
Birr received in year 1. This is inconsistent with the generally accepted economic
principle that 1 Birr today is more valuable than 1 Birr at some future date.
[Link] Future Income Flows in Project Analysis
 The undiscounted measures fail to take into account adequately the timing
of benefits.
 In economics that inter-temporal variations of costs and benefits influence
their values and a time adjustment is necessary before aggregation.
 Therefore a time dimension should be included in our evaluation.
 That means we need to express costs and benefits in terms of value by
discounting all items in the cash flows back to year 0.
• Discounting is a technique or a process by which one can reduce future
benefits and costs to their present worth or present value.
• Costs and benefits are discounted by a factor that reflects the rate at which
today’s value of a monetary unit decreases with the passage of every time
unit.
• Any costs and benefits of a project that are received in future periods are
discounted, or deflated by some factor, r, to reflect their lower value to the
individual (society) than currently available income.
• The factor used to discount future costs and benefits is called the discount rate
and is usually expressed as a percentage.
• The discount rate is usually determined by the central authorities (national
Bank).
Discounted Project Assessment Criteria

1. The Net Present Value (NPV)

 The most widely used and straightforward discounted measure of project worth is the net present worth or the net
present value (NPV).
 The NPV is defined as the difference between the present value of benefits and the present values of costs.
 The NPV can be obtained by discounting separately for each year, the difference of all cash outflows and inflows
accruing throughout the life of project at a fixed, pre determined interest rate.

Where Bt are the project benefits in period t

n
( Bt  Ct )
NPV  t Ct are the project costs in period t
t 0 (1  r )

r is the appropriate financial or economic discount rate

n is the number of years for which the project will operate
Having set the discount rate, an investment project is deemed acceptable if the discounted net benefits (benefits minus
costs) is positive. Accept all projects that show positive or zero NPV at the predetermined discount rate and reject all
projects that show negative NPV.

Thus, the decisions is to accept if NPV > 0. We can also discount benefits and costs separately, and if B > C then NPV =
B-C>0
Example: Consider the following Discounted Cash Flow for the ABC Project in m. Birr)

Year Cash flow Discount factors for 10 percent Discounted cash flow (10%)

0 -20 1.00 -20.0

1 4 0.909 3.64
2 4 0.826 3.30
3 4 0.751 3.00
4 4 0.683 2.73
5 4 0.621 2.48
6 4 0.564 2.26
7 4 0.513 2.05
8 4 0.467 1.87
9 4 0.424 1.70
10 4 0.386 1.54
NPV 4.57

Since discounting the cash flow at 10 percent produces a positive NPV of 4.57 million Birr we conclude that the
project should be undertaken. Suppose now that cost of capital were to be raised to 20 percent, the project produces a
negative NPV of 3.21million Birr. In this event the project would have to be rejected.
NPV and Decision Rule for Independent Projects

Independent projects are projects that are not in any way substitutes for each other. In such cases the decision rule is to
accept the project if the NPV is greater than or equal to 0(approve any project for which NPV>=0). If two projects have
positive NPV and there is no budget constraint both should be accepted and you do not need to choose the one with
higher NPV. For example, if two independent projects road and fisheries development projects in different locations are
being considered and both have a positive NPV, then both should be undertaken.

Decision Rule for Mutually Exclusive Projects

A mutually exclusive project is defined as a project that can only be implemented at the expense of an alternative
project as they are in some sense substitutes for each other. Example of the mutually exclusive projects includes two
versions of the same project, say with different technology, scale or time. The decision rule for such projects is to
accept the project with the highest NPV.
Advantages of NPV Approach

The major advantage of the NPV selection criteria is that it is simple to use and does not rely on complex conventions
about where costs and benefits are netted out, as do some ratio measures. In addition it is the only selection criteria that
can correctly be used to choose between mutually exclusive projects, without further manipulation.
Limitations of the Net Present Value Test
[Link] projects could be deferred from implementation although they show positive NPVs, due to scarcity of funds.
Thus passing the NPV test may be a necessary condition but not a sufficient condition.
[Link] some projects are mutually exclusive then the implementation of one would naturally exclude the execution of the
other.
[Link] selection of an appropriate discount rate is another limitation.
[Link] does not show the exact profitability rate of the project.
[Link] Internal Rate of Return of a Project (IRR)

