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	Table of Contents
p. 59 of 74 BACK | NEXT 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

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

1. A project to rehabilitate an irrigation system covering 90,000 hectares of land has been proposed and costed. The main benefits from the rehabilitation would be an increase in the proportion of land that was irrigated, with corresponding increases in cropping intensity and yields. Also, the scheme at present requires a lot of maintenance work; there would be some decline in operation and maintenance costs with the project. The investment would take place over a three-year period and the life of the scheme with normal maintenance has been estimated at 25 years. The total cost of the investment including construction activities and institutional support during the implementation period is about Rs1,800 million. The annual operating and maintenance (O&M) costs will decline from Rs10 million to around Rs7.9 million.

2. Table 1 shows the expected impact on area, cropping intensity, and yields without and with the project. Irrigated areas are used to grow rice, and these areas will increase with rehabilitation. Unirrigated areas are used to grow vegetables for the local market, and these areas will decrease with rehabilitation. Taking all these factors into account, it is expected that there will be a substantial increase in rice production from the irrigation scheme area, but an overall decline in vegetable production. For both rice and vegetable production, yield increases are expected to build-up uniformly to the with project levels of Table 1 over the first five years after full implementation.

3. The project investment and O&M costs, together with the agricultural inputs and outputs, have been estimated at financial prices. They need to be reexpressed in economic prices. A shadow exchange rate factor of 1.33 has been estimated for the country and used in a number of other recent projects. In the project area, a shadow wage rate factor at domestic prices for hired labor of 0.8 has been estimated. Economic project costs and benefits will be estimated in national currency at the domestic price level, in the first instance using just these two general conversion factors.

4. The farm-gate price of rice in the project area is Rs6,335 per metric ton. However, rice is imported into the country and the incremental rice as a result of the irrigation rehabilitation will substitute for imports. In economic prices, rice is valued at its cost insurance freight (CIF) price to the country, plus the additional costs of getting the rice to the project area where most of it will also be consumed. The cost breakdown of the border price equivalent value (BPEV) of rice is 80 percent foreign currency and 20 percent of other nontraded costs in the country. This cost breakdown is given in Table 2. Table 2 also gives the cost breakdowns of the financial price values of the other project outputs and inputs. The vegetables are grown and sold in the project area; they are not of sufficient quality to be considered for export or to substitute for imports. Other agricultural inputs are basically nontraded, except for fertilizers, which are imported with a small import tax and some handling and transport charges. Extra demand for fertilizer, as well as extra demand for other agricultural inputs, are valued at their supply price converted to economic values. The investment costs are a mixture of imported equipment and materials together with nontraded materials sourced locally, and labor that is surplus in the area. The institutional support costs are dominated by international consultants with a small expenditure on domestic consultants and office services. The O&M costs are predominantly labor costs, with some input of imported parts for equipment and nontraded construction materials.

Conversion factors using domestic price numeraire.

5. The cost breakdowns of financial price values have been used, together with the SERF and SWRF, to derive a conversion factor for each project item. These are also shown in Table 2. At the domestic price level, several of the conversion factor values are above 1.0 showing mainly that the foreign exchange they use or save is worth more to the national economy than is given by the official exchange rate. On the other hand, the labor component of project items is revalued downward by the SWRF, which represents the opportunity cost of labor at the domestic price level.

6. These conversion factors can be applied to the estimates of agricultural net output with and without the project. It is anticipated that input costs per ton will rise for irrigated rice production compared with unirrigated, while inputs into vegetable production per ton will remain the same in quantitative terms without and with the project. Table 3 shows the effect of converting to economic prices for agricultural production in the without and with project cases. Despite lower economic than financial prices, the economic costs of rice production rise because of higher input use with the project. This is partly compensated for by the higher value given to rice output at economic prices. Nevertheless, the economic net output per ton of rice is less with the project than without the project. The project rice benefits come from the increase in area, cropping intensity and yield that the irrigation rehabilitation brings about. At the domestic price level, the nontraded vegetable output is valued the same at economic and financial prices. However, the economic cost of inputs into vegetable production is less than their financial cost and so there is an improvement in economic net output per ton and per hectare.

Economic values in national currency at the domestic price level.

7. These net output estimates at economic prices are used, together with the project investment and O&M costs at economic prices, to derive the project economic statement at shadow prices. Project economic costs and benefits are shown in Table 4. The project costs include the investment and O&M costs. It has also been assumed that one-tenth of irrigated and nonirrigated production will also be lost as a result of implementation activities. The project benefits include the agricultural net output with the project less the agricultural net output without the project, together with the saving in without project O&M costs. There is only one other adjustment that is taken into account. For both the rice output and the fertilizer input there is expected to be a change in relative price in the next few years. The real price of rice is expected to fall by about 26 percent over the next ten years. Over the same period, the real price of fertilizer is expected to rise by about 8 percent. Both estimates are taken from the World Bank Commodity Price projections. Taken together, these imply a decline in the value of net output of rice at economic prices that will in part offset the increases in cropping intensity, rice area and yields. These forecast changes in real prices have been used to adjust the estimate of incremental net output from rice production over the first ten years of the project.

8. The economic internal rate of return (EIRR) calculated in Table 4 is 19.0 percent. This rehabilitation project is not a marginal project. There is no major nontraded input that needs to be revalued through a specific conversion factor; in other words there is no need for a second iteration of project economic analysis as described in the main text. However, this basic EIRR result should be subject to sensitivity and risk analysis to see how robust it is and where the project risks might lie (see Appendix 21).

^aSome values change annually up to year 10. Economic values using domestic price numeraire.

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