Agricultural or natural resource developments might best be
defined, explained, analyzed, and understood as projects. Projected
cash flows over a period of time are required for comparisons among alternative
development projects or other investment decisions.
In defining a project, Gittinger (1982) said:
FIGURE 3-1 Pastoral Economies.
We generally think of an agricultural project as an investment
activity in which financial resources are expended to create capital assets that
produce benefits over an extended period of time. In some projects, however,
costs are incurred for production expenses or maintenance from which benefits
can normally be expected quickly, usually within about a year.
Range or marginal land development projects (such as seeding)
can be viewed in the same terms as an agricultural project, although the
investments, costs, and returns may be substantially different in substance and
in timing of flows. For example, the returns on a rehabilitation project may
take several years to realize depending on the starting conditions and project
management. These returns, however, may be in the form of higher stocking rates,
which may have caused the problem in the first place.
An alternative approach is to examine potential losses that are
avoided through rehabilitation. This approach is similar to determining the
benefits of flood control projects. If degradation is not halted, then adjacent
agricultural land may be placed at risk.
Gittinger also distinguishes between a project that may be
relatively small, or perhaps quite large, but is of a nature that it can be
analyzed, evaluated, developed, and administered as a unit. A "program" would
typically be larger than a single project, and encompass multiple projects or
aspects of development that are beyond the project definition and boundaries.
A project should contain relatively homogeneous resources so
that investment requirements, costs, and returns from different parts within the
project can be accurately represented. If a project becomes large enough to
become heterogeneous, then a part of the project - which may in fact be
uneconomical or unfeasible - may be hidden or masked and carried by other parts
of the project that are worthy of development. When dealing with scarce
resources, the concept of homogeneity within a project is important. Past
experience has shown that in many instances projects have failed because of lack
of social homogeneity; that is, within the target group of pastoralists,
subgroups with contrary interests existed (see, for example, Sanford, 1983).
Economic and Financial Analyses
By definition, the economic analysis compares all returns and
costs associated with a project during its useful life. Costs include initial
and recurring annual expenditures, whereas the revenues include returns as a
result of the project over and above what they would have been without it.
Financial or cash flow analysis is the determination of the
project's cash flow positions over the period of the project. This shows whether
the project is self-supporting or whether deficits are likely to develop. It is
simply to compare revenues and expenditures, including debt service on an annual
cash basis. The objective of financial analysis is to consider and make
estimates of the effects the flow of project costs and returns will have on
people participating directly in the project, including families or community
groups that make direct use of the project and the primary users. Financial
analyses also must consider administration, management, and taxes of the project
and costs to the government and donors for those activities.
In financial analyses, market prices, if available, are used to
reflect the value of production. Project returns may also include a very
significant contribution in the form of food or fuel consumed directly in the
household. If subsidies are paid by the government in association with the
development of a project, then that also becomes part of the income to the
direct beneficiaries from the standpoint of financial analysis. Financial
analysis also considers revenue to the goveronment (taxes) for project
administration, which have been considered in the costs of the primary
The "economic" aspects of project analyses and evaluation, in
contrast to financial aspects, considers the project from the standpoint of the
affected society and economy as a whole. Financial and economic analyses differ
in three significant ways:
1. Taxes that are treated as costs to primary project
participants in financial analyses are viewed by government and society as
revenues, not costs.
2. In economic analysis, market prices may be adjusted
and become "shadow" or "accounting" prices or social costs/benefits" to
reflect more accurately the economic values to society.
3. In economic
analysis, interest on capital and repayment of borrowed capital are not treated
as project costs. Although interest is a cost to the project, it is a return to
society and the economy as a whole, if actually earned, and hence becomes a
"wash" item in economic analysis and accounting for the project. Similarly, the
repayment of borrowed capital, although a requirement for the project, neither
increases nor decreases net national product.
Comparison Without and With a Project
The purpose of project analysis is to identify and estimate
benefits and costs that will arise "without" the project and compare them with
benefits and costs "with" the proposed project. The difference between them is
the incremental or marginal net benefit arising from the project.
The results of the without-with comparisons may be the same as
comparing a particular project situation "before" and "after." Often, however,
the comparisons are not the same and may be greatly different because
productivity may improve (increase) even without a project. Hence, the
projection of the without situation would reflect higher productivity and
returns than the current or before project situation. The benefits from a
project designed to improve productivity at a more rapid rate than would occur
without the project would be overstated by a before and after comparison,
because improvements without the project are ignored.