 It is also called the yield of an investment method or simply the yield method.
 It is possible to think a level of interest rate that could result in NPV of zero. This rate
of interest rate is termed as the Internal Rate of Return (IRR).
 The IRR is the rate of discount, which makes the present value of the benefits exactly
equal to the present value of the costs.
 Thus, it is the discount rate at which it is worthwhile doing the project. This is the
interest rate that a project could pay for the resources used if the project is to recover
its investment and operating cost and still can be at the break-even point.
Decision rule Using IRR
According to the IRR version of economic criterion we implement all projects that show an IRR greater than the
predetermined discount rate (opportunity cost of capital), i.e., accept all independent projects having an IRR >= the
opportunity cost of capital (cut off rate). The reference discount rate which is also called the target rate, is
predetermined by the Central Bank(r).
All projects with an internal rate of return greater than some target rate of return, r*, should be accepted

Once the IRR is identified, the decision rule is ‘accept the project if the IRR is greater that the cost of capital, say r.
Note also that:

When NPV > 0 then R > r

NPV = 0 then R = r
NPV < 0 then R < r
cont…
cont…

“r”can be found through trial & error method.

When r = 23.068 percent

the value in the above equation in the RHS will be equal

to about 1000.00 which is equal to the value in the LHS.

The problem with this method is that the value of

r (IRR) can only be found by trial and error
cont…

The procedure can be described as follows:

1. Select an arbitrary value of r;
2. Calculate the value of the RHS equation with this value of r.

3. If the RHS < LHS reduce the value of r.

If the RHS >LHS, increase r; continue this until RHS is very close to
the LHS.
When the RHS is more or less equal to LHS, it is that value
of r, which is the IRR.
Advantages of the IRR
1. The IRR is used in many projects
2. It is the only measure of project worth that takes account of the time profile of a
project but can be calculated without reference to a predetermined discount rate.
3. It is a measure that could be understood easily by non-economists since it is
closely related to the concept of the return on investment.
4. It is a pure number and hence allows projects of different size to be directly
compared.
Problems with the IRR

[Link] IRR is inappropriate to use for mutually exclusive projects and independent
projects when there is a single period budget constraint.
2.A project must have at least one negative cash flow period before it is possible to
calculate its internal rate of return. This is because the NPV will always be positive no
matter how high the discount rate used to discount it, unless the project has at least one
negative cash flow period.
[Link] problem with the IRR is that in some cases it my be possible to compute more
than one IRR for a project. For instance, the net benefit stream of an oil-drilling project
become negative half way though the project’s life because it is necessary to replace rigs
after a number of years. If a project has more than one IRR, then neither an be reliably
used and another decision rule such as the NPV must be used rather than the IRR.
•[Link]
The benefit cost ratio is the earliest discounted project assessment criterion to be
employed. 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. This is given as,
•The Decision rule for BCR

•A project should be accepted if its BCR is greater than or equal to 1

(i.e. if its discounted benefits exceed its discounted costs). But if BCR
is less than 1 , the project should be rejected. The BCR will be less
than, equal to, and greater than one when the discount rate used is
greater, equal to, and less than the IRR.

•One possible advantage o the BCR, on top of being easy to show to

non-economists is that it is easy to show the impact of a percentage
change in cost or benefits on the projects viability.
•Its major disadvantage is the need to specify and adhere to
conventions regarding the designation of expenditures as costs and
benefits.
Chapter 3. The Economic Analysis of Projects

 In financial analysis, the analyst is concerned with the profitability of the project from an
individual point of view (firm’s profitability).
 The main objective here is to maximize the income of the firm or to analyze the budgetary
impacts.
 In financial analysis the analysis is done by applying market prices.
 From the standpoint of the economy as a whole, however, the objective is to maximize
national income no matter who receives it. But financial analysis will rarely measure a
project’s contribution to the community’s welfare.
 The starting point for the economic analysis would be the financial prices.
 They are adjusted as needed to reflect the value to the society as a whole of both the inputs
and outputs of the project.
3.1. The Rationale for Economic Analysis

 The objective of any legitimate government should be the promotion of community

welfare. They will be more concerned with their public work programs to promote
community welfare than they merely maximize financial profits at distorted local prices.
 The basic question here is whether it is possible to use market prices to assess the
economic worth of projects. The answer is obviously no. Prices could be distorted
because of failures of markets, the absence of perfect knowledge, and the existence of
externalities, consumer and producers surplus, government and public goods, etc. So
governments must choose projects on the basis of an economic analysis if they wish to
promote the community’s welfare.
The major conditions under which it is impossible to use market prices to assess the economic
worth of projects can be grouped under three or four major headings:

