PED guidebook main sxn rev6. FINAL.pdf - LGRC DILG 10

Project Evaluation and DevelopmentPART IINTRODUCTION TO THE PED GUIDEBOOKProject Evaluation and Development (PED) consists of tools and techniques that are needed toenhance planning, investment programming, budgeting, and the linkages between these phasesin the planning cycle. All projects identified in the PDIP will undergo preliminary evaluation.Projects that require lumpy resources will need to be subjected to a finer screening process.This process will determine objectively the benefits and costs of projects with full considerationof their social, financial and economic impacts – both intended and unintended over theirexpected economic life.At the very least, the PED technician should imbibe the discipline of a PED technician and, atbest, be skillful in PED tools and techniques.A. IMPORTANCE OF PED IN LGU PLANNING AND EXPENDITURE MANAGEMENTPED improves the effectiveness of public expenditure:Effectiveness refers to theextent by which goals aremet by the investment orproject.• By screening out projects that do not meetthe stated goals of the province• By screening out projects that may conflictwith other goals of the provincePED improves the (allocative) efficiency of public expenditure:Efficiency refers to theamount of resourcesrequired to produce a unitof output.• By prioritizing projects that meet prioritydevelopment goals of the province• By prioritizing projects that create enablingconditions for other projects• By screening out redundant projects• By screening out projects that meet thegoals but at a very high costRGEdillon January 20061

Project Evaluation and DevelopmentB. PED AND THE OVERALL PLANNING CYCLEPDP PDIP AIPProjects forLocal fundingProjects forexternal fundingSmall ProjectsBig ProjectsPreliminaryEvaluationPreliminaryEvaluationPreliminaryEvaluationComplete PEDComplete PEDCovered in PED GuidebookProjectproposalProject evaluation takes off from the provincial plan, the multi-year investment plan and theannual investment plan. Projects will first be classified according to funding source. All projectswill undergo the preliminary evaluation. The complete PED, however, will be limited to only thebig projects and those that will be proposed for external funding. Essentially, the complete PEDis concerned with the finer screening of projects. In the next part, we suggest a scheme toclassify projects into “big” or “small”.The next stage is to specify the plans for the efficient implementation of projects that passed theproject evaluation stage. This includes specifying, in detail, arrangements for implementationand the subsequent operations and maintenance of the project. Many of the steps undertakenin the project evaluation will be used in this stage.For projects that is proposed for external funding, a full blown project proposal will bedeveloped.RGEdillon January 20062

Project Evaluation and DevelopmentC. PLAN OF THE GUIDEBOOKThis guidebook explains in detail what we mean by “discipline of a PED technician” anddiscusses the PED tools and techniques.There are two major sections in this guideline - Project Evaluation and Development(PED), and Project Proposal Development. A Technical Appendix on PED is included.This contains the more detailed and technical discussion on the principles and conceptsbehind PED. This is a recommended reading for everyone who is interested inconducting serious PED.RGEdillon January 20063

Project Evaluation and Development1.2.2 impact evaluation - where the interest is on the outcome and impact of theproject on the intended beneficiary and societyWith respect to the planning phase, the usage of Project Evaluation is more akin to exanteevaluation. This is also sometimes called the feasibility study.2. Feasibility study pertains to the whole gamut of analyses carried out to determine if theproject can be implemented and achieve the desired goals. It includes market analysis,technical, financial, and economic analyses, assessment of environmental and marketrisks and institutional analysis. These components of a feasibility study are explained inthe next section.3. Pre-feasibility study is similar to the feasibility study in terms of the principles and stepsfollowed. The difference lies in the depth and, therefore, accuracy of the analysis. Thisis largely due to the short duration of time allowed for the conduct of the pre-feasibilitystudy. Usually, the purpose of a pre-feasibility study is to determine if a more in-depthfeasibility study is warranted.4. Project appraisal is similar to the feasibility study in terms of the steps followed.Oftentimes, however, the parties responsible for financing the project are the ones thatconduct the appraisal. This, being the case, the interest is in verifying the assumptionsused in the earlier feasibility study.5. Economic life refers to the time span over which the project is able to generate benefits(or earnings) and influence development or economic behavior. This is determined bythe rate of depreciation subject to operations and maintenance schemes, andobsolescence when new (and better) technologies become available.6. Discount rate reflects the opportunity cost of money. The concept is based on thepremise that money received now is more valuable compared to money to be receivedat some time in the future. Its value depends on the alternative defined. The next twodefinitions illustrate this concept.The discount rate 1 is equal to the interest charged on a loan but deducted in advance. IfP is the amount of the principal, r is the interest rate, and the repayment period is just 1year, thenAmount in year 1 is P (1 + r)If the interest is deducted in advance, the amount to be given to the borrower atyear 0 is:P= +dP 1 r7. Financial rate of discount is applied when the resources devoted to the project are seento compete with private investments. Usually, this is pegged at the commercial lendingrate. In other words, the resources to be spent for the project is compared againstprojects that can be undertaken by the private sector and earn an average rate of return.1 Note that the terms “discount rate” and “rate of discount” are used interchangeably.RGEdillon January 20065

Project Evaluation and DevelopmentExample (a): Supposed your friend wants to borrow from you the amount of P 150,000with a promise to be paid back after 1 year. Will you be satisfied with a repayment ofexactly P 150,000?The answer is most likely a “no”. If you are a businessman, you could have invested itsomewhere profitable and earned an interest of 20%. With this in mind, you can lendthe amount of P 125,000 now and agree to accept payment of P 150,000 a year fromnow.8. Social rate of discount or social rate of time preference reflects the opportunity cost ofmoney as valued by society as a whole, and not just by the finance sector. It is the rateat which an individual would be willing to give up current consumption. In other words,the resources devoted to the project are seen to compete with private consumption.Usually, this is pegged at the interest rate paid on long-term government bonds. 2Example (b): Let us modify the premise of example (a). Suppose you are not abusinessman and are unlikely to undertake investments. The alternative for you is toplace the money in a bank where it will earn the savings rate. Even better, you canpurchase government bonds with maturity of 1 year. If this latter promises an interestearning of 7%, then you can allow your friend to borrow P 140,186.91 now in exchangefor the promised repayment of P 150,000 a year from now.150,000140,186.91=1.079. Market price vs. Economic price.9.1 Market price is the price at which the good or service is being bought and sold at theend-users’ market (as opposed to farmgate). We also sometimes refer to this asfinancial price.9.2 Economic price reflects the value that society places on the good or service withdue consideration for its scarcity and relative importance, absent market distortions.For instance, there is consideration as to whether the inputs are sourceddomestically or imported, or whether the outputs are marketed only within thecountry or are exported, etc. If they are traded in the international market, thenprocuring them (in the case of project inputs) or supplying them (in the case ofproject outputs) will affect the country’s foreign exchange situation.Example (c): The cost of one kilo of fresh tomatoes, when sold in the farm inBulacan is only P20. When sold in the wet market in Cubao is P50. Assuming thatthe tomatoes come from Bulacan, this means that only P20 will be received by thetomato farmer and the difference goes to the trade and transport cost. The marketprice, in this case, in Cubao is P50 but the economic price is only P20.2 The NEDA Public and Investment Staff estimates the social rate of discount. Sometimes, funders have their ownvalues of the social rate of discount. It is suggested that both be consulted by the PROJECT EVALUATIONanalyst.RGEdillon January 20066

Project Evaluation and Development10. Shadow prices. The more popular term for economic price is shadow price. It is basedon the same principle that the true price reflects the relative scarcity of the good insociety. In particular, the NEDA estimates the values of the shadow discount rate(SDR), reflecting the true opportunity cost of money, the shadow exchange rate (SER)reflecting the true opportunity cost of foreign currency and the shadow wage rate (SWR)reflecting the true opportunity cost of labor. Presently, the shadow discount rate isestimate to be 15%, the shadow exchange rate is 20% more than the official exchangerate and the shadow wage rate of unskilled labor 3 at only 60% of the current wage rate. 411. Present value is the value now of future incomes and costs. It is computed by applyingthe appropriate discount rate that reflects the opportunity cost of money. The formula isgiven below, where PV t is the present value of the amount X in year t and r is thediscount rate.XtPVt= (1+ r)tExample (c): A project is expected to generate revenues beginning year 2 until year 5.Every year the revenue amounts to P 100,000.00. We are interested to know thepresent value of this revenue stream (that is, at year 0). Assume a discount rate of 15%.Year UndiscountedamountFormula0 01 0100,0002 100,000.00 2(1 + 0.15)100,0003 100,000.00 3(1 + 0.15)100,0004 100,000.00 4(1 + 0.15)100,0005 100,000.00 5(1 + 0.15)Discountedamount75,614.3765,751.6257,175.3249,717.67TOTAL 400,000.00 248,258.993 There is no official definition that distinguishes skilled from unskilled labor. A skilled worker may derive hisskills from professional or technical education, or acquired on the job. In practice, we consider a skilled worker asone who bring expertise to the performance of a given job.4 The values of the SDR, SER and SWR may change from time to time. Therefore, the PED analyst is advised toverify the values with the NEDA-PIS.RGEdillon January 20067

Project Evaluation and Development12. Net present value (NPV). The stream of benefits and costs can be expressed in presentvalue terms. The net present value (NPV) is the difference between the present value ofbenefits and the present value of costs.B CtNPV = −t(1+ r) (1+r)TTt∑ t ∑t= 0 t=0where B t and C t are the benefits and costs accruing at time t, respectively.The decision rule is to reject a project thatyields a negative NPV.YearExample (d) : Consider the previous example (c). Let us assume that the projectentails an investment cost of P 150,000 and all these are spent on year 0.Undiscountedamount0 150,000 01Cost Revenues Revenuesless CostFormula Discounted Undiscounted Formula Discountedamount amountamount150,000(1 + 0.15)150,000 (150,000)2 100,000100,0002(1 + 0.15)3 100,000100,0003(1 + 0.15)4 100,000100,0004(1 + 0.15)5 100,000100,0005(1 + 0.15)75,614.37 75,614.3765,751.62 65,751.6257,175.32 57,175.3249,717.67 49,717.67T O T A L 248,258.99 98,258.99The net present value (NPV) is computed to be P 98,258.99. Since the NPV is positive,we conclude that the project is viable.13. Rate of return, or financial rate of return, is the ratio of the earnings from the asset to thevalue of that asset. For public projects, we normally do not compute for the financial rateof return since these are not expected to yield profits.14. Internal rate of return (IRR) is the discount rate at which the net present value is zero.RGEdillon January 20068

Project Evaluation and Development⎛ B C ⎞− ⎟=0t⎝(1 r) (1 r) ⎠∑ T t t⎜ tt=0 + +where B t is the value of benefits at time t and C t is the value of costs at time t. Theproject life is T years.15. Economic internal rate of return (EIRR) is similarly defined as the IRR except that thebenefits and costs are expressed in economic prices.The decision rule is to reject a project that yields anEIRR that is less than the social rate of discount.16. Benefit-cost ratio (BCR) is simply the ratio of the total benefits to total cost. Discountingis applied when considering future streams of benefits and costs.The decision rule is to reject a project that yieldsBCR that is less than 1.Example (e): Referring to example (d), we note the following information:Present value of benefits = P 248,258.99Present value of costs = P 98,258.99PV of benefitsBCR = = 2.53PV of cos tsIn other words, we enjoy benefits amounting to more than 2 and ½ times the amount wespent for the project.RGEdillon January 20069

Project Evaluation and DevelopmentExample (f) using Microsoft Excel:The computation of the IRR is quite involved and requires a combination of interpolationtechniques and trial-and-error. Fortunately, this function is found in Microsoft Excel sothe computation is now easy.Consider the above example. We can lay out the data on costs and benefits accruing toeach year. We then compute for the undiscounted net benefits (benefits less cost).Year Costs BenefitsBenefits lessCost0 150,000.00 (150,000.00)1 -2 100,000.00 100,000.003 100,000.00 100,000.004 100,000.00 100,000.005 100,000.00 100,000.00IRR =The procedure IRR is found in Microsoft Excel under the Main Menu “Insert”, submenu“function”.RGEdillon January 200610

Project Evaluation and DevelopmentYou will then be shown a list of functions that are in the software. Choose the functioncategory (left side of the box) “Financial” and under function name (right side of the box),choose ‘IRR”.RGEdillon January 200611

