Debre Markos University Burie campus

Department of Economics
Development planning and project analysis
II

1 Course Code: Econ-3132

 Chapter I: Basic Concepts
Projects,
The Cutting Edge
of Development

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1.1. The Project Concept Definition:
What is a Project?
 Different organizations and provide different
authors
definitions for the concept project.

A project is a proposal for an investment create,

and/or
to develop certain facilities in order to expand
increase the
production of goods/services/during a certain period of time in
a community, region, country, market area and/or certain
organization (firm, public organization, NGO, etc).

A project is defined as a complex economic activity in which

scarce resources are committed in the expectation of benefits
that exceed these resources(costs).
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 According to Little and Mirrlees, a project is a scheme/እቅድ/,
or part of scheme, for investing resources which can
reasonably be analyzed and evaluated as an independent unit.

 A project is an investment activity upon which resources are

expended to create capital assets that will produce benefits
over an extended period of time and which logically lends
itself to planning, financing and implementation as a unit.
 A specific activity, with specific starting point and specific
ending point, intended to accomplish a specific objective.
(Gittingger,1982)

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Generally, a project is:-
An investment activity which lends itself to
planning, financing and implementation as a unit;
Expressed in terms of definite location, time and
target group or beneficiaries;
Expected to generate specific output(benefit) after
its completion;
Managed by a separate administrative structure
or operated through the existing structure

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 A project is viewed as a conversion process. This implies that a
project involves a transformation of some form of inputs into an
output

 In the above diagram, we observe that project is a conversion

process which serves in transforming inputs into outputs.
 Inputs represent want or need whereas outputs represent
satisfied need. Constraints consist of factors such as financial,
legal, ethical, environmental, time, and quality. Mechanisms
include people, knowledge of expertise, capital, tools and
techniques, and technology.
Basic characteristics of a project
1. A project involves the investment of
scarce resources in the expectation of future benefits.
 Projects have specific benefits that can be identified,
quantified and valued, either socially or
monetarily/commercially/.

2. Projects have measurable objectives

 Projects have specific beneficiaries which needs to be
specifically spelt out during project planning.

3. A project is the smallest operational unit.

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 A project can be planned, financed and implemented as a
unit.
Despite the fact that a project constitutes many activities

and tasks, it is defined as the smallest operational unit.

Because, it is bounded by different factors. These are:
Projects are conceptually bounded.

The problem and specific objective of a project involves

conceptual delimitations.
Projects are geographically bounded.

Projects are organizationally bounded.

There should be certain organizational unit responsible

7 for project implementation.

 Projects are time bounded.

 Projects have specific lifetime, with a specific start and end time.

4. Uncertainty and risks is inherent in any project.

 Achieving project objectives can not be predicted in
advance with accuracy.
 The factors that make project risk are:

A.Significant and multiple types of scarce resources

are committed today expecting outcome in the future;
B.Benefits are expected to be generated in the future, which
is less predictable;
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C. Capital investments are irreversible, i.e. exit has its own
costs.
5. It has a scope that can be categorized into definable tasks.
 Projects usually have well defined sequence of investment
and production activities

6. It may require the use of multiple resources.

 This has an implication on management of project implementation.

 The more diverse the types of resources are mobilized, the

more complex will the management be.
 The outcome of project and hence development endeavor
is sensitive to the management of each type of resources.
 Un managed resource can contribute more to cost than to benefit.

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Why Project Planning?
There is basic economic problem of scarcity in
the face of unlimited needs.
This leads to make choices on the means and ends
of development, which involves the rational use of
limited resources to attain the economic ends.
Thus, investment decisions are an essential part of
the development process.
The more sound the investment decision is, the
more success will be in the development endeavor.

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The need for project planning, preparation and study emanates
from:
A. Thequest for change: dissatisfaction with the
present and/or pressure or incentive for
improvement in the future

B.Change involves investment/commitment of resources to

realize the objectives.

C.The scarcity of investible resources and

unlimited development/business needs;

D.Investment is all about resource commitment into the future,

which is less predictable;
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 E. An investment schemes have an inherent high
risk
F. The costs and benefits are temporally spread
and particularly the large part of the costs are
incurred earlier and the benefits are generated
later on.
 This raises the question of comparing and
equating the future and present values.

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  Decision-making is not simple and perfect as it is
assumed in orthodox economics.
 These features of investment decisions constitute:
• the reasons that justify the significance and relevance
of
project planning and
• the major constraints and challenges faced by any
project planner and decision maker in project viability
studies.
Thus, makers have to make every effort to
decision
systematically rationalize their decisions by undertaking
rigorous viability studies.

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 Types of Projects

 There are different types of projects. That is; a project

can be;
– New, updating and / or expansion
– Market based, Resource based, Felt need
– Private, NGOs, and/or government/public
– Industrial, Agricultural and Service

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 1.3. The Project Cycle
• Project cycle is the different stages, phases, levels, steps,
events or sequences that a project follows.
• There are several models of project cycle but the
most important ones are:
• Baum Project Cycle Model- developed by WB
• The UNIDO project cycle model

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 PROJECT CYCLE (W.C BAUM)

Identificatio
n

Evaluation Interactio Preparation

n

Implementation Appraisal
 UNIDO P.C. Model
Identification

Post-evaluation Pre-feasibility

Implementation Feasibility

Appraisal
Alternatively, we can categorize project cycle in to three

main phases (UNIDO, 1991)

1. Pre-investment phase

A. Identification/opportunity study/

B. Pre-feasibility study/ pre-selection/

C. Feasibility study

D. Support study;

E. Appraisal study

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2. Investment phase

A. Negotiating and contracting;

B. Engineering design;

C. Construction;

D. Procurement

E. Erection and installation

F. Pre production marketing;

G. Manning and training

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3. Operation phase

A. Commissioning and hand over and starting of

operation

B. Post project evaluation/appraisal/

C. Replacement/rehabilitation

D. Expansion/innovation

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1. Identification (Opportunity studies)

The first stage in the project cycle is to find potential projects.

It is the identification of investment opportunities.

Project ideas can emanate from a variety of sources.

In general, one can distinguish two levels where project

ideas are born: The macro level and the micro level.

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At the macro level, project ideas emerge from:

1. National policies, strategies and priorities as may be

initiated from time to time;

2. National, sectoral, sub-sectoral or regional plans and

strategies

3. General surveys, resource potential surveys, regional

studies, master plans, statistical publications which indicate
directly or indirectly investment opportunities;

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4. Constraints on the development process due to
shortage of essential infrastructure facilities, problems in the
balance of payments, etc.;

5. Government decisions to correct social and regional

inequalities or to satisfy basic needs of the people through
the developments of projects;

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6. A possible external threat that necessitates projects aiming
at achieving, for example, self sufficiency in basic materials,
energy, transportation, etc;

7. Unusual events such as draughts, floods, earth-quake,

hostilities, etc.;

8. Government decision to create project-implementing

capacity-Example- in construction

9. Project ideas can also originate from multilateral or

bilateral development agencies

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 In addition individual/entrepreneurial/ inspiration, institutions,

workshops, trade fairs, development experiences of other

countries may point to some interesting project ideas.

 At the micro-level-Project ideas may emanate from:

1. The identification of unsatisfied demand or needs

2. The existence of unused or underutilized natural or

human resources and the perception of opportunities for their
efficient use

3. The need to remove shortages in essential material

services, or facilities that constrain development
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efforts
4. The initiative of private or public enterprises in response
to incentives provided by thegovernment.

5. The necessity to complement or expand

investments previously undertaken, and

6. The desire of local groups or organizations to enhance

their economic status and improve their welfare
 Project proposals can also originate from foreign
firms seeking for their profit

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2. Preparation and Analysis
Once project ideas have been identified and selected, the process

of project preparation and analysis starts.

Project preparation must cover the full of technical,

range institutional-organizational-managerial,
social, financial, economic and commercial,
environmental analysis necessary to which are
achieve the project’s objective.
Critical element of project preparation is identifying and

comparing technical and institutional alternatives for achieving

the project’s objectives.
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A. Technical Aspects
Since a technically unfeasible project cannot be promoted,
technical study of a project provides the technical basis for all
other aspects of a project study.
The main and challenging task in technical analysis is to
identify the appropriate technology for the objective that the
project is intended to meet.
In general, this part of project study address issues related to:

A. Project design and processes: to ensure that there is

appropriate technology and engineering work, the study
should consider and evaluate alternative technologies and
alternative machines and equipment;

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B. The input – output relationship
This aspect may the of
include scientists and works in engineers, soil
agronomists projects. of, say,
The agricultural
technical analysis concerned with the project’s
case
is
inputs (supplies) and outputs of real goods and services and

the technology of production and processing.

This is crucial because the rest of the project analysis cannot
be conducted without information from the technical study.

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In general the technical analysis is primarily concerned with

1. Material inputs and utilities

2. Location, site and environment
3. Manufacturing process/technology/ and engineering

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B. Institutional-Organizational-Managerial Aspects
This basically incorporates the socio-cultural patterns and

institutions of the population that the project is believed to

serve.
Does the project takes into account the cultural setup and

customs of the beneficiaries?

Or will it disturb the accepted pattern?

If so how should this be included as part of the project design?

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To have a chance of being carried out, a project must be

related properly to the institutional structure of the country

or region where the project is to be carried out.
Examples include: the land tenure system, use of local

institutions such as Idir etc.

Similarly, managerial issues are critical for successful

completion of projects.
Thus, the project analyst must examine the ability of
available staff to carry out the managerial needs of the
project.
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Organization and Manning

Dividing the project into organizational units in line with the

marketing, supply, production and administrative functions is

necessary not only from the operational point of view, but also
during the planning phase, to allow the assessment and
projection of overhead costs.

The organizational set-up depends to a large extent on the size

and type of the industrial enterprise and the strategies, policies

and values of the organization.
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Plant organization and management
Organization is the means by which the operational
functions and activities of the enterprise are structured and
assigned to organizational units.
This represents managerial staff, supervisors and workforce,
with the objective of coordinating and controlling the
performance of the enterprises and the achievement of its
business targets.
The organizational structure of an enterprise indicates the
assignment of responsibilities and delegation of authorities to
the various functional units of the company.
The organizational functions are the building blocks of the
company.

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They may be grouped into the following organizational units
in line with the specific requirements of the individual
company:
 General Management
 Finance, financial control and accounting
 Personnel administration
 Marketing, sales and distribution
 Supplies, transport, storage
 Production:
Main plant
Service plants
Quality assurance
Maintenance and repair
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The organizational structure of the company can also take a

number of shapes, the most common being the pyramid shape,

which has the following three organizational levels:
 Top management

 Middle management, and

 Supervisory management

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C. Social Aspects

This aspect is more important to public projects. Project

analysts are expected to examine the broader social
implications of the proposed project.
That is; sufficient attention should be given to the
social soundness of a project.
This is particularly related to:

1. The attitude and the likely response of the beneficiary groups;

2. The existence of potential implementation capacities
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or organization within communities;
3. The cultural factors related to the implementation
and outcomes of the project;
4. The political factors;
5. Income distribution implications of the project,
6. Employment creation: income distribution could be related
to employment creation.
7. Issues of balanced regional development,
8. The displacement impact of the project
9. The gender implication of the adopted technology;
10. Environmental impacts etc.
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D. Commercial aspects
 The commercial aspects of a project include the arrangements for

marketing the output produced by the project and the arrangements

for the supply of inputs needed to build and operate the project.
 On the output side, careful analysis of the proposed market for the

project's production is essential to ensure that there will be an

effective demand at a remunerative price.

Questions that must be addressed include:

 Where will the products be sold?

 Is the market large enough to absorb the new production without

39 affecting the price?

 If the price is likely to be affected, by how much?

 Will the project still be financially viable at the new price?

 What share of the total market will the proposed project supply?

 Are there suitable facilities for handling the new production?

 Is the product for domestic consumption or for export?

 Does the proposed project produce the grade or quality that

the market demands?
 What financing arrangements will be necessary to market
the output?
 What special provisions need to be made in the project to
finance marketing?
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 On the input side-appropriate arrangements must be made so as
to create adequate input supply to the project.
 Questions that must be addressed include:

 Do market channels for inputs exist?

 Do market channels have enough capacity to supply new inputs on time?