[Link] in and failures of goods markets including the markets for internationally traded
goods.
[Link] in and failure of factor markets including the market for labour, capital, and
foreign exchange.
[Link] existence of externalities, public goods and consumer and producers surplus.
[Link] knowledge, that consumers and producers have full knowledge of about all aspects
of the economy relevant to their choice of operations. This is unrealistic because of poor
transport and communication and low education levels.
3.2. The Essential Elements of an Economic Analysis
The economic analysis of a project has many features in common with a financial analysis.
[Link] involve the estimation of a project’s cost and benefits over the life of the project for inclusion in the project’s cash flow.
[Link] both the cash flow is discounted to determine the project’s net present value, or other measures of project worth
[Link] may also use sensitivity or probability analysis to assess the impact of uncertainty on the project’s NPV.
But an economic analysis goes beyond a financial analysis appraisal, as it will also involve all or some of the following
adjustments.
a) The elimination (deduction) of transfer payments within the economy from the project’s cash flow. Transfer payments are
payments that transfer the command over the use of resources but do not, themselves use resources.
Examples:
 Taxes-Personal and company income taxes, VAT, indirect taxes.
 Subsidies ---- Including those given via price support schemes.
 Tariffs on imports and exports subsidies and taxes .
 Producer surplus - gains received by a supplier
 Credit transactions - loans received and repayment of Interest and principal
b) The estimation of economic or shadow prices for project outputs and produced
inputs (included internationally traded and non-traded goods) to correct for any
distortions in their market prices.
 In financial analysis inputs and outputs are valued at actual market prices while in
economic analysis accounting (shadow) prices are employed.
 Example: enterprises will pay workers the market wages and in real Birr (not shadow
ones) irrespective of what is believed to be their opportunity cost from the economy’s
viewpoint. Similarly, the enterprise will collect for its exports the equivalent of local
currency calculated at the official exchange rate, even when the foreign currency is
undervalued.
c) The estimation of economic prices for non produced project inputs (including labor,
natural resources and land) to correct for any distortions in their market prices.
d) The valuation and inclusion of any externalities created by the project in economic
analysis
e) The valuation and inclusion of any un-priced outputs or inputs such as public goods or
social services.
[Link] ECONOMIC VALUES

 As indicated earlier according to (financial analysis) inputs and outputs of a project are
valued at prices prevailing in the domestic market
 The rationale for using market prices lies in the assumption that these prices reflect both
marginal utilities of consumption and marginal production costs. But this assumption may
only hold true under the ideal condition of perfect competition and therefore, the
optimality of resource allocation depend on whether such conditions actually prevail in
the market.
 It now generally accepted that market prices are very far from this ideal. For social,
political, historical, and economic reasons the markets are distorted and consequently the
signals they give in the form of prevailing prices are also distorted and do not reflect
marginal product ivies and marginal utilities.
• All sections of the domestic market are distorted due to a variety of
reasons.

• Divergence between economic and market prices could be due to

market failure, government interventions, externalities, public goods
and distributional considerations.

• Hence serious distortions exist in the market for labor, capital, and
foreign exchange and efforts are necessary to replace the signals from
these markets by more appropriate measures.
 The key to understanding of economic analysis is the concept of opportunity cost.
 When a commodity or service is used for one purpose we must give up the
benefit we could have received had we used the good or service for the next best
good or service.
 The opportunity cost is equal to the marginal value product (the contribution of
an additional unit of a commodity to output) and the market price of the item in a
relatively competitive market.
 In financial analysis the price is the opportunity cost because we give up what
we could have done with the money we paid for an item if we had used it for
some other purpose.
 Economic pricing involves making adjustments to market prices to correct
for distortions and to retake account of consumer and producers surplus.

 The adjusted price should then reflect the true opportunity cost of an input
or people’s willingness to pay for it.

