Improving Access Water Supply and Basic Sanitation for the Urban Poor
5. Financial and Economic Analysis
June 2006
1
IFinancial and Economic Analysis (EU-Grant)
The document is split into two main sections:
The financial (1) and the economic analysis (2) for water and basic sanitation.
The WSTF is a pro-poor basket funding instrument pursuing a demand driven approach. The commercialized Water Service Providers (WSPs) submit project proposals to the WSTF which aim at the extension of their services to the urban poor through water kiosks. There are a total number of 7 Water Service Boards and about 50 recently formed urban WSP. It is expected that for the implementation of the action a total of 70 projects will be carried out over the four-year period.
In order to be able to assess the impacts of the action in financial and economic terms, a standard project is defined as one WSP setting up 7 water kiosks. For the standard WSP in the analysis, base data has been obtained from the KfW Feasibility-Stduy for the Nzoia Cluster and from other KfW and GTZ reports. The assumptions underlying the cash-flow analysis have been made on the basis of the experience from the pilot projects.
The assumptions are listed in Annex 1. Whenever additional assumptions are made in the calculations, they are indicated directly in the relevant section.
IIFinancial Analysis
II.1Financial viability of undertaking entity
To demonstrate the financial viability of the undertaking entity, a representative WSP in charge of providing water and sanitation services i.e. in the city of Kitale is examined. The WSP currently employs 64 staff and has 2935 connections. Currently the WSP produces 2,086,705 m³ of water per year. Annex 2 indicates the projected real cash flows for the utility over the economic life time of the project, i.e. 15 years. The only source of income is from water services. Year 1 shows the expected revenues for 2005. It is assumed that because of additional customers as well as tariff increases revenues will increase by 5% per year up to year 10. Afterwards the WSP should have reached full efficiency and all customers should be served, thus collection stays constant.
With regards to the expenses, the analysis distinguishes the main cost categoriesenergy, material, administrative, and replacement costs. For further details see KfW-Feasibility Study annexed. It should be noted that all expenses – except for personnel – are kept constant. The underlying rationale is that realised efficiency gains on the one side and real price increases on the other side balance each other. Personnel expenses are assumed to grow at a rate of 5% per year up to year 10 when the company has reached the saturation point. Finally, replacement costs amount to 0.5% annually of assets currently in place, thus the WSP keeps its assets base constant.
The resulting Net Cash Flow is negative for the first two years but at a decreasing rate. This is a realistic scenario because most of the commercialized WSPs have started operation only in 2003. Due to considerable tariff increases and better cost control enforced by the regulator, cost recovery has gradually increased. Year three is the turning point after which the Net Cash Flow grows continuously until year 10. Consequently, the company is financialy viable and able to cover the O&M requirements and the replacement costs. This conclusion is supported by the present value analysis presented in Annex 3. Using a real discount rate of 8.5% (given nominal rates of 28% and an expected inflation rate of 18%) the value of the discounted net cash flow over the 15 years is EUR1,459,218.
II.2Required share of investment grant
The project under consideration comprises the construction of water kiosks. A standard water kiosk has average initial investment costs of EUR10,000 (of which EUR8,500 can be attributed to physical investment costs and EUR 1,500 for accompanying consultancies). The lifespan of a water kiosk is at least 15 years. Annex 4 shows the cash flow calculation of a standard water kiosk and the underlying assumptions. Starting with 1,000 customers per kiosk this number increases overtime to 1500 due to a continued urbanisation process and population growth. Water consumption increases slightly from 11 litre per person per day (l/c/d) to 15 l/c/d over time. The initial tariff is EUR1.07 per m³ and increases in line with the overall tariff policy to EUR1.28 per m³. Using these figures the revenue of the water kiosk can be calculated. The expenses are the production costs, the margin of 70% of revenues the vendor of the kiosk receives, maintenance costs (1% of initial activated investment costs), and the kiosk supervision. As can be seen in Annex 4 once a kiosk has been set up, it is financially viable and produces a growing positive cash flow in each of the 15 years.
Taking account of the initial investment costs of EUR10,000 and calculating the Net Present Value (NPV) of a standard water kiosk leads to EUR-3,349 or an internal rate of return (IRR) of 2.75%. (see Annex 5). A commercially oriented company would therefore not invest into a standard water kiosk without any external obligations or grant funding. A grant element of 100% is required at this stage.
The number of customers per kiosk are based on experiences of the Nyeri Water and Sewerage Company, NYEWASCO, which has been managing some kiosks systems for over tens years. Experiences of water kiosk projects like in the biggest slum of Kenya, Kibera show, that the number of customers is higher. This clearly indicates that the income scenario in larger cities will be more positive than described, making investments in these cities more feasible.
Situation without the project
In the current situation in the peri-urban areas the majority of the population has no access to safe water. They have a choice of getting water of poor quality from rivers, hand dug wells,hand pumps or to buy water from private vendors. While the open water sources and hand pumps are adequate technologies in rural areas, they are often not safe in urban areas due to the pollution of ground and surface water sources in and around high population densities settlements. Drinking water from unsafe sources leads to high incidence of water related diseases. Many infants and small children die of diarrhoea which is a common disease in these areas. Each year during the rainy season there are outbreaks of cholera. Next to the human tragedy of easily preventable deaths, there