Slide 1 An Inroducion o PAM Based Projec Appraisal Sco Pearson Sanford Universiy Sco Pearson is Professor of Agriculural Economics a he Food Research Insiue, Sanford Universiy. He has paricipaed in projecs ha combined field research, inensive eaching, and policy analysis in Indonesia, Porugal, Ialy, and Kenya. These projecs were concerned wih sudying he impacs of commodiy and macroeconomic policies on food and agriculural sysems. This effor culminaed in a dozen co-auhored books. These research endeavors have been par of Pearson s longsanding ineres in undersanding beer he relaionships beween a counry s policies affecing is food economy and he underlying efficiency of is agriculural sysems. Pearson received his B.S. in American Insiuions (1961) from he Universiy of isconsin, his M.A. in Inernaional Relaions (1965) from Johns Hopkins Universiy, and his Ph.D. in Economics (1969) from Harvard Universiy. He joined he Sanford faculy in 1968. The framework used in his lecure has been developed in conjuncion wih Carl Gosch, he auhor of he Benefi-Cos compuer uorial included in his series. Maerials in he lecure and compuer uorial have benefied from he work of J. Price Giinger, Economic Analysis of Agriculural Projecs. The book is on-line and, where possible, links have been made o i from he lecure and he uorial. The book provides boh a solid heoreical foundaion and deailed examples for compuing benefi-cos raios (B-C) and inernal raes of reurn (IRRs).
Slide PAM Basics Gaher daa on echnical relaionships (I-O able) and privae and social prices Using he same I-O able, compue privae and social profis o deermine compeiiveness. (Gross revenues minus inpu and resource coss.) Subrac social from privae elemens (revenues, coss, profis) o deermine governmen policy involvemen or marke imperfecions The Policy Analysis Marix (PAM) approach is based on wo ses of commodiy budges, one compued using privae (marke) prices, he second using social (economic) prices. Cells may represen individual commodiies or a mix of commodiies ha reflec a farming sysem. The PAM analysis is an imporan sep in deermining which invesmens are likely o have a high payoff. For example, invesing resources in expanding he producion of commodiies ha are socially unprofiable is generally an unwise sraegy.
Slide 3 PAM Ideniies-- Marix Forma Revenues Inpu Coss Facor Coss Profis Privae A B C D Social E F G H Divergences I J K L 1. This slide shows all welve enries for a PAM, given by he leer symbols A hrough L. I adds a hird row ermed he Effecs of Divergences row. As noed above, divergences arise from eiher disoring policies or marke failures; eiher source of divergence causes observed marke prices o differ from heir counerpar efficiency prices.. The symbol I measures divergences in revenues (caused by disorions in oupu prices), he symbol J sands for divergences in radable inpu coss (caused by disorions in radable inpu prices), he symbol K represens divergences in domesic facor coss (caused by disorions in domesic facor prices), and he symbol L is he ne ransfer effec (arising from he oal impac of all divergences). 3. In empirical PAM analysis, he effecs of divergences (in he hird, boom row) are found by applying he divergences ideniy. According o ha accouning principle, all enries in he PAM marix under he hird row (defined as effecs of divergences) are idenically equal o he difference beween enries in he firs row (measured in privae prices) and enries in he second row (measured in social prices). Therefore, I is idenically equal o (A E), J is idenically equal o (B F), K is idenically equal o (C G), and L is idenically equal o (D H).
Slide Benefi-Cos Basics Using regular PAM mehods, compue privae (D) and social (H) profiabiliy. Call his he wihou projec case. Compue a second PAM using an inpu-oupu able incorporaing he impac of a capial invesmen. Call his profiabiliy he wih projec case (D, H ). Compue capial invesmen coss, e.g., pumps, dams, exension programs, research projecs. B-C raio = incremenal revenues ( wih projec minus wihou) divided by invesmen cos The daa gahered in he course of a benefi-cos analysis is very similar o he daa colleced in a PAM appraisal. There are wo major addiions: (1) informaion on he cos of he projec invesmen whose benef is being evaluaed, and () a second inpuoupu able ha incorporaes he impac of he invesmen. In he case of an invesmen in pumps, for example, he second inpu oupu able would reflec increases in yields ha irrigaion makes possible as well as new crops ha can be grown wih he addiional waer. The iniial PAM provides he daa for he wihou projec case. A second PAM, uilizing he informaion in he new inpu-oupu able, provides he profiabiliy in he wih projec case. Subracing he wihou projec profis from he wih projec profis yields he incremenal benefis of underaking he invesmen. These are compared wih he cos of he invesmen o deermine if he benefis exceed he coss. hen incremenal benefi, he difference beween he wih and wihou projec profiabiliy, exceeds he cos of invesmen ( B/C > 1), he invesmen should be underaken.