 When the market price of any good or service is changed to make it more
closely represent the opportunity cost to the society the new value assigned
becomes the Shadow Price also called the accounting price.
 The shadow price is what we call the economic price.
1. Adjustment for Transfer Payments
 It is important when undertaking a project appraisal to identify the major distortions that
will create the mot serious divergence between market (financial) and economic prices in
the market for a project’s outputs and inputs.
Transfer payments are defined as payments that are made without receiving any good or
service.
They involve the transfer of claims over real resources from one person or entity in
society to another, rather than payments made for the use of or received from the sale of
any good or service. So they do not reflect changes in the national economy.
 Some examples of items that are considered as transfer payments are:
a)Taxes –
 Personal and company income taxes, value added taxes and other indirect taxes, excise
taxes stamp duties, etc. In financial analysis a tax is clearly a cost. When an individual
pays taxes his net benefit is reduced.
 But this payment does not reduce national income. Rather it is transfer from the
individual to the government so that the income can be used for social purposes that
are important to the society.
 Thus payments of taxes does not reduce national income, it is not a cost from the
standpoint of the society as a whole.
 Thus economic analysis, which assesses the impact of a project on national income, we
would not treat the payment of taxes as a cost in project accounts.
c) Production Subsidies are simply direct transfer payments that flow in the opposite direction from taxes.
Different from of subsidies may exist ranging from lowering the selling price of inputs below what otherwise
would be the market price to the raising or increasing of the price received by the producer. Subsidies do not
increase or decrease national income. It merely transfers control over resources from a taxpayer to another
individual. Of course the subsidy increases the individual’s income, so it is revenue for the receiver.

c) Credit Transactions are also transfer payments because the lender transfers control over resources to the
borrower. Loans received and payment of interest and capital when these transactions occur between
domestic borrower and lenders are examples of such credit transactions. The payment of interest and
repayment of capital (debt service) is treated as an outflow in financial analysis but treated as transfer
payments and are omitted from economic accounts.
3.4. Efficiency or Economic shadow Prices

 Once it is decided that market prices are inappropriate in project selection, the question arises
how the necessary accounting prices should be estimated. Thus the economic analysis of
projects requires that inputs and outputs be valued at their contribute
 Definition of shadow (accounting) prices
 Accounting or shadow prices are simply a set of prices that are believed to better reflect the
opportunity cost, i.e. the cost in their best use, of goods and services.
 It represents all non market prices. It is the value used in economic analysis for a cost or a
benefit in a project when the market price is left to be a poor estimate of economic value.
Efficiency shadow prices are border prices determined by international trade.
 An accounting or shadow prices reflect the increase in welfare resulting from one more unit of
an output or input being available.
Shadow pricing and the numeraire
 The implicit objective of project analysis when project items are valued at opportunity cost is to

maximize the net resources available to the economy. For many project items the opportunity cost will be
given directly by its border prices. A numeraire is a unit of account. Shadow prices can be expressed in
two ways:
a) Either they can all be expressed directly in foreign exchange units - valuing all project effects at
world prices termed as the world price numeraire. If a world price numeraire is adopted then the domestic
market price of the import substitute needs to be adjusted downward to its world price.
b) They can be expressed in domestic price units termed using a domestic price numeraire.
Conversely if a domestic price numeraire is adopted the border price of export products need to be
adjusted upwards by a certain factor (conversion factor).
•Shadow price estimates can be made at two levels:
• · Economic analysis
• · Social analysis
•
•Distinction stems from the objectives pursued in project appraisal. In economic
analysis resource efficiency also is considered. In social analysis growth and
income distribution objectives are pursued. In practice estimates of the parameters
needed for a social analysis are relatively rare.
3.3. Traded and Non Traded Goods

The valuation of goods and services depends on whether the good can be traded in international market or whether it is
consumed locally such as in a closed economy.

Goods and services produced by the project or that serves as project inputs can be classified as:
· Non-traded goods
· Traded goods or
Non-Traded Goods
• The non-traded goods are goods that do not enter into the international trade because of their nature or physical
characteristics.
• So the non-traded inputs and outputs of a project cannot be valued directly at border or world prices directly. Some
also consider goods which do not enter into trade because of protection is presently instituted (trade barriers).
Example: Electricity is only rarely transmitted across frontiers. Unskilled labor is also another example of non-traded
commodity. Inland transportation and cement or cement is usually considered as non-traded goods.
In both cases the non-traded inputs and outputs of the project cannot be valued directly at border or world prices. So the
valuation of non traded goods at world prices consists of a number of steps.

a) net out taxes from the domestic market price of the commodity.
b) The net of taxes price is decomposed into its traded and non-traded cost elements. For the traded components a
border price is available by definition and they are valued at this price.
Traded Goods

