1. Training on Financial
and Economic Project
Evaluation
(cost benefit analysis)
May 15th 2013

2. Learning objectives
1. Understand the concept, utility and limits of
financial/private and economic/social project
evaluation (cost benefit)
2. Know how to interpret the results of financial/economic
evaluations (cost benefit)
3. Understand the opportunities of financial/economic
evaluation being part of the PCM and its implication for
results based project management
4. Identify development projects for which the concept
can be applied, and for which kind of projects other
methods are more adequate

3. Group Work
Social Entrepreneur selling a technology like micro
irrigation to poor farmers
1. What do you need to know to make this business a
success and not a bankruptcy?

4. Objective of CBA applied to project
evaluation
Make better informed decisions on whether to
invest or not
Relying on the necessary information to
quantify variables which are related to
• investment,
• operational costs and
• incomes

5. Market / feasibility
Study
Technical Study
Organisational study Financial Evaluation
Important studies needed for project
formulation and evaluation
Economic Evaluation

6. The different studies provide information for
the project evaluation - business approach -
Benefits / Costs Return on investment
Market Study
Objective: Determine the
existence of the unmet
demand and quantify it
Technical Study
Objective: Verify the
technical feasibility
Organisational Study
Objective: define the
optimal organisational
structure
 Analysis of demand
 Analysis of supply
 Price or fee
 Marketing strategy
 Production capacity
 Technology
 Infrastructure
 Human resources
 Information system
 Legal aspects

7. What is cost-benefit analysis (CBA)?
The aim of the cost benefit analysis is to assess the
profitability of investments over time, by comparing the
costs of a project with its benefits
COSTS =  investment costs
 running costs or operational costs
 financial costs
 support costs
Only real costs are considered in the CBA, i.e. costs that correspond to flows of
cash, and the costs are computed at the time when they occur during project life.
BENEFITS:  increased production, project sales
 reduced costs
 social benefits, improved livelihood, reduced poverty,…

8. Quantification is required!
CBA requires to quantify all the costs and benefits, which is sometimes rather
challenging. Where quantification is not possible, benefits and costs should be
included in the discussion and interpretation of the models, or another method
should be selected (e.g. Cost effectiveness)
Whose costs should be considered ?
Beyond financial evaluation: all costs need to be taken into account
• SDC project costs
• Other counterpart costs
• Costs beneficiaries bear (incl. in-kind contributions)

9. Note: the CBA compares additional costs and additional benefits
for the users / for the enterprise, etc. i.e. the costs and benefits WITH
or WITHOUT the project
Example of a CBA
Note: year 0 is only virtual, so that the project can start in year 1 it is necessary to have the
funds available on the day before the project starts
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
COSTS -100 -12 -13 -11 -13 -12
Investment -100
Operations -10 -10 -10 -10 -10
Other costs -2 -3 -1 -3 -2
BENEFITS 0 12 20 50 50 100
Sales 12 20 50 50 50
Residual
value
50
CASH FLOW -100 0 7 39 37 88

10. DISCOUNTING
Principle:
1 dollar today is worth more than 1 dollar tomorrow
Question: what is the value today of the money you will earn next year,
or in 2, 3 or 10 years from now?
Example: on your savings account you have 5’000 CHF
earning 2% per year
How much will you have on your account after 5 years? (assuming that
you have no transaction costs and that the interest rate remains
unchanged)
Interest 1st year = 5’000 * 2% = 5’100 CHF
Interest 2nd year = 5’100 * 2% = 5’202 CHF
Etc…

11. Compound interest Discounting
capital (P) = today 5'000 capital (P) = today 4’528
interest (r) 2% interest (r) 2%
time (years) (n) 5 time (years) (n) 5
accumulated capital (A) 5’520 accumulated capital (A) 5’000
A = P(1 + r)n P= A(1+r)-n

12. Net Present Value and Internal Rate of Return
Net present value (NPV) = value today of the cash flow of
each year of the analysed period
In Excel, use +NPV(10%;year1...year5)+year 0 (here = 15.00)
Internal Rate of Return (IRR) = rate that the project generates
over time (this rate can be compared with interest rate of banks
or alternative use of the capital
In Excel, use +IRR(year0 ... Year5) (here = 13.81%)
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
COSTS -100 -12 -13 -11 -13 -12
BENEFITS 0 12 20 50 50 100
CASH FLOW -100 0 7 39 37 88

13. Evaluation criteria
Net present value (NPV)
• Expresses the difference
between total
expenditure and income
of the project (cash flow)
but discounted to the
value of money at
project start.
• Shows the surplus after
having received the
demanded profitability
(discount factor) and
having retrieved the total
investment
• The convention is to
accept the project if the
NPV is bigger or equal
to 0.
Internal rate of return
(IRR))
• Shows the maximal
profitability that can be
expected of the
investment.
• The project is accepted
if the IRR is bigger or
equal to the discount
factor.
• IRR only tells us if the
project is better than the
alternative use of funds
(IRR does not allow to
compare different
project)
Benefit – Cost Relation
(BC)
• Compares the present
value of the benefits with
the present value of the
costs including the
investment, shown as a
ratio
• The project is accepted
if the ratio is bigger or
equal to zero.one

14. EXTERNALITIES
Externalities are “side effects” of projects or enterprises
which are not included in the costs and benefits; they can be
positive (external benefits) or negative (externals costs). In the
case of negative externalities, the costs are usually paid by the
society
Examples of external benefits
 Access to electricity for villagers after a factory was installed in
the neighbourhood
 After a village installed electricity supply, an enterprise decides
to settle in the neighbourhood ( job creation)
Examples of external costs
 Pollution, noise, traffic, etc.

