Discounted cash flow techniques
Discounted cash flow (DCF) techniques allow the value of future
benefits and costs to be converted to a single value represented in current
dollars. DCF techniques are needed to (a) ensure the future stream of benefits
associated with an investment will be sufficient to pay for the capital and
operating costs of establishing and maintaining it, and (b) help choose between
investment alternatives which may have different costs and benefits. Such
techniques use a discount rate. Rate options include the money market rate of
interest, the opportunity cost of capital and the social time preference rate.
Net present value
The net present value (NPV) of an investment is one form of DCF
technique. Assuming there is no budget constraint investments are acceptable
when the NPV is greater than or equal to zero; that is, when the discounted flow
of benefits is greater than or equal to the discounted flow of costs.
Internal rate of return
The internal rate of return (IRR) of an investment is a second
common form of DCF technique. The IRR shows the return on the capital used in an
investment. Assuming there is no budget constraint, an investment is acceptable
when the IRR is greater than or equal to a chosen discount rate.
Domestic resource costs
Another method referred to by Gittinger for evaluating between
alternatives is to examine the domestic resource cost (DRC) associated with an
investment or operation. DRC calculations require an estimate of domestic
resources used in earning or saving a unit of foreign exchange. From a policy
point of view, resources should be allocated only to those commodities or
production systems where there is an international comparative advantage.
Economic consistency models
Theoretically, a price is determined when supply equals demand.
Economic consistency models broadly attempt to break up the source of any
supply, and show the groups in society responsible for demanding that supply.
Two categories of consistency model are generally discussed: (a) social
accounting models (SAMs), show where production and income has come from, and
how it has been used and spent; and (b) commodity accounting models (CAMs),
which do the same thing, normally for food items, but expressed in terms of
volume of commodity.
Revised minimum standard model
The World Bank has produced a consistency model called the
revised minimum standard model (RMSM), the assumptions behind which can be
adapted to meet the circumstances of individual countries. This model is usually
available to any country wishing to use it. The model is based on standard
accounting principles, and permits projections of, e.g., imports to be cross
checked for consistency against expected changes in output, consumption, and
All countries require money to undertake investments and meet
financial commitments. This money is either generated internally, through
savings, or borrowed externally. It is generally financially impossible for most
developing countries to borrow on international capital markets. International
borrowing is usually at concessional rates, i.e. below market interest rates,
offered by multilateral lending institutions such as the World Bank.
In the post war/post colonial period, many governments decided
that they, rather than the private sector, should control key areas of
strategic production, distribution and pricing. Over the years, state controlled
companies have evolved, (with a minimum of 51% share ownership), to produce
energy, store grains and market food surpluses. Such organizations are
All countries need to import items. In order to pay for these
imports, countries must use foreign exchange, earned through exporting products
or generating net service income through activities such as shipping, insurance
or tourism. Although barter operations do occur, the general mechanism for
paying for exports and imports is through the use of foreign currency. An
exchange rate is used which reflects the value of one country's currency against
another. The stronger a country's currency, the more the exchange rate will be
in that country's favor.
Employment opportunities in poorer countries are generally
limited. Work opportunities may be abroad, in countries which are either labor
deficient or sufficiently rich to employ foreign labor to undertake basic
production and service activities. These foreign employees send income back to
their families who live in their country of origin. In many countries, this type
of remittance income can amount to a very substantial percentage of total income
earned by nationals in employment.
Public investment program
There are many activities for which government must take, or
chooses to take, responsibility. This is particularly true in poorer countries,
where the private sector is likely to lack adequate investment resources and
capacity. These activities may include public sector service delivery covering
gas, electricity, water, transport, health and education. In order to ensure
that no public investment project is started in these sectors until it has been
properly appraised, it is normal to prepare a public investment programme (PIP)
of projects which have passed criteria set by government. This procedure should
ensure that only projects of the highest priority are started and, even then,
only when budgetary resources permit.
Project preparation facility
Most public sector projects go through a project cycle, which
traditionally includes identification, preparation, appraisal, implementation,
monitoring and evaluation. Although government might identify good project
ideas, it is often an expensive exercise to go to the second stage, that of
project preparation. Without this level of detail, the selected funding agency
will find it difficult to decide whether to lend money to permit project
implementation. The World Bank has a project preparation facility (PPF) which
helps countries prepare project plans. The PPF can also be made available to
allow a project to be prepared on a pilot basis, prior to preparing the project
on a larger scale.
Indicative planning figure
UNDP country programmes are usually costed over a five year
cycle. The level of funding is defined as the country indicative planning figure
(IPF). It gives Government a broad outline of UNDP resources available for
Structural adjustment is defined as an attempt to effect a major
change in an economy. It aims to get the economy back to a healthy state,
improving its balance of payments over the medium term, i.e. about five years.
The main policy instruments used are incentives to increase production, saving,
and investment in the public and private sectors, together with supporting
monetary and budgetary policies.
Direct costs are those costs immediately attached to the
procurement of services or goods, i.e. the purchase price. Direct cost for the
reconstruction of a building, for example, is the total of all material and
labor costs for the project.
Indirect costs are all costs associated with any goods or
services beyond the intrinsic value of the thing itself. The indirect cost for
the reconstruction of a disaster-destroyed building might be the loss of income
to the workers in the building who cannot report to work or the service
personnel who take care of the building.
Opportunity cost is a term used to capture the idea that if
funds are spent on one activity, (e.g. repairing a building) those same
resources are unavailable for another project (e.g. building a school or
clinic). The opportunity to build a school or clinic is lost when the funds are
used to rebuild or repair. If mitigation measures had been taken in the
construction of the building, the likelihood of having to spend money on repair
and reconstruction would be