 What about financing for the suppliers of inputs and credit for
the farmers to purchase these supplies?
 Should new channels be established by the project or should
special arrangements be made to provide marketing channels for new
inputs?
 Commercial aspects of a project also include arrangements for
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the procurement of equipment and supplies.
 E. Financial Aspects
 In the financial analysis part, analysts should try to identify and
analyze the projects financial efficiency, incentive impact to the
participants in the project, creditworthiness and liquidity.
 The aspects that should be considered during financial analysis
include:
1. Investment outlay and costs of the project
2. Means of financing
3. Cost of capital
4. Projected profitability
5. Break-even point
6. Cash flows of the project
7. Investment worthwhileness
8. Projected financial position
9. Level of financial risk
F. Economic Aspects
The economic aspect of project preparation is primarily

concerned with the impact/contribution of the project to the

whole economy (the society as a whole).
 The focus is on the social costs and benefits of a project,
which may often be different from its monetary costs, and
benefits.
The financial analysis views from the participants (or owners)

point of view, while the economic analysis from the society’s

point of view.

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 There are three important distinctions between the two types of

analyses
1. Treatments of taxes and subsidies: these items are treated as
transfers in the economic analysis while in financial analysis taxes
are usually treated as cost and subsides as a return/income.
2. Use of Prices: in the financial analysis we will use actual market
prices.
 In economic analysis the market prices are adjusted to accurately
reflect social and/or economic values.
 The latter prices are termed as ‘shadow prices’ or ‘economic

accounting prices’.
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3. Treatment of interest on capital: in economic analysis

interest on capital is never separated and deducted from the

gross return.
 Because, it is part of the return from capital which is
available for the society as a whole.
Such interest is deducted from benefit stream in financial

analysis whose point of view is the firm and hence interest is a

cost to the firm.

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G. Environmental/Ecological/ analysis
 Ecological analysis should be done particularly for major projects,

which have significant ecological implications like:

 power plants

 irrigation schemes

 environmental polluting industries

 etc.

 The key questions raised in ecological analysis are:

1. What is the likely damage caused by the project to the

environment?
2. What is the cost of restoration measures required to ensure that
47 the damage to the environment is contained within acceptable
limits?
3. Appraisal

 After a project has been prepared, it is generally appropriate for a

critical review or an independent appraisal to be conducted.

 This provides an opportunity to reexamine every aspect of the

project plan to assess whether the proposal is appropriate and sound

before large amount of resources are committed.

 The appraisal process builds on the project plan, but it may involve

new information if the specialists on the appraisal team feel that

some of the data are questionable or some of the assumptions are
faulty.
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Three decisions

1. Approve-if the appraisal team concludes that the project

plan is sound

2. Amend- appraisal team may request for amendments if

there are some errors which can be corrected easily

3. Reject- appraisal team can reject project proposal if it

finds serious errors or if the project is not worthy totally.

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4. Implementation

After approving a project proposal, the next step is changing

into action/implementation/.
Thus, implementation is the most important part of the project
cycle.
 There are some aspects of implementation that are of
particular relevance to project planning and analysis. These
include:
First, the better and more realistic a project plan is, the more
likely it is that the plan can be carried out and the expected
benefit realized.
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 Second, project implementation must be flexible.

Circumstances can change, and project managers must be

able to respond intelligently to these changes.
Technical, economic, political etc. changes can change the
way we should implement the project.
The greater the uncertainty of various aspects of the
project, or the more innovative and novel the project is, the
greater the likelihood that changes will have to be made.

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Even as project implementation is under way, project managers

will need to reshape and replan parts of the project, or

the entire project.
Implementation is a process of refinement, of learning from

experience-in effect, it is a kind of “mini-cycle” within the

larger project cycle we have outlined.
Project analysts generally divide the implementation phase into

three different time periods.

First-the investment period- when the major project

investments are undertaken.

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Second- the development period-it is when the project builds

up its production.
Third- project life- after full development is reached,
it continues for the life of the project.
Usually the project life is keyed to the normal life of the major

asset.
However, for practical reasons, a project life rarely
exceeds 25-30 years.
Both the financial and economic analyses of the project relate

to this time horizon.

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5. Evaluation
The final phase in the project cycle is evaluation.

 The analyst looks systematically at the elements of success

and failure in the project experience to learn how better to plan
for the future.
It is important managerial tool in ongoing projects, and rather
formalized evaluation may take place at several times in the
life of a project.
Evaluation may be done by many different people or
organizations.

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The extent to which the objectives of a project are
being realized provides the primary criterion for an evaluation.
The evaluators also evaluates the appropriateness of
the objectives and the plan in light of the objectives.

 Evaluators try to evaluate:

Was the technology proposed appropriate?

Were the institutional, and managerial

organizational, arrangements suited to the
conditions?
Were the commercial aspects properly considered?

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Were the financial aspects carefully worked out on the basis

of realistic assumptions, and were the economic implications

properly explored?
How did the project in practice compared with each aspect of

the project analysis?

Did the institutional and organizational structure in the project

permit a flexible response?

Did management respond quickly enough to changes?

Finally, evaluators will recommend for improvements for the

future.
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 Review Questions
Answer the following questions.
1. What is project?
2. What is the importance of project plan?
3. Explain the reasons that makes project risky.

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 CHAPTER -TWO
FINANCIAL ANALYSIS AND
APPRAISAL OF PROJECTS

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2.1. Scope and Rationale for Financial
Analysis of Projects
2.1.1.What is financial analysis?
 It is concerned with assessing the feasibility of a new project
from the point of view of its financial results.
 Financial helps to determine the financial
analysis
profitability of a project.
 It will be worthwhile to carry out a financial analysis if the
output of the project can be sold in the market or can be valued
using market prices.
 The project’s direct benefits and costs are, therefore, calculated
in financial terms at the prevailing (expected) market prices.
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 This analysis is applied to appraise the soundness and acceptability
of a single project as well as to rank projects on the basis of their
profitability.
 In other words, financial analysis is all about the assessment,
analysis and evaluation of the required project inputs, the outputs
to be produced and the future net benefits, with the aim of
determining the viability of a project to the private investor or the
executing public body.
 The financial analysis deals with two issues:

1. Investment profitability analysis, with different methods of

analysis;
a. Simple methods of analysis of rate of return/static
methods/ non- discounted techniques/.
This include:
 Simple rate of return;
 Pay-back period;
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b. Discounted-cash-flow methods/dynamic methods
 Net Present Value/NPV/;

 Internal Rate of Return/IRR/

2. Financial analysis/ ratio analysis/

a. Liquidity analysis;

b. Capital structure analysis (debt-equity ratio).

The two types of analysis are and not
complementary substitutable.

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2.2 Identification and Analysis of the Estimates of Costs and
Benefits
 In project analysis, the identification of costs and
benefits is the first step.
 This involves:
 the specification of the costs and benefit variables for
which data should be collected,
 identification of the sources of information,

 collection of the information and

 assessment of the quality and reliability of the

collected information.

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Objectives and the Identification of Costs and Benefits

 The costs and benefits of a project depend on the objectives the

project wants to achieve.

 So, the objectives of the analysis provide the standard against

which costs and benefits are defined.

A cost is anything that reduces an objective, and a benefit is

anything that contributes to an objective.

However, each participant in a project has many objectives.

 For a farmer, a major objective of participating may be

to maximize family income.

63
 But this is only one of his/her objectives.

She/He may also wish her/his children to be educated,

which reduces the available labor force for farm work.

Taste preferences may force the farmer to continue growing

a traditional variety although a new and high yielding
variety may be available.
She/He may also wish to avoid risk and thus continue
cropping a variety, which She/he knows well.

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 For a private business firm or government corporations, a
major objective is to maximize net income.

 However, both have significant objectives other than simply

making the highest possible profit.

 Both will want to diversify their activities to reduce risk.

 A society as a whole will have as a major objective increased

national income, but it clearly will have many significant,
additional objectives.

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 Example:

 income distribution,

 creating employment opportunities,

 increase the proportion of saving for future investment,

 increasing regional integration,

 raising the level of education,

 improve rural health, or safeguard national security.

 Any of these may lead to the choice of a project that is not the
alternative that would contribute most to national income which is
narrowly defined.
 No formal analytical technique could possibly take into account all
the various objectives of every participant in a project.
72 Some selection will have to be made.
Mostly, the maximization of income is taken as the dominant
objective of the firm.
 Because, the single most important objective of an
individual economic agent is to increase income and
increased national income is the most important objective of
national economic policy.
Thus, anything that reduces national income is a cost and
anything that increases national income is a benefit.

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 Quantification:
 Once costs and benefits are listed, the next step is accurate
prediction of the future benefits and costs which then
be quantified in monetary units/Birr/.
 Thus, quantification involves the quantitative assessment
of both physical quantities and prices over the life span of
the project.

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2.3. Classification of Costs and Benefits
2.3.1 Classification of Cost
 There are alternative ways of classifying costs and benefits of a
project.
 One is to categorize both costs and benefits into:
 Tangible and
 Intangible once.
Another classification is in terms of:
1. Total investment costs;
2. Operational/running costs;

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Another classification:
1. Total investment costs including:
a. Initial investment costs;
• Fixed investment costs;
• Pre-Production expenditures;
b. Investment required during plant operation / rehabilitation and
replacement investment costs/
c. Net working capital
2. Operating costs/costs of goods sold

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Tangible costs of a project
In almost all project analysis, costs are easier to identify (and
value) than benefits.
The prices that the project actually pays for inputs are the
appropriate prices to use to estimate the project’s financial
costs.
 Some of the project costs are tangible and quantifiable while

many more are intangible and non quantifiable.

The costs of a project depend on the exact project formulation,
location, resource availability, or objective of the project.
In general, the cost of a project would be the sum of the total
outlays.

71 These include:
Initial Fixed Investment costs
 The initial fixed investments constitute the major
resources required for constructing and equipping an
investment project.
 These include the following tangible initial fixed investments.
1. The cost of land and site development
 Land charges
 Payment for lease
 Cost of leveling and development
 Cost of laying approach roads and internal roads
 Cost of gates
 etc.

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2. The cost of buildings and civil works
 Buildings for the main plant and equipments

 Buildings for auxiliary services (workshops, laboratory, water

supply, etc.)
 Warehouses and show rooms

 Non factory buildings like guest house, canteens,

residential quarters, staff rooms
 Garages and workshops

 Other civil engineering works

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3. Plant and machinery
 Cost of imported machinery which might include the FOB
value, shipping freight and insurance costs, import duty,
clearing, loading, unloading, and transportation costs
 Cost of local or indigenous machinery
 Cost of stores and spares
 Foundation and installation charges
4. Miscellaneous fixed assets
Expenses related to fixed assets such as furniture, office
machines, tools, equipments, vehicles, laboratory equipments,
workshop equipments

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 5. Pre-production Expenditures
Another component of the initial investment cost
includes both tangible and intangible costs is the which
production pre-
expenditures.
 In every project, certain expenditures are prior
incurred to commercial production.
This includes the following investment cost items.

1.Intangible assets: these assets represent

expenditures which yield benefits extending over a long time
period.
These include:
a. Patents, licenses, lump sum payments for technology,
engineering fees, copy rights, and goodwill.
b. Preparatory studies, like specific functional studies and
investigations, consultant fees for preparing studies,
75
supervision costs, project management services, etc.
2.Preliminary expenses: these costs include:
 preliminary establishment expenses, (registration and
formation expenses),
 legal fees for preparation of memorandum and articles of
associations and similar documents.
In addition, it includes costs of advertisements, brokerage for
mobilizing resources, shareholders, expenses for loan
application and its processing.

3. Other Pre-operation expenses

These include:
Rents, taxes etc
Trial runs, start-ups and commissioning expenditures(
raw materials and other inputs consumed immediately
before
82
commercial operation);
Salaries, fringe benefits and social contributions
security
of personnel engaged during the pre-production
period;
Pre-production marketing costs, promotional
creation of sales network, etc;
expenses,
Training costs, including all fees, travel, living expenses etc;

Insurance charges

Miscellaneous expenses

77
 6. Plant and Equipment Replacement Costs
Every machinery and equipment does not have
equal
economic life.
There are machineries and equipments that productively
be operated for many years.
 On the other hand there are equipments, machinery
components and parts which need to be regularly replaced for
smooth operation of the same technology.
So, sound project planning work should
adequately
provide for replacement of components and parts.
Thus, it is necessary to identify such items and then estimate
the costs for replacement and then the same should be
reflected in the financial and economic analysis.
78
7. Terminal Values/End-of-Life Costs/Salvage Costs/
 Though firms may be institutionally organized to live and
operate for unlimited period of time and hence unlimited age,
technologies, machineries and equipment do have limited
operational/economic/ life.
During the end of the economic life of a good/machinery,
equipment, building, etc) there is some salvaged value and the
salvation may involve incurring of costs.
The costs associated with the decommissioning of fixed assets
at the end of the project life, minus any revenues from the sale
of the assets, are end-of-life costs.
Major costs are the costs of dismantling, disposal and land
reclamation.
79
 8. Net Working Capital
Net working capital is part of the total investment outlays.

It is defined as current assets (the sum of inventories,

marketable securities, prepaid items, accounts receivable and
cash) minus current liabilities (accounts payable).
This investment is required for financing the operation of the
plant.
Working capital is generally categorized into gross working
capital and net working capital (NWC).

