Financial and Economic Analysis Part 2 XG

8/14/2019 Financial and Economic Analysis Part 2 XG

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Ghent University Department Agricultural Economics

Project Management

Financial and economic analysisof investment projects


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Essential questions

Firms ability to meet its obligations Evaluate the return generated by the

investment


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Balance sheet Balance sheet describes on the one

hand the property of a firm (assets)and on the other hand the way inwhich these assets are financed(liabilities)

Assets are always equal to liabilities Balance sheet is important for the

need of financial needs (financing)


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Balance sheet

Assets Fixed assets: investments in land,buildings, machinery,

Current assets: stocks, accountsreceivable, cash, short term deposits, ...


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Balance sheet Liabilities: How assets have been financed

Share capital and reserves Long term liabilities (>1 year): loans Short term liabilities (


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Financial ratios

Financial, solvency, profitability Based on the balance sheet or profit

and loss account


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Liquidity Current ratio: current assets/current liabilities

0.8-2.0; >2=poor cash management


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Profitability Operating profit/turnover Profit before interest and taxes/fixed

assets


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Economic analysis

Why a socio-economic analysis? Tax instruments weak Income distribution distorted=> Much broader approach compared to a

financial analysis (individual organisation)


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Economic analysis

5 phases:1) Financial analysis2) Shadow prices to obtain net benefits3) Project effects on savings and investments

4) Project impact on income distribution5) Social value/analysis of products used/produced


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Economic analysis

Social cost of a resource = total cost of the usePrivate cost (market cost)External cost (loss of welfare)

Social benefits: value of benefits for society of using the resources

Social cost-benefit analysis of different options:comparing opportunity costs or the willingness-to-pay for the project


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Shadow prices Shadow prices = real value for society as a whole

= after adjusting for distortions= opportunity cost= value of its best alternative

Examples: labour, fuel, milk


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Problem: distorted markets In principle market prices reflect opportunity costs

of resources or WTP But: markets are distorted because of

interventions by public authorities (e.g. currency value =>use of shadow prices)

project may influence market (corrected prices)

externalities (welfare effects) Financial analysis needs to be corrected for these

distortions


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Why market distortions? Inflation Overvalueing currencies Labour market Imperfect capital markets Large scale projects Inelasticity of demand for export products Protectionism: import levies & export subsidies Lack of savings or public income Unbalanced distribution of income Externalities such as environmental impact


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Principles in calculating SPs? World price approach:

- free trade on international markets- but currencies artificial level, labour,

Opportunity cost approach:- for inputs: withdrawing resources

- for outputs: benefit of alternative project, WTP Combining approaches:

- international oriented projects -> world market- locally oriented projects -> opportunity costs


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Steps in determining SPs?

1. Identify tangible and intangible goods

2. Eliminate all direct transfer payments3. Value traded items4. Value non-traded items


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Traded items Border prices such as CIF, FOB increased with

transportation and marketing costs (at project border) Parity prices: shadow price = alternative on

international markets 4 situations:

- inputs are imported = CIF + local costs- inputs are exported without project = FOB- outputs are exported = FOB- outputs are substitute imports = CIF + local costs


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Non-traded items (1) CIF-price > local production cost > FOB because of

public intervention Use of market prices: project production is relatively

small; locally produced input from industry working atfull capacity

New price => benefit for old users & correct price for new users => (new + old price)/2 Output substitution => resources saved in the other

market


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Non-traded items (2) Input from industry with overcapacity => opportunity

cost = marginal variable cost (not fixed cost) Combination of traded and non-traded goods Non-produced items such as labour and land


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Shadow exchange rate

When governments intervene in financialmarkets, the prices expressed in local currencymay not reflect the real value of input or output

Example: custom duties of 20% Use of parity prices


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Negative externalities

Cause a loss of welfare to (a group of)individuals

Are not compensated The size of the problem depends on:

The number of individuals affected The scarcity of the resource The capacity of regeneration


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Internalisation of costs

Problem: private individuals only look at privatecosts and benefits

necessary to internalize the external cost Internalisation of cost can be:

Endogeneous (scarcity) Exogeneous (command- and control measures like

standards or norms)


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Social benefitsSocial benefits = Total Economic Value (TEV)

TEV = UV + EV + OV + QOVWith UV = use value

EV = existence value

OV = option valueQOV = quasi option value


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Measuring non-market values

The same principle as in case of distorted marketscan also be applied in case there is no market(externalities): Measuring the WTP (for goodimpacts) or WTA (willingness-to-accept) for badimpacts

Possible methods: hedonic prices (e.g. house price related to landscape) travel cost method contingent valuation

Financial and Economic Analysis Part 2 XG

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