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Project Identification and PPP Screening

38.1. Performance Indicators

The main performance indicators in economic-analysis are the economic Net Present Value and the economic Internal Rate of Return (eNPV and eIRR, respectively). Mathematically speaking, the eNPV consists of the projected costs and benefits, duly discounted using a suitable discount rate, and the eIRR is the value of the discount rate that makes the NPV equal to zero. Generally speaking, the eNPV should be positive, thereby indicating that the project generates or is capable of producing higher benefits than costs, after allowing for differences in the timing of the costs being incurred and the benefits being received.

The selection of the discount rate to be used is a key issue for a proper CBA, so that the eNPV is properly calculated in terms of opportunity costs. See box 3.9. There is no universal consensus on the determination of this discount rate, which leaves too much room for 'ad hoc' interpretation and application (and which opens the door for manipulation of the data)[24]. The difficulty of finding an 'acceptable' discount rate should be taken into consideration in interpreting the outputs of the CBA. It may be appropriate to conduct sensitivity analysis using a range of different discount rates.

Due to the difficulty in determining the appropriate discount rate, particularly if this is done for every individual project, some governments identify and publish a standard rate to be used and, in some cases, also publish the appropriate range for sensitivity analysis. For example, in Australia a standard practice is to use a 7 percent real discount rate as the base case, and to conduct sensitivity tests using 4 percent and 10 percent real discount rates[25]. Where a standard rate is published, the government may change it from time to time, and the most up to date rate should always be used.

As CBA evaluates the economic merit of a project regardless of how it is delivered, the fact that the project might become a PPP does not affect the discount rate used.

BOX 3.9: Usual Approaches to Discount Rate

  • Use the opportunity cost of capital. Since the analysis is dealing with public assets, the discount rate could be the public debt interest rate (at the longest term available). Inflation has to be removed in order to establish the rate in real terms.
  • Use an approximation of the Social Time Preference Rate (STPR), which is defined as “the value that society attaches to present, as opposed to future, consumption”. This approach is advised or prescribed in a number of countries such as the United Kingdom (UK).
  • Use the estimate or the targeted rate of future growth of the economy (gross domestic product – GDP) in real terms. This would imply that only those projects from which an increase in the society’s welfare (at least equal to the economy’s expected or targeted growth rate) is expected will be developed, which means that all projects will at least help the GDP grow as forecast.

A proper analysis should avoid: (i) rejecting projects that generate a strong value for society; and (ii) approving an inadequate project and using public resources that generate a significant net opportunity cost for society.

In some instances though, the eNPV may not be the most appropriate indicator, since it does not consider the volume of resources employed. In cases in which alternatives have significant differences in terms of resource consumption, the eIRR ratio may be more appropriate for the selection. In these circumstances, it is prudent to consider the results based on both eNPV and eIRR, as well as any qualitative analysis.

The main data for economic projections must be adjusted as described below.

 

[24] For further details see: Grimsey, D., Lewis, M. (2004).  Discount Debates: Rates, Risk, Uncertainty and Value for Money. In PPPs in Public Infrastructure Bulletin Vol.1 Issue 3 Article 2; Grout, P. (2002).  Public and Private Sector Discount Rates in Public-Private Partnerships. In CMPO session of the Royal Economic Society Conference 2002 (University of Warwick). Shugart, C. (2006).  Quantitative methods for the preparation, Appraisal, and management of Private Participation in Infrastructure (PPI) projects in Sub-Saharan Africa.  Prepared for the New Partnership for Africa's Development (NEPAD) Secretariat Funded by PPIAF.

[25] Infrastructure Australia (2013), Reform and Investment Framework Templates for Use by Proponents: Templates for Stage 7 Solution evaluation (Transport infrastructure), page 7.

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