Project Evaluation and DevelopmentA dialog box appears and you will be asked to indicate the data range corresponding tothe “values”.Year Costs BenefitsBenefits lessCost0 150,000.00 (150,000.00)1 -2 100,000.00 100,000.003 100,000.00 100,000.004 100,000.00 100,000.005 100,000.00 100,000.00IRR = 34%Note that the dialog box also asks another information, that is, “guess”. This is becausein some cases, the IRR may not exist or there may be multiple values of the IRR.RGEdillon January 200612

Project Evaluation and Development17. Cost-effectiveness ratio (CER). Sometimes, it is difficult to quantify project outcomes, asin the case of health, sanitation and education projects. In cases like these, the projectunder evaluation is compared against other projects that will yield the same outcomes.The appropriate indicator to compare is the cost per unit outcome, e.g., cost per childimmunized or cost per cases found and treated, etc.The decision rule is to reject a project that yields thehighest CER, or cost per unit outcome, among allpossible strategies that produce the same outcome.18. Financial and economic viability.18.1 If the project yields a positive NPV where the costs and benefits are expressed inmarket prices, the project is said to be financially viable. We also say that a projectis financially viable if the project yields an internal rate of return (financial internalrate of return) that is higher than the financial rate of discount.18.2 If the project yields a NPV where the costs and benefits are expressed in economicprices, the project is said to be economically viable. We also say that a project iseconomically viable if the project yields an internal rate of return (economic internalrate of return) that is higher than the social rate of discount.C. OVERVIEW OF PROJECT DEVELOPMENT1. As the phrase implies, project development is a process, wherein the project undergoestransition from inception to completion. It covers the following sub-processes:Pre-investmentProject identificationProject preparationProject appraisal and financingInvestmentDetailed engineering and designProject implementationPost-investmentProject operationEx-post evaluation2. Note that the project identification is undertaken beginning with the planning stage (PDP)and refined during the investment programming stage (PDIP and AIP). During projectpreparation stage, the project is evaluated and is subjected to further screening and/orfine-tuning. Projects that passed the finer screening are then appraised. It is the funder,or any party acting on behalf of the funder, that conducts the appraisal. As mentionedbefore, the interest is to verify the assumptions used and methodologies employed in thefeasibility study. There may also be other criteria for approval, aside from economicviability. Approved projects are then provided the necessary financing.3. Detailed engineering and/or design are usually undertaken only for approved projects.This is because this phase requires substantial resources, which are, in turn, built intoRGEdillon January 200613

Project Evaluation and Developmentthe project cost. Note that projects that do not involve construction of hard infrastructuredo not require detailed engineering. In such cases, only the detailed design needs to bedone. This includes the arrangements for implementation – project management, funddisbursement and accounting, monitoring and evaluation, etc. If a project is proposedfor external funding, some description of these arrangements may be already requiredbefore a project is approved.4. The next step is to implement the project according to the detailed design. For projectsthat involve construction of hard infrastructure, project operation commences only afterthe structure is built. For other projects, or for projects that include non-infrastructurecomponents, project implementation coincides with project operation. Examples of thelatter are immunization project, supplementary feeding, an irrigation project withtechnical assistance component, etc.5. Some time after the project implementation and operation, it is recommended that an expostevaluation be conducted. Results from the ex-post evaluation can enhance thedesign of future projects in order to increase its effectiveness and efficiency.6. In the next sections, we will be discussing project evaluation and development in thecontext of the project preparation stage. We will also refer to this as the PED.D. MAJOR COMPONENTS OF PROJECT EVALUATION AND DEVELOPMENT1 Earlier, we said that Project Evaluation or feasibility study pertains to a whole gamut ofanalyses undertaken to determine if the project is worth pursuing of not. Most manualson project evaluation or feasibility study enumerate and discuss the component studiesthat need to be undertaken. The usual broad classification (or sub-studies are) is thefollowing:• Market analysis• Technical analysis• Financial analysis• Economic analysis• Analysis of externalities• Risk and sensitivity analysisWe briefly describe below the objectives of these studies/analyses. The details areexplained in the subsequent sections.1.1 Market analysis answers the questions:a. Does the current situation imply that there is a shortage in supply of the project’sintended output?b. Is there a demand for the project’s output even in the medium term (say 10years)?c. If I charge a fee for the use of the project’s output, by how much will demandlikely decrease?1.2 Technical analysis answers the questions:a. Is the proposed project strategy technically sound?b. What are the alternatives to produce the desired project outputs?RGEdillon January 200614

Project Evaluation and Developmentc. Is the proposed project strategy the most cost-effective among the alternativesidentified in 1.2.b?1.3 Financial analysis answers the questionsa. How much does the project cost?b. How much does it cost to operate and maintain the project so that it will beuseful?c. If the project can generate revenue, how much is the projected revenue?d. If the project cannot generate revenue, how much is the required subsidy tooperate and maintain the project?e. What is the financial internal rate of return? (See Definition 12 above.)1.4 Economic analysis answers the questions:a. How much is the true cost of the project to society (economic cost)?b. How much is the true benefit of the project’s output to society (economicbenefit)?c. How do these economic costs compare with the economic benefits?1.5 Assessment of externalities answers the questions:a. Will any of the project’s activity and output pose hazard to the environment?b. What are the potential risks to other people’s health, lives and property?c. What is the likelihood of these potential hazards?d. How can these hazards be mitigated and if possible, prevented?e. How much is the cost of mitigation and/or prevention?f. Will any of the project’s activity and output generate benefits even to theunintended beneficiaries of the project?1.6 Risk and sensitivity analysis answers the questions:a. Will the project still be financially viable if there are deviations in input and outputcosts, including the possibility of time overrun?b. Will the project still be economically viable if there are deviations in input andoutput costs, including the possibility of time overrun?2 This guidebook discusses these same components but takes a different approach. Inthis section, we provide a brief rationale of the steps involved in PED. The underlyingprinciples for the steps involved are discussed in detail in the Technical Appendix.3 In conducting PED, it is important for you to:3.1 KNOW the project and3.2 UNDERSTAND it in sufficient detail, enough to be able to3.3 ANALYZE it thoroughly, and3.4 JUDGE it fairly.E. PROJECTS TO BE SUBJECTED TO PROJECT EVALUATION AND DEVELOPMENTRGEdillon January 200615

Project Evaluation and Development1. Undertaking PED will, by themselves, entail the use of time and manpower resources.Thus, it is not advisable to subject each and every project to rigorous PED. By this, wemean that for “small” projects, the steps to be undertaken can end with “UNDERSTANDthe project”, but for “big” projects, there should be a complete analysis.2. The question that comes to mind is “How do we define big and small projects?” Thisquestion should be answered in relation to the competing needs for the fiscal resourcesof the province. A suggestion is to subject projects to the complete PED if the projectcost meets the following:Pr oject cos t>20%development fundnumber of municipalitiesThe above scheme is easily justified:2.1 If we consider one municipality to be just as important as the next, and2.2 If the project will require resources greater than the amount computed at equalsharing, then2.3 We will need to be able to defend the project to the other municipality that will haveto forgo some of its share from the “fiscal pie”.Annex 1 shows the latest IRA data (2003) of provincial LGUs and the corresponding cutoffbetween small and big projects. It is suggested that the cutoff be re-computed asnew data becomes available.3. All projects that are proposed for external funding will be subjected to thorough PEDanalysis, regardless of the size of the project. The reason for this is because the fundingsource will want to be assured that the funds (whether in the form of loan or aid) will, onbalance, benefit society. Note that your proposed project will have to compete againstproposed projects of other provinces and even agencies of the national government!F. PROCEDURES IN CONDUCTING PED1. KNOW THE PROJECT1.1 Before proceeding, it is important to identify the good or service that the project willprovide. Having done this, you will need to characterize this output as to:1.1.1 Whether the good is private, public or mixed. Be guided by the following setof questions: 5a. If I consume the good, does it mean that others cannot consume it?b. Can I limit consumption only to those who paid for the good?c. Is the project’s output divisible and can consumption be measured?d. Is it feasible to collect fees from the consumers?5 Please refer to the Technical Appendix, pages 2-4 for a more detailed discussion of the typology of goods andservices.RGEdillon January 200616

Project Evaluation and Developmente. Will I need to contend with congestion issues?1.1.2 Whether the good is tradeable, nontradeable or limited tradeability. Beguided by the following set of questions:a. Is the good being traded in the international market?b. From the Philippine point of view, do we import a good of similar type?c. From the Philippine point of view, do we export a good of similar type?d. Are there restrictions governing the import and export of this good?1.2 This step will help us anticipate the “pricing” problem that needs to be confrontedwhen conducting the PED.1.2.1 If the good possesses the characteristic of a private good, then users can becharged a fee. There can be revenues from the project.1.2.2 If the good is a public good, then it is either not possible or administrativelyinfeasible, to charge a user’s fee. The project benefits will not be expressedby way of revenues.1.2.3 If the good is being traded in the international market, procuring it (in the caseof inputs) and producing it (in the case of outputs) will have foreign exchangeimplications on the country. These will need to be considered in theeconomic analysis.2. UNDERSTAND THE PROJECT IN SUFFICIENT DETAILThis step is interested in answering the following:• Are the project goals and objectives in line with the goals and objectives articulatedin the PDP?• Is there a logical path coming from the proposed activities of the project to thedesired outputs and the promised outcomes and impacts?• How can the transformation from input to output to outcome and impact beimproved? Will the project require other components or other projects to effect thetransformation?Following is a series of questions that need to be answered satisfactorily to helpunderstand what the project is about. Note that the proponent is the major actor in thisphase.If the project proponent is not able to provide a satisfactoryanswer to any of the questions below, then the projectconcept is not yet fully developed. In this case, theproponent will need to go back to the “drawing board” tofinalize the project concept.2.1 What is the rationale for the project?RGEdillon January 200617

Project Evaluation and Development2.1.1 Develop the log frame for the project. 6 The project proponents, with guidancefrom the PED technician, will model the project in matrix form, clearlyspecifying thei. Goal of the sector to which the project belongs,ii. the expected impact of the project that will contribute to meeting this goal,iii. the project’s outputs that will result in the expected impact,iv. and the project’s inputs that are needed to produce the output.v. Important assumptions are stated andvi. a list of verifiable indicators of success is given,vii. together with the proposed strategy to measure accomplishment.2.1.2 Note that the Project Proponent must be able to trace the goal of the projectback to the development goals articulated in the Provincial Development Plan(PDP).Table 1MatrixNarrative Summary Indicators M&E AssumptionsGoal:Purpose:OutputsInputsExample (g): Consider a project that will construct a communal irrigation system. Thelogframe may resemble the following:6 Please refer to the Technical Appendix, pages 12-15, for a more detailed discussion of logical framework analysis.RGEdillon January 200618

Project Evaluation and DevelopmentProject: Communal Irrigation SystemNarrative Summary Indicators M&E AssumptionsGoalTo promote food securitymean and variance of domesticsupply of riceBAS recordsTo reduce poverty among rice farmerspoverty incidence among ricefarmersFIES and APISPurposeTo increase and reduce volatility in thedomestic production of riceTo increase and reduce volatility in theincome stream of rice farmersvolume of rice produced per year special evaluationis increased by 1.8 times surveynumber of harvest is at least 2 per special evaluationyearsurveyreduced variance in rice production special evaluationper yearsurveyincome of farmers from rice is special evaluationincreased by 1.8 timessurveyreduced variance in annual income special evaluationof rice farmers from ricesurveyadequate supply of farminputs; available capital topurchase farm inputs;properfarm managementadequate postharvest andstorage facilitiesaggressive marketingstrategysavings mobilizationschemes for farmersOutputsIrrigation service area with covering 100hectares of rice plainsconstruction of CIS with servicearea of 100 hectaresprojectaccomplishmentreportsproper O&M and watershedmanagementInputsPhp 10 millionEngineering supportAdmin supportfunds disbursement rate% accomplishmentprojectaccomplishmentreportsROW secured on time2.2 The primary function of projects is to catalyze development.2.2.1 Society will continue functioning even without the project. The proponentneeds to adequately describe the “without project” scenario and contrast thisagainst the “with project” scenario. Again, this procedure is facilitated by theproject’s logframe. Table 2 can also help. Not all cells need to be filled up,only those that are relevant to the project. However, it will be useful to collect(and regularly update) this information from every barangay in the province.a. Start with the outcome, describe the current situation.b. Forecast 7 what will be the outcome going into the future if the project willnot be undertaken. We refer to this as the “without project” scenario. Besure to consider the following:• This “without project” scenario should consider future developments.• It is not always correct to assume that over time, the “without project”scenario will simply be the value of the outcome at the initial year.• The “initial year” should not coincide with extraordinary events, like anEl Nino, an earthquake, etc., unless these are normal occurrences.c. We will need a time series to be able to forecast outcomes given the“status quo”.7 Refer to Technical Appendix, pages 16-21 for pointers and some simple techniques on demand forecasting.RGEdillon January 200619