Conversely, a different, perhaps more common, and certainly more
serious situation could be one of rapid deterioration in productivity and
resource or environmental conditions without a project. A project could be
designed with the aim of ameliorating or reversing the deterioration; improved
productivity could be a distinct bonus. It may therefore be difficult to compare
or economically justify such a project when it may only retard the rate of
degradation and keep the returns constant. Intangible benefits must then be
considered such as the quality of the environment and the costs associated with
people moving to urban centers to escape declining land productivity.
A decision needs to be taken that leads to implementation,
modification, or cancellation of the project. Certain costs and benefits
(payoffs) are associated with any of these decisions. The decision may be to
endorse the project and proceed with implementation based on a degree of
Problems and sources of uncertainty are classified in five
1. Price structures and changes (values)
methods and responses, including weather effects and other natural phenomena
(technical input/output coefficients)
3. Prospective technological
4. The behavior and capacities of people associated with the
5. The economic, political, and social contexts in which a range
improvement project exists.
All these sources of uncertainty affect the analysis of projects
and are factors to be reckoned with in implementation and evaluation of results.
The basic principle for carrying out an economic analysis is to
compare alternatives on an equivalent basis, such as a fixed output, time frame,
and constant dollar values. In the analysis, the quantifiable assumptions must
first be established as follows:
· All baseline project assumptions, such as the period of
analysis, discount rate, cost of capital, and other economic and financial
variables must be determined.
· Estimates must be made of project costs
including capital costs, onetime costs such as permits, annual operating and
maintenance costs, and provisions for renewals and replacements. Estimates of
fees, construction, labor and materials, and legal fees must all be determined
and placed within the desired schedule.
· Project benefits, principally
the increased production, must be ascertained.
· The source of financing
and the specific terms of the loan must be defined.
· An appropriate
economic analysis methodology must be chosen, and economic and financial
feasibility must be established.
· A sensitivity analysis must be
performed to determine how costs and benefits react to variations in such
factors as discount rate, financing, and productivity.
· The persons or
groups of persons who gain and who lose by the introduction of the project must
be identified; there are always some losers.
The common approach to economic analyses has been to compare
costs and revenues over a consistent time period on a ratio basis or net
positive benefit basis. Several measures using discounted cash flow techniques
can be employed: internal rate of return, benefit-cost ratio, net present value,
and life-cycle costs. Each technique has its advantages, disadvantages, and
The discount rate is used for determining economic feasibility,
whereas the interest rate is used to ascertain financial feasibility. The proper
rate to use for testing economic feasibility is the opportunity cost of capital
to society. This is the rate of return that could be earned by investing the
capital cost of the project in a venture of similar risk or an alternative
Discounted Cash Flow
One of the basic tools for determining economic feasibility is
discounted cash flow. All cash expenditures are tabulated for comparison during
the chosen period each year. The total cash expenditure for each year is then
discounted to the present and cumulatively added to a single sum. This sum is
then compared with similar sums of discounted expenditures for alternatives. The
alternative with the smallest sum is clearly the least costly. A similar
comparison is made with cash revenues or receipts for the same period. The ratio
between the sum of the discounted receipts and the sum of the discounted
expenditures yields the benefit-cost ratio.
Certain rules must be followed in making discounted cash flow
· The same period of years must be used for each
alternative set of cash expenditures and each alternative set of cash
· The alternatives must have the same production and capacity.
In some cases, this may require adjustments to the costs of the lowest cost
· Cash expenditures will include renewals and replacements;
however, if the years in which these will be made cannot be accurately
predicted, an estimated average annual cash expenditure for renewals and
replacements as well as an accelerated depreciation schedule can be used, since
those costs will occur far in the future.
Discounting transforms all future costs and revenues into the
present time frame so they can be compared on a current monetary basis. These
sums are simply called the present worth or present value. All future
expenditures and revenues are modified or discounted by a factor that provides
escalation arising from opportunity costs and resource depletion.
The benefit-cost ratio technique is perhaps the most commonly
applied in analyzing capital projects. The method compares the current worth of
costs and benefits on a ratio basis. Projects with a ratio of less than one are