CAPÍTULO I MARCO TEÓRICO
ANÁLISIS DE COSTOS DE PROYECTO
Once both the benefits and costs of a proposed public intervention are available, the question that arises is how can this information be used to assess the desirability of specific public investment. There are three criteria commonly employed within the framework of the CBA. These are net present value (NPV), internal rate of return (IRR) and benefit-cost ratio (BCR). These are elaborated below.
Net Present Value: The basic criterion for comparing the costs and benefits of a project relative to the baseline case is the net present value (NPV), which is the discounted value of all future costs and benefits. The NPV is defined as (Abelson, 1996):
NPV=
∑
(3.10)
Alternatively, separating benefits and costs:
NPV =
∑
Bt (1 + r)-t – ∑Ct (1 + r)-t (3.11)where Bt and Ct are the total benefits and costs in period t respectively, r is the discount
rate, and n is the time horizon. The summation ∑ runs from t = 0, meaning the first year of the project to t = n, meaning the last year of the project. The expression in brackets is the discounted factor where the rate of discount is assumed to be the real rate of interest
r in period n. In the above equation, benefits and costs are discounted relative to present benefits and costs in order to obtain their present values.
For a project to be accepted, the discounted value of its benefits should exceed the discounted value of its costs, i.e. NPV > 0. In other words, when there is only one potential project, the project can proceed if the net present value of social benefits is positive. Where there is more than one alternative to the status quo, the rule is slightly more complicated: select the project with the highest NPV. As Hanley and Spash (1993) state “this criterion [net present value] is firmly based on the Kaldor-Hicks principle of neo-classical welfare economics: under these conditions, any project passing the NPV
test is deemed to be an improvement in social welfare” (p: 18). In such a case, the project can be said to represent an efficient shift in resource allocation, given the data used in the CBA.
Bt -Ct (1+r) t n t=0 t=0 n n t=0
Internal Rate of Return: The internal rate of return (IRR) is defined as the rate of return on an investment which will equate to the present value of benefits and costs. It is found by an iterative process and is equivalent to the discount rate (r) that satisfies the following relationship (Dixon et al., 1996):
∑ (3.12)
or
∑ Bt/(1+IRR)t=
∑Ct/(1+IRR)t(3.13)
The IRR is the discount rate that would result in a zero net present value for a project. The project is acceptable if IRR > r, which in most cases implies NPV > 0 (Young, 2001). However, the IRR is criticised as a flawed measure of resource allocation for two principal reasons: first, many projects can generate multiple IRRs from the same data set, so the analyst does not know which to select as the decision- making criteria; and second, the IRR is unreliable when comparing performance across many projects in a portfolio (Hanley, 2000).
Benefit-Cost Ratio: The benefit-cost ratio (BCR) is simply the ratio of discounted benefits to discounted costs. The BCR can be expressed as follows (Munasinghe, 1993):
BCR
=[
∑
Bt/(
1+
r)
t]/ [∑
Ct/(
1+
r)
t]
(3.14)where all the symbols are as before. This ratio compares the discounted benefits to discounted costs. A project with a BCR greater than one has also a positive NPV, that is, if BCR > 1, then NPV > 0 and the project is acceptable.
Both BCR and IRR criteria have its strengths and weaknesses, but NPV is probably the most useful. However, “where resource statements are drawn up using the same information and assumptions, these three criteria yield the same decision for single projects” (Curry and Weiss, 1993: 45). Although it is presented here for the case of desirability of a single project, the decision criteria can also be used for choosing a project among alternative options.
These criteria can be used only as information and guidance, and need to be supported with other information as to the state of the environment and long term
n t=0 n t=0 Bt -Ct (1+IRR) t n t=0
= 0
n n t=0 t=0impact of the project on the economy. Cultural, ethical or moral issues are also more important than just the mere fact that the quantified benefits of the action outweigh the costs. This is particularly relevant for developing countries like Bangladesh.
Two examples from the recent policy debate in Bangladesh might be pertinent. First, the ready-made garments industry, the largest export earner in the economy, employs a lot of child labour in Bangladesh22. The opportunity cost of this labour is
almost zero. If not employed in the garment industry, many would have engaged in pick-pocketing in the streets or in hooliganism. Although from the economic point of view it is acceptable, the concept of child labour may be morally unacceptable.
Second, against the backdrop of finding a significant amount of natural gas reserves under Bangladesh soil, a debate is currently taking place (as of mid-September, 2003) as to whether the country should export gas abroad23. The political regime in
power supports exports, while the main opposition camp expresses its vow to oppose it at any cost. A couple of years back, the scenario was completely different. The current opposition party was at that time in power and was a strong proponent of exporting gas (see, for example, the Fifth Five Year Plan adopted during that regime). In contrast, the current government party (then in opposition) strongly opposed the idea of exporting gas. Now the country, through exporting gas explored by multinational companies, may receive a large positive payment and apparently incurs no costs. This may lead to a practically infinite IRR and a very high positive value of NPV. This example helps illustrate both the weakness of using the decision criteria and the mistakes that may be made if ‘other information’, such as social, long term economic impacts and the
22 Due to the extreme poverty of parents, social backwardness, lack of adequate schooling facilities and so on, many of these children cannot go to school.
23The country’s energy resources consist of traditional fuels such as fuelwood, crop residuals and animal dung (55 percent), natural gas (24 percent), imported oil and coal (19 percent) and hydro-electricity (2 percent) (PC, 1998). The current potential gas reserve has been estimated at about 24.75 trilion cubic feet (TCF) of which 15.51 TCF is considered as commercially recoverable and as of December, 2000, cumulative exploration is 4.08 TCF and net recoverable reserve is 11.42 TCF (MOF, 2001). Less than five percent of the households are currently covered by the gas supply network. The Fifth Five Year Plan (1998-2002) states that “[w]ith the projected demand and known recoverable resources of gas, the country will start facing gas shortage after 2010 if no gas fields are discovered” (PC, 1998: 361). Although the country has a reputed public sector company (Petrobangla) capable of exploration, production and delivery of gas, the authorities seem to be more interested in inviting foreign multinational companies. The contract signed with the multinational companies for gas exploration is highly confidential and in many cases the terms and conditions favour them. For instance, in 1997, during a drilling in Magurchara, a well was blown up and a vast area of land (rich with natural resources) including many residents’ houses was destroyed. No compensation
opportunity cost of depriving a country’s own people from providing the gas, is left out of the decision-making process.
Because of such factors, it may be necessary to rely on other participatory and political processes, and also to take into consideration ethical, moral and cultural issues to make a final judgement about a proposed action. Seen in this context, the CBA can make an important contribution to these judgements providing the necessary information in a common yardstick for the policy makers.