Project Evaluation and DevelopmentExample (h): Consider the following possible time series indicating volume of riceproduction.ABCD1 2 3 4 5 6 7 8YearWe have plotted four possible scenarios – A, B, C and D. The actual time series isgiven by the black dots and the black lines. The forecast trend is given by the bluebroken line. Note that scenarios B and especially C are cases where the status quomay lead to desirable outcomes, even without the project. Scenario A warrants aproject to change the situation into a desirable one. In scenario D, the project maybe more interested in sustaining desirable outcomes.2.2.2 Why should government be engaged in providing this output? 8a. If the “without project” scenario will already result in desirable outcomes,the government need not undertake the project.b. The PED analyst should consider the alternative strategy of instituting theproper policy and regulatory framework in order to produce the sameoutcomes, instead of undertaking the project. Some guideposts to aid theanalysis are:• Can the output be packaged commercially?8 The Technical Appendix, page 10 discusses the Role of Government and Role of Projects in Development.RGEdillon January 200620

Project Evaluation and DevelopmentNote that to merit public provision, the answer to the previousquestion should be a NO. If the answer is YES, we need to resolvethe following issues next:• Will it be profitable to private entrepreneurs? At what price should theoutput be sold for it to be an attractive commercial undertaking?• At this price, will consumers be able to afford it? What is the adverseeffect if the intended beneficiaries will not “buy” the good or service?• Is there enough private capital to undertake the investment to producethe output?• Just how soon can private investment be expected to start?• In case of regulation, how will compliance be monitored?Example (i.1): If the interest is to produce irrigation services, the obviousalternative is for individual farmers to put up their own shallow tube wells.If government updates the hydrological map of the province, will this beenough to encourage farmers to undertake the investment?Example (i.2): The private sector is also engaged in providing educationservice. However, this means that they will charge tuition fees. Can thefamilies of the potential student afford the fees? Will this discourageschool participation?Example (i.3): The provincial LGU plans to showcase the province’sscenic spots by hosting a national event. However, there are not enoughlodging places to house the prospective delegates. Should the LGUconstruct lodging facilities? Or can the private sector be encouraged toconstruct the facility? What will it take? Suppose the LGU constructs aconference facility and present plans to encourage tourism and use of theconference facility, will this be sufficient “come-on” for the private sector?Example (i.4): In highly urbanized areas, the private sector may beenticed to build and operate the public market. BUT, they will want to beassured that the LGU will not allow sidewalk vendors to operate in closeproximity to the “strategic” site identified.2.2.3 It is also important to trace the output and outcome pathways of the project.This will identify any pre-conditions for the project to generate output. On thisbasis, we can classify the project as:a. (S) Stand-alone – meaning that it can produce output on its ownb. (R) Required project – meaning that it provides the enabling mechanismfor other projects to produce output. The project can be analyzed as astand-alone or as component of a package of projects.c. (C) Needs a Companion project – meaning that its ability to produceoutput depends on the success of another project. The project needs tobe packaged with the other project that provides the “enablingmechanism.”RGEdillon January 200621

Project Evaluation and Development2.2.4 In the preceding step, the PED analyst needs to refer back to the PDIP. Oneshould watch out for projects that have been forcibly subdivided in order toescape being subjected to a complete PED. A possible red flag is forprojects that are proposed to be implemented in the same locality.Example (h): Consider again the P 10 million Communal Irrigation Project. Theexpected output is a communal irrigation system that will generate 100 hectares ofirrigation service area. The expected outcome is increased cropping intensity,leading to increased palay production and reduced volatility in the supply of palay.The expected impact is increased farm income of the farmer beneficiaries andreduced volatility in income stream. The pathway may be illustrated as follows:P 10 million projectAdmin costIncreased Cropping intensityIncreased Palay outputReduced volatility in supplyIncreased Farm incomeReduced volatility in income streamThe main diagnostic question is: Is the irrigation system all that is needed toincrease cropping intensity, increase palay output and reduce volatility in supply?In other words, does it qualify as a stand-alone project? Obviously not.Constructing an irrigation system will not be enough to produce the outcome thatthe project promises. We know that, in addition to good weather, there has to beadequate water supply for the CIS to be able to provide irrigation service. Thus,we should include as project component systems for watershed managementand proper operations and maintenance of the CIS. Proper farm managementhas a direct effect on farm output. We may want to enhance current practices byproviding technical assistance to farmers. Now, from increased farm output toincreased farm income, there is the intermediate process of postharvest andmarketing. We may want to include components in the project that enhance theefficiency of postharvest facilities and improves the marketing strategies of thefarmers.RGEdillon January 200622

Project Evaluation and DevelopmentP 10 million projectAdmin costOther costsGood weatherReliable water supplyProper farm mgtWatershed Mgt SystemProper O&M of CISTechnologyIncreased Cropping intensityIncreased Palay outputReduced volatility in supplyPostharvest efficiencyMarketing strategyIncreased Farm incomeReduced volatility in income streamWith the inclusion of these additional components, we must realize that theproject will now cost more than P 10 million. It will also produce additionaloutputs, say:• Watershed management systems and procedures• Manual of systems and procedures for the O&M of the CIS• Number of farmer field schools established• Modern postharvest facility• Organization of marketing and/or farmers’ trading cooperativesRGEdillon January 200623

Strengthening Provincial/Local Project EvaluationPlanning and Expenditure Management and DevelopmentName of Community:Table 2PERMANENT PROFILEMunicipalityBarangays Covered:Distance from town centerTopographyClimateSoil typeWater resourcesLand area of which: Agri. area:Income class:Without Project SituationPUBLIC AND PRIVATE FACILITESWith Project SituationFacilities for Agri ProdnPostharvest facilitesAgri-processing facilitiesIrrigation systemsRoads and BridgesTraining facilitiesPotable water supply # hh served # hh servedLevel ILevel ILevel IILevel IILevel IIILevel IIIHealth facilitiesEducational facilitiesRGEdillon January 200624

Strengthening Provincial/Local Project EvaluationPlanning and Expenditure Management and DevelopmentName of Community:Table 2 (page 2)VARIABLE PROFILEHuman CapitalPopulation people householdsGrowth rateAge-Sex DistributionMale Female Total 65Labor Forceof which% in agriculture# of days employed per yearHealth StatusMortality rateMorbidity rateNutritional Status of PS Status # of PS Status # of PSNormalNormal1st degree1st degree2nd degree2nd degree3rd degree3rd degreeTOTALTOTALOther RemarksRGEdillon January 200625

Strengthening Provincial/Local Project EvaluationPlanning and Expenditure Management and DevelopmentName of Community:Table 2 (page 3)Income ProfileAve. hh farm incomeAve. hh nonfarm incomeAve hh incomeIncome opportunitiesFarmingCropping pattern Major crops Area planted T Yield Gross Return Cost of prodn Major crops Area planted Yield Gross Return Cost of ProdnLivestock Livestock Number Gross Return Cost of Prodn Livestock Number Gross Return Cost of ProdnEnterprise Enterprise Capitalization Net Income No. employed EnterpriseCapitalization Net Income No. employedRGEdillon January 200626

Strengthening Provincial/Local Project EvaluationPlanning andExpenditure Management and DevelopmentTable 2 (page 4)Name of Community:Fixed wage Establishment No. employed Ave. wage Establishment No. employedAve. wageTechnological profileFarming technologyAccess to technologyFinancial CapitalAccess to formal credit institutionsLending Inst # who access Status Lending Inst # who access StatusAccess to informal credit institutionsMarketing OutletRGEdillon January 200627

Strengthening Provincial/LocalPlanning and Expenditure ManagementProject Evaluationand Development3. ANALYZE IT THOROUGHLYAt this stage, we are left only with “big” projects or those that are to be fundedexternally and all of these passed the initial screening (i.e., the steps in KNOW andUNDERSTAND the project).To ensure that the same standard is applied across the different projects, following isa series of questions that need to be answered satisfactorily.A project may be screened out if the answer to any of theseis not satisfactory. Moreover, since the questions need tobe asked in sequence, once the answer to one isunsatisfactory, the remaining questions need not be asked.3.1 What is the market situation like for the project’s output? 93.1.1 We can have an idea of the likely demand for the project’s output byobserving the existing demand and supply of the same good. If thedemand is more than the supply of the good, then clearly, there is a supplygap and this can be filled up by the project’s output.Example (j): Long queues at hospitals and clinics imply a shortage in the supply ofhealth care facilities. Overcrowded classrooms indicate a shortage in the supply ofclassrooms (and even teachers). High incidence of absenteeism during certainschool days (say, rainy season) may indicate poor access of the classroom to thehouses of the students.Example (k): Consider a proposal from Community C to construct a schoolbuilding.At present, the nearest school is more than an hour’s walk from the house nearest totheir barangay hall. Below is their projected demand, based on population projectionof the age cohort 6-12 years old.RequiredProject number ofschoolersnumber ofclassroomsYear 0Year 1 287 7Year 2 296 7Year 3 305 8Year 4 314 8Year 5 334 8Year 6 354 9Year 7 374 9Year 8 394 10Year 9 414 10Year 10 434 119 This is similar to market analysis.RGEdillon January 200628

Strengthening Provincial/LocalPlanning and Expenditure ManagementProject Evaluationand DevelopmentGiven the above profile, we may consider putting up a 7-classroom building andpossible expansion on year 6.3.1.2 The relevant questions to ask in describing the market situation are thefollowing:a. Is there a demand for the project’s output?b. Is there a current supply of a good similar to the project’s output? Forhow much is the good being sold?c. Is there a supply gap?d. How responsive do you think is the level of demand to the price of thegood? This is what we refer to as elasticity of demand.e. How responsive do you think is the level of current supply to the priceof the good? This is what we refer to as elasticity of supply.We may construct a matrix, like the one below, to summarize theseanswers.Table 3Project output 1Without projectCurrentdemandCurrentsupplyWith projectlevelpriceelasticityForecastdemandForecastsupplySupply fromprojectSupply fromother sourceslevelpriceelasticityASSUMPTIONS and SOURCES OF DATAImportant Notes:In most cases, you cannot rely on surveys or data released by the PhilippineStatistical System, especially if you require sub-provincial disaggregation of the data.However, the departments concerned (within the provincial LGU) collectsRGEdillon January 200629

Strengthening Provincial/LocalPlanning and Expenditure ManagementProject Evaluationand Developmentadministrative data that can be used for this purpose. An alternative is to conduct aninterview with key informants to arrive at a rough estimate.Estimating demand and supply elasticities is a complex and sophisticated process,even for economists 10 . For purposes of the Project Evaluation, we need only toknow if demand (or supply) is price elastic or inelastic. If you are conducting a keyinformants interview, you simply ask the following series of questions:a. If the good or service is provided for free, how many do you think will avail ofthe good or service?b. If we charge a price, say Php 100 per unit (or per use or per month), howmany do you think will be willing to avail of the good or service?c. You can then vary the price quotation in b, until you arrive at the followingtable:Label Price (P) Potential Demand (D)(P 0 , D 0 ) free 100 users(P 1 , D 1 ) 100 50 users(P 2 , D 2 ) 50 75In computing the elasticity, we disregard the information on potential demandwhen the price is free. The estimate of elasticity is given by the followingformula:εDPln ( D2) − ln ( D1)=ln ( P ) − ln ( P)2 1The function ln corresponds to the natural logarithm. In the above example,we compute the following:ε DPln (75) − ln (50)= =−0.58496ln (50) − ln (100)3.2 Is the project technically feasible?3.2.1 The PED technician may enlist the help of other experts, especiallyengineers, to identify the alternative to the project. What other projectswill produce the output that the project under analysis is promising toproduce?3.2.2 In general, the type of provision may differ according to the following:a. Fixed capital requirements (land, location, resource base)b. Production techniquec. Level and quality of supply10 See Technical Appendix, pages 6-7; 23-24, for a more detailed discussion of elasticity.RGEdillon January 200630