 Traded goods are defined as goods and services whose use or

production causes a change in the country’s net import or export
position.
 Examples: all kinds of manufacturing
Agricultural goods
Intermediate goods
Raw materials
Some services such as tourism and consultancy services
 Traded goods are either exportable or importable goods (or services).
Exportable goods are those whose domestic cost of production is
below the FOB export price that local producers can earn for the good
Conversion Factors
 A conversion factor is defined as the factor by which we multiply the actual
price in the domestic market of an input or output to arrive at its accounting
price when the latter cannot be observed or estimated directly. The more the
inputs and outputs are traded the less will be the need to use conversion
factors.
 The conversion factor is simply the ratio of the shadow price of the item
to its market price.
 A conversion factor is estimated simply by taking the ratio of border
prices (world prices) to domestic market prices of the good.
 As it has been indicated earlier the market distortions vary from commodity
to commodity, therefore, the conversion needed varies from case to case.
 It is therefore possible to estimate commodity specific, service specific, or
sector specific like electricity, transportation, construction etc., or for a basket
of goods e.g. consumption goods for a particular income group conversion
 But at least we need one conversion factor to multiply all the domestic market prices of all no traded components of
the input and output of a project. This parameter is called the standard conversion factor.
 The Standard Conversion Factor
 This is an all-inclusive conversion factor used in place of commodity - or sector specific
conversion factors, either because they cannot be estimated accurately, or because we
believe that they cannot be estimated accurately or because they do not differ
substantially from the standard conversion factor. It is a summary measure to calculate
accounting prices for non traded commodities.
 In the case of Ethiopia the standard conversion factor is interpreted as a summary and
approximate quantification of the distorted markets (domestic) as compared to the
international market. It is therefore estimated as the ratio of the value of imports and
exports of a country at border prices (CIF and FOB) to their value at domestic prices.
The formula for computing the standard conversion factor is give as:

M X
SCF 
( M  Tm  S m )  ( X  S x  Tx )

Where M and X are total imports and exports respectively at world prices converted at the official
exchange rate.

 Tm and Tx are the total trade taxes on imports and exports respectively
 Sm and Sx are total trade subsidies on imports and exports respectively
Broadly, there are two methods of measuring

economic costs and benefits of a project:

UNIDO approach and

Little-Mirrlees approach.
Two approaches of measuring economic costs & benefits of a project

UNIDO Approach: In this method economic benefits &

costs may be measured at domestic prices using
consumption as the numiraire, with adjustment made for
divergence between market prices and economic values,
and making domestic and foreign resources comparable
using shadow exchange rate (SER).

 In this method, if commodities are traded, first all these

traded goods will be adjusted for any distortions in the
domestic markets.

 After this adjustment is made the adjusted domestic

price will be multiplied by SER to make domestic
resources be comparable with foreign resources.
……..
Suppose we have a project producing export item that
uses both foreign & domestic inputs.
The net benefit would be estimated as:
Net benefit = SER (X-M)-D
Where
X - border price of exports in FC
M - border price of imported goods in FC
D - adjusted (economic) values of domestic goods in DC
SER - is the shadow exchange rate
Shadow Exchange Rate: Premium
SER =Pd/Pw
Where Pd - domestic price
Pw - world price in foreign currency
Little-Mirrlees Approach

The other method of adjusting market prices into

economic prices is the Little-Mirrlees approach.
In this approach benefits and costs measured at world
price to reflect the true opportunity cost of outputs and
inputs

The fact that foreign exchange is taken as a nureraire

does not mean that project accounts are necessarily
expressed in foreign currency.

The unit of account can remain the domestic currency,

but the values recorded are the foreign exchange
equivalent that is, how much net foreign exchange is
earned.
……..
But if the goods or inputs in question are non-traded
goods, the analyst needs to use conversion factor to
translate domestic prices into their border price
equivalent.

CF = economic price /market price

So the economic price for a non-traded good is its

market price multiplied by the conversion factor.
How are conversion factors derived?
……..
A project that produces export goods can be assessed as
follows.

