Guide to COST-BENEFIT ANALYSIS of investment projects - Ramiri

EXAMPLE: A FINANCIALLY UNSUSTAINABLE PROJECTThe following table presents an example of a project which is unsustainable from a financial perspective:YEARS1 2 3 4 5 6 7 8 9 10Total financial resources 165 25 0 10 0 0 0 0 0 0Total operating revenues 0 45 115 125 108 115 115 115 115 115Total inflows 165 70 115 135 108 115 115 115 115 115Total operating costs 0 -56 -98 -98 -101 -101 -101 -101 -101 -101Total investment costs -165 -6 -2 -24 -3 0 -26 0 0 0Interest 0 0 0 0 -0.2 -0.2 -0.2 -0.2 -0.2 0Loans reimbursement 0 0 0 0 -2 -2 -2 -2 -2 0Taxes 0 -6 -7 -8 -9 -9 -9 -9 -9 0Total outflows -165 -68 -107 -130 -115.2 -112.2 -138.2 -112.2 -112.2 -101Total cash flow 0 2 8 5 -7.2 2.8 -23.2 2.8 2.8 14Cumulated net cash flow 0 2 10 15 7.8 10.6 -12.6 -9.8 -7 7The project is not sustainable because the cumulated net cash flow is negative in the years 7, 8 and 9.2.4.6 Financial return on capitalThe final step is the appraisal of the financial return on capital (Table 2.8). The objective of thiscalculation is to look into the project performance from the perspective of the assisted public and possiblyprivate entities in the Member States. These entities will for sure enjoy an increase in their potentialproject net returns, just because the European Union grants them funds. In other words, for a giveninvestment cost, the beneficiary (the ‘owner’ of the project) will need to sink less capital in it, because theEU taxpayer covers a share of the project costs. In fact, the rationale of the EU grant itself in theframework of Cohesion Policy is to increase investment opportunities by a shift in capital needs.In order to consider this effect, the best approach is simply to focus on the funds provided by thebeneficiary (‘after the EU grant’), including those funds that should be made available as national publiccontributions, private equity, if any, and the need to pay back loans and interest to third party financiers.To do this, the suggestion is to build an account where the outflows are: the operating costs; the national(public and private) capital contributions to the project; the financial resources of third parties at the timein which they are reimbursed; the related interest on loans. The inflows are the operating revenues only (ifany) and the residual value (including all assets and liabilities at the end year). Table 2.8 shows this accountand readers may see, by comparison with Table 2.5, that the former focuses on sources of national funds,while the latter focuses on total investment costs, with the remaining items being the same.The financial net present value of the capital, FNPV(K), is the sum of the net discounted cash flows thataccrue to the project promoter due to the implementation of the investment project. The financial rate ofreturn on capital, FRR(K), determines the return for the national beneficiaries (public and privatecombined).When computing FNPV(K) and FRR(K), all sources of financing are taken into account, except for theEU contribution. These resources are taken as outflows (they are inflows in the financial sustainabilityaccount), instead of investment costs (as it is done in the calculation of the financial return oninvestment).Even if the FRR(C) is expected to be very low, or even negative for public investment (especially forparticular sectors, such as water), the FRR(K) will often be positive. As mentioned above, the EC standardfinancial discount rate is 5% real, and the return for the beneficiary should, in principle, be aligned withthis benchmark (see also Annex C). In fact, when the project expects a substantial positive FRR(K), thisfact shows that the grant from the EU would bring supra-normal profits to the national beneficiaries.Under a PPP, private beneficiaries will be involved in the project. From their point of view, any grantreceived, either from the EU or the national public sector should be ignored in the calculation of the43