Strengthening Provincial/LocalPlanning and Expenditure ManagementProject Evaluationand Developmentd. Investment lage. Requirements for operations and maintenancef. Economic lifeTable 4Fixed capital rqmts Production SupplyOutput Option Land Location technique Level Quality O&M costEconomicLife3.2.3 The project must be rated as the most cost-effective among alltechnically feasible options. The above table may be revised asnecessary. What is important is the process of considering otherpossible alternatives.Example (l): Consider the following two examples. The first project aims toprovide irrigation service. There are four options that can be considered.The first two – A1 and A2 - differs only with respect to location of the CIS,whether Barangay A or B. If the project is located in Barangay B, the projectwill be more expensive in unit terms and coverage will be reduced. The othertwo options – B and C are not technically feasible.RGEdillon January 200631

Strengthening Provincial/LocalPlanning and Expenditure ManagementProject Evaluationand DevelopmentProject output Option Type of project Location Total Cost Amount of Supply Remarksirrigation service A1 CIS Barangay A Php 10 million 100 has. more cost-effectiveA2 Barangay B Php 6 million 50 has. less cost-effectiveB STWC SFRno shallow aquiferno feasible siteclassrooms D Barangay A 2,800,000.00 7 classrooms for further evaluationD1 Barangay B 2,800,000.00 7 classroomstarget pupils arefrom Barangay A.From A to B ismaximum of 2 hourswalkclassrooms +access roadD2 Barangay B 12,800,000.00 7 classrooms + 10 for further evaluationkms. of roadThe second project aims to build a schoolbuilding with 7 classrooms. Thetarget pupils are in Barangay A. We can consider three options:• Option D will build the school in Barangay A.• Option D1, will add classrooms to the nearby school in Barangay B,but this will entail at most a 2-hour walk for Barangay A pupils.• Option D2 – add classrooms to school in Barangay B and constructan access road from Barangay A to B.The least desirable is Option D1. Meanwhile, we will need to consideroption D in comparison with option D2.3.3 How much will the project cost? Can we sustain project operations?3.3.1 Following is a series of questions that the Project Proponent must beable to answer with reasonable accuracy. The PED technician mustverify the basis of the answers.a. How much is needed to operate and maintain the project in usableform?b. If we can charge user fees, how much should it be? How muchmore is needed to collect the fees (administrative cost of collectingthe fees)?c. Given the fees, what is the projected number of users?d. If we do not collect the fees, what is the projected number of users?e. If the project cannot be expected to pay for itself, will the provincialgovernment be willing to subsidize its operations and maintenance?By how much?RGEdillon January 200632

Strengthening Provincial/LocalPlanning and Expenditure ManagementProject Evaluationand DevelopmentThis phase of the study is similar to financial analysis. It differs only interms of rigor and emphasis where our interest concerns publicprovision of goods and services and not profitability.The answers to c and d depend on the assumed elasticity of demand.3.3.2 Projects that will be subjected to the review and approval procedures ofthe Investment Coordinating Committee (ICC) need to accomplishprescribed forms. ICC Form 3 asks for the cost of the project duringthe investment phase while ICC Form 4 asks for the operating andmaintenance costs. These forms are attached as Annexes 2 and 3,respectively.3.3.3 For projects that will not be subjected to ICC review and approval, wemay use Table 2 in answering the above questions.We may summarize the answers to the above questions in a simple tableof costs, benefits and revenue projections with explicit consideration fortiming. The simple table can be of the following form:Table 5Year12345678910Costs Benefits RevenuesOperationsandNumber ofNumber ofNetInvestment Maintenance per user Users Total Unit fee users Admin Cost RevenuesA B C D E = C*D F G H I=F* G-H3.3.4 Alternatively, we may use a more sophisticated table of financial flows.The information will have to be provided by a finance officer oraccountant of the department concerned. Note that this step can betaken up in the feasibility study, that is, if the project passed the prefeasibilitystage.The following is taken from NEDA (2000).Financial receipts:SalesLess: Changes in Account ReceivablesResidual valuesLandEquipmentRGEdillon January 200633

Strengthening Provincial/LocalPlanning and Expenditure ManagementProject Evaluationand DevelopmentBuildingsTotal InflowsFinancial expenditures:Investment Expenditures/Opportunity CostsNew investmentLandType 1 EquipmentType 2 EquipmentBuildingsExisting assets (if any)LandEquipmentBuildingsOperating ExpendituresRaw material (1)Raw material (2)Raw material (n)ManagementSkilled laborUnskilled laborMaintenanceLess: Changes in Account PayableLess: Changes in Cash BalanceTotal OutflowsNet Cashflow3.3.5 At the pre-feasibility stage, it may be too much to require the ProjectProponent to submit the information listed in 3.3.3. An alternative is torequire a simple schedule of cash flows, clearly indicating the timingand the amount of receipts and expenditures.Cash flow analysis differs from normal accounting in the followingrespects 11 :a. In normal accounting, income and expenditure represent the valuesof goods or services delivered and received. In cash flow analysis,we consider cash received and cash paid out for them.b. Normal accounting shows financial liabilities with respect to interestand tax. In cash flow analysis, we reflect payments.c. A financial allowance for depreciation and obsolescence of capitalis made in normal accounting. In cash flow accounting, we onlyconsider anticipated renewals and replacements as well as thescrap value of the equipment. The latter is reflected on the lastyear of the economic life of the equipment.11 Taken from Little and Mirrlees (1974).RGEdillon January 200634

Strengthening Provincial/LocalPlanning and Expenditure ManagementProject Evaluationand Development3.3.6 It should be obvious by now that we can conduct a cash flow analysisonly for projects that are expected to generate revenues. However,even for projects that will not generate revenues, it is still useful to havean estimate of the cash flow. At the very least, this informs us of thetiming of the need for subsidies.The following example illustrates a simplified cash flow analysis thatcan be useful in anticipating the need for subsidies. This will serve thepurposes of a pre-feasibility study. For the feasibility study, a morerigorous cash flow analysis needs to be undertaken. Following are thesimplified steps:a. Forecast the cash outflow - investment costs, cost of operations,maintenance and administration by yearb. Forecast the cash inflow (revenue from all users/uses of theproject’s output by year.c. Get the difference between cash inflow and cash outflow.d. Convert the difference in present value terms. Get the sum. This isyour NPVe. Analyze the cash flow:Beginning balance (year t) = Ending balance (year t-1)Ending balance (year t-1) = Beginning balance (year t-1) +[Cash inflow (year t-1) – Cash outflow (year t-1).]f. Convert the figures derived from e into present values.At this point, we have an idea of the cost of investment, operations and maintenance as wellas the potential revenue of the project. The decision rule is:If operations and maintenance of the project cannot besustained, either from project revenues or subsidies fromthe province, the project investment should not beundertaken.RGEdillon January 200635

Strengthening Provincial/Local Project EvaluationPlanning and Expenditure Managementand DevelopmentExample (m): Consider the following very simple schedule of projected cash flows of our irrigation project. It has a servicearea of 100 hectares. It costs a total of P 10 million to build, requires regular maintenance costing P 1500 per hectare peryear and periodic maintenance costing P 5000 per hectare every 5 years. The irrigation service fee is 100 kg of palay perhectare during the wet season and 150 kg/ha during the dry season. Let us first assume no escalation of relative prices, thatis, the cost of operating and maintaining the facility will just move with the price of palay, equal to Php 11.00 per kg. We alsoassume a residual value of 1% of investment cost. Below is the projected cash flow.The first thing we note is that the irrigation project is really a losing proposition if benefits are reckoned only at the possible ISFcollection. The NPV is negative. This also means that it is not an attractive undertaking for the private sector. Consider the nexttwo tables where we look at cash flow and where we should be prepared to offer subsidies:RGEdillon January 200636

Strengthening Provincial/LocalPlanning and Expenditure ManagementProject Evaluationand DevelopmentUndiscounted Cash FlowsBeginningBalanceIn less Out forthe Year Ending Balance0 (4,000,000.00) (4,000,000.00)1 (4,000,000.00) (5,945,000.00) (9,945,000.00)2 (9,945,000.00) 101,000.00 (9,844,000.00)3 (9,844,000.00) 101,000.00 (9,743,000.00)4 (9,743,000.00) 101,000.00 (9,642,000.00)5 (9,642,000.00) 101,000.00 (9,541,000.00)6 (9,541,000.00) (249,000.00) (9,790,000.00)7 (9,790,000.00) 101,000.00 (9,689,000.00)8 (9,689,000.00) 101,000.00 (9,588,000.00)9 (9,588,000.00) 101,000.00 (9,487,000.00)10 (9,487,000.00) 101,000.00 (9,386,000.00)11 (9,386,000.00) (249,000.00) (9,635,000.00)12 (9,635,000.00) 201,000.00 (9,434,000.00)The above table implies that the project will not be able to pay for the cost of development,operations and maintenance out of the ISF collection. It appears that government will needto subsidize both the operations and maintenance.The alternative is to consider the cost of development as a grant. Another option is torequire counterpart payment. This latter option also fosters a sense of ownership amongthe farmer-users and may lead to more efficient operations and maintenance of the facility.The next table is the cash flow analysis. Note that it is constructed from the point of view ofthe farmers (or irrigators’ association) so that the development grant, amounting to P 4million and P 6million during years 0 and 1 (respectively) are treated as an inflow. The ISFcollection will then be able to finance the operations and maintenance as well as shoulderthe remainder of the loan.The debt payment is pegged at P 110,000.00 each year. Note that labor payments foroperations and maintenance is now P10,000.00. This means that we expect the irrigator’sassociation to provide labor counterpart as well. Still, government needs to extendassistance (which can be in terms of a loan) to finance the periodic maintenance on years6 and 11. In both years, the assistance will amount to P 345,000 in real terms,undiscounted. We recommend that the assistance on year 6 be treated as a grant whilethe assistance on year 11 be treated as partly grant, partly loan.The second table below shows the cash flow analysis from the point of view of LGU, sothat debt payment of the IA is treated as debt receipt and grants are treated as outflows.Note that this latter scheme results in slightly less burden on the LGU (PHP -8.87 million,discounted at 15%). Still, the very important question that should be answered is: “Is theprovince willing to extend this type of assistance? How can this subsidy and assistance bejustified?”RGEdillon January 200638

Strengthening Provincial/Local Project EvaluationPlanning and Expenditure Managementand DevelopmentInvestmentYear Phase (Total) Personnel MOOECash OutflowOperating PhaseCash Flow Analysis from the Point of View of the Irrigators' AssociationCash InflowMaintenanceCosts Debt Payment Total OutflowIrrigationService Fee Residual value Grant TOTALIN LESS OUT(CURRENTYEAR)Cash Flow0 4,000,000.00 4,000,000.00 4,000,000.00 4,000,000.00 - -1 6,000,000.00 6,000,000.00 55,000.00 5,945,000.00 6,000,000.00 - -2 10,000.00 4,000.00 150,000.00 110,000.00 274,000.00 275,000.00 275,000.00 1,000.00 1,000.003 10,000.00 4,000.00 150,000.00 110,000.00 274,000.00 275,000.00 275,000.00 1,000.00 2,000.004 10,000.00 4,000.00 150,000.00 110,000.00 274,000.00 275,000.00 275,000.00 1,000.00 3,000.005 10,000.00 4,000.00 150,000.00 110,000.00 274,000.00 275,000.00 275,000.00 1,000.00 4,000.006 10,000.00 4,000.00 500,000.00 110,000.00 624,000.00 275,000.00 345,000.00 620,000.00 (4,000.00) -7 10,000.00 4,000.00 150,000.00 110,000.00 274,000.00 275,000.00 275,000.00 1,000.00 1,000.008 10,000.00 4,000.00 150,000.00 110,000.00 274,000.00 275,000.00 275,000.00 1,000.00 2,000.009 10,000.00 4,000.00 150,000.00 110,000.00 274,000.00 275,000.00 275,000.00 1,000.00 3,000.0010 10,000.00 4,000.00 150,000.00 110,000.00 274,000.00 275,000.00 275,000.00 1,000.00 4,000.0011 10,000.00 4,000.00 500,000.00 110,000.00 624,000.00 275,000.00 345,000.00 620,000.00 (4,000.00) -12 10,000.00 4,000.00 150,000.00 210,000.00 374,000.00 275,000.00 100,000.00 375,000.00 1,000.00 1,000.00Cash Flow Analysis from the Point of View of the LGUDebt Receipts Grant IN less OUT PV at 15%0 - 4,000,000.00 (4,000,000.00) (4,000,000.00)1 - 5,945,000.00 (5,945,000.00) (5,169,565.22)2 110,000.00 - 110,000.00 83,175.803 110,000.00 - 110,000.00 72,326.794 110,000.00 - 110,000.00 62,892.865 110,000.00 - 110,000.00 54,689.446 110,000.00 345,000.00 (235,000.00) (101,596.99)7 110,000.00 - 110,000.00 41,353.078 110,000.00 - 110,000.00 35,959.209 110,000.00 - 110,000.00 31,268.8710 110,000.00 - 110,000.00 27,190.3211 110,000.00 345,000.00 (235,000.00) (50,511.66)12 210,000.00 - 210,000.00 39,250.50NPV (8,873,567.02)RGEdillon January 200639