Net Present Value (NPV) = OER (X-M) - SCF.D

Where -OER- official exchange rate

X- exported goods in foreign currency
M- imported goods in foreign currency
SCF- standard conversation factor
D- price of non-traded goods in domestic currency

To summarize, as long as SCF is the ratio of OER to SER, the

two approaches - UNIDO and Little-Mirrless - differ only to
the extent that SER is different from the actual exchange
rate.
Chapter four: Project Monitoring and
Evaluation
4.1. What is Monitoring and Evaluation?
Monitoring
Is the systematic collection and analysis
of information to enable managers and
key stakeholders to make informed
decisions, maintain existing practices,
policies and principles and improve the
performance of their projects.
It is the regular gathering, analyzing and
reporting of information that needed for
evaluation.
It is either ongoing or periodic
observation of a project’s implementation
to ensure that inputs, activities, outputs,
Evaluation
Is a selective and periodic exercise that
attempts to objectively assess the overall
progress and worth of a project.
It uses the information gathered through
monitoring and other research activities.
Monitoring Vs Evaluation
Monitoring checks whether the project is
on track while evaluation questions
whether the project is on the right track.
Monitoring is concerned with the short-
term performances of the project while
evaluation looks more at long-term
effects of project goals.
Monitoring tends to underline little problems
before they become big ones while evaluation
is a systematic examination of a project to
determine its efficiency, effectiveness, impact,
sustainability, and the relevance of its
objectives.
Traditionally, evaluation has been the last step
in the project life cycle and in the project
development process.
However, it does not make sense to wait until
the project is finished to ask the question “Did
we do the right thing?” Indeed, you could
evaluate the effectiveness at each stage of the
project life cycle.
4.2. Why Monitoring and Evaluation?
M&E can help an organization to extract
relevant information from past and ongoing
activities that can be used as the basis for
future planning.
A structured M&E approach makes information
available to support the implementation of
projects and which enhance project
sustainability.
M&E can helps to strength project
implementation and encourage useful
partnerships with key stakeholders. The main
objectives of M&E are :
Ensure informed decision-making
Enhance organizational and development
Provide mechanisms for accountability
Promote partnership and knowledge transfer
to key Stakeholders
Build capacity in M&E tools and techniques
4.3. Kinds of Monitoring and Evaluation?
Internal Project M&E
Is built for the design of a project and is
undertaken by the team that is
responsible for management and
implementation of the project.
External Project M&E
Is carried out by an outside team, which
is not directly responsible for the
management or implementation of the
project.
It assess the effectiveness of the internal
M&E put in place by the project
management team.
External monitoring can take place once
the project has been completed, and/or
during implementation of the project.
External M&E is often required by donor
agencies or government organizations, if for
example, they need to know how their funds
are being spent or if their policies are being
adhered to.
Findings and recommendations of external
monitoring are often documented in a review
or evaluation report.
External M&E also monitors and evaluates
internal M& E
4.4. Monitoring Levels
Traditionally, M&E focused on assessing the
inputs and activities of a project.
Project inputs, activities and risks are also
important, however, as they all affect outputs.
For example, if the budget (an input) is cut by
50%, this will obviously affect the outputs of
the project and will need to be taken into
account when conducting the M&E.
There are various monitoring levels in a
project; thus are:
1) Input Monitoring
 It is the monitoring of the resources that are
put into the project; these include budget,
staff, skills, etc.
Information on this type of monitoring comes
mainly from management reports, progress
reports and accounting.
For example, ways of measuring this can
be the number of days consultants are is
employed, or the amount of funds spent
on training and equipment.
2) Activity Monitoring
It monitors what happens during the
implementation of the project and
whether those activities, which were
planned, were carried out.
This information is often taken from the
progress report.
3) Output Monitoring
It is a level between activity and impact
monitoring.
This type of monitoring assesses the result or
output from project inputs and activities.
The measurements used for output monitoring
will be those which show the immediate
physical outputs and services from the project.
4) Impact Monitoring
Impact monitoring relates to the objectives of
the project.
The aim of impact monitoring is to analyze
whether the broader development objectives
of the project have been met.
It demonstrate changes that are fundamental
4.5. Monitoring and Evaluation Procedures
M&E procedure sets out the steps in planning
and implementing external M&E.
The M&E procedure must be customized to the
specific needs of each project, taking into
account the project objectives, inputs, outputs,
activities, stakeholders and beneficiaries.
The M&E steps will vary from situation to
situation.
Step 1: Establish the Purpose and Scope
ofM&E
Specifying the purpose and scope of the
M&E helps to clarify what can be
expected of the M&E procedure, how
comprehensive it should be and what
resources and time will be needed to
implement it.
When formulating the purpose of M&E,
relevant stakeholders including the
project management team, should be
consulted or at least made aware of and
understand the purpose of the M&E
For example, to verify that the
development objective and outputs of
the project have been achieved within
What is the purpose of M&E?
How much money is available for your M&E?
What type of information is required by project
management donor agents or other
stakeholders?
What is the level of M&E expertise available?
To what extent should local communities and
other stakeholders, participate in the M&E
procedure?
Step 2: Identify Performance Questions
and Indicators
1) Performance Questions
A performance question is used to focus
on whether a project is performing as
planned and if not, why not.
Performance questions will be guided by
the broader development objective, the
project outputs, as well as the M&E
purpose.
Once performance questions have been
identified, it will be easier to decide what
information is needed to evaluate the
project.
2) Indicators