80
The gross working capital consists of all the current
assets, including:
a. raw materials;
b. stores and spares;
c. work-in-process;
d. finished goods inventory;
e. Debtors/accounts receivable/;
f. Cash and bank balance.
Net working capital is defined as gross working capital
less current liabilities.
For the purpose of financial analysis and even financial
management of operational firms, it is net working capital
which is the center of decision makers.
81
9. Costs of Goods Sold/Operating costs
Once the project idea has been accepted and the project is
being implemented, the cost of production may be worked
out.
For instance, for an agricultural project the following may be
necessary:
Material cost- this comprises the cost of raw materials,
chemicals, components, fertilizer and pesticides for increasing
agricultural production, concrete for irrigation canal
construction, material for the construction of homes etc and
consumable stores required for production.
It is not the identification that is difficult in this case but the
problem of finding out how much is needed from each.
82
Utilities- consisting of power, water, and fuel are also
important cost components.
Labor: this is the cost of all manpower employed in the
enterprise.
Factory Overhead: the expense on repairs and maintenance,
rent, taxes, insurance on factory assets, etc. are collectively
referred to as factory overheads.
Land-is the cost incurred for the land to be used for the
project.

83
Contingency allowances- are usually included as a regular
part of the project cost.
Sound project planning takes into consideration in advance for
possible adverse changes in physical conditions or prices that
would add to the baseline cost.
Contingency allowances may be divided into
physical
contingencies and price contingencies.
Price contingencies comprises two categories-relative changes
in price and general inflation.
Physical contingency allowances and price contingency
allowances for relative changes in price are expected and form
part of the cost base when measures of project worth are
calculated.
84
To avoid the problem of inflation on the other hand it is
advisable to work with constant prices instead of current
prices.
This approach assumes that all prices will be affected equally
by any rise in the general price level.
So contingency allowances for inflation will not be included
among the costs in project accounts other than the financing
plan.
Taxes: payment of taxes including tariffs and duties is treated
as a cost to the project implementer in financial analysis.
Debt service: the payment of interest and the repayment
of capital.
 Both are treated as an outflow in financial analysis.

85
Sunk costs

Sunk costs are those incurred in the past and upon which the
proposed new investment will be based.
Costs that have already been incurred and cannot be recouped

Such costs cannot be avoided.

When we analyze a proposed investment, we consider only
future returns to future costs; expenditures in the past, or sunk
costs do not appear in our account.
For example, if an item, initially purchased for $100 can
subsequently be sold for a maximum of $40, the sunk cost is
$60, and the recoverable cost is $40.
Sunk costs are a sub-category of ‘fixed costs. If the item
86 described above is a machine used in production, the fixed cost
of the machine is $100, of which $60 is sunk cost.
 Tangible Benefits
Tangible benefits can arise either from
increased
production or from reduced costs.
In general the following benefits can be expected:
 Increased production
 Quality improvement
 Changes in time of sale
 Changes in location of sale
 Changes in product form (grading and processing)
 Cost reduction through technological advancement
 Reduced transport costs
 Looses avoided
 Other kinds of tangible benefits
87
Secondary Costs and Benefits
 Projects can lead to benefits created or costs incurred outside
the project itself.
 Incorporating secondary costs or benefits in project analysis
can be viewed as an analytical device to account for the value
added that arises outside the project but is a result of the
project investment.
 If a project has a substantial effect on the quantity other
producers are able to sell in imperfect markets-and most
markets are imperfect-there may be gains or losses not
accurately accounted for.
Benefits:
 Reduction in cost of transport due to improved road/rail
 technological spillover or technological externalities
 Multiplier effect

88
Cost:
 Example: Adverse ecological effects

 pollution

 Irrigation development may reduce the catch of fish

 When these technological externalities are significant and can

be identified and valued, they should be treated as a direct cost
of the project (as might be the case for reduced fish catches), or
the cost of avoiding them should be included among the
project costs.

89
 Intangible Costs and Benefits
Almost every agricultural project has costs and benefits
that are intangible.
These may include creation of new job opportunities,
better health and reduced infant mortality as a result of
clinics, better nutrition, reduced incidence of waterborne
more rural
disease as a result of improved rural water supplies etc
Such intangible benefits are real and reflect true values.

They do not, however, lend themselves to valuation.

But, since intangible benefits are a factor in project selection,

it is important to carefully identify and, where at all possible,
quantified, even though valuation is impossible.
90
For example:

 How many children will enroll in new schools?

How many homes will benefit from a better system of water

supply?
 How many infants will be saved because of more
rural clinics?
Intangible costs:

Such costs might be incurred if new projects disrupt traditional

patterns of family life, if development leads to increased
pollution, if the ecological balance is upset, or if scenic values
are lost.

91
Again, although valuation is impossible, intangible
costs be carefully identified and if possible quantified.
should
In general, every project decision will have to take
intangible factors into account through a subjective evaluation.

intangible costs can be significant
Because, and because benefits can make an
intangible important of acontribution
many of the objectives to
project or beyond.

92
2.4 The valuation of financial costs and benefits
This is an issue of pricing/valuing/ of the project’s inputs and
outputs.
 The inputs and outputs of a project appear in physical form
and prices are used to express them in value terms in order to
obtain common denominator.
For the purpose of the feasibility study, prices should reflect
the real economic values of project inputs and outputs for the
entire planning horizon of the decision makers.
The financial benefits of a project are the revenues
received and the financial costs are the expenditures that
are actually incurred.

93
In financial analysis, all these receipts and expenditures are
valued as they appear in the financial balance sheet of the
project, and are therefore, measured in market prices.
Market prices are just the prices in the local economy, and
include all applicable taxes, tariffs, trade mark-ups and
commissions.
Since the project implementers will have to pay market prices
for the inputs and will receive market prices for the outputs
they produce, the financial costs and benefits of the project are
measured in these market prices.
The financial benefit from a project is measured in terms of the
market value of the project’s output, net of any sales taxes.

94
Prices may be defined in various ways, depending on whether
they are:
1. Market/explicit/ or shadow/imputed/ prices;
2. Absolute or relative prices;
3.Current or constant prices.
Market/Shadow prices:
Market or explicit prices are those present in the market, no
matter whether they are determined by supply and demand or
by the government.
They are the prices at which the firm will buy the inputs and
sell the outputs.
In financial analysis market prices are applied.
95
In economic analysis we raise the question whether market
prices reflect real economic value of project inputs and
outputs.
In economic analysis, if the market prices are distorted, then
shadow or imputed prices will have to be used for economic
analysis.
Absolute/relative prices:
Absolute prices- reflect the value of a single product in an
absolute amount of money
Relative prices- express the value of one product in terms of
another.
For instance, the absolute price of 1 tone of coal may be 100
monetary units and an equivalent quantity of oil may be 300
monetary units.
96
In this case the relative price of coal in terms of oil would be
0.33, meaning that the relative price of oil is three times the
price of coal.
The level of absolute prices may vary over the lifetime of the
project because of inflation or productivity changes.

This variation does not necessarily lead to a change in relative

prices.
In other words, relative prices may sometimes remain
unchanged despite variations in absolute prices.

Both absolute and relative prices can be used in

analysis.
financial
97
Constant Vs Current prices
 Current and constant prices differ over time due to inflation, which
is understood as a general rise of a price levels in an economy.
 If inflation can have a significant impact on project inputs and
output prices, such an impact must be dealt with in the financial
analysis.
 Wherever relative input and output prices remain stable, it is
sufficiently accurate to compute the profitability or yield of an
investment at constant prices.
 Only when relative prices change and project input prices grow
faster (or slower) than output prices, or vice versa, then the
corresponding impacts on net cash flows and profits must be
included in the financial analysis.
 If inflation impacts are negligible, the planner may use either
current
104or constant prices.
 The Treatment of Transfer Payments in Financial Analysis
Some entries in financial accounts represent shifts in claims to
goods and services from one entity in the society to another
and do not reflect changes in national income.
These payments are called direct transfer payments.

These direct transfer payments include taxes, subsidies, loans,

and debt services.
Taxes: taxes that are treated as a direct transfer payment are
those representing a diversion of net benefit to the society.

99
 A tax does not represent real resource flow; it represents
only the transfer of a claim to real resource flows.
In financial analysis a tax is clearly a cost.

When a firm pays taxes its net income reduces.

But, the payment of taxes does not reduce national income.

As a result, in economic analysis, taxes will not be treated as

a cost in project account.

A tax can be a direct tax or an indirect taxes such as sales

tax, an excise tax, or tariff or duty on an imported input for
production.
100
Subsidies:
Are simply direct transfer payments that flow in the opposite
direction from taxes.
Direct subsidies represent the transfer of a claim to real
resources from one enterprise, sector or individual to another.
Subsidies may be open or disguised and are provided on the
input or output side.
On the input side, subsidies reduce costs to the project, e.g.
subsidies to fertilizers.
If the subsidy is granted on the output side i.e., increase the
revenue of the project; we should deduct the amount of the
subsidy from the revenue that includes subsidy.

101
If a firm is able to purchase an input at a subsidized price, it
will reduce its costs and thereby increase its net benefit.
But, the cost of the input in the use of the society’s
real resources remains the same.
The resources needed to produce the input or to import it from
abroad reduce the national income available to the society.

Hence, for economic analysis of a project, we must enter the

full cost of the input.

Again it makes no difference what form the subsidy takes.

One form is that which lowers the selling price of the
input below what otherwise would be their market price.
102
But a subsidy can also operate to increase the amount the
owner receives for what he sells in the market, as in the case
of a direct subsidy paid by the government that is added to
what he receives in the market.
A more common means to achieve the same result does not
involve direct subsidy.
The market price may be maintained at a level higher than it
otherwise would be by, say levying an import duty on
competing imports or forbidding competing imports

altogether
. it is not a direct subsidy, the difference
between the competing imports that would prevail
without
Althoughsuch measure does represent an
indirect transfer from the
109consumer to the producer.
Credit Transactions:
These are the other major form of direct transfer payments.
A loan represents the transfer of a claim to real resources from
the lender to the borrower.
When the borrower repays loans or pays interest he/she
is transferring the claim to the real resource back to the
lender.
From the standpoint of a firm, receipt of a loan increases the
production resources it has available.
Whereas, payment of interest and repayment of
principal reduces them.
But from the standpoint of the national economy, loans do not
reduce the national income available.
It merely transfers the control over resources from
104
the lender to the borrower.
2.5 Investment Profitability Analysis
1. Non-Discounted Measures of Project Worth
1. Ranking by Inspection
It is possible, in certain cases, to determine by mere inspection
which of two or more investment projects is more desirable.
There are two cases under which this might be true.

I. Two investments have identical cash flows each year up to the

final year of the short-lived investment, but one continues to
earn profits in subsequent years.
The investment with the longer life would be more desirable.
 Accordingly project B is better than investment A, since all
things are equal except that B continues to earn proceeds after
A has been retired.
More analysis is required to decide between C and D.
105
Example: consider the following hypothetical irrigation
project
Investment Initial cost Net cash proceeds per year
(project)
Year I Year II
A 10,000 10,000 ---
B 10,000 10,000 1,100
C 10,000 3,762 7,762
D 10,000 5,762 5,762
II. Two investments may have the same initial outlay, the same earning
life and earn the same total proceeds (profits), but one project has
more of the flow earlier in the time sequence.
 In this situation, we choose the one for which the total proceeds is
greater than the total proceeds for the other investment earlier.
 Thus investment D is more profitable than investment C, since D
earns 2000 more in year 1 than investment C, which does not make
106
up the difference until year 2.
2. The Payback Period
 The payback period is also called the payoff period.
 The payback period is defined as the length of time or the number of
years it is expected to take from the beginning of the project
until the sum of its net earnings (receipts minus operating costs)
equals the project’s initial capital investment cost.
 This criterion is most often used in the business enterprises.
 Example: if a project requires an original outlay of Birr 300 and is
expected to produce a stream of cash proceeds of Birr 100 per year
for 5 years, the payback period would be
 300/100 = 3 years.
 Note: if the expected proceeds are not constant from year to year,
then the payback period must be calculated by adding up the
proceeds expected in successive years until the total is equal to the
original outlay.
107
 Cont’d
• When net cash flows are not annuity, payback period is obtained
by adding net cash flows for successful years until the total is
equal to initial investment.