Strengthening Provincial/LocalPlanning and Expenditure ManagementProject Evaluationand Development4. JUDGE IT FAIRLYThus far, we have achieved the following:• We already know the project• We understand it in sufficient detail• We analyzed it thoroughlyWe are now ready to judge the project on the basis of its true cost and benefits tosociety. 12 If at this point you feel that you do not yet have an in-depth grasp of theproject, you may want to ask the proponents to run by you again the above pointspertaining to the project.4.1 How much is the true cost of the project to society?4.1.1 Clarification of Conceptsa. The true cost of a good or service is sometimes referred to as itseconomic cost. The use of the term “economic” is deliberate in that weare interested in knowing the scarcity of the good or service in relation toother goods or services.b. The basic premise behind economic pricing is that the market price doesnot accurately inform us of the true value of the good or service. Rather,the market price is distorted by taxes, subsidies, transport and handlingcosts. 13c. The economic cost is given by the undistorted price at which suppliers arewilling to sell a given quantity of their produce. This means that we needto know the supply price, corrected for distortions such as taxes,subsidies, transport and handling costs.Example (m): Consider a unit of good that costs P 220 per bag, inclusive of a 10%VAT. What this means is that only P 200 is received by the seller of the good, the P20 is remitted to government. Thus, the economic cost of this good 14 is P 200, andnot P 220.4.1.2 Classification of Inputs.To guide the determination of economic costs, we need to indicate thefollowing for each major project input:a. If the good is wholly tradeable, partly tradeable or wholly nontradeable12 Before proceeding, it must be mentioned that the techniques to be discussed henceforth are more complex. It issuggested that the reader go through this entire subsection, proceed to the Technical Appendix then review thissubsection once again.13 Please refer to the Technical Appendix, pages 7-9, for a more detailed explanation.14 We implicitly assume that the good is nontradeable.RGEdillon January 200640

Strengthening Provincial/LocalPlanning and Expenditure ManagementProject Evaluationand DevelopmentBy tradeable, we mean that the good is being demanded and/or suppliedin the international market. The National Statistics Office keeps track ofexternal trade statistics and this provides information on whether the goodis being imported or exported.b. If wholly tradeable, is it an exportable or importable good?If the domestic price of the good is less than the freight-on-board (FOB)price at the border, then the good must be exportable. On the otherhand, if the domestic price of the good is higher than the cost-ofinsurance-and-freight(CIF) price at the border, then the good must beimportable. Again, external trade statistics can provide the necessaryinformation.c. If partly tradeable, what proportion of the cost is due to tradeable inputs?d. For projects to be funded internally, we can skip questions a-c and simplyanswer: How much is the cost of the good at the project site? Net oftaxes?The following matrix may be useful in summarizing this information:Table 6Major ProjectInput Tradeable ? % TradeableExportable?Importable?Cost at projectsite known?How much is theunit cost?4.1.3 Computation of Economic Cost. The computation of economic cost dependson whether the good is wholly tradeable (importable or exportable), partlytradeable or non-tradeable.i. Good is non-tradeable.• The true cost is a weighted average of the demand and supply prices.d d s sP= w *P + w *P ;d sw + w = 1RGEdillon January 200641

Strengthening Provincial/LocalPlanning and Expenditure ManagementProject Evaluationand Developmentwhere w d is the weight given to demand and w s is the weight given tosupply; P d is the demand price and P s is the supply price.• Recall that the demand price is the price that consumers pay for thegood while supply price is the price that producers receive for thegood. The demand and supply prices differ from the market price bythe amount of the tax or subsidy.Example (n): 10% VAT on lighting bulbs that cost Php 25, net of taxes.Demand price = Php 25 * (1+10%) = Php 27.50Supply price = Php 25Example (o): Php 3 subsidy to producers per kilo of sugar. Market price is Php30Demand price = Php 30Supply price = Php 30 + 3• In the Technical Appendix we explain in detail why a weighting isdone between the demand and supply prices. The over-simplifiedreason is that the project will result in additional input demand, saydemand for cement, etc. Under certain conditions, it can push pricesup, thus forcing other consumers to buy at a higher price. Just howmuch higher will depend on the relative elasticities of the demand andsupply.• We usually just choose among the following weights, corresponding todifferent assumptions on demand and supply elasticities.Table 7Weighting Demand price Supply priceScheme1 1.00 0.002 0.67 0.333 050 0.504 0.33 0.675 0.00 1.00• The first one assumes that price is entirely determined by demandand that supply is inelastic (quantity supplied does not respond tochanges in prices). In this case, supply may be very constrainedespecially in the short term. At the other extreme, we have the casewhere price is entirely determined by supply, meaning that demand isinelastic. There are intermediate statesScheme 2 - demand is more responsive than supplyScheme 3 – demand is just as responsive as supplyScheme 4 - demand is less responsive than supplyRGEdillon January 200642

Strengthening Provincial/LocalPlanning and Expenditure ManagementProject Evaluationand Developmentii. Input good is tradeable1. In this case, the scarcity of foreign currency also needs to beconsidered in determining the true cost of the input. This is doneby imposing a foreign exchange premium (FEP) on the officialexchange rate. The value of the FEP is determined by the NEDA-PIS and may change from time to time. The most recent value is1.2.Example (p): Suppose the current exchange rate of P 54.75. With an FEP of1.2, this means that any imported input will cost 20% more when expressed indomestic currency. That is, a $ 100 worth of goods is equivalent to$ 100 x 54.75 x 1.2 = Php 6570.00in domestic currency. This is the value that will be used in subsequent economicanalysis.2. Moreover, the true cost will not include taxes and subsidies asthese are merely transfers from one economic agent to another.3. We need to further distinguish between importable and exportableinputsiii.Input good is importableEP = CIF _ price * ER * FEP + (handling _ cost less taxes) + (transport _ cost less taxes)where EP is the economic priceCIF_price is the CIF price of the good at the portER is the prevailing exchange rateFEP is the foreign exchange premium determined by NEDAHandling_cost is the cost of handling at the portTransport_cost is the cost of transporting the good from the port to the projectsiteiv. Input good is exportableEP = FOB _ price * ER * FEP + (handling _ cost less taxes) + (transport _ cost less taxes)where EP is the economic priceFOB_price is the FOB price of the good at the portER is the prevailing exchange rateFEP is the foreign exchange premium determined by NEDAHandling_cost is the cost of handling at the portTransport_cost is the cost of transporting the good from the port to the projectsitev. The good is partly tradeable, or, the good itself may be nontradeable butthe process of producing the good requires tradable goods.RGEdillon January 200643

Strengthening Provincial/LocalPlanning and Expenditure ManagementProject Evaluationand Developmentt t d d s sP= s *CF*P + (1− s )*[w P + w P ]where s t is the proportion that is tradeable, CF is the conversion factor orthe amount used to express financial prices to economic prices and theothers are as defined before.vi. Labor inputsThe true cost of labor is equal to the opportunity cost of labor. Skilled laboris more scarce than unskilled labor, but the income of skilled labor istaxable while the income of unskilled labor is non-taxable. In effect, thereare negative and positive tradeoffs. In the Philippines, wages of skilledlabor is taken to be the true cost of skilled labor while wages of unskilledlabor is multiplied by a factor of 0.6 to arrive at the true cost of unskilledlabor. This conversion factor may change over time. The PED technicianshould verify with the NEDA-PIS about the current value.Example (q): Consider the following example of a rural roads project where thecost of inputs at the project site is known. Most of the inputs that will be used,e.g., gravel and sand are nontradeable but they make use of some tradeableinputs. Meanwhile, labor is considered tradeable and is valued at the opportunitycost of labor In A, we specify the cost structure of the project in terms ofmaterials, equipment and labor. This is further broken down in B into local andforeign (tradeable) component and for labor, into skilled and unskilled. Assume aforeign exchange premium of 1.2.Input Factor Financial Cost ECF Economic CostA B C D E F = D*Eof whichMaterials 40 Php326,000.00Local 40 130,400.00 1 130,400.00Foreign 60 195,600.00 1.2 234,720.00Equipment 35 285,250.00Local 25 71,312.50 1 71,312.50Foreign 75 213,937.50 1.2 256,725.00Labor 25 203,750.00Skilled 30 61,125.00 1 61,125.00Unskilled 70 142,625.00 0.6 85,575.00TOTAL Php815,000.00 815,000.00 Php839,857.50vii. The case of projects that generate negative effectsThe technical term for these negative effects is negative externalities.What is needed is to identify the cost of preventing these externalities andinclude this as part of project cost.RGEdillon January 200644

Strengthening Provincial/LocalPlanning and Expenditure ManagementProject Evaluationand DevelopmentExample (r ) A communal irrigation project promotes the growth of parasitesthat cause schistosomiasis. The prevention measure takes the form of frequentcleaning of the canals to get rid of snails. The cleaners need to use specialequipment for cleaning. This cost as well as the labor component needs to beincluded as part of the O&M cost.Example (s): The construction of a “solar dryer” for palay exposes theneighboring residents to respiratory hazards. This can be mitigated by installingfinely-meshed nets around the solar dryer. The cost of the nets as well as thereplacement has to be included.4.2 How much is the benefit of the project truly worth to society?We value the economic benefit of the project’s output at the price that consumersare “willing to pay” for the good. Again, we consider several cases:4.2.1 Good is nontradeable.The same rules as in valuing nontradeable inputs apply. Refer to 4.1.3 a.4.2.2 Output good is importableAs in the case of importable input, we consider the CIF price, but this time, wesubtract from it the handling and transport costs from port to project site.EP = CIF _ price * ER * FEP −(handling _ cost less taxes) − (transport _ cost less taxes)where EP is the economic priceCIF_price is the CIF price of the good at the portER is the prevailing exchange rateFEP is the foreign exchange premium determined by NEDAHandling_cost is the cost of handling at the portTransport_cost is the cost of transporting the good from the port to the projectsite4.2.3 Output good is exportableAs in the case of exportable input, we consider the FOB price, but this time, wesubtract from it the handling and transport costs from port to project site.EP = FOB _ price * ER * FEP −(handling_ cost less taxes) − (transport _ cost less taxes)where EP is the economic priceFOB_price is the FOB price of the good at the portER is the prevailing exchange rateFEP is the foreign exchange premium determined by NEDAHandling_cost is the cost of handling at the portTransport_cost is the cost of transporting the good from the port to the projectsiteRGEdillon January 200645

Strengthening Provincial/LocalPlanning and Expenditure ManagementProject Evaluationand Development4.2.4 Some proportion of the good is tradeable.The same rules as in valuing “semi-tradeable” inputs apply. Refer to 4.1.3e.4.2.5 Labor outputs or increased labor productivityThe same rules as in valuing labor inputs apply. Refer to 4.1.3f.4.2.6 Commodity-specific Conversion Factor (CSCF)It is practical to compute for commodity-specific conversion factors for somegoods (whether inputs or outputs) that are frequently used. Commodity-specificconversion factor (CSCF) is simply the ratio between the economic price andfinancial price. Now, for the same good but pertaining to different project sites,the CSCFs will vary somewhat. Nonetheless, the previously computed CSCFsmay serve as a guide for evaluating future projects.For emphasis, recall the following differences between financial and economicprices in the case of tradeable goods.Table 8Variable Financial Price Economic PricePrice at portConverted usingprevailing exchange rateExchange rate ismultiplied by the ForeignExchange Premium(FEP)Tariffs, Taxes, subsidies Taken at full value Multiplied by a conversionfactor equal to 0Labor Taken at full value Multiplied by a conversionfactor, distinguishingbetween skilled andunskilled laborExample (t): Consider our communal irrigation project with financial cost of Php10 million. Note that the classification “foreign” pertains to the tradeablecomponent, while the classification “local” pertains to the nontradeablecomponent.The CSCF is computed as follows:In column A, we specify the prevailing price, I.e., the financial price. In column B,we indicate the conversion factor. Note that taxes are given a conversion factorof 0. This is because taxes are simply considered transfers from the taxpayer togovernment; there was no additional output that was produced. In column D, wespecify the proportion that is tradeable and this amount is multiplied by theRGEdillon January 200646

