Economic Analysis of Projects - Appendix 1: Key Questions for the Economic Analysis of Projects

Table of Contents

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I. Introduction

II. Background

III. The Economic Rationale of A Project

IV. Macroeconomic and Sectoral Context

V. An Integrated Approach To Economic Analysis

VI. Identification and Quantification of Costs and Benefits

VII. Valuation of Economic Costs and Benefits

VIII. Large Projects, Linkages, and National Affordability

IX. Least-Cost and Cost-Effective Analysis

X. Investment Criteria: Economic Viability

XI. Discount Rate

XII. Uncertainty: Sensitivity and Risk Analysis

XIII. Sustainability of Project Effects

XIV. Distribution of Project Effects

XV. Projects and Policies

XVI. Appendices

Appendix 1: Key Questions For The Economic Analysis of Projects

Appendix 2: Project Economic Rationale: Market and Nonmarket Failures

Appendix 3: The Project Framework

Appendix 4: Identification and Measurement of Consumer Surplus

Appendix 5: Treatment of Working Capital

Appendix 6: Depletion Premium

Appendix 7: The Use of Constant Prices In The Economic Analysis of Projects

Appendix 8: General Methodology For Building Up Project Statements

Appendix 9: Economic Evaluation of Project Output and Input

Appendix 10: Economic Price of Traded Goods and Services

Appendix 11: Valuation of Nontraded Outputs and Inputs

Appendix 12: Shadow Wage Rate and The Shadow Water Rate Factor

Appendix 13: The Economic Price of Land

Appendix 14: Treatment of Resettlement Components of Projects

Appendix 15: Calculating Economic Prices At The Domestic Market Price Or World Market Price Levels

Appendix 16: Estimating The Shadow Exchange Rate Factor and The Standard (Or Average) Conversion Factor

Appendix 17: Example of An Economic Rate of Return: An Irrigation Rehabilitation Project

Appendix 18: Effect On Net Foreign Exchange and Budget Flows: An Example

Appendix 19: Least-Cost Analysis and Choosing Between Alternatives

Appendix 20: Estimating The Economic Opportunity Cost of Capital

Appendix 21: The Treatment of Uncertainty In The Economic Analysis of Projects: Sensitivity and Risk Analysis

Appendix 22: User Charges, Cost Recovery, and Demand Management: An Example For Piped Water

Appendix 23: Financial Returns To Project Participants: An Illustration

Appendix 24: Economic Evaluation of Environmental Impacts

Appendix 25: Distribution of Project Effects

Appendix 26: Impact On Poverty Reduction

Appendix 27: Difference Between Economic and Financial Prices

Appendix 28: Use of Economic Prices In Measuring Effective Protection

Appendix 29: Exchange Rate Issues In Project Analysis

XVII. Others

Guidelines for the Economic Analysis of Projects : XVI. Appendices

Appendix 1 : Key Questions for the Economic Analysis of Projects

1. These guidelines are for use by

consultants producing project feasibility studies in project preparation,
consultants updating and reviewing government feasibility studies, and
Bank staff working directly on feasibility studies and project loan documents.

2. The scope of economic analysis of projects should be broadly understood to answer a series of questions relating to project design, and to bring together the information required to make a decision whether to proceed with the project or not. Table 1 below summarizes the main issues that should be addressed in making an economic analysis of a project. They follow the structure of the guidelines.

3. In each case there is a limit on the resources available for economic analysis of projects. Early in project processing, as early as writing the terms of reference for project preparation consultants or agencies, an explicit decision should be made on a project by project basis about the emphasis to be placed on the series of issues to which the questions relate. For example, not all projects will place the same emphasis on distributional issues. Environmental sustainability will be much more important for some projects than for others. A view should be taken on the balance of time to be devoted to the basic assessment of economic viability or cost-effectiveness, including sensitivity analysis, to financial incentives and fiscal impact, and to environmental and distributional issues.