While performance questions help to decide
what should be monitored and evaluated,
indicators provide the actual measurements
for M&E and determine what data needs to be
gathered.
The project itself may have indicators by
which it monitors it's own progress - these may
be used for external M&E, if relevant.
Indicators might be either qualitative or
quantitative.
Quantitative data is factual while
qualitative information is based on
opinions and perceptions and thus may
be subject to further interpretation
During M&E, one should aim to have both
qualitative and quantitative indicators.
Relevant - The indicators should be
directly linked to the project objectives/
outputs.
Technically feasible - The indicators
should be capable of being verified or
measured and analyzed.
Reliable - The indicators should be based
on exact information's.
Usable - People carrying out the M&E
should be able to understand and use the
information provided by the indicators to
evaluate the
project.
Participatory - Relevant stakeholders
should be involved in the collection of
information generated by the indicators,
Step 3: Establish M&E Functions, Assign
Responsibilities and Financial Resources
Establishing M&E functions and responsibilities
at the beginning of the procedure can help to
avoid major communication issues, conflicts of
interest, duplication of tasks and wasted
efforts.
Organizing responsibilities means deciding
which stakeholders will be involved and
clarifying and assigning roles to these
stakeholders as well as to funding organization
officials, project management and any partner
organizations.
Stakeholders may need to be trained in
different aspects of the M&E procedure.
M&E will require financial resources in
Among the items that should be included in
M&E costs are:
Staff salaries;
Fees and expenses for consultants;
Fees and expenses for M&E training;
Fees and expenses for organizing M&E
meetings and other participatory exercises.
Consultants can play an important role in
enabling projects to fulfill its M&E
responsibilities by providing specialist
knowledge and expertise that may not be
readily available in the organization.
Step 4: Gather and Organize Data
Data gives life to M&E. However,
selecting methods of data collection can
be confusing, unless it is approached in a
systematic fashion.
Instead, using multiple methods helps to
validate M&E findings and provides a
more balanced and holistic view of
project progress and achievements.
The performance questions and
indicators will provide guidance in
deciding what data/information to gather
and the methods to be used.
Data can either be primary or secondary.
Data Sources and Data Collection
Methods
Potential data sources and data
collection methods are listed below:
Document Review: .
Interviews :
Surveys and Questionnaires:
Field Visits and Transect Walks
Expert Opinion Obtaining the views of
experts who are knowledgeable about
particular aspects of the project's.
Organizing and Storing Data
Data needs to be captured, organized
and stored so that it can be readily used
for the M&E purposes
Proper capturing, organizing and storage
is particularly important when
information has been collected from
different sources with different methods.
Step 5: Analyze Data and Prepare an
Evaluation Report
The captured and organized data needs
to be analyzed, and findings and
recommendations summarized and
compiled into a report.
In this regard, the performance questions and
indicators can provide important assessment
tools for the analysis.
A final comparison with the outputs and
impacts of the project should then be made.
In this way performance, progress and
achievements of the project can be assessed.
Reporting
Feedback and reporting are key to both
internal and external M&E as, in this way,
information can be meaningfully
combined, explained, compared and
presented.
All reporting should thus be as accurate and
relevant as possible.
As mentioned earlier, external M&E will
frequently use the internal project progress
reports and other relevant information as part
of the information gathered to externally
monitor and evaluate the project.
For external M&E the report is usually called
an evaluation or review report.
Step 6: Disseminate Findings and
Recommendations
The evaluation reports, or summaries of
these reports, should be widely
distributed and presented to decision-
makers and key stakeholders including
those who were consulted in the M&E
Step 7: Learn from the M&E
M&E provides information and facts that,
when analyzed, understood and accepted,
become knowledge that can be used to
improve Project management.
Besides learning about the
progress/achievements of the project
outputs, etc, it is essential to learn from
what works regarding partnership
strategies, project design and
implementation, and to feed this
knowledge back into ongoing and future
projects and policies
This information also provides a means to
regulate the sustainable management of
state projects by other agencies.
Project evaluations can help to
bring development partners
