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In practice, the decision criterions to select investment projects are different between the public and private sectors. The public sector or policymaker selects projects based on the outcomes of the social and economic analysis, whereas a private company (or project owner) and lender consider a project based only on the financial viability (Tánczos and Kong, 2001). The financial appraisal of a project is normally limited to an analysis of commercial

profitability and the return on investment capital for the private investment. On the other hand, economic appraisal extends the analysis of the benefits and costs broader, including those incurred outside the project. The economic appraisal expands the scope of the analysis beyond the project to cover the economic welfare of the region or country (European

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the entire society, not just the investors (as in financial appraisals). In principle, the economic appraisal differs from the financial appraisal in the following three factors (SOAS, 2009): i) The scope of evaluation: The economic appraisal captures a wider range of impacts than

in financial appraisals. The scope of economic appraisal extends to cover externalities, such as a third party‘s impact.

ii) Market Price: The market price in the economic appraisal is difficult to find or it may not reflect the marginal benefit and cost that project may receive.

iii) The discount rate: The discount rate used in the economic appraisal may differ from the financial appraisal.

Economic and financial appraisals are used by practitioners to evaluate large-scale transport projects. There are many studies in the field of transport appraisals. Among those studies are Grant-Muller et al. (2001), Kerali (2003), Shaoul (2002), and Tánczos and Kong (2001). It should be noted from these studies that there are some important differences between economic and financial appraisals, which are summarised in the following table:

Topic Economic appraisal Financial appraisal

Focus National wealth Project feasibility

Objective Maximize public benefit Maximize shareholder or

owner wealth

Viewpoint Public, society Private, PPP

Perspective Evaluates from a national

perspective, which takes a broad view of the benefits and costs.

Evaluates from a project- specific perspective, which takes a more detailed view of the benefits and costs. Appraisal coverage Financial, social-economic,

environmental, and policy

Focus on financial analysis

Technique CBA, MCA, qualitative

assessment

NPV, IRR, cash flow model, return on equity (ROE), return on investment (ROI)

Project variables Tries to define variables in

monetary terms with market price. However, shadow price and

Uses the actual market price and the actual cost in

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Topic Economic appraisal Financial appraisal

opportunity cost may be used instead of the market price if: - The market price did not provide a good measure of the social opportunity cost of inputs and outputs. This is because the market price may be distorted from an inefficient market. - It is difficult to find an observed price for environmental, social, or health effects.

Timeline Lifetime or longer than the

expected life of the project

Project or concession life, usually between 15-30 years Discount rate The discount rate should take into

account the opportunity cost, risks, externalities, and taxes.

The discount rate used should reflect how the future economic benefits and costs are to be valued against the present values of the benefits and costs.

The discount rate uses the interest rate quoted in the financial market.

The discount rate uses the private discount rate that ignores externalities (impact to third parties).

Market failure or inefficiency may cause differences between the economic discount rate and the financial discount rate. Project alternatives Minimal project alternatives,

without project alternatives, or select one or more project alternatives

Select among project alternatives

Taxes, subsidies Excluded Included

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Topic Economic appraisal Financial appraisal

The sensitivity analysis of the impact of the discount rate on the project‘s NPV

The difficulty of finding monetary value or a market price that reflects the true benefits and costs of the project

used

The sensitivity analysis of the impact of the discount rate on the project‘s NPV The sensitivity of the impact of other factors, such as traffic growth and

construction costs, on the project‘s NPV

Table 2.2: The differences between economic and financial appraisals

Sources: European Commission Guidelines (2008), Grant-Muller et al. (2001), Kerali (2003), Shaoul (2002), Tánczos and Kong (2001)

In summary, the economic (or social and economic) appraisal is mainly measured by the public sector whereas the financial appraisal evaluates the financial viability of the project by the private sector. The economic appraisal of an infrastructure project is proposed to

determine the types of project investments (alternatives), investment sizes, and the expected economic return (Kerali, 2003). For a publicly funded project, the evaluation should be conducted by an economic appraisal that represents the true impact of the project on the economy system. With limited budgets and resources, governments have encouraged private investments in projects through PPP methodology. The private sector normally evaluates the feasibility of a project via analysing the project‘s cash flow in which the return on investment is a significant criteria.

The appraisal methods that are used differently by the public and private sectors have created a gap. The gap between economic and financial appraisals increases when the project

investment is economically feasible but financially non-viable. To close the gap, support from the public and private sectors in the project is necessary, though such support is subjective and non-quantifiable. Concerning the aim of this research, an attempt to quantify the value of support from both the public sector and the private sector, including the financial institution, was made. The main objective of this study was to apply financial tools, such as real option, to quantify the value of government and private sector support. The main focus of this study

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is financial appraisal, which is mainly used by private companies and financial institutions to evaluate the financial viability of a project.