15. Economic analysis
SHADOW PRICES / economic prices
(also called opportunity costs)
Market prices do not always reflect the real value of products. This
is the case for instance when subsidies or taxes are paid / charged.
Example:
fertiliser price on the market = 100’000 VND
subsidy from the Government = 25%
real value of fertiliser = 100’000 VND + 25% = 125’000 VND
In this case, farmers get fertilisers cheaper than the real value, the
financial value is lower than the economic value

16. FINANCIAL VS ECONOMIC ANALYSIS
Financial Economic
CBA shows
the interests
of ...
Private enterprise: is
the project profitable
for the investor?
Society: is the project
beneficial to the society
(whole economy)
Prices
considered
Costs and benefits at
market prices
Shadow prices
(opportunity prices), i.e.
prices are corrected from
subsidies, taxes, etc.
Externalities Not considered Considered

17. Excel data

18. Reserve Slide: Structure of the flow of
funds statement
+ Income (tax relevant)
- Expenditure (tax relevant)
- Expenditure not implying cash flows, but tax relevant
(depreciation and amortization)
= Profit before taxes
- Taxes
= Profit after taxes
+ Adjustment for expenditures not implying cash flows
(depreciation and amortization)
- Expenditure not relevant for taxes (investments)
+ Benefits not relevant for taxes (residual value)
= Cash Flow

19. Consideration concerning the cash flow
Time horizon of the evaluation
• Is highly dependent on the characteristics of each project.
• If the project life time can be foreseen, and is not long term, the most
convenient is to construct the flow of funds for this number of years.
• If the enterprise (or structure) the project wants to create will stay in
the market (no exit strategy), the general convention is to project the
flow of funds for 10 years.
• The expected benefits beyond the 10th year are then reflected in the
residual value.

20. Risk within projects
When preparing and evaluating projects one has to rely
on assumptions, e.g. with respect to
– population growth,
– demand,
– supply,
– technologies,
– availability of inputs,
– estimation of costs,
– estimation of benefits,
– etc., etc., etc.
… where there are assumption there are
risks

21. Mainly serves for :
a. Determine critical variables and their ranges of
variation.
b. Study and determine the effects of the critical
variables on the results of the project.
c. Evaluate the project with different external
conditions.
Sensitivity analysis

22. Methods for sensitivity analysis
Select the critical variables :
Consider the variables that are difficult to predict
Select the variable with the biggest impact on the NPV
… or those with the highest uncertainty.
Move one variable at a time (Ceteris Paribus)
Construct different scenarios for a group of the above
variables and re-calculate the project criteria.

23. Possible Alternative: Cost Effectiveness
Analysis
• Applied when benefits cannot be quantified (with
reasonable effort)
• Instrument for comparing different approaches to reach a
certain benefit
• Choose the approach that creates the biggest and lasting
benefit for the beneficiaries
• Used to justify an approach for funding (as compared to
alternatives)

24. Cost Effectiveness Analysis
Impacts that the project
is supposed to reach
Distinguish major impact
and side impacts (or
secondary impacts)
Starting point =
project design
COSTS =
Direct costs
Investment costs,
Support costs
(coaching,
backstopping, etc.)
Maintenance costs
Costs for SDC and
costs for partner
organisations
Indirect costs may also
be considered
BENEFITS: are the
benefits really the same,
how sustainable are the
benefits, etc.

25. Important to remember
1. You need solid numbers
a) to construct financial and economic
evaluations, evaluate results before, after,
during
b) to formulate your project: market studies etc.
2. Financial (private) evaluation shows whether
private sector part is viable or what the project
needs to do to make it viable

26. Important to remember
3. Financial and economic evaluation are key
tools to improve result management:
 Identify benefits
 Quantify benefits
 Establish causality
… even if no precise NPV can be calculated.

27. Important to remember
4. Economic/social evaluation provides valuable,
additional decision criteria (not the only ones!)
a) to approve or reject projects
b) to identify more objectively and quantified
what works and can be scaled up

28. 1. Reserve Slide: Domains of application of
CBA in development cooperation
• CBA can be applied in a wide range of projects, key condition is
the quantification of costs and benefits
• CBA can be applied to entire projects or to selected project
components
Difficulty to apply
Low Medium High
Project
dealing with
Income generation,
livelihood, economic
development
Health, education,
nature conservation,
biodiversity, etc.
Governance, policy
dialogue, institutional
development
Examples of
CBAs (done
or in
preparation)
Vietnam, Mongolia,
South Africa, Latin
America
Macedonia,
Moldavia
Balkan region

29. 2. Reserve Slide: Basic steps to conduct
meaningful CBAs
• First step: define the boundaries of the project or
component that is to be analysed
 What exactly is to be analysed? What is the purpose of the analysis?
(includes geographic, institutional, topical boundaries, etc.)
• Second step: what are the outcome / impact hypotheses?
 How do costs relate to benefits, what are the expected outcome/impact
chains?
• Third step: list all the costs related to the selected project /
component (including local contributions, investment costs,
operational costs and management costs) and the benefits (in three
categories:
i) easy to quantify, ii) difficult to quantify, iii) non quantifiable)
• Fourth step: assess data availability; plan and implement data
collection
• Fifth step: set up CBA model and interpret it