A6.  ECONOMIC ANALYSIS

The economic feasibility of any proposed project is judged by determining whether the value of the resources created by the investment is greater than the value of the resources consumed. The approach used in the identification of costs and benefits for the financial analysis is similarly used for the economic analysis. The two analyses differ in the way costs and benefits are measured.

Economic Viability Indicators

•  Economic Internal Rate of Return

•  Economic Net Present Value on the project

•  Benefit-Cost Ratio

The EIRR is the return on the resources invested. If it is greater than the SDR, the project is economically feasible. The ENPV is the economic value of a series of future payments assuming a given discount rate. The discount rate used here is the Social Discount Rate (SDR), which is currently set by the ICC at 15 percent. If the ENPV is greater than zero then the project is feasible. The SDR is the benchmark against which projects are measured to determine which potential projects are most desirable.

The BCR is the oldest measure for estimating economic feasibility and is equal to the present value of the ratio of the sum of the benefits and the sum of the costs. If the BCR is greater than one, the project is feasible. The larger the value, the more desirable the project becomes.

Resources Used

•  Net Resource Investment

•  Net Operation and Maintenance

The value of the resources consumed is not always exactly the same as the cost of investment. For example, if the cost of the steel to be used constructing the facility in the FIRR includes substantial taxes, the tax component of the cost is not included in the economic analysis because it is not part of the real resource cost of the steel (even if it is an important monetary cost). In this case, economists substitute shadow prices for monetary prices to capture the real value of the resource consumed.

However, at this level of feasibility, we have not been able to make a detailed breakdown of the investment costs into materials (both domestic and imported) and labor to make the required adjustment. Some conservative assumptions were made, however, to estimate the real resource cost of the investment. The labor component was assumed to be 30 percent of the total cost (excluding capitalized interest). Forty percent was assumed to be unskilled labor, valued at 0.6, which is the shadow wage rate for unskilled labor. The remaining 70 percent was multiplied by 0.9 to adjust for the value-added tax.

When preparing the economic analysis, the proponent would use detailed information on the materials and equipment and would deduct an additional 20 percent from the imported component to remove the effect of import duties. To the extent that there are any imported components in this example, the economic cost estimate is inflated, making the project less feasible.

Operation and maintenance costs are included as a proportion of the total costs for the new enterprise as the existing enterprise would have O&M expenditures regardless. Although we cannot directly measure the additional business that this sample project will generate, we can use proxies to estimate the value-added from the facility, shown below:

Benefit Proxies:

•  Employment generation from new businesses in the shopping center and market

•  Income generation from new businesses in the shopping center and market

•  Increased land values around the center

The value-added of the facility is the net increase in commercial activity due to the presence of the facility. We assume here that 15 percent of the businesses in the facility are new enterprises and the remaining 85 percent have relocated from somewhere else. The direct benefits are at least equal to the value of the employment generated per new enterprise and the estimated net income of the businesses.

In addition to the new enterprises within the facility, there are also indirect benefits accruing to the businesses around the facility. Although we cannot directly estimate the value of additional commercial activity in the surrounding area, the value can be indirectly measured by the anticipated increase in land prices in the immediate surroundings.