Key Questions in Economic Analysis of Projects

1. Project rationale	What is the rationale of the project: what market or government failure does it address? What is the rationale for public sector involvement/private sector operations? What is the main alternative to the project? Have changes in policy been considered as an alternative to investments? Have efficiency improvements been compared with capacity expansions?
2. Macroeconomic and sectoral context	How does the project relate to the overall development strategy? What particular development problem does it address? What is the policy environment for the project: taxes & sub- sidies, trade controls, exchange rate & interest rate policy? How does the project relate to sectoral strategy? What is the sectoral policy context in terms of market structure and regulation? Is the project a priority public investment?
3. Project alternatives	Have project alternatives been considered in terms of location, scale, timing? How has the best alternative been chosen? Have the subprojects been ranked in an appropriate way? Has the least cost alternative been identified for the project or major subprojects? Has cost-effectiveness analysis been used when benefits cannot be quantified or valued? Has the most cost-effective means been identified? Is it also the most effective means? What is the additional cost of the most effective means? Does the project have several outcomes: how have they been weighted to assess cost-effectiveness?
4. Demand Analysis	What is the basis for projecting the demand for project output? How will demand be affected by income growth? What other sources of supply are there for meeting the demand? How will demand be affected by an increase in price or user charge?
5. Identification of costs and benefits	Have the without and with project situations both been described? Have all project costs, comparing the with and without project situations, been identified? Have all project benefits, comparing the with and without project situations, been identified? Which benefits have been quantified and valued, and which have not?
6. Use of shadow prices	Has an economic rate of return been calculated? Which numeraire has been used in the application of shadow prices? Has it been used consistently? Have project outputs been identified as nonincremental and incremental? Have they been valued appropriately? Was all the data available for valuing project outputs and inputs? Has a cost-effectiveness analysis been conducted where benefits cannot be measured? Have the major project costs been identified as incremental or nonincremental, and valued appropriately? Have benefits and especially costs been broken down into traded and nontraded items? What value of the SERF/SCF has been used: has it been correctly applied? Have more specific conversion factors been used for some items: how were they derived? What discount rate has been used: to choose between alternatives, and to assess economic viability?
7. Sensitivity analysis	What type of sensitivity analysis has been applied? Does it relate to underlying benefit and cost variables? Have the key variables been identified? Have switching values been calculated? What measures are proposed to monitor the key variables?
8. Risk analysis	Is there a quantitative risk analysis? Have probabilities been attached to any of the key sensitivity variables? Have institutional risks been assessed? Are there sufficient incentives for government participants in the project? What measures have been proposed for reducing project risks?
9. Financial and fiscal sustainability	Has the FIRR for the project been calculated? Have the financial returns to different project participants been calculated? Are they adequate to attract investment/ensure active involvement? What is the level of charges for goods and services? Is the economic analysis related to the charge level? What is the difference between the FIRR and EIRR, and what accounts for the difference? Have the average incremental financial and economic costs been calculated? What is the level of cost recovery? Is there any explicit or implicit subsidy to the project? What is the justification for the subsidy? Has the fiscal impact on the capital and recurrent budget been calculated? What will be the source of funds to meet net fiscal requirements: extra taxation, extra borrowing, or a reallocation of expenditure?
10. Environmental sustainability	Have the environmental effects of the project been identified: costs and benefits? How have they been quantified and valued? Are they expressed in the same numeraire as the basic economic analysis? Have they been integrated into the economic analysis: for choosing between project alternatives; for assessing economic viability? Have required mitigatory and monitoring expenditures been identified?
11. Distribution analysis	Has a distribution analysis been undertaken for the project? Have levels of income been projected both without the project and with the project? Has the effect of different levels of charges for goods and services been assessed for operators, customers and government? Has the distribution of costs, especially on the poor, been identified? Has the distribution of benefits, especially to the poor, been identified? What proportion of net benefits will go to poor people? Is the distribution of costs and benefits analyzed by gender? Is there a substantial foreign involvement in investment and operation? Has the proportion of incomes and revenues going to foreign investors, lenders and workers been identified?
12. Benefit monitoring and evaluation	What are the key variables necessary to identify project impact during implementation and operation? Does this include key performance variables, physical or financial, for the implementing agency? Is a system in place to collect data on all the key variables?
13. Overall assessment	Have the major conclusions of the economic analysis been clearly spelt out? Does the project incorporate the best alternative? Is the project economically viable? Are any policy changes necessary to complement project implementation? Are any capacity building measures necessary: to provide incentives or training to the executing agency and other participants?

SERF - Shadow exchange rate factor
SCF - Standard conversion factor
FIRR - Financial internal rate of return
EIRR - Economic internal rate of return

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XVI. Appendices

Appendix 2: Project Economic Rationale: Market and Nonmarket Failures

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Appendix 1 : Key Questions for the Economic Analysis of Projects