• To exemplify, assume that a project requires an initial

investment of Br. 60,000. The after taxes cash flows (or net
cash flows) are as follows:

• In the above example, if the 1st three years’ net cash flows are
added, the sum is equal to Br. 45,000.
Cont’d
• But the initial investment is Br. 60,000. If the fourth year net
cash flows (Br. 20,000) is added to Br. 45,000, the sum is Br.
65,000 which is greater than the initial investment. Thus, the
payback period is between year 3 and year 4. To find the exact
payback period, we take the three years and divide the
remaining cash flows by the fourth year net cash flows. If the
exact payback period is needed in months the fraction can be
computed as follows:

Decision Rule for Payback Period

i. Accept the project if its payback period is less than or equal to
the required payback period (standard)
ii. Reject the project if its payback period exceeds the required
payback period. The shorter the payback period, the more desirable
the project.
 Cont’d
Advantages of Payback Period
1. It is simple both in concept and application
2. It is a rough and ready made method for dealing with risk
3. It may be a sensible criterion when the firm is pressed with
problems of liquidity
Disadvantages of Payback Period
1. It fails to consider time value of money
2. It ignores cash flows beyond the payback period
3. It is a measure of the project’s capital recovery, not profitability.
4. It does not indicate the liquidity position of the firm as a whole.
 Discounted measures of project
worth
1.Net Present Value Method
• The net present value of project is the difference between the
present value of net cash inflows and present value of initial
investment. In formula,

Where:
NPV = Net present value Ct = Net cash flows at the end of year t
n = Life of the project r = Discount rate I0 = Initial investment
Net present value can also be determined as follows:
NPV = PV of NCF – I0
Where: PV = Present value and NCF = Net cash flows
To illustrate, assume that a project is expected to have initial
investment and life of Br. 40,000
and five years respectively.
111
The annual after tax net cash flow is estimated at Br. 12,000 for each of the five
years. The required rate of return is 10%. Net present value is determined as
follows: NPV = PV of NCF – I0

The same procedure can be followed if net cash flows are not in annuity form.
To illustrate the computation of NPV when net cash flows are not annuity,
suppose the project has initial investment and useful life of Br. 30,000 and four
years112
respectively. Its annual cash flows are as follows: Year 1, Br. 10000; Year
2, Br. 8000;
 Cont’d
year 3, Br. 15000; and year 4, Br. 12,000. If the required rate of
return is 10%, NPV is determined as follows:

Decision Rule for NPV

1. If NPV is greater than zero (NPV > 0), the project is considered
desirable.
2. If NPV is less than 0, the project is considered undesirable.
Internal Rate of Return (IRR)
 Internal Rate of Return is the discount rate which equates the
project NPV equal to zero.
 It is the discount rate at which the present value of Net cash flows
is equal to the present value of initial investment.
 In other words, IRR is the rate of return on investments in the
project.
 The determination of IRR is purely based on project cash flows.
Mathematically, at IRR,

 IRR is determined using trial and error: the complexity of

determining IRR is greater if net cash flows are not in annuity
form. This section illustrates the determination of net cash flows
when cash flows are annuity as well as non-annuity.
A. Determination IRR when NCFs are annuity.
 Assume that the project has initial investment of Br. 40,000, and
useful life of five years. the annual net cash flows is estimated at
Br. 12000 for five years. The required rate of return is 10%. The
following steps can be followed to determine IRR.
Step1: Compute the leading discount factor (payback period)

Step 2. From the present value of annuity table, find two discount
factors and their corresponding interest rates closest to the computed
leading discount factor. If we look in the PV of annuity table on n =
5 years row (horizontally), the leading discount factor (3.333) is
found between 15% and 16%.
Step 3: Compute the actual IRR using the following formula

Where:
r = either of the two interest rates (15% or 16%) DFr = Discount factor
for the taken interest rate
DFrL = Discount factor for the lower interest rate DFrH = Discount
factor for the higher interest rate Let's take r = 15%, IRR is determined
as follows:
B) Determination of IRR when net cash flows are non-annuity
 The steps followed in the preceding section are equally applicable
for non-annuity cash flows. However, one step is added at the
beginning to determine the weighted average net cash flow, which
will be used to determine the leading discount factor. To illustrate,
assume that a project has initial investment of Br. 40,000 and the
following net cash flows: year 1, Br. 15,000; year 2, Br. 10,000;
year 3, Br. 10,000; year 4, Br. 15000; and year 5, Br. 15,000. The
discount rate is 15%. The following steps can be used to compute
IRR:
Step 3: From the present value of annuity table, find the starting rate (a good 1st
guess) by looking for the closest interest rate and discount factor. In this case,
the nearest rate is 18%

Since, at IRR, NPV is equal to zero, 18% is not the exact IRR. Thus, another
rate should be tried. Which rate should be tried next? Generally as we go down
(in rate decreasing direction), discount factor increases. Now we need to find a
rate at which NPV = 0. Thus, we should try a higher rate. The next (2nd) guess
could be 19%. Then NPV should be computed at 19% using the above
 At 19% NPV is negative, this implies that IRR lies between 18% and
19%. Thus, such iteration process ends when two neighboring rates,
at lower rate NPV is positive and at higher rate is negative. To find
the exact IRR, steps 4 and 5 will be followed:
Step 5: Divided the NPV of the smaller rate by the absolute sum and
add to the smaller rate

Decision Rule for IRR

 Accept: If the IRR is greater than the discount rate
 Reject: If the IRR is less than the discount rate
Profitability Index (PI)
 The profitability index, also called benefit - cost ratio, is the ratio
of the present value of net cash flows and initial investment.

 To illustrate, assume that a project is expected to have initial

investment and useful life of Br. 90,000 and four years
respectively. Annual net cash flows amounted to Br. 40,000. The
discount rate is 10%. Profitability index can be computed as
follow:

 Decision rule for profitability Index

 ii. Accept if the project's profitability index is greater than 1
 iii. Reject if the project's profitability index is less than 1
124
 NPV and Decision Rule for Independent Projects
Independent projects are projects that are not in any
way substitutes for each other.
In such cases the decision rule is to accept the project if the
NPV > 0.
If two projects have positive NPV and there is no budget
constraint both should be accepted and you do not need to
choose the one with higher NPV.
For example, if two independent projects road and fisheries
development projects in different locations are being
considered and both have a positive NPV, then both should
be undertaken.
Both will increase community’s welfare if they were
undertaken and hence both should be undertaken.
125
Decision Rule for Mutually Exclusive Projects
A mutually exclusive project is defined as a project that can
only be implemented at the expense of an alternative project
as they are in some sense substitutes for each other.
Example of the mutually exclusive projects includes two
versions of the same project, say with different technology,
scale or time.
The decision rule for such projects is to accept the project
with the highest NPV.

126
Decision rule for independent projects
According to the IRR version of economic criterion, we
implement all projects that show an IRR greater than the
predetermined discount rate.
Once the IRR is identified, the decision rule is ‘accept the
project if the IRR is greater than the cost of capital, say r.

127
The IRR and Mutually Exclusive Projects

 While the IRR cannot be directly used to choose between mutually

exclusive projects, it can be employed for further manipulation.
 This manipulation entails the subtracting the cash flow of the
smaller project from the cash flow of the larger one and calculating
the internal rate of return of the residual cash flow.
 If the residual cash flow’s internal rate of return exceeds the target
discount rate, which could only occur if the larger project has a
higher NPV, then the larger project should be undertaken.
 If the analyst encountered with mutually exclusive projects with
IRR greater than the target interest rate, it cannot merely choose
the project with the highest IRR.
128
Advantages of the IRR
The IRR is used in many projects

It is the only measure of project worth that takes account of

the time profile of a project but can be calculated without
reference to a predetermined discount rate. (Useful for
international institutions like the WB since they cannot do
with different discount rate for different countries.
It is a measure that could be understood easily by non-
economists since it is closely related to the concept of the
return on investment.
It is a pure number and hence allows projects of different size
to be directly compared.
129
Problems with the IRR
 The IRR is inappropriate to use for mutually exclusive projects and
independent projects when there is a single period budget
constraint.
 A project must have at least one negative cash flow period before it
is possible to calculate its internal rate of return.
 This is because the NPV will always be positive no matter how
high the discount rate used to discount it, unless the project has at
least one negative cash flow period.

 Another problem with the IRR is that in some cases it is possible to

compute more than one IRR for a project. If a project has more
than one IRR, it cannot be reliably used.
 Thus, another decision rule such as the NPV must be used
rather than the IRR.

130
2.6. Sensitivity Analysis
Another method popularly used for analysis of risk is what
is called sensitivity analysis.
Sensitivity analysis is
a financial model that determines
how target variables are affected based on changes in
other variables known as input variables. By creating a
given set of variables, an analyst can determine how
changes in one variable affect the outcome
This consists varying key parameters (individually or in a
combination) and assessing the impact of such changes or
manipulation on the project’s net present value.
It consists of testing the sensitivity of the NPV or IRR to
changes of basic variables and parameters that enter the
project’s input and output streams.
The common practice is to vary them by fixed percentage
131

such as 10%.
THANK YOU
 CHAPTER – THREE
ECONOMIC ANALYSIS OF PROJECTS

133
 In financial analysis, the analyst is concerned with the
profitability of the project from an individual point of view
(firm’s profitability).
 The main objective here is to maximize the income of the firm
or to analyze the budgetary impacts.
 The financial analysis is done by applying market prices.

 In economic analysis, the objective is to maximize national

income no matter who receives it.
 But financial analysis will rarely measure a project’s
contribution to the community’s welfare.

134
Thus, the project analyst must not only be sure that a proposed
project will be profitable enough to attract investment interest
but also that the project will contribute sufficiently to the
growth of national income.

The starting point for the economic analysis is the financial

prices.

They are adjusted as needed to reflect the value to the society

as a whole of both the inputs and outputs of the project.

135
3.1. Overview of Economic Analysis
Social Cost Benefit Analysis (SCBA), also known as economic
analysis.
Is a methodology developed for evaluating investment projects
from the point of view of the society (or economy) as a whole.
In the economic analysis of projects, we are interested in the
total return or productivity or profitability to the whole society
or economy of all the resources committed to the project.
In economic analysis, the focus is on social costs and benefits
of a project which tends to differ from financial analysis.
Economic analysis is used primarily for evaluating public
investments;
SCBA has received increasing emphasis in recent years in
view of the growing importance of public investments in many
136countries, particularly in developing countries, where
governments are playing a significant role in economic
development.
 SCBA is also relevant, to a certain extent, to private
investments, as these have now to be approved by various
governmental and quasi-governmental agencies that bring to
bear larger national considerations in their decisions.
In the context of planned economies, SCBA aids in evaluating
individual projects within the planning framework which spells
out national economic objectives and broad allocation of
resources to various sectors.
In other words, SCBA is concerned with tactical decision
making within the framework of broad strategic choices
defined by planning at the macro level.
The perspectives and parameters provided by the macro level
plans serve as the basis of SCBA which is a tool for analyzing
and appraising individual projects.

137
3.2. Identification of Cost and Benefits of Economic Analysis
Basically, the procedures followed and the criteria used (NPV,
IRR, BCR) are the same in economic and financial analysis of
projects.
 But the values, which the NPV, IRR and BCR assume, are
different in economic analysis and financial analysis.
The main factors, which explain this difference, are:

1.The items considered as inputs and outputs of the project;

