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p. 33 of 203 BACK | NEXT Foreword 1. Introduction to the Guidelines 2. User Instructions 3. Preparing and Appraising Investment Project 3.1. Investment Projects Overview 3.2. Possible Investment Projects 3.3. Appraisal Checklists 3.4. Forecasting 3.4.1. Introduction to Forecasting 3.4.2. Using the COSTAB Model 3.4.3. Preparing Project Cost Estimates 3.4.4. Determining Contingencies 3.4.5. Disbursement Profiles 3.4.6. Preparing Financing Plans 3.4.7. Computing Incremental Project Cash Flows 3.5. Preparing Financial Benefit-Cost Analyses 3.6. Loan Covenants 3.7. ADB Reports 4. Financial Management of Executing Agencies 5. Reporting and Auditing 6. Financial Institutions 7. Knowledge Management

Financial Management and Analysis of Projects : 3. Preparing and Appraising Investment Project : 3.4. Forecasting

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3.4.7. Computing Incremental Project Cash Flows

3.4.7.1. A project's annual net cash flows should be forecast over the project life (including the implementation period). Annual net cash flow is the difference between annual cash receipts and annual cash payments. In cases where the project represents incremental development - for instance, the extension of an existing power plant - flows should be computed on an incremental basis (e.g., "with project scenario" and "without project scenario").

3.4.7.2. The cash flows should include all payments incurred to construct, operate, and maintain the project facilities over its useful life. The cash flows should be expressed in real terms (i.e., current costs excluding any inflation elements). The cash flows should also exclude any interest paid or received. All kinds of taxes in the forms of customs and excise duties, value added taxes, similar levies, and income taxes should be included. The estimate of taxes on earnings should be based on operating income (before financial expenses but after depreciation) generated from the project and at the effective tax rate.

3.4.7.3. The capital cash flows should be reconcilable with the project cost estimates; that is with the base costs and physical contingencies, but with the exclusion of price contingencies and financial charges during development (FCDD). Price contingencies are excluded because the FIRR is calculated in real terms (i.e., without the effects of price escalation and/or foreign currency rate fluctuations). FCDD are excluded so that project benefits can be compared with project costs-this effectively segregates the investment decision from the financing decision. The benefits should include all cash receipts (including subsidies) in real terms derived from project inputs and salvage (resale) values receivable on asset disposals. Typically the enterprisewide forecasting period for financial analysis presentations won't exceed 5 years beyond the completion of project construction, even though normal operating levels may not have been reached; this will not provide enough information to prepare a financial benefit-cost analysis for the project investment on a discounted cash flow basis. This shortcoming may be overcome by preparing an income statement forecast for the project in isolation up to the achievement of capacity operations and assuming that the net cash flow is held constant thereafter. If the project is one of several being executed by an EA (e.g., railways), separate projections must be prepared.

3.4.7.4. Project cost streams are calculated using real terms. The relevance of contingencies for the project financial analysis therefore depends upon whether or not the contingencies reflect the use of additional real resources: (i) physical contingencies represent the estimated cost of the expected additional real resources required and therefore should be included in this analysis of all projects; (ii) price contingencies should be excluded from a financial benefit-cost analysis; and (iii) risk contingencies, that may be included in project cost estimates, should be included where these represent the likely cost of a physical risk, but excluded where they relate to a cover for the risk of changes in prices (as for price contingencies in the previous paragraph). But it should be noted that risk contingencies that relate to pricing of goods and services are often withdrawn following receipt of bids. The results of these bids may require revisiting the financial benefit-cost analysis.

Difference Between Current and Real Terms Nominal price/cost is used interchangeably with current price/cost, and real price/cost with constant price/cost. Current price/cost includes the effects of general price/cost inflation. Real price/cost refers to a value from which the effect of general price/cost inflation has been removed. Example: A project is expected to require 100 units of materials per annum. Today, a unit can be purchased for $1.00. However, inflation is forecast to be 10% per annum.
	Today		One Year		Two Years
	Unit Price	Cost	Unit Price	Cost	Unit Price	Cost
Real Cost	$1.00	$100	$1.00	$100	$1.00	$100
Current Costs	$1.00	$100	$1.10	$110	$1.21	$121
Appendix 7 of the Guidelines for the Economic Analysis of Projects provides further guidance on price concepts.

3.4.7.5. Financial analyses such as cash flow projections or financing plans are to be prepared in current price terms and should include all contingency allowances.

3.4.7.6. Exchange rates for converting currencies must be fixed at a particular date. These rates must be consistently applied throughout the forecast period.

3.4.7.7. An example of a net cash flow calculation is shown in the table below (Note that years 2006-2009 are not shown in this example). The project costs comprise: (i) phased investment payments during 2001-2004, (ii) operation and maintenance costs ($1.40 per m³; water sold), (iii) sales taxes (1% on water sales, 3% on connection fees), (iv) business and land taxes (lump sum of $100,000 per year), and (iv) connection costs ($1,425 per connection).

3.4.7.8. A clear statement of assumptions should support the forecast cash flows. The assumptions should state the exchange rates used for conversion purposes. Furthermore, the assumptions must state whether the forecast cash flows have been prepared in current or real terms. Where they have been prepared in real price terms, the reasons for doing so must be state

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