Slide 5 Single-Period B-C Marix Forma Privae Calculaions GR Coss Profi I-Cos B-C A B C D /O A B C D D I P D/I P Social Calculaions E F G H /O E F G H H I S H/I S A single-period analysis in a marix forma: There are wo PAMs, one reflecs he wihou projec case, he oher he wih projec case. (The example refers o he reurns on a single-period invesmen, e.g., ferilizer. Oher inpus such as pesicides would have a similar characerisic, i.e. reurns ocurr in he same period ha he invesmen is made.)
Slide 6 Numerical Single-Period B-C Privae Calculaions GR Coss Profi I-Cos B-C 36 1 1 8 /O 1 1 6 1.5 Social Calculaions 36 18 1 8 /O 1 1 6.5 The PAM represening he wihou projec case (/O) gives no evidence of governmen policy inervenions or marke failures. (Subracing social elemens from privae elemens resuls in zeros.) The wih projec analysis, () on he oher hand, show subsidies o radable inpus (reduced coss). A privae prices, he increase in revenues resuling from he privae invesmen and he subsidies o inpus is sufficien o generae a B-C raio greaer han one. On he basis of he privae analysis, he projec should be underaken. Privae producers have he necessary incenives o adop a new inpu. A social prices, however, he increase in revenues resuling from he invesmen are no sufficien o produce a posiive B-C raio. From he perspecive of he economy as a whole, adoping he new inpu would be inefficien. As he PAM analysis shows, i is he subsidy o inpus, no he increase in produciviy, ha accouns for he posiive privae B-C raio.
Slide 7 Muli-Period B-C Basics ih projec benefis Ne Benefis Plus Minus ihou projec benefis Years 1. Projec evaluaions ordinarily reflec siuaions ha ake place over a period ime. In he iniial years of he projec, ne benefis are expeced o be negaive as he coss of implemening he projec ouweigh any benefis ha migh be forhcoming.. Subsequenly, he posiive reurns ouweigh he negaive reurns. The analys mus deermine if he sum of he posiive reurns, when discouned o reflec he opporuniy cos of capial, are greaer han he sum of he negaive reurns, also properly discouned.
Slide 8 Muli-Period B-C Formula = n = 1 = n ( 1+ i) ( 1+ i ) = 1 D I P where: i = ineres rae n = life of he projec in years The formula shown above yields a discouned benefi-cos raio. This is he raio obained when he presen value of he benefi sream is divided by he presen value of he cos sream. The benefi-cos raio was originally developed o evaluae waer resource projecs in he U.S. and is sill used by such organizaions as he U.S. Army Corps of Engineers and he Bureau of Reclamaion. However, for echnical reasons, i is no widely used in developing counries where discouned cash flow measures such as he inernal rae of reurn (IRR) are more popular.
Slide 9 Numerical Muli-Period B-C Analysis Rev Coss Profi Inves Cos Inpus Facors Discoun Discoun 3 1 1 /O 1 1 Y 1 3.636 Y 1.653 Y 3 1.5 Y 1.366 Y 5 1. Discouned @ 1% (NPV) 5.763 3.636 B/C 1.58 In he numerical example, he reurns o he invesmen coninue for years wihou he need for furher capial infusion. The resul is a B-C raio greaer han 1.. The individual enries, discouned a 1%, are shown in he example.
Slide 1 IRR Formula IRR = he discoun rae (i) such ha : = n = 1 D I ( 1+ i) P = The inernal rae of reurn (IRR) is he discoun rae ha would make he ne presen value of he benefi sream or he incremenal cash flow equal o zero. I is he maximum ineres rae ha can be paid for invesmen and operaing coss if he projec is o break even. The inernal rae of reurn is an imporan measure of projec worh. I is he measure used by he orld Bank for pracically all of is economic and financial analyses and he measure used by mos oher inernaional financing agencies. 3. The formal selecion crierion for he IRR measure of a projec is o accep all independen projecs having an inernal rae of reurn equal o or greaer han he opporuniy cos of capial. An IRR can only exis if he cash flow has a leas one negaive elemen. I can only be used in a crude way o rank projecs.
Slide 11 Numerical IRR Analysis Rev Coss Profis I-Cos Cash Inpus Facors Flow 3 1 1 /O 1 1 Y 1 - Y Y 3 Y Y 5 IRR 35% 1. The algorihm used o compue he IRR is one of Excel s financial funcions. The projec should be acceped if he opporuniy cos of capial is less han 35%.