2. The prices used in the valuation of inputs and output
3. The treatment of taxes, subsidies and other transfer payments.
1. Items considered as inputs and outputs ; Often, some real
costs and benefits attributed to projects do not appear among its
inputs and outputs when it is analyzed from the enterprises
138

viewpoint and, therefore, they do not enter the calculations of

financial NPV, IRR, and benefit cost ratio.
The main reason for excluding certain cost and benefits is
that they are considered “external” to the enterprise.
But costs or benefits viewed as “external” to the enterprise
are “internal” when they are considered from the economy’s
angle;
Somebody pays for these “external” costs and somebody
receives these “external” benefits, even if it is not the
enterprise.
Consequently, to the extent that they can be measured and
valued they are included in the calculations of the economic
NPV, IRR, and BCR.
Good example of externalities is the costs incurred in
providing the project area with infrastructure inputs, e.g.;
access roads, energy lines, sewerage services
139
• An externality, also referred to as an external effect, is a
special class of good, which has the following characteristics:
(i) It is not deliberately created by the project sponsor but is an
incidental outcome of legitimate economic activity.
(ii) It is beyond the control of the persons who are affected by it,
for better or for worse.
(iii) It is not traded in the market place.
An external effect may be beneficial or harmful. Examples of
beneficial external effects are:
 An oil company drilling in its own fields may generate useful
information about oil potential in the neighboring.
 The approach roads built by a company may improve the
transport system in that area.
 The training programme of a firm may upgrade the skills of
its workers thereby enhancing their earning power in
140 subsequent employments.
 Cont’d
Examples of harmful external effects are:
 A factory may cause environmental pollution by emitting large
volumes of smoke and dirt. People living in the neighborhood may
be exposed to health hazards and put to inconvenience.
 The location of an airport in a certain area may raise noise level
considerably in the neighborhood.
 A highway may cut a farmer's holding in two, separating his grazing
land and his cowsheds, thereby adversely affecting his physical
output.
2. Prices used
• Another difference between financial and economic analysis is
that even inputs and outputs “internal” to both the enterprise
and the economy are valued differently.
• In financial analysis the rule is to value inputs and outputs at
actual market prices.
Cont’d
• In economic analysis shadow or Efficiency or Accounting
prices are employed.
• Consequently, using different prices will give different
economic and financial NPV, IRR, and BCR even if the
inputs and outputs are identical in physical terms
• Market prices, which form the basis for computing the
monetary costs and benefits from the point of view of project
sponsor reflect social values only under conditions of perfect
competition.
• When imperfections are obtained, market prices do not reflect
social values.
• The common market imperfections found in developing
countries are:
• (i) rationing,
• (ii) prescription of minimum wage rates, and
• (iii) foreign exchange regulation.
Cont’d
 Rationing of a commodity means control over its price and
distribution.
 The price paid by a consumer under rationing is often
significantly less than the price that would prevail in a
competitive market.
• When minimum wage rates are prescribed, the wages paid to
labor are usually more than what the wages would be in a
competitive labor market free from such wage legislations.
 The official rate of foreign exchange in most of the
developing countries, which exercise close regulation over
foreign exchange, is typically less than the rate that would
prevail in the absence of foreign regulation.
 This is why foreign exchange usually commands premium in
unofficial transactions.
3. Taxes, subsidies and other transfer payments
 The other reason why financial and economic NPV and IRR
might differ emanates from the treatment of taxes, subsidies
and other transfer payments.
 Taxes and customs duties from which the enterprise is not
exempted are taken as cost in financial analysis
 subsidies paid to the enterprises by the government are
viewed as transfer payments and are excluded from
consideration in economic analysis,
3.3. Determining economic values
Due to social, political, historical, and economic, etc reasons,
markets are distorted.
As a result, the market prices are also distorted and do
reflect marginal productivities and marginal utilities.
not
Divergence between economic and market prices could be due
to market failure, government interventions, externalities,
public goods and distributional considerations.
Hence serious distortions exist in the market for labor, capital,
and foreign exchange and efforts are necessary to replace the
signals from these markets by more appropriate measures.

145
The key to understanding of economic analysis is the concept
of opportunity cost.
The opportunity cost is equal to the marginal value product
and the market price of the item in a relatively competitive
market.
Economic pricing involves making adjustments to market
prices to correct for distortions and to retake account of
consumer and producers surplus.
The adjusted price should then reflect the true opportunity cost
of an input or people’s willingness to pay for it.
So, we use Shadow Price which is also called the accounting
price.
The shadow price is what we call the economic price.
146
3.3.1. Adjustment for Transfer Payments
Transfer payments are defined as payments that are made
without receiving any good or service.
They involve the transfer of claims over real resources from
one person or entity in society to another, rather than payments
made for the use of or received from the sale of any good or
service.
 So they do not reflect changes in the national economy.

Some examples of items that are considered as

transfer are:
payments
A. Taxes - personal and company income
taxes, value added taxes and other indirect taxes,
excise taxes stamp duties, etc.
147
In financial analysis a tax is clearly a cost.
When an individual pays taxes his net benefit is reduced.

 But this payment does not reduce national income.

Rather it is transfer from the individual to the government so

that the income can be used for social purposes that are
important to the society.
Thus payments of taxes does not reduce national income, it is
not a cost from the standpoint of the society as a whole.
That is, taxes remain a part of the overall benefit stream of the
project that contributes to the increase in national income.

148
B. Production Subsidies: are simply direct transfer payments
that flow in the opposite direction from taxes.
Subsidies do not increase or decrease national income.
 It merely transfers control over resources from a taxpayer to
another individual.
But, subsidy increases the individual’s income, so it is revenue
for the receiver.
C. Credit Transactions: Loans received and payment of interest
and capital when these transactions occur between domestic
borrower and lenders are examples of such credit transactions.
The payment of interest and repayment of capital (debt
service) is treated as an outflow in financial analysis but
treated as transfer payments and are omitted from economic
accounts.
149
D. Charitable gift or welfare support services: are also
considered as transfer payments.
E. Producer surplus- gains received by an existing supplier of a
factor as a result of an increase in the price of that factor.
 But in an economic analysis of a project, any change in
consumer surplus as a result of the project should be included
in the project’s economic cash flow, because these changes
represent real effects on peoples welfare.

150
3.3.2. Efficiency or Economic shadow Prices
In economic analysis of projects, inputs and outputs should be
valued at their contribution to the national economy, through
efficiency or shadow prices.
The application of shadow prices is based on the underlying
notion of opportunity cost.
From the national economic point of view, it is the alternative
production foregone or the cost of alternative supplies that
should be used to value project inputs and outputs.
An economic or shadow price reflects the increase in welfare
resulting from one more unit of an output or input being
available.

151
 Definition of shadow (accounting) prices
Accounting or shadow prices are simply a set of prices that are
believed to better reflect the opportunity cost, i.e. the cost in
their best use, of goods and services.
It represents all none market prices.
It is the value used in economic analysis for a cost or a benefit
in a project when the market price is left to be a poor estimate
of economic value.
 It implies a price that has been derived from a complex
mathematical model such as linear programming.
Efficiency shadow prices are border prices determined by
international trade.
The project inputs and outputs are thus valued on the basis of
international trade.
152
The basic assumption here is that international market is less
distorted than the domestic market and thus taking
international price is more realistic to value the true cost of
goods and services.
It is an estimate of efficiency prices.

Example: shadow wage rate set by estimating the marginal

value product of labor.
So shadow prices are used instead of domestic market prices in
guiding the allocation of resources since the market prices are
distorted and using them would lead to resource misallocation.
In practice economic pricing involves making adjustments to
market prices to correct for distortions and to take account of
consumer and producer surplus.
153
Shadow pricing and the numeraire
The implicit objective of project analysis when project items
are valued at opportunity cost is to maximize the net resources
available to the economy.
 For many project items the opportunity cost will be given
directly by its border prices.
A numeraire is a unit of account.

Shadow prices can be expressed in two ways:

A.Directly in foreign exchange units - valuing all project effects

at world prices termed as the world price numeraire.
B. In domestic price units using a domestic price numeraire.

154
The use of different numeraire to express opportunity
costs will not affect the relative value of project outputs and
inputs.
Shadow price estimates can be made at two levels:

 Economic analysis

 Social analysis

Distinction stems from the objectives pursued in

project appraisal.
 In economic analysis resource efficiency is also considered.

Insocial analysis growth and income distribution

objectives are pursued.

155
3.3. Traded and Non Traded Goods
 Goods and services produced by the project or that serves as project
inputs can be
 Non-traded goods

 Traded goods

 Non-Traded Goods

 Non-traded goods are goods that do not enter into the international
trade because of their nature or physical characteristics.
 So the non-traded inputs and outputs of a project cannot be valued
directly at border or world prices.
 Some also consider goods which do not enter into trade because of
protection(trade barriers).

156
Example: Electricity is only rarely transmitted across frontiers.
Unskilled labor is also another example of non-
traded commodity
Inland transportation and cement.
cement is usually considered as non-traded goods.
When goods do not enter into trade by their very nature
decomposing is a pre-requisite to their valuation in terms of
world prices.
For some non-traded goods no reference border prices are
available. Example: Teff.
For other commodities the local supply price is below the CIF/
Cost, Insurance, and Freight/ price of potential imports but
above the FOB price of potential exports.

157
In both cases the non-traded inputs and outputs of the project
cannot be valued directly at border or world prices.
So the valuation of non traded goods at world prices consists
of a number of steps.
A.Net out taxes from the domestic market price of the
commodity.
B.The net of taxes price is decomposed into its traded and non-
traded cost elements.
 For the traded components a border price is available by
definition and they are valued at this price.
The non -traded items are further decomposed into traded and
non traded and the procedure continues until in successive
rounds the original inputs or outputs is developed into traded
components and labor.
158
Example: consider the production of electricity from coal

Major cost elements are

Coal, transport of coal to its site, transmission costs, wages and

salaries, etc.
But this procedure is cumbersome if not difficult because it
requires detailed production data and cost, which are not easily
available and time consuming.
Furthermore, the additional accuracy obtained in successive
rounds of decomposition will diminish fast.
Thus one or two rounds of decomposition might be sufficient.

159
After one or two rounds the non-traded components will be
valued at the domestic price and multiplied by a conversion
factor.
Traded components will be valued at border prices and labor at
the shadow wage rate.
If the output of a project is a non-traded good for which border
prices are however, known and if its domestic supply price is
below CIF but above the FOB, a convenient approximation is
to value it at the average of the two.

160
Traded Goods
 Traded goods are defined as goods and services whose use or
production causes a change in the country’s net import or export
position.
 Traded goods produced or used by a project do not actually need to
be imported or exported themselves, but must be capable of being
imported or exported.
 Examples:
 All kinds of manufacturing
 Most agricultural goods
 Intermediate goods
 Raw materials
 Some services such as tourism and consultancy services


161
Traded goods are either exportable or importable goods (or
services).
Exportable goods are those whose domestic cost of production
is below the FOB export price that local producers can
earn for the good on the international market.
Importable goods are goods whose landed CIF import cost
is less than the domestic cost of producing these goods.

162
 3.3.4. Measurement of the economic value
of tradeables (Valuation of Tradeables)

In almost all cases, the economic benefits of producing

tradeable outputs and costs of using tradeable inputs are
measured by the border price of these inputs and outputs.
An importable border price is its CIF import price - its
price landed in the importing country before the effects of
any tariffs or quantitative restrictions have been added to
its price.
The landed cost of an import on the port or other entry
point in the receiving country includes the cost of
international freight and insurance and often includes the
cost of unloading in the port.
163
  But this excludes any charges after the import touches the port
and excludes all domestic tariffs and other taxes or fees.

 The CIF price represents the direct foreign exchange cost of

the input up to the port or the border.

 The reason for using border prices to measure the economic

value of a project’s tradeable inputs can be understood in terms
of the assumption that the international markets are
comparatively competitive and free of distortions.

164
The international price paid for goods and services will be
a good measure of the increase in welfare
created
consumingfromthe foreign exchange earned by producing a
particular tradeable goods or service.
Similarly an exportable good should be valued at a border
price or FOB export price.
The FOB price is the price that would be earned by the
exporter after paying any costs to get the good to the border,
but before any export subsidies or taxes were imposed.

165
The border price (FOB price) should be netted from handling,
transportation and marketing expenses to arrive at the project
site price or farm/factory gate price.
By subtracting these expenses one arrives at the factory or
farm gate value of the exportable output at border prices.

The FOB border price is the actual foreign exchange earned

from exporting( the export price minus any marketing margins
and transport costs to get the good from the project site to the
border).

166
 Import and Export substitutes
If the project output substitutes for imports, the relevant
accounting price is the CIF of the substituted import adjusted
for marketing expenses.
If a project uses as inputs a commodity that could otherwise
have been exported, we should value this input at the FOB
price adjusted for transportation cost, handling, marketing
margins, etc.
For traded goods shadow prices are based on prices on the
world market, with no reference to value in domestic use or
supply.
With suitable adjustments world prices provide a norm against
which to assess the costs of domestic production of traded
167
goods.
But finding an appropriate world price may be difficult since
export may go to different countries or imports may come from
many countries with differing imports or export prices.
Under such circumstances one approach is to take the lowest
import price and the highest export price (optimal approach).
Another approach may be to take an average.

But long run prices instead of temporary prices should be used

in project appraisal.

168
3.3.5. Border Parity Pricing
If the domestic price of inputs a project uses is far higher than
under conditions of free trade, a project that uses the protected
input may have a low financial NPV.
On the other hand, if a project produces a good that enjoys
protection, the project’s financial NPV may be higher than under
conditions of free trade.
So the market prices need to be adjusted to reflect the real
economic values of tradable inputs and outputs.
In almost all cases, the economic benefits of producing tradable
outputs and costs of using tradable inputs are measured by the
border price of these inputs and outputs.
the opportunity cost of tradable goods is defined by their
border prices.
 The efficiency/shadow prices are border prices determined by
169

international trade.
The project inputs and outputs are thus valued on the basis of
international trade.
The basic assumption here is that international market is less
distorted than the domestic market and thus taking
international price is more realistic to value the true cost of
inputs and outputs.
World prices are normally measured as border prices reflecting
the value of a traded good at the border or port of entry (airport
or sea port) of a country.
Border price is the unit price of a traded good at a country’s
border or point of entry.
Border prices are either CIF or FOB prices suitably adjusted
for internal transport and other costs, but net of taxes and
subsidies.
It is to be recalled that values in project financial statements
170will normally be at prices received by the project - ex - factory

or farm gate prices or paid by the project for inputs.