Strengthening Provincial/LocalPlanning and Expenditure ManagementProject Evaluationand Developmentforeign exchange premium, estimated to be 1.2. The CSCF, or the ratio betweenthe economic and financial price is estimated to be 1.03 in this case.ProjectCommunal IrrigationTotal Investment Cost Factors Financial Cost ECF Economic Costof whichMaterials 40 Php4,000,000.00Local 40 1,600,000.00 1 1,600,000.00Foreign 60 2,400,000.00 1.2 2,880,000.00Equipment 35 3,500,000.00Local 25 875,000.00 1 875,000.00Foreign 75 2,625,000.00 1.2 3,150,000.00Labor 25 2,500,000.00Skilled 30 750,000.00 1 750,000.00Unskilled 70 1,750,000.00 0.6 1,050,000.00TOTAL Php10,000,000.00 10,000,000.00 Php10,305,000.00Memo: ConversionFactor 1.03RGEdillon January 200647

Strengthening Provincial/LocalPlanning and Expenditure ManagementProject Evaluationand DevelopmentExample (u): In this second example, we consider a project that providestechnical assistance to farmers to improve corn productivity. We compute for theCSCF of corn as follows:Importable OutputProject Site = Community CProduct : CORNParticularsFinancialPriceUnadjustedConversionFactorUnadjustedEconomicValuePercentTradableFEP (20%)EconomicValue(Adjusted)[A] [B] [C = A * B] [D] [E = A*D*.2] [F = C + E]1 CIF $ (Manila) 212.002 CIF Php (Manila) 11,766.00 1.00 11,766.00 100.00 2,353.20 14,119.20Plus:3 Tariff @ 352.98 0.004 VAT @ 10% 1,211.90 0.005 Port Charges 300.00 1.00 300.00 30.00 18.00 318.006 VAT @ 10% 30.00 0.007 13,660.88 1.00 13,660.88 100.00 2,732.18 16,393.05Net Importer's Price (2+3+4+5+6)8 VAT 1,366.09 0.00 0.00 0.009 Importer's Price (7+8) 15,026.97 1.00 15,026.97 100.00 3,005.39 18,032.36Less10 Inter-Island freight 1,560.00 1.00 1,560.00 50.00 156.00 1,716.0011 VAT @ 10% 156.00 0.0012 Port Charges and inland transpo 575.00 1.00 575.00 30.00 34.50 609.5013 VAT @ 10% 57.50 0.00Price Net of Tax14 [9 - (10+11+12+13)] 12,678.47 1.00 12,678.47 100.00 2,535.69 15,214.1615 VAT @ 10% 84.96 0.0016 Factory Gate Price (14+15) 12,763.43 1.00 12,763.43 100.00 2,552.69 15,316.1117Conversion Factor (EconomicValue/Financial Price) 1.20RGEdillon January 200648

Strengthening Provincial/LocalPlanning and Expenditure ManagementProject Evaluationand Development4.3 The case of public goods 154.3.1 There are cases when it is difficult to determine the true willingness-to-payso that whatever information we can get will clearly underestimate the truevalue of the benefit to society. We have seen this to be the case with publicgoods. There is always an incentive to free-ride. We can do either of twothings (or both):• Find a proxy for willingness-to-pay• Add to the original variable a fixed amount that will incorporate the truevalue of the benefit to society.4.3.2 The following table provides some examples.Good Willingness-to-pay Benefit to society Adjustmentirrigation service irrigation service fee food security value of rice productionreduced povertyincidence amongfarmersincreased income offarmerssafe and easy accessto water supplywater consumption feeimproved productivitygood health to (less absences frombeneficiaries work and school)environmental option value for tourismsanitation potentialreduced workload option value for time offor women womenelelctricityelectricity consumptionfeeimproved accessto informationoption value for theincreased number ofhours that can be usedfor productive purposes4.3.3 For completeness, we summarize the methodologies as surveyed by deCastillo (1998) involving several project evaluation studies.15 Although this part falls neatly into 4.2, it merits special attention particularly since most public sector projects willfall into this category.49RGEdillon January 2006

Strengthening Provincial/LocalPlanning and Expenditure ManagementProject Evaluationand DevelopmentType of ProjectWater supply systemUrban roadsRoad projectMarketplaces and transportstationsLand development for housingAdministrative buildingsRehab of buildings and facilitiesRural electrificationMethodologyConsumer's surplus is estimated on thebasis of:beneficiary populationwater supply and demand and prospectivegrowth in the next 20 yearswater consumption per capitawater tariffssavings in time and effortreduction of transport timedecrease in vehicle operating costdecrease in vehicle repair and maintenancecostincreased agricultural productionincreased incomeincrease in market and transport stationrevenueincrease in rental value after projectsavings on rentssavings on discounted cost of building newbuildings and facilities in the futureimprovement in quality of lifegeneration of additional employmentgeneration of additional income throughincreased operation of local businesses andindustriesFarm equipment for communalusePostharvest facilitiesSkills programDay care centersincreases in area under cultivationincrease in yieldsincrease in incomereduced processing costssavings in time and effortincreased crop areasincreased production, income andemploymentadditional income and employmentincrease in work capacity of mothersadditional incomeincrease in leisure time, educationalactivities and food preparationRGEdillon January 200650

Strengthening Provincial/LocalPlanning and Expenditure ManagementProject Evaluationand Development4.3.4 The case of project outputs with benefits that cannot be monetizedExamples of these are projects that improve health and sanitation, or peace andorder, preserve culture, or promote harmony. Some studies still venture toestimate consumers’ “willingness-to-pay” for such goods. However, theapplication may be so limited to a certain group of people as to be useful ingeneral. The projects can still be evaluated in comparison to alternative types ofprovision.a. Identify a measure of effectiveness.b. Determine the effectiveness level for each type of provision.c. Determine the economic cost of each type of provision.d. Compute for the cost-effectiveness ratio, or the ratio of the economic costto the measure of effectiveness.Example (v): Objective of the project: Promote good health among elementarystudents in depressed barangaysMeasure of effectiveness: proportion of elementary students that have normalweight for heightType of provision Coverage Entire CostDaily hot meals All elementary students Php 5,400 dailyRation of 1 kg rice daily All families of elementarystudentsPhp 4,320 dailySuppose that at the end of 1 semester, we found out that the proportion ofstudents with normal weight for height increased from 60% to 80% in the case ofthe hot meals project, while it increased from 60% to 75% in the case of the riceration project, we arrive at the following analysis table:Type of provision Cost Effectiveness CosteffectivenessratioDaily hot meals Php 5,400 daily 20% increase 270Ration of 1 kg ricedailyPhp 4,320 daily 15% increase 288Conclusion: The hot meals project is more cost-effective in increasing theproportion of children with normal weight for height.RGEdillon January 200651

Strengthening Provincial/LocalPlanning and Expenditure ManagementProject Evaluationand DevelopmentExample (w): Objective of the project: To promote population managementMeasure of effectiveness: reduction in total fertility rateType of provision Coverage Entire CostIEC campaign using mass Entire provincePhp 2 millionmediaHouse-to-house campaign Entire province Php 480,000 (RATA ofBHW) + Php 2 million(condoms and pills)Type of provision Cost Effectiveness CosteffectivenessratioIEC/mass media Php 2 million Reduction in TFR from 4 million4 to 3.5House-to-housecampaignPhp 2,480,000 Reduction in TFR from4 to 32.48 millionConclusion: The house-to-house campaign is more effective.4.3.5 Project’s output produce other benefitsa. The project’s logframe (Table 1) as well as the impact pathwaydemonstrated in Part II-A can help determine if the positive externality isdue to the project alone, or in conjunction with other factors. In general,we only consider benefits that is due to the project alone. For instance,road construction may lead to an increase in real estate prices within thevicinity of the road, but only if there are business opportunities in the area.A water supply project will increase the influx of tourists, but only if therewill be tourism development in the area.b. If the benefit is attributable to the project alone, the valuation will followthe same rules given above.c. In general, if the economic benefits outweigh the financial benefits, theproject is said to generate positive externalities.4.4 What is the net impact of the project to society?In 4.1 we determined the economic cost of the project’s inputs to society. In 4.2, wedetermined the economic benefit of the project’s output to society. We are nowready to determine the net impact of the project to society. We simply comparethese economic costs and economic benefits.4.4.1 Parameter to useThe project’s net benefits take into consideration the incremental benefitof the project, the cost of the project and any externalities (positive ornegative) that may result from the project. All of these figures should beexpressed in economic values.52RGEdillon January 2006

Strengthening Provincial/LocalPlanning and Expenditure ManagementProject Evaluationand DevelopmentRecall that the recommended indicator of “worth” is the net present value(NPV). This is because of the following advantages:a. The NPV always exists, unlike the IRR and EIRR.b. The NPV is not sensitive to project scale unlike the IRR, EIRR andBCR.c. The NPV is additive unlike the IRR, EIRR, BCR and the CER.Meanwhile, the cost-effectiveness ratio is used only when the benefits aredifficult to quantify and/or monetize. And when used, the CER is used tocompare between different technologies to produce the same good orservice.The IRR and EIRR are convenient measures because they can easily becompared against commercial interest rates and other measures offinancial profitability.Table 9YearCost of InvestmentBenefitsFinancial Prices Economic Prices Economic PricesConstructConstructWithoutIncrementalion O&M ion O&M Project With Project Benefit Benefit-Cost Discounted B-CA B C D E F G = F - E H = G - (C+D) I = [H/ ((1+r)^t)]012345678910NPVSum of all I4.4.2 Consideration for differences in economic lifeCaution must be exercised when comparing projects that have differenteconomic lives. The project with the shorter life-span can be adjusted, asif we will implement the project again in order to make it comparable.Alternatively, we can shorten the benefit stream of the project with thelonger life with the proper adjustment also done on the cost side.4.4.3 Distribution of benefitsThe project’s benefits may differ depending on the point of view. It isimportant to qualify these points of view in so far as they differ accordingRGEdillon January 200653

Strengthening Provincial/LocalPlanning and Expenditure ManagementProject Evaluationand Developmentto the type of individuals, suppliers or demanders (or constituencies). Insumming up the benefits, the usual principle is “a peso is a peso.” This isdevoid of distributional biases. If the province has very strong equity biasthen different weights can be assigned to the different types ofstakeholders.Example (x): Consider example (m). In the first table, we value the benefits atthe average willingness-to-pay of farmers for the irrigation service. We alreadyknow that it yields a negative NPV when expressed in financial prices. Applyingthe CSCF we computed in example (t), we find that even when expressed ineconomic prices, the NPV is negative. See Table (first part).Now, consider the externality benefits of the project. One hectare of rice farmyields 3,347 kilos of paddy rice. In 2000 prices, the average of demand andsupply price of paddy rice is Php 9.035 per kilo. Given 100 hectares, the totaloutput is valued at Php 3,024,014.50. With an irrigation service facility, we canhave two cropping seasons. The economic analysis is given in the following,considering that rice is a nontradeable good 16 . The breakdown of incrementalbenefits (undiscounted) is as follows:Additional income to farmer-ownersAdditional income to hired laborAdditional income to owners of capital1,035,529.00913,300.00327,700.00The remainder, amounting to about Php 747,500 per year (undiscounted) is thebenefit derived by the consumers of rice. The above figures are based on thecost and return tables produced by the Bureau of Agricultural Statistics.The expanded economic analysis yields a positive NPV. Based on 4.3.5 c, weknow that this means that the project generates positive externalities, eventhough it is not financially viable.If the economic analysis yields a negative NPV, the projectshould not be undertaken. This means that the benefits theproject can give to society is less than the amount it coststo implement it.16 Strictly speaking, rice is an importable good. The problem, however, is that the trade is governed by quantitativerestrictions, instead of the usual tariff schedule.RGEdillon January 200654