together, and when this occurs the
learning from M&E goes beyond
project to stakeholders involved in
other development and natural
resource
management activities.
Chapter Five:
Evaluation: Some Basics of Impact
Evaluation Methodologies
5.1. Introduction
Impact assessment is the process of
identifying the anticipated or actual impacts of
an intervention, on those social, economic and
environmental factors in which the intervention
is designed to affect.
Impact evaluation provides a framework
sufficient to understand whether the
beneficiaries are truly benefiting from the
program and not from other factors.
The main question of impact evaluation is one
of attribution isolating the effect of the
5.2. Qualitative vs Quantitative Impact
Assessment
Méthodologies
Impact evaluation could be qualitative and
quantitative methods.
Qualitative method of analysis
It seeks to measure potential impacts
that the program may generate, the
mechanisms of such impacts, and the
extent of benefits to recipients from in-
depth and group-based interviews.
It is not generalizable and generate
information that may be critical for
understanding through which the
program helps beneficiaries.
Some degree of qualitative interpretation may
be necessary in all impact assessments, in
order to evaluate the causes of impacts which
have been observed.
It can't assess outcomes against relevant
alternatives or counterfactual outcomes.
That is, it doesn’t really indicate what might
happen in the absence of the program.
Quantitative method of analysis
It involving baseline studies, the precise
identification of baseline conditions,
definition of objectives, target setting,
rigorous performance evaluation and
outcome measurement.
This methods is costly, limited in the types of
impacts which can be accurately measured,
and may pose difficulties for inference of cause
and effect.
Basically, there are two types of quantitative
impact evaluation methodologies: thus are, ex
post and ex ante
Ex ante impact evaluation:
It attempts to measure the intended
impacts of future programs and policies,
given a potentially targeted area’s
current situation.
Ex post evaluations:
In contrast, measure actual impacts
obtained by the beneficiaries that are
It can also be much more costly than ex ante
evaluations because they require collecting
data on actual outcomes for participant and
nonparticipant groups.
5.3. Methodologies in impact evaluation
A number of different methods can be used in
impact evaluation theory to address the
fundamental question of the missing
counterfactual.
Counterfactual refers to the state of
beneficiaries without project intervention.
Each of these methods carries its own
assumptions about the nature of potential
selection bias in program targeting and
participation, and the assumptions are
crucial in developing the appropriate
The most popular methods of impact
evaluation are:
Randomized evaluations
Matching methods, specifically propensity
score matching (PSM)
Double-difference (DD) methods
Instrumental variable (IV) methods
These methods vary by their underlying
assumptions regarding how to resolve selection
bias in estimating the program treatment
effect.
Randomized evaluations
Randomized evaluations involve a
randomly allocated initiative across a
sample of subjects (communities or
individuals, for example); the progress of
treatment and control subjects exhibiting
similar preprogram characteristics is then
tracked over time.
Randomization could be conducted purely
randomly (where treated and control units
have the same expected outcome in
absence of the program)
This method requires ensuring external
and internal validity of the targeting
design.
Careful selection of control areas (or the
Propensity score matching (PSM)
PSM constructs a statistical comparison
group that is based on a model of the
probability of participating in the project,
using observed characteristics.
Participants are then matched on the
basis of this probability, or propensity
score, to nonparticipants.
PSM methods therefore assume that selection
bias is based only on observed characteristics;
they cannot account for unobserved factors
affecting participation.
Double-difference (DD) methods
DD methods assume that unobserved
selection is present and that it is time
invariant;
The treatment effect is determined by
taking the difference in outcomes across
treatment and control units before and
after the program
intervention.
It can be used in both experimental and
non-experimental settings.
IV methods
IV models can be used with cross-section
or panel data and in the latter case allow
for selection bias on unobserved
characteristics to vary with
time.
we may be interested in the effect of
time-invariant variables (like gender,
region……./ but FE can’t
In the IV approach, selection bias on
unobserved characteristics is corrected by
finding a variable (instrument) that is
correlated with participation but not
correlated with unobserved
characteristics
affecting the outcome
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