 To move from market to shadow price analysis therefore,
shadow prices must be expressed in terms of world prices to
the project.
This means that for traded goods domestic margins, relating
to transport and distribution (including port handling) will
have to be adjusted to prices at the border to obtain values at
the project level.
The decomposition of these margins is referred to as border
parity pricing.
A parity price or parity economic value is the price or value
of a project input & output that is based on a border price
adjusted for expenses between border and the project
boundary
 To assess the full economic values of a traded good in a world
price system requires both its foreign exchange worth at the
171 border, plus the value at world price of the non-traded activities
of transportation and distribution required per unit of output
Recall that for tradable goods,
1. CIF prices < Domestic market prices;
2. Fob prices > Domestic market prices.
Where a project imports an input its border parity price is the
CIF price plus transport and distribution costs up to the
destination to the domestic market.
An importable border price is its CIF price of imports - its price
landed in the importing country before the effects of any tariffs
or quantitative restrictions have been added to its price.
The landed cost of an import on the dock or other entry point in
the receiving country includes the cost of international freight
and insurance and often includes the cost of unloading onto the
dock.
But this excludes any charges after the import touches the dock
and excludes all domestic tariffs and other taxes or fees.
The CIF price represents the direct foreign exchange cost of the
172
input up to the port of entry (air port, seaport, land port (eg
Moyale)).
Similarly an exportable good should be valued at a border
price or FOB export price.
For goods that are traded directly by a project the border parity
price for the project output is the FOB price minus the value of
transport and distribution
The FOB price is the price that would be earned by the
exporter after paying any costs to get the good to the border,
but before any export subsidies or taxes were imposed.
These later costs must be deducted since real resources are
required before the good can be exported.
The FOB border price should be netted from handling,
transportation and marketing expenses to arrive at the project
site price or farm/factory gate price.
173
By subtracting these expenses one arrives at the factory or
farm gate value of the exportable output at border prices.
The FOB border price is the actual foreign exchange earned
from exporting at the export price minus any marketing
margins and transport costs to get the good from the project
site to the border
If the project does not actually import or export the goods
concerned but produces that save imports (import substitutes)
and uses domestic goods that could have been exported
(exportable) or could have been imported (importable) the
adjustment is less straight forward.
The reason for using border prices to measure the economic
value of a project’s tradable inputs can be understood in terms
of the assumption that the international markets are
174
comparatively competitive and free of distortions.
The international price paid for goods and services will be a
good measure of the increase in welfare created from
consuming the foreign exchange earned by producing a
particular tradable goods or service.

175
Conversion Factors
It has been already stated that all project inputs and outputs
should be valued at the world prices(border prices).
World prices are used to measure the opportunity cost to the
economy of goods and services which can be bought and sold
in the international market.
However, in practice, there are significant number of
commodities for which there will be no direct world price to
use as a measure of economic value.
Example: Teff
These commodities fall under the general heading of non-
traded goods.
Even when non-traded goods are decomposed there always
remain items that are non traded and for which there is only
domestic market.
176
Thus, some world price equivalent figure need to be derived
for these non-traded goods.
To estimate the accounting prices for all other non traded
goods (inputs and outputs) we use conversion factors.
A conversion factor is defined as the factor by which we
multiply the actual price in the domestic market of an input or
output to arrive at its accounting price.
The conversion factor is simply the ratio of the shadow price
of the item to its market price.
 A conversion factor is estimated simply by taking the ratio
of border prices (world prices) to domestic market prices of
the good.
The conversion factor for any item ‘i’ is defined as: CFi = SPi/
177 Mpi. Where SPi is the shadow price for the item in question
and MPi is the market price
Since market distortions vary from commodity to commodity,
the conversion needed varies from case to case.
 Therefore, it is possible to estimate commodity specific,
service specific, or sector specific like electricity,
transportation, construction etc., or for a basket of goods e.g.
consumption goods for a particular income group conversion
factors depending on the degree of aggregation desired.
Thus conversion factors can be calculated at different levels:

For individual commodities. E.g. coffee conversion factor

For broad sector example: construction conversion factor

For categories of expenditure. Example investment

conversion factor
For the economy as a whole example ACF.
178
Inall cases one is comparing a value at world price,
which should reflect the shadow price, with the domestic
price.
Inprinciple we should have one conversion factor for
each non-traded commodity or for each group of commodities.
 Thus, the use of conversion factor is only the second
best approach.
The best approach is to use the accounting price.

Thus, for homogenous groups of goods and services it is

convenient to have readily available conversion factors to be
used in all project, instead of decomposing them every time a
project is analyzed.

179
The question now is how many conversion factors do we need?
There is no definite answer to the question.
 It all depends on the data availability, the variations of
market distortions, the time it takes to estimate conversion
factors ,etc.
 But at least we need one conversion factor to multiply all
the domestic market prices of all non-traded components of
the input and output of a project.
This parameter is called the standard conversion factor.

3.3.6. National parameters and standard conversion

factor

180
The Standard Conversion Factor
 It is a summary measure to calculate accounting prices for non
traded commodities.
 In the case of Ethiopia, the standard conversion factor is interpreted
as a summary and approximate quantification of the distorted
markets (domestic) as compared to the international market.
 Therefore, it is the ratio of the value of imports and exports of a
country at border prices to their value at domestic prices.
 The formula for computing the standard conversion factor is give
as:

 Where M and X are total imports and exports respectively at

world prices converted at the official exchange rate.
 T and T are the total trade taxes on imports and exports
m x
respectively
 Sm and Sx are total trade subsidies on imports and
exports
190 respectively
 All values should refer to the same year or to an average over the
same period.
 The SCF is a summary measure to calculate accounting prices for
non traded goods.
 This is achieved by multiplying the net of taxes domestic price of
the commodity by the SCF.
 The border price is obtained by multiplying the net of taxes
domestic price of the commodity by the SCF.
 Thus, every effort must be made to decompose the non-traded goods
into traded and non traded elements and apply the SCF only to the
latter.
 The rule for the non-traded goods should be still decomposition and
the SCF should be used only when this is impossible, very difficult
or is not worth the effort.
 The SCF is revised from time to time by the central economic
authorities and adopted by planning bodies.

182
National Parameters
 There are some important parameters that have general applicability
in the sense that they are used in all projects.
 These parameters should take the same value in all projects although
they can change from time to time.
 That is; such parameters are national so that they apply to all
projects regardless of their sector, and they are economic because
they reflect the shadow price of the items concerned.
 For instance, a typical list of national economic parameters
may cover conversion factors for:
 Unskilled and skilled labor
 Some of the main non-traded sectors
 Some aggregate conversion factors such as consumption conversion
factor, a standard average conversion factor, the discount rate, etc.
183
A project analyst can apply these parameters directly to
the project under analysis.
They are called national parameters to distinguish them from
the project specific shadow prices.
They are estimated by the central planners and are taken
as given by the project analyst.
Some of the important national parameters include:

The standard conversion factor

The shadow wage rate

The discount rate, and

The shadow exchange rate( SER= Pd/Pw)

Pd- domestic price, Pw- world price in foreign currency

184
3.4. Social Cost Benefit Analysis
The Purpose of Social Cost Benefit Analysis
 In financial and economic project appraisal, it is implicitly
assumed that income distribution issues are beyond the
concern of the project analyst or that the distribution of
income in the country is considered appropriately.
 For a private commercial entrepreneur project choice is a
rather simple exercise.
 If he/she knows his/her objectives, all he/she has to do is to
ascertain which projects satisfy his/her objectives best.
 But in most countries, governments are not only interested in
increasing efficiency but also in promoting greater equity.
 A financial objective is narrow one for a public agency to
pursue and for public decisions; a broader social objective
would be more appropriate.
185
When a project is chosen from alternative projects, the choice
has consequences for employment, output, consumption,
savings, foreign exchange earnings, income distribution and
other things of relevance to national objectives.
The purpose of SCBA is to see whether these consequences
taken together are desirable in the light of the objectives of
national planning.
 Therefore, a social appraisal of projects goes beyond
economic and financial appraisal to determine which project
will increase welfare once distributional impact is considered.
The project analysts will not be only concerned to determine
the level of project’s benefits and costs but who receives the
benefit and pays the costs.
186
In an economic analysis of a project, it is implicitly assumed
that a dollar received by any individual will increase
the
community’s welfare by the same amount as a dollar
received by any other individual.
But an extra dollar given to a very poor person will usually
increase the person’s welfare by much more than would a
dollar given to a rich person.
A rationale in welfare economics for the social analysis of
projects is therefore, quite strong, the marginal utility of
income of a person who receives a low income is expected to
be greater than the marginal utility of income of the same
person if he/she receives a high income.

187
Basic Arguments for the Application of Social Cost
benefit Analysis
 The basic arguments include:

Existence of market imperfection

Existence of externalities

Concern for savings

Concern for redistribution

Merit wants

188
3.5. Cost Effectiveness Analysis
 Both cost - benefit analysis (CBA) and cost - effectiveness analysis
(CEA) are useful tools for program and project evaluation.
 Cost - effectiveness analysis is a technique that relates the costs of a
program/project to its key outcomes or benefits.
 Cost - benefit analysis takes that process one step further, attempting
to compare costs with the dollar value of all (or most) of a program
’ s many benefits.
 These seemingly straightforward analyses can be applied anytime
before, after, or during a project/program implementation, and they
can greatly assist decision makers in assessing a projet ’ s efficiency.
 However, the process of conducting a CBA or CEA is much more
complicated than it may sound from a summary description.

189
Cost - effectiveness analysis seeks to identify and
place dollars on the costs of a project.
It then relates these costs to specific measures of
project effectiveness.
Analysts can obtain a project ’ s cost - effectiveness (CE)
ratio by dividing costs by what we term units of
effectiveness:

Units of effectiveness are simply a measure of any quantifiable

outcome central to the project’s objectives.
190
For example, a dropout prevention program in a high school
would likely consider the number of dropouts prevented to be
the most important outcome.
For a policy mandating air bags in cars, the number of lives
saved would be an obvious unit of effectiveness.
Using the formula just given and dividing costs by the
number of lives saved, you could calculate a cost -
effectiveness ratio, interpreted as “ dollars per life saved. ”

191
 You could then compare this CE ratio to the CE ratios of other
transportation safety policies to determine which policy costs less
per unit of outcome (in this case lives saved).
 Although it is typical to focus on one primary outcome in CEA, an
analyst could compute cost - effectiveness ratios for other outcomes
of interest as well.

Mutually exclusive programmes

Incremental cost-effectiveness ratios =

ΔC = Cost of new treatment – cost of current

treatment ΔE Effect of new treatment – effect of current
treatment

201
Steps in Cost - Effectiveness and Cost - Benefit Analysis
1. Setthe framework for the analysis
2. Decide whose costs and benefits should be recognized
3. Identify and categorize costs and benefits
4. Project costs and benefits over the life of the program,
if applicable
5. Monetize (place a dollar value on) costs
6. Quantify benefits in terms of units of effectiveness (for CEA),
or monetize benefits (for CBA)
7. Discount costs and benefits to obtain present values
8. Compute a cost - effectiveness ratio (for CEA) or a net
present value (for CBA)
9. Perform sensitivity analysis
10. Make a recommendation where appropriate
193
 Review Questions
Answer the following questions in a precise way.
1. Assume a project is expected to export its product. Write
the procedures that we should follow so as to get economic
export parity price at project location.
2. Explain the objective of undertaking social-cost benefit
analysis of a project?
3. In economic analysis, the valuation of non-traded goods at
world prices has a number of steps. Write the necessary
valuation steps and procedures precisely.
4. How the existence of public good lead to market price
distortion?