Strengthening Provincial/Local Project EvaluationPlanning and Expenditure Managementand DevelopmentCost of InvestmentBenefits (ISF)Financial Prices Economic Prices Economic PricesYear CIP construction O&M CIP construction O&M Without Project With Project Incremental Benefit Benefit-Cost Discounted B-C0 4,000,000.00 4,120,000.00 - - - - (4,120,000.00) (4,120,000.00)1 6,000,000.00 - 6,180,000.00 - - 55,000.00 55,000.00 (6,125,000.00) (5,468,750.00)2 150,000.00 - 154,500.00 - 275,000.00 275,000.00 120,500.00 96,061.863 150,000.00 - 154,500.00 - 275,000.00 275,000.00 120,500.00 85,769.524 150,000.00 - 154,500.00 - 275,000.00 275,000.00 120,500.00 76,579.935 150,000.00 - 154,500.00 - 275,000.00 275,000.00 120,500.00 68,374.946 500,000.00 - 515,000.00 - 275,000.00 275,000.00 (240,000.00) (121,591.47)7 150,000.00 - 154,500.00 - 275,000.00 275,000.00 120,500.00 54,508.088 150,000.00 - 154,500.00 - 275,000.00 275,000.00 120,500.00 48,667.939 150,000.00 - 154,500.00 - 275,000.00 275,000.00 120,500.00 43,453.5110 150,000.00 - 154,500.00 - 275,000.00 275,000.00 120,500.00 38,797.7811 500,000.00 - 515,000.00 - 275,000.00 275,000.00 (240,000.00) (68,994.26)12 150,000.00 - 154,500.00 - 275,000.00 275,000.00 120,500.00 30,929.35NPV (9,267,122.19)Cost of InvestmentBenefits (Additional Output)Financial Prices Economic Prices Economic PricesYear CIP construction O&M CIP construction O&M Without Project With Project Incremental Benefit Benefit-Cost Discounted B-C0 4,000,000.00 4,120,000.00 - 3,024,014.50 3,024,014.50 - (4,120,000.00) (4,120,000.00)1 6,000,000.00 - 6,180,000.00 - 3,024,014.50 6,048,029.00 3,024,014.50 (3,155,985.50) (2,817,844.20)2 150,000.00 - 154,500.00 3,024,014.50 6,048,029.00 3,024,014.50 2,869,514.50 2,287,559.393 150,000.00 - 154,500.00 3,024,014.50 6,048,029.00 3,024,014.50 2,869,514.50 2,042,463.744 150,000.00 - 154,500.00 3,024,014.50 6,048,029.00 3,024,014.50 2,869,514.50 1,823,628.345 150,000.00 - 154,500.00 3,024,014.50 6,048,029.00 3,024,014.50 2,869,514.50 1,628,239.596 500,000.00 - 515,000.00 3,024,014.50 6,048,029.00 3,024,014.50 2,509,014.50 1,271,144.837 150,000.00 - 154,500.00 3,024,014.50 6,048,029.00 3,024,014.50 2,869,514.50 1,298,022.638 150,000.00 - 154,500.00 3,024,014.50 6,048,029.00 3,024,014.50 2,869,514.50 1,158,948.789 150,000.00 - 154,500.00 3,024,014.50 6,048,029.00 3,024,014.50 2,869,514.50 1,034,775.7010 150,000.00 - 154,500.00 3,024,014.50 6,048,029.00 3,024,014.50 2,869,514.50 923,906.8711 150,000.00 - 154,500.00 3,024,014.50 6,048,029.00 3,024,014.50 2,869,514.50 824,916.8512 150,000.00 - 154,500.00 3,024,014.50 6,048,029.00 3,024,014.50 2,869,514.50 736,532.90NPV 7,355,762.52RGEdillion January 200655

Strengthening Provincial/LocalPlanning and Expenditure ManagementProject Evaluationand Development%Change4.5 Nothing is certain. Is the project worth pursuing despite the uncertainties?Increase inCost4.5.1 We need to subject our analysis to sensitivity analysis. As the name of theprocedure implies, we need to know how sensitive are the results givenuncertainties in benefit and cost assumptions. Note that we did not factor inthe effect of inflation. This implicitly assumes that inflation will affect allprices and therefore, relative prices are maintained.A sample summary table is given below:Decrease inBenefitsTable 10Increase in Net Present Value Resulting from:Increase in Cost + IncreaseDecrease in Benefits in CostFinancial Prices10% NPV (B, C+10%) NPV (B-10%, C) NPV (B-10%, C+10%)20%30%40%50%60%70%80%90%100%DecreaseinBenefitsEconomic PricesIncreasein Cost +DecreaseinBenefits4.5.2 The table implies that the analysis will be undertaken under varyingassumptions of the increase in cost, decrease in benefits and both. Thismeans recalculating the NPV while varying the assumptions on cost,benefits and both. This information will also guide our decision to undertakethe project if the original estimates of costs and benefits no longer hold. Wecan also reinforce our project by including risk-mitigating components.Example (y.1) NPV (B, C+10%).• All cost estimates are increased by 10%,• estimates of benefit stream remain the same.• Compute the corresponding NPV.Example (y.2) NPV (B-10%, C).• All cost estimates remain the same,• estimates of benefit stream are reduced by 10%.• Compute the corresponding NPV.RGEdillon January 200656

Strengthening Provincial/LocalPlanning and Expenditure ManagementProject Evaluationand DevelopmentExample (y.3) NPV (B-10%, C+10%).• All cost estimates are increased by 10%,• estimates of benefit stream are reduced by 10%.• Compute the corresponding NPV.Example (y.4): Consider again our communal irrigation project. The result of thesensitivity analysis is given below. Here, we see that the project is more sensitiveto changes in the benefit stream. A 30% decrease in benefits will make the NPV tobe negative. We, therefore, need to reinforce our CIP and include provisions for theproper operations and maintenance. Any component that can raise productivity,e.g., better technologies will also address this problem.NPV resulting from% Change Increase in Cost Decrease in BenefitsIncrease in costand Decrease inBenefits10 6,295,769.95 3,764,624.87 2,704,632.2920 5,235,777.37 173,487.21 (1,946,497.94)30 4,175,784.80 (3,417,650.44)40 3,115,792.2250 2,055,799.6560 995,807.0770 (64,185.50)8090100Also, from the table we see that a 70% increase in the cost of investment andoperations and maintenance costs will cause the NPV to be negative. Thus, weshould be wary of implementing this project if the project costs escalate by about70%. Still, we note that the margin of 70% is liberal. We should be able toinclude the technical assistance package without compromising the economicfeasibility of the study, at the same time that the benefit stream is assured.If the project’s economic viability is compromised, givensmall deviations from the assumed cost and benefitstreams, the project should be reinforced or else shelved. Itcan still be undertaken if the deviation is deemed highlyunlikely to happen within the implementation period.RGEdillon January 200657

Strengthening Provincial/LocalPlanning and Expenditure ManagementProject Evaluationand DevelopmentSummarizing the AnalysisWe reiterate the series of questions that need to be answered in conducting the projectevaluation.5.1 Each project needs to be subjected to the first two sets of questions.5.1.1 What is the rationale for the project?Before proceeding, we need to determine if the project is a Stand-alone project,Required project for other projects to achieve output, or Needs another project toachieve output.If the rationale for the project cannot be traced back to the developmental goalsof the province, as spelled out in the PDP, we need not proceed.5.1.2 What is the market situation like for the project’s output?If there is no clear excess demand for the project, we need not proceed.5.2 If there is excess demand (supply gap is another way of putting it), we subject theproject to the next set of questions:5.2.1 Is the project technically feasible?5.2.2 How much will the project cost? Can we sustain project operations?5.3 If the project cannot be expected to “pay for itself”, is the province willing tosubsidize the operations and maintenance? By how much? What are we giving upin exchange?5.3.1 How much is the true cost of the project to society?5.3.2 How much is the benefit of the project worth to society?5.3.3 What is the net impact of the project to society?5.3.4 Nothing is certain. Is the project worth pursuing despite the uncertainties?RGEdillon January 200658

Strengthening Provincial/LocalPlanning and Expenditure ManagementProject Evaluationand DevelopmentG. THE PED TEAMHaving discussed what Project Evaluation and Development entails, we now identify theideal composition of the PED Team. In the following table, we summarize the outputs to begenerated for each broad procedure of the PED and the corresponding PED Team. Therequired skills of the PED Team are implied from the required outputs. The Team, asidentified in the table below, does not include the person/s or office/s responsible for thereview and approval of the outputs of the PED Team.Table 11Procedure Required Outputs Composition of PEDTeamKNOW the project 1. Identification of the good or service that • Economist/Statisticianthe project will provide2. Characterization of good service• Project proponent• Whether private, public or mixedpublic-private good• Whether tradeable, nontradeable,or partly tradeable• If tradeable, whether importable orexportableUNDERSTANDthe projectANALYZE itthoroughlyJUDGE it fairly1. Logical framework analysis of theproject2. Forecast excess demand for the outputof the project1. Technical feasibility analysis2. Estimate of cost of investment,operations and maintenance3. Estimate of potential revenue4. Discounted cash flow analysis1. Estimate of economic cost2. Estimate of economic benefits3. Benefit-cost analysis4. Risk analysis5. Sensitivity analysis• Economist/Statistician• Project proponent• Planning Officer• Economist• Project proponent• Engineer• Accountant• Economist/Statistician• Project proponent• Environmentalspecialist/EngineerRGEdillon January 200659

Strengthening Provincial/LocalPlanning and Expenditure ManagementProject Evaluationand DevelopmentPart IIIPROJECT PROPOSAL DEVELOPMENTA. INTRODUCTIONYou will need to develop a full-blown project proposal for projects that have been identifiedfor external funding and those that require high investment costs. As mentioned in II.C.3,detailed engineering and design are usually done only for approved projects. However,some description of the project design is already required in the proposal.Developing the project design early on ensures the efficient implementation of projectsbecause of the following:1. It takes off from results of the PED where we get the following inputs:1.1 necessary components to enhance the effectiveness of the project to achievethe desired outcomes1.2 project cost and potential revenues, if any1.3 forecast schedule of required subsidy, if any1.4 possible risks to the environment, personal life, property, etc.1.5 impact of under-estimation of costs, over-estimation of benefits and both2. It specifies the following to ensure that the project will be successfully implemented:2.1 Implementation arrangements, including institutional arrangements, to includeamong others, protocol for:a. Financial managementb. procurement of inputsc. project administrationd. operations and maintenancee. collection of fees, if any2.2 Plans for monitoring and evaluation of accomplishmentFor projects with approved external funding, a detailed operations manual covering 2 aboveis usually required.B. PLAN OF THE SECTIONThis section discusses tips on how to develop a project proposal. Developing the projectproposal is easier once you have conducted a comprehensive evaluation of the project.We begin the next part of this section by discussing the need for a more in-depth feasibilitystudy. Next, we enumerate the information you will need to package the project proposal.We then proceed to describe the usual format of project proposals.C. NEED FOR A FEASIBILITY STUDYIn Part II, we discussed the procedures involved in conducting a pre-feasibility study. Theprinciples and concepts are discussed in the Technical Appendix. The same procedures,RGEdillon January 200660

Strengthening Provincial/LocalPlanning and Expenditure ManagementProject Evaluationand Developmentprinciples and concepts apply to the conduct of a feasibility study. The only difference is therigor applied.1. A pre-feasibility study relies only on secondary data to forecast demand and supply.A feasibility study may conduct a beneficiary survey to estimate a demand andsupply model. Alternatively, it may make use of reputable studies to forecastdemand and supply.2. A pre-feasibility study needs a simple financial table, like Table 5, to demonstratefinancial viability. A feasibility study requires a financial flow analysis.3. A pre-feasibility study can make use of rough estimates of the costs of investment,operations and maintenance. A feasibility study requires more detailed engineeringspecifications to arrive at more accurate estimates.4. A pre-feasibility study may make use of secondary data to estimate willingness-topayfor the project’s output. A feasibility study may conduct a beneficiary survey orestimate a more sophisticated model to capture willingness-to-pay (based onsecondary data).Obviously, conducting a feasibility study requires more resources, both in terms of timeand technical skills. A consulting firm is usually engaged to conduct the feasibility studysince they have the technical manpower and more comprehensive data in stock. For“big-ticket” projects being proposed to international funding agencies, it may be wise tocontract a reputable firm to conduct the feasibility study for two reasons:1. It increases the chances of approval of the project proposal. Remember that theprospective funder will conduct his own appraisal of the project. This time, theinterest is in validating the assumptions used in the feasibility study. An independentfeasibility study provides you this comfort zone, knowing that the project will standthe test to be done by independent technical experts.2. It ensures that the project being proposed, which will entail huge public investments,is indeed economically viable.If you have conducted the pre-feasibility study comprehensively, you should not besurprised if the results and even estimates of the feasibility study turn out to be the same.This should be taken as an affirmation of the earlier study.D. REQUIREMENTS IN PACKAGING A PROJECT PROPOSALYou will need two sets of inputs – one concerns the project and the other, the prospectivefunder.1. Inputs about the projectYou will need the tables you filled up in Part II. These are:Table 1 Project’s Log FrameTable 2 Situational profile - Without and With ProjectTable 3 Estimates of Demand for and Supply of Project’s OutputRGEdillon January 200661

