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CHAPTER XII
BIOGAS INSTALLATION COST AND FINANCIAL VIABILITY 11
12.1 INTRODUCTION
Decisions about capital investment in different projects or assets involve comparisons of payments of money
at different points of time. Whether to invest on a particular project depends upon the costs involved in that
activity and the benefits derived from it. The simple decision rule is that if the benefits exceed the costs, the
project is worth undertaking; otherwise not.
Costs and benefits are of two types: private and social. The cost that only the individual decision maker bears
is the private cost. Likewise, the gains/benefits received only by the decision makers is the private benefit.
Besides private costs and private benefits, the same activity may also impose some costs or provide
benefits to others as well. The sum of private costs and the costs to others is social costs. Similarly, the
sum of private benefits and the benefits obtained by others is the social benefits.
Let us take an example of private/social costs and benefits. Cost of transporting goods to market is a private
cost, while the depreciation of road and the effect of pollution to the community should also be included
while calculating social costs. Similarly, the benefits that a horticulturist gets from his apple farm is his
private benefits, while the benefits that a bee farmer may get from that farm should be included while
calculating social benefits.
12.1.1 The Discount Rate and the Net Present Value
In general, the value of one hundred rupees paid in the future is less than one hundred rupees today. Why?
Because, you can earn interest on that money by putting it in a bank! If the interest rate is 10 percent per
annum, you will get Rs 110 after one year if you put Rs 100 in a bank now. So, Rs 100 today is equivalent to
Rs 110 after one year. In other words, if you put Rs 90.91 today in a bank earning 10 percent year, at the end
of the year you will have exactly Rs 100. That is, Rs 90.91 plus interest payments of Rs 9.09 (Rs 90.91 times
0.10 rounded to the nearest paisa) equal Rs 100.
The process of translating a future payment into a value in the present is called discounting. The value in the
present of a future payment is called the net present value (NPV). 12 The interest rate used to do the
discounting is called the discount rate. In the preceding example, a future payment of Rs 100 has a net
present value of Rs 90.91, and the discount rate is 10 percent. If the discount rate were 20 percent, the net
present value of a future payment of Rs 100 would be Rs 83.33. It follows that the higher the discount rate,
the lower the net present value of a future payment.
It follows from the above discussions that
payment in one year
Net present value =
(1 + the discount rate)
Or, NPV = F
1+ r
where NPV is the net present value, F is the future payments, and r is the discount rate.
To obtain the formula for the case where the payment is two years in the future, we have to do the
discounting twice so that the corresponding formula for NPV would be
11 This chapter is based upon the presentation of lecture made by Professor Dr. Nav R. Kanel in course of
Training for the Trainers of Junior Biogas Technology organized by Biogas Support Programme (17-20 May
2000)
12 Net present value is also called present discounted value.
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