194
 CHAPTER-FOUR

PROJECT MONITORING
AND EVALUATION

195
Introduction: Monitoring and Evaluation What is
Monitoring and Evaluation
 Monitoring and Evaluation is the systematic collection and

analysis of information to enable managers and key stakeholders

to make informed decisions, maintain existing practices, policies
and principles and improve the performance of their projects.
 Monitoring and Evaluation is a process of continued gathering

of information and its analysis, in order to determine whether

progress is being made towards pre-specified goals and
objectives, and highlight whether there are any unintended
(positive or negative) effects from a project/programme and its
activities.
196
 4.1Why monitoring and Evaluation
 There are many reasons for carrying out project M& E.
 Project managers and other stakeholders need to know to
what extent their project is meeting its objectives.
 M& E build greater transparency and accountability in terms
of use of project resources
 Information generated through M&E provides project staff
with a clearer basis for decision making.
 Lessons learned from project experience can be used to
improve future project planning and development.
 M&E Provide the evidence basis for building consensus
between stakeholders
 M$E enable to identify problems early and propose solutions

197
 4.2 Kinds of Monitoring and Evaluation
 Monitoring: is a continuous process of gathering, analyzing
and interpreting of information on the daily use of inputs and
their conversion into outputs.
 This enables us to make timely adjustment or correction on
the development program/project when necessary.
 Monitoring can also mean keeping a check on the use of
resources.
 Monitoring is also used to mean the systematic 'tracking' of a
particular condition, or set of conditions to identify trends

198
 MONITORING
Star Continuo
t us

It is a It is concerned
management
review by with:
to:

• Assess progress •Ensuring that

[ inputs ]
• Identify difficulties •Through
• Ascertain problem areas [ activities]
•Recommend •Are transformed into
remedial action(s) [outputs]
199
 Key elements of project monitoring and control
 Project Status reporting
 Conducting a project review with stakeholders
 Controlling schedule variances
 Controlling scope and change requests
 Controlling budget
 Tracking and mitigating risks
Types of Monitoring (What to Monitor?)
1. Process monitoring and
2. Impact monitoring.
or
3. Physical progress monitoring
4. Financial expenditure
5. Project Quality
6. Project Assumption
200
 Process Monitoring helps to assess:

The progress of activities, the outputs/results

achieved (quantity & quality) while the project is on
progress

The use of resources (Human resource, finance,

material & equipments)

The way the activities are carried out

(management style)
 How critical assumptions are addressed

201
 Impact monitoring helps to measure:
 Changes brought as a result of the project/program
intervention while the project is still on progress.
 This might be:

 Economic aspect,

 Social Aspect,

 organizational,

 technological,

 attitude, etc. or other intended and unintended

results over a longer period.

 Impact monitoring is different from impact evaluation or
assessment which is expected some time after the project is completed.
21
6
 1. Project Physical Progress Monitoring
It is checking of whether activities in the project & expected
results are up to schedule or not.
Activity Monitoring - Activity monitoring monitors what
happens during the implementation of the project and
whether those activities which were planned, were carried
out.
This information is often taken from the progress report.

203
 Items to be considered during program/
project physical monitoring are:-
Activities executed & inputs utilization
Results of activities/project outputs/
Progress of project towards objectives
The way the project is managed (quality
style
work) of
Problems encountered
(variance)
Etc.

204
  Specific questions to be answered are:
Is theproject physical progress as a whole
and its individual components :
 On schedule,
 ahead of schedule, or
 behind schedule?
If there is a variation, where did it occur, why did it
occur, who is responsible for it, and what would be its
implications?
 What are the slipping tasks/activities?
What is the trend of the performance?
What would be the likely final cost
completion date output, of and
components? the project individual
What action has to be and its
22
0
taken?
 Three situations may be considered
in measuring/assessing physical progress
1. Quantifying Output of the activity in absolute terms.
EX: number of wells constructed for a water supply project or number
of houses constructed for housing development project
Work Performed x
100 (%) Work Planned
2. Valuing the output of the
activity
Value of work done x 100
(%) Total Value of work planned
3. Using time spent
Time spent to date x 100
(%) Total time to complete
206
 2. Project Financial Progress Monitoring
 Managers are concerned to measure financial
progress to ascertain:
The cost of individual items and activities within
the project and its comparison with the original
estimate.
This requires financial plan for the project.
Once the budget has been prepared and the project
is on progress, the project manager require:
A cost reporting system to provide information
on:
actual costs incurred in relation to the

207
activities performed and output attained.
 Specific questions to be answered are:
 Has the cost of the project as a whole (and its individual
component) been as per the estimated budget, less or
more than the budget estimates?
 If there is a variation, where did it occur?, why did it
occur?, who is responsible for it?, and what would be its
implications?

208
 The following must be measured periodically (in
most cases monthly & quarterly) for purposes of cost
monitoring and control:
 Costs incurred to date
 Budgeted costs to date
 Value of work done to date
 Cost over–run (under–run) to date
 Costs incurred to date: this can be obtained by summing up
costs incurred in accomplishing various project activities
 Budgeted costs to date: this can be readily obtained
from the cost projections made at the beginning.

209
 Value of work done to date: when costs are measured, an
estimate should be made of the extent of work accomplished.
 The value of work done can then be obtained as
follows: Budgeted costs X % of work accomplished
 Example: to construct a single block of
condominium has a budgeted cost of Birr 1.5ml
and at the time of the periodic progress review it is
estimated that 60% of the work has been accomplished
 Hence, the value of work done is simply (1.5 x 0.6)
Birr 900,000
 Cost over–run /under–run to date:
 There is cost over-run when the cost incurred is more
than the value of work done and vise versa.

210
 3. Project Quality Progress Monitoring
 Quality monitoring varies from project to project.
In the case of physical construction there will be
established system of supervision, testing and
checking against the original/given specification.
In projects with institutional outputs such as new
service delivery systems, and the like;

there is a need to develop specific systems and
specifications/indicators of quality checking.
In all aspects, project managers are responsible to
ensure that the outputs produced by the project are as
per the quality standards or specifications
established in the project design.
211
 4. Project Assumption
Monitoring
 Assumption is an event, a condition or a decision which is
necessary for project success, but which is largely or
completely beyond the control of project management.
Ex: Suitably qualified staff willing to
work in rural areas
Mothers willing to attend clinics
Prices of project inputs and outputs
 Project managers should pay critical attention to elements
that are outside the project during the monitoring process.

212
 Evaluation

 Evaluation a systematical and periodical

gathering,
is analyzing and interpreting of information
on the operation as well as the impacts of a
development program/project.
It is an assessment of:
 The overall project performance and objective achievement in
light of relevance, efficiency, effectiveness, impact and
sustainability
 Reasons contributing for success or failure
 An in-depth review of the strategy used
 Lessons learned both from on-going &/or completed
213 project
 When & What do we Evaluate?
 In addition to determined time, during
planning/design,
project evaluation may be carried when:
 Monitoring report indicates an unexpected result which
is positive or negative
 Management requires additional information for
decision- making
 Key questions to be resolved are identified
during monitoring process
 The need to extract key lessons learned arises.

214
 Evaluation criteria
 Most of the basic evaluation criteria and concepts are
universally accepted and used by all the organisations as
well as by the donors’ community.
 The criteria for evaluation addresses five major sets of
issues:
1. Relevance
2. Efficiency
3. Effectiveness
4. Impact
5. Sustainability

215
  Although it varies on the type of evaluation carried
among others, we have to assess:
 Relevance of the project
Did the project address priority problems faced by
the target areas and communities?
Was the project consistent with policies of both
donors and recipient governments (or agencies)?
 Effectiveness
 Have outputs and outcomes been achieved?
 Efficiency of resources (availability & utilization)
Were inputs (staff, time, money, equipment) used in
the best possible way to achieve outputs? Could
implementation been improved/ was there a better
216
way of doing things?
 Sustainability factors
Have the necessary systems been put in place to ensure the
project itself and more particularly the project benefits continue
once the project and its (foreign) funding has ended?
 Impact
What has been the contribution of the project to the
higher level development goals?
Did the project have any negative or unforeseen
consequences?

217
 Types of Evaluation
 It can be seen in two ways:
1. In periods/time of evaluation and
2. By persons involved in the evaluation process.
1 - Based on the Period / time
i. Ex-ante / start-up/ evaluation,
ii. On-going or mid-term /
formative/ evaluation,
iii. Terminal /summative/ evaluation; and
iv. Ex-post/impact evaluation.
219
Ex-ante/start-up Evaluation:
 It is an evaluation carried out before the implementation of
the program or project activity in order to determine:
The needs and potentials of the target group and its
environment
Assess the feasibility and potential effects and impacts of
proposed program or project
 It can be considered as a “baseline” study in which the
situation of the project area , the target group and its
environment is described.

Hence, at a latter stage, the effects and impacts of the
program or project can be compared with this situation.
220
 On-going/Mid-term/Formative Evaluation:
 It takes place while the implementation of the
planned project is on-progress or in the mid of the
project life.
 It primarily focuses on project performance and to
see immediate and intermediate results.
 May help to analyze the relation between outputs
and effects/outcome
 Help to modify the design and implementation strategies.

221
  Major Issues To Be Seen During On-going
Include:
Evaluation
 Efficiency in resource utilization

Procurement of necessary goods and services from national and

international sources (in many projects, procurement delays are a
major obstacle to effective implementation)
 Progress in output or physical work (construction), including the
quality of work
 Progress in financial expenditure

 Volume and quality of inputs and services made available

 Organization structure and management capacities of the project

 Progress and problems in staff recruitment and placement

 etc.
236
 Terminal [Summative] Evaluation
 Known as a project completion report
 Conducted when the funding for the project comes to an
end or certain phase of the project is completed.
 The distinguishing features of terminal evaluation are:
 It examines the initial outputs and effects
 It undertakes a careful examination of
implementation performance
 It assess the sustainability of the benefits accruing to the target
area/group from the project

223
 Ex-post Evaluation
 Often called impact evaluation/ impact assessment
 Designed as in-depth study of the impact of a
project that has been already executed or an
intervention (support) given for certain development
activities.
 Carried some time after the program/project activity
has been terminated (usually 6 months to 3 years
after project completion) in order to determine its
impact on the target group and the local area.

224
 2. Evaluation Based on Evaluating Persons:
1. Internal Evaluation:
 Performed by persons who direct role in
have
program/project a
implementation the
 Can be done by the management team or persons assigned from
the implementing agency
2. External Evaluation:
 It is carried out by persons / institutions from outside the
program/project implementers
 In most cases, it is conducted by the funding /sponsoring/ agencies
with formally designated consultants/evaluators outside the
project at fixed points in time
 Terminal and ex-post evaluation are often conducted by external
23 evaluators
9
 Assess Assess Determine
Goals, Activitie
Project
Project
& Strategies whether
Objectives s implementation is
Mobilize
according to
Stakeholders,
schedule
Enhance Trac
Teamwork & Build Progre
k
Shared ss
Commitment
P l a n / Purpos
PrImproveme
og r a o
nt eM & Assess
mre/-pprloanject f Output
E /Results
Practice
Bench- Assess as
Marking targete
beneficiaries
the
dreache
are
d
Enhan Identify
Accountabil Gath Lessons for
ce Ensure information
ity Manageme er
change
Quality early
nt for and
warning Improveme
24
0 nt
 Distinction between M & E
Themes Monitoring Evaluation
Purpose/objective Specific Broad

Scope Narrow Broad

Frequency/Time Continuous Periodic

Data Gathered Primarily Primarily

Quantitative Qualitative
Main Action Oversight / In-depth
analysis
supervision
Focus Inputs/Outputs Impact and
2
Sustainability
41
 Distinction Themes …
Themes Monitoring Evaluation
What does it  Activities performed Why and
answers?  Outputs achieved how results were achieved
(objectives)  Resources used or not
 Strategy and policy options
 Quality of work performed
 Problems encountered
(focuson effectiveness, and
Rectifying measures
(focuses on inputs,
relevance or impact)
output
process,
and work plan)

Actors Mainly Internal Internal/External

Analysis Simple Comparative Analytical tools

Primary Users Small group/project Managers Large group /Project

Managers, planners,
Financers, stakeholders
etc.)
24
2
Setting-up Monitoring And Evaluation System
 Establishing M&E system is vital in order to:
 collect data, analyze and interpret in a systematic way to see
 The progress of the project
The achievements [output and outcome] and
impact/ sustainability of development program or
project

Establishing M&E system may differ from sector to sector

and form project to project .

However, having a designed system is required to

provide information at different levels:
National level, line ministries, regional and local level agencies
229 , project financer, project management and the like
Prerequisites for a Successful M & E System
 The data to be gathered need to be accurate, with in the
timeframe and should be collected by a reasonable cost.
 The system has to be designed at an early stage of project
preparation & baseline data collected well in advance.
 Managers should develop and own the system &
be committed to its use
 The system designed must ensure gathering of data both
from internal & external sources:
 In an appropriate forms and
 Disseminate the information vertically and horizontally between
the different levels of organizations units for timely and effective
decision making.

230
1.3 Procedures in Monitoring and Evaluation
 Determine the objectives of M&E

 Identify and involve the stakeholders

 Define what should be monitored and evaluated

 Ex: activities, inputs, outputs, results,
critical assumption, impacts
 Determine the priority areas to be monitored
and evaluated
 Determine the important issues to be considered for
decision making
 Identify and indicate key elements and indicators to
be focused
5.
231 Design and test M&E instrument
 Plan how you will execute M&E
 Determine how data will be collected, processed
and analysed
 Progress report, progress review meeting, field
visits, weekly or fortnightly, Survey, literature
 Prepare, disseminate and use the M&E report
• determine type of information needed

• Identify who requires the information

• Know why the information is required

• Determine when and how it is needed

• Know how important the information is

232
Commonly Used M & E Tools

1. Logical Framework
2. Report
3. Questionnaires
4. Interview
5. Key Informant Interview
6. Review of Documents
7. Trend Analysis
8. etc

233
Review Questions
Answer the following questions.
1. Why we monitor and evaluate projects?
2.What is the importance of having a
developed monitoring and evaluation system?
3.Why we include monitoring and evaluation tools in
project proposals?