Strengthening Provincial/LocalPlanning and Expenditure ManagementProject Evaluationand DevelopmentTable 4 Table of alternative methods of providing the desired outputTable 5 Tables of Costs, Benefits and Revenue ProjectionsTable 6 Analysis of the Project’s InputsTable 9 Analysis of Net Economic Benefits of the ProjectTable 10 Sensitivity AnalysisTable 11 Working Table for Prioritization of ProjectsFor convenience, we have appended these table templates at the end.2. Information about the Prospective FunderIt is best to know your prospective funder. You will need to know the following:a. Current thrusts of the funder. Note that these are subject to change and youmust not rely on previous information. Each funder develops its own “CountryAssistance Strategy”, although the name may differ. This indicates the type ofprojects that they prefer to support in a country (sometimes region) over acertain period.b. Review procedure. As in (a), this is also subject to change depending onemerging literature on the role of projects in development and the impact ofODA on development.c. Requirements for application. You are interested in form templates, proposaltemplates, other forms or requirements such as SP or PDC resolution, etc.d. Other nuances. Some funders indicate their own preference for the discountrate to be used, conversion factors for some commodities, foreign exchangepremium, etc.e. Procedures for follow-up. First find out if they regard the process of followingup as acceptable and desirable. At the very least, though, you will need tomake yourself and the one who conducted the feasibility study available forfurther clarifications regarding the project and/or the feasibility study.E. FORMAT OF A PROJECT PROPOSALEach funder requires a different format for the project proposal. The format is intended tofacilitate their review and especially if they have to decide among competing proposals.However, the difference may be more in terms of style and sequence rather than content.Most of them will require the following sections:1. Project TitleThe title should characterize the project. In coming up with a title, it is better to becomprehensive rather than fancy (or catchy), but with serious attempts to be simpleand brief.2. Location/Target PopulationBriefly describe the community and target population that the project intends toserve. You will have the opportunity to describe in detail the intended beneficiariesin the main body of the proposal.RGEdillon January 200662

Strengthening Provincial/LocalPlanning and Expenditure ManagementProject Evaluationand Development3. Implementing AgencyThis refers to the agency responsible for carrying out the activities of the project.4. Executing AgencyThis refers to the agency that will be responsible for the financial management of andany coordination that needs to be done for the project.5. Start DateExpected starting date.6. DurationExpected total duration of the project in months and years7. Project Costa. External Financing Requirement – proposed budget for external fundingb. Domestic Financing Requirement – proposed budget for financing by LGUc. Total Project Cost – sum of all funds required, whether for external or internalfinancing8. Current Situation (Problems and Needs)Refer to Table 2. Describe the without project scenario, particularly the problemsand needs identified.9. Justification and BenefitsRefer to Table 2. Describe what will be the “with-project” scenario.Justify the project in terms of the following:a. Forecast excess demand for the project’s output that the project will fill in (Table3).b. Technical feasibility and cost-effectiveness of the project over other alternativesconsidered (Table 4)c. Economic viability of the project (Table 9)d. Economic viability of the project given reasonable departures in existingconditions (Table 10)Remember to indicate the assumptions used and the basis for these assumptions.10. Project ObjectivesRefer to Table 1. What are the goals of the sector under which the project is beingproposed? What are the general and specific objectives of the project?11. Project Description/Main ComponentsRefer to Table 1. Describe the project. You may also refer to the output and impactpathways that you have developed for the project (Technical appendix).12. Project Management and OrganizationRGEdillon January 200663

Strengthening Provincial/LocalPlanning and Expenditure ManagementProject Evaluationand DevelopmentDescribe the expertise of the implementing and executing agencies. If a pilot projecthas been implemented along similar lines, it is better to mention this to demonstrateexperience in implementation.13. Expected Environmental ImpactsDescribe the expected negative and positive impacts of the project. For theexpected negative impacts, indicate the risk-mitigating measures that will beimplemented. Refer to Part II, F.4.1.3.vii. As much as possible, the funding for theserisk-mitigating measures has to be sourced internally. Oftentimes, you only need toinstitute regulatory mechanisms.14. Monitoring and EvaluationDescribe the plans for monitoring and evaluation of the project’s accomplishment. Ifmonitoring forms have already been developed, include this in the appendix. TheRegional Project Monitoring and Evaluation System (RPMES), established in 1989,provides a scheme for M&E, including institutional and reporting arrangements.15. BudgetUsing Table 5 as input, list down the financial requirements of the project, includingthe operational costs for the first year after completion of the project. This will bebroken down by proposed funding source – external and domestic.16. Cost Recovery and SustainabilityDescribe how you intend to sustain the operations of the project. Focus on thefollowing:16.1 Priority being given by the province to the project (Table 11)16.2 Arrangements for cost recovery (Table 5)16.3 Commitment of the provincial LGU to implement projects that will enhancethe impact of the project (Table 11)17. Terms of Reference for Consultants to be hired under the projectIf the project will require the services of highly specialized experts, indicate this in theproposal. At the very least, there is the assurance that the project will be takencared of by an expert in the field. The Terms of Reference of these experts need tobe included in the proposal.18. Appendices18.1 Tables of Commodity-Specific Conversion Factors (CSCF) for major inputsand outputs of the project.18.2 Analysis of Net Economic Benefits18.3 Sensitivity Analysis18.4 Other supplemental studiesBy now, you will have understood what we said earlier about proposal developmentbeing facilitated greatly by how you have conducted your pre-feasibility and feasibilitystudies. After all, the best convincing factor you can present to prospective funders isyour own conviction that the project is indeed a worthwhile undertaking.RGEdillon January 200664

Strengthening Provincial/LocalPlanning and Expenditure ManagementProject Evaluationand DevelopmentF. SOME GENERAL TIPSFollowing are some of the criteria that are being used by funders to rate projects:1. Focus of the project1.1 Funders prefer projects where the focus coincides with the thrust of the fundingagency (particularly if the request is for a grant). This focus may be in terms ofthe output being produced (health care, family planning, education, etc.) or thesector that will most likely benefit (children, women, farmers, etc.).1.2 It helps to know if the prospective funder has any “interest” in your province.2. Likelihood of success2.1 Funders will have to be convinced that the project will be a success. For loanapplications, you must demonstrate capacity to repay the loans. There must besufficient evidence of groundwork, that is, the PED.2.2 You also need to convince them that you have the institutional capacity toundertake the project.2.3 If the province has implemented something similar in the past, it will help tomention this and any meritorious evaluation you may have received.2.4 You should also describe the monitoring and evaluation process that you plan toundertake to demonstrate to the funder that you are serious aboutimplementation and the success of the project. You may mention thecommitment of the Project Monitoring Committees created under the RPMES toensure the efficient and effective implementation of the project/2.5 If the project will require counterpart funding or funding from other sources, youwill need to convince this prospective funder that the chances of securing theother funds are highly probable.3. Social ImpactThere are other considerations pertaining to the project aside from its expectedfinancial and/or economic viability. Even the ICC looks at other criteria, particularlythe social impact, as demonstrated in any or all of the following: 173.1 Income distribution, or more accurate income redistribution. These are projectsthat benefit the poorest of the poor or result in redistribution of income or assetsfrom the nonpoor to the poor.3.2 Employment – The number of jobs created during project implementation andthe subsequent operations and maintenance.3.3 Access to Land – This is consistent with the priority accorded to land reform. Ifthe project includes a land settlement or land reform element, the distribution ofland rights with and without the project should be demonstrated.3.4 Internal Migration – The project contributes to stemming the rural-urbanmigration.3.5 Nutrition and Health – The project is expected to benefit families and individualsthat suffer from health and nutrition problems.17 Based on ICC Project Evaluation Procedures and Guidelines.RGEdillon January 200665

Strengthening Provincial/LocalPlanning and Expenditure ManagementProject Evaluationand Development3.6 Other Indicators of Quality of Life – The project is expected to improve thequality of life. Especially in the rural areas, these are projects that provideelectricity, access to potable water, schools, etc.4. Contribution of the project to overall development4.1 There is now an emerging strand in PED literature to adopt a programmaticapproach in rating “projects”. This means looking at the entire investmentportfolio of the proponent. This arises from the realization that funds arefungible. They may think they are funding a “worthy” project, when it fact, itfrees up internal resources for the province to undertake “marginal” projects.4.2 You may be asked to present your entire investment portfolio. Should the needarise, you need to convince the funder that all projects went through a criticalprocess of screening and prioritization.Following is a suggested prioritization scheme:4.2.1 Given the set of projects that passed all the above tests in Part II and if itis still necessary to prioritize, we may begin by summarizing the results ofall the analyses undertaken as in Table 11.4.2.2 We may present the results, first by prioritizing R projects over S projects,and over C projects.4.2.3 The next iteration may look into the location and sectors that will bebenefited by the project. The prioritization will then follow the LGUsdevelopment strategy.4.2.4 The final iteration will compare net present values (NPV), but adjusted sothat the time frame of the analysis is maintained. 1818 Refer to Technical Appendix, pages 28-30 for a more detailed discussion of comparing NPV of projects withdifferent economic lives.RGEdillon January 200666

Strengthening Provincial/Local Project EvaluationPlanning and Expenditure Managementand DevelopmentTable 11Working Table for Prioritization of ProjectsProject Title Output Location SectorType of ProjectS R NEconomicLifeImpactTiming ofNPV(Unadjusted)NPV(Adjusted)RemarksLegend for Type of Project:S - Stand-alone projectR - Requisite project for other projects to achieve impactC - needs a Companion project to achieve impactRGEdillon January 200667

Strengthening Provincial/LocalPlanning and Expenditure ManagementProject Evaluationand Development1.1 Table 1MatrixNarrative Summary Indicators M&E AssumptionsGoal:Purpose:OutputsInputsProject output 1Table 3Without projectCurrentdemandCurrentsupplyWith projectlevelpriceelasticityForecastdemandForecastsupplySupply fromprojectSupply fromother sourceslevelpriceelasticityASSUMPTIONS and SOURCES OF DATA68April 2006

Strengthening Provincial/LocalPlanning and Expenditure ManagementProject Evaluationand DevelopmentTable 4Fixed capital rqmts Production SupplyOutput Option Land Location technique Level Quality O&M costEconomicLife2 Table 5Year12345678910Costs Benefits RevenuesOperationsandNumber ofNumber ofNetInvestment Maintenance per user Users Total Unit fee users Admin Cost RevenuesA B C D E = C*D F G H I=F* G-H3 Table 6Major ProjectInput Tradeable ? % TradeableExportable?Importable?Cost at projectsite known?How much is theunit cost?69April 2006

Strengthening Provincial/LocalPlanning and Expenditure ManagementProject Evaluationand DevelopmentTable 9YearCost of InvestmentBenefitsFinancial Prices Economic Prices Economic PricesConstructConstructWithoutIncrementalion O&M ion O&M Project With Project Benefit Benefit-Cost Discounted B-CA B C D E F G = F - E H = G - (C+D) I = [H/ ((1+r)^t)]012345678910NPVSum of all I4 Table 10%Change10%20%30%40%50%60%70%80%90%100%Increase inCostDecrease inBenefitsIncrease in Net Present Value Resulting from:Increase in Increase inCost + CostDecrease inBenefitsFinancial PricesDecrease inBenefitsEconomic PricesIncrease inCost +Decrease inBenefits70April 2006