234
“Great ideas are born within one
hour, but killed in a second”
 CHAPTER-FIVE

EVALUATION: SOME BASICS OF

IMPACT EVALUATION

236
 5.1. Impact Evaluation Basics
Impact evaluation is an effort to understand whether the
changes in well-being are indeed due to project or program
intervention.
Impact evaluation is the way of checking whether an
intervention is responsible for the change in the outcome
variable or not.
So, impact evaluation focuses on outcomes and impacts.

The objective of impact evaluation is quantifying the impacts

of programs and projects on the beneficiaries such as
individuals, households and the community

237
Since impact evaluation is time and resource intensive,
it should be applied selectively.
Policy makers may decide whether to carry out an
impact evaluation on the basis of the following criteria:
 The program intervention is innovative and of
strategic
importance.
 The impact evaluation exercise contributes to the knowledge
gap of what works and what does not. (Data availability and
quality are fundamental requirements for this exercise.)

238
Why Should We Do Impact Evaluation?
 The best way to undertake a particular impact evaluation
depends in part on its purpose and who its primary intended
users are.
 The obvious need for impact evaluation is to help policy
makers decide
 whether programs are generating intended effects;
 To promote accountability in the allocation of resources
across public programs; and
 To fill gaps in understanding what works, what does not,
and how measured changes in well-being are attributable to
a particular project or policy intervention

239
 To decide whether or not to continue or expand
an
 To learn how to successfully adapt a successful
intervention to suit another context.
 To reassure funders, including donors and taxpayers
(upward accountability), that money is being wisely
invested.
• To inform intended beneficiaries and communities
(downward accountability) about whether or not, and in
what ways, a program is benefiting the community.

240
Quantitative versus Qualitative Impact Assessments
 Quantitative impact assessments use quantitative data and
approaches to determine the effectiveness of programs with
far-reaching goals such as lowering poverty or increasing
employment.
 Qualitative impact assessments use qualitative information
such as understanding the local socio-cultural and institutional
context, as well as program and participant details which are
essential to undertake sound quantitative assessment.

241
But a qualitative assessment on its own cannot assess
outcomes against Counterfactual outcomes or
relevant alternatives
That is, it cannot really indicate what might happen in the
absence of the program.
Quantitative analysis is also important in addressing potential
statistical bias in program impacts.
A mixture of qualitative and quantitative methods (a mixed-
methods approach) might therefore be useful in gaining a
comprehensive view of the program’s effectiveness.

242
Quantitative Impact Assessment: Ex post versus
Ex ante Impact Evaluation
 There are two types of quantitative impact evaluations: ex
post and ex ante.
 An ex ante impact evaluation attempts to measure the
intended impacts of future programs and policies, given a
potentially targeted area’s current situation.
 This may involve simulations based on assumptions about
how the economy works.
 Many times, ex ante evaluations are based on structural
models of the economic environment facing potential
participants.
 That is, using the structural models we predict
256
program impacts.
Ex post evaluations, in contrast, measure actual impacts
accrued by the beneficiaries that are attributable to program
intervention.
One form of this type of evaluation is the treatment effects
model.
Ex post evaluations have immediate benefits and reflect
reality.
These evaluations, however, sometimes miss the mechanisms
underlying the program’s impact on the population, which
structural models aim to capture and which can be very
important in understanding program effectiveness.

244
 Ex post evaluations can also be much more costly than
ex ante evaluations because they require:
 collecting data on actual outcomes for participant
and
nonparticipant groups and
 other accompanying social and economic factors that
may have determined the course of the intervention.
• An added cost in the ex post setting is the failure of
intervention, which might have been predicted through ex
the
ante analysis.

245
 The Problem of the Counterfactual
The main challenge of an impact evaluation is to determine
what would have happened to the beneficiaries if the program
had not existed.
That is, one has to determine the per capita household income
of beneficiaries in the absence of the intervention.
A beneficiary’s outcome in the absence of the intervention
would be its counterfactual.
A program or policy intervention seeks to alter changes in the
well-being of intended beneficiaries.

246
 Ex post, one observes outcomes of this intervention
on intended beneficiaries, such as employment or
expenditure.
Now , we have to ask:

Does this change relate directly to the intervention?

Has this intervention caused expenditure or employment to

grow?
In fact, with only a point observation after treatment,it
is impossible to reach a conclusion about the impact.
At best one can say whether the objective of the intervention
was met.

theBut the itself.
program result after the intervention cannot be attributed
26
0 to
 The problem of evaluation is that while the program’s impact
(independent of other factors) can truly be assessed only by
comparing actual and counterfactual outcomes, the
counterfactual is not observed.
So the challenge of an impact assessment is to create a
convincing and reasonable comparison group for
beneficiaries in light of this missing data.
Ideally, one would like to compare how the same household
or individual would have fared with and without an
intervention or “treatment.”

248
But one cannot do so because at a given point in time a
household or an individual cannot have two simultaneous
existences.
That is; a household or an individual cannot be in the treated
and the control groups at the same time.
Finding an appropriate counterfactual constitutes the main
challenge of an impact evaluation.
How about a comparison between treated and non-treated
groups when both are eligible to be treated?
How about a comparison of outcomes of treated groups
before and after they are treated?
These potential comparison groups can be "counterfeit”
counterfactuals.
249
 5.2 Methodologies in impact evaluation

The major impact evaluation methodologies include:

1. Randomized evaluations
2.Matching methods, specifically propensity
score matching (PSM)
3. Double-difference (DD) methods
4. Instrumental variable (IV) methods
5. Distributional impacts
6. Structural and other modeling approaches

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3
1. RANDOMIZED EVALUATION
• Allocating a program or intervention randomly across a sample of
observations is one solution to avoiding selection bias, provided
that program impacts are examined at the level of randomization.
• Careful selection of control areas (or the counterfactual) is also
important in ensuring comparability with participant areas and
ultimately calculating the treatment effect (or difference in
outcomes) between the two groups
• The treatment effect can be distinguished as the average treatment
effect (ATE) between participants and control units, or the
treatment effect on the treated (TOT), a narrower measure that
compares participant and control units, conditional on participants
being in a treated area
 Randomization could be conducted
 Purely randomly: where treated and control units have the same
expected outcome in absence of the program
Cont’d
 This method requires ensuring external and internal validity of the
targeting design. In actuality, however, researchers have worked in
 Partial randomization settings: where treatment and control samples
are chosen randomly, conditional on some observable characteristics,
 for example, landholding or income.
 If these programs are exogenously placed, conditional on these
observed characteristics, an unbiased program estimate can be made.
 STATISTICAL DESIGN OF RANDOMIZATION
 In finding the counterfactual, it can be very difficult to ensure that a
control group is very similar to project areas, that the treatment
effects observed in the sample are generalizable, and that the effects
themselves are a function of only the program itself.
 Statisticians have proposed a two-stage randomization approach
outlining these priorities.
Cont’d
 In the first stage, a sample of potential participants is selected
randomly from the relevant population.
 This sample should be representative of the population,
within a certain sampling error.
 This stage ensures external validity of the experiment
 In the second stage, individuals in this sample are randomly
assigned to treatment and comparison groups, ensuring
internal validity in that subsequent changes in the outcomes
measured are due to the program instead of other factors.
THE IDEAL EXPERIMENT WITH AN EQUIVALENT CONTROL GROUP
Cont’d
 The above graph illustrates the case of randomization
graphically. Consider a random distribution of two “similar”
groups of households or individuals—one group is treated and
the other group is not treated.
 They are similar or “equivalent” in that both groups prior to a
project intervention are observed to have the same level of
income (in this case, Y0).
 After the treatment is carried out, the observed income of the
treated group is found to be Y2 while the income level of the
control group is Y1
 Therefore, the effect of program intervention can be described as
(Y2− Y1).
 CALCULATING TREATMENT EFFECTS
 Randomization can correct for the selection bias by randomly
assigning individuals or groups to treatment and control
groups.
 Consider the classic problem of measuring treatment effects.
 Let the treatment, Ti , be equal to 1 if subject i is treated and 0
if not.
• Let Yi(1) be the outcome under treatment and Yi(0) if there is
no treatment.
• Strictly speaking, the treatment effect for unit i is
Yi(1) – Yi(0), and the ATE is:
ATE = E[Yi(1) – Yi(0)],
This formulation assumes that everyone in the population has an
equally likely chance of being targeted.
Cont’d
 But in practice we only observe:
 The average outcomes of the treated, conditional on being
in a treated area:
E[Yi(1)|Ti = 1]
 The average outcomes of the untreated, conditional on not
being in a treated area,:
E[Yi(0)|Ti = 0]
 With nonrandom targeting and observations on only a
subsample of the population:
 E[Yi(1)] is not necessarily equal to E[Yi(1)|Ti = 1], and
E[Yi(0)] is not necessarily equal to E[Yi(0)|Ti = 0].
 Alternate treatment effects are observed TOT: TOT = E[Yi(1)
– Yi(0)|Ti = 1]
The difference in outcomes from receiving the program as
compared with being in a control area for a person or subject i
randomly drawn from the treated sample
Cont’d
 The TOT reflects the average gains for participants,
conditional on these participants receiving the program.
 Suppose the area of interest is the TOT: TOT = E[Yi(1) –
Yi(0)|Ti = 1]
2.Propensity score matching (PSM)
 A direct comparison of the treated and the control group is
misleading because the differences between them may not be
resulted solely from the treatment but due to other socio-
economic factors too.
 Hence, the basic task here is to establish methods which can
help to identify the true effect of the intervention.
 PSM constructs a statistical comparison group that is based
on a model of the probability of participating in the
treatment, using observed characteristics.
 PSM compares each observation of the treated group with the
control group having similar observed characteristics where
the mean outcome difference between the two groups yields
the average treatment effect of the intervention
Steps in PSM
 Conduct sample surveys of eligible non-participants and
participants
 Pool the two samples and estimate the probability of
participation using a logit / probit model with observable
individual characteristics that are likely to determine
participation (age, gender, income, education, etc.).
 Get predicted probability of participation (propensity score)
for every sampled participant and non- participant.
 For each individual in the sample of participants, find a small
n (e.g. 5) observations in the non-participant sample with the
closest propensity scores.
 Note that, however, there are various matching algorithms
including Nearest- Neighbor Matching , Kernel-Based
Matching , Radius Matching and Stratification Matching.
Cont’d
 Calculate the mean of the outcome for the chosen n
observations.
 The difference between that mean and the actual outcome of
the participant is an estimate of the program impact for that
participant.
 Calculate the mean of these individual program impacts to
obtain the average overall program impact.
 It is known as the average treatment effect for the treated
(ATT) and can be shown mathematically as;
Cont’d

 Example: Estimating the impact of fertilizer adoption on

farmers income.
 Data Set:
 Primary data has been collected from 400 farmers.
 287 fertilizer adopters (Treatment group) and 113 non-
adopters (Control group
Application of PSM
Cont’d
 Region of common support
 Once the propensity score estimation of the covariates has
been estimated, the common support region should be
imposed on the propensity score distributions of both sample
groups
 The area of common support is those propensity scores within
the range of the lowest and highest estimated values for
households in the treatment group.
 The results of the estimated propensity scores for the case of
fertilizer suggested the region of common support of
[0.14108334, 0.99943489] where only 16 (4%) out of 400
observations were out of the common support
Cont’d
 Perform balancing tests: The participants and nonparticipants
should have balanced covariates.
 Comparison of standardized bias (difference in means ÷
standard deviation) before & after matching: Lower after
matching
 Joint significance (likelihood ratio tests): insignificant after
matching.
 Psuedo-R2: lower after matching
Cont’d
 Estimate the average treatment effect of the treated
 Adoption of fertilizer resulted in an increment in total income
of households‟ range from Birr 8369 to 10710 based on
different matching algorithms.
THANK YOU VERY MUCH
 Review questions
Try to answer the following questions
1. What is the difference between evaluation and impact
evaluation?
2. What is the advantage of undertaking impact
evaluation?
3. What is counterfactual?

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Assignment- this is a requirement to complete the course.

Please identify any profit oriented project idea and prepare a

complete project proposal. The project proposal should
incorporate all aspects of project preparation as much as
possible.
NB: The life of the project should not be less than 7 years
and the proposal should clearly show the payback period,
NPV, BCR and IRR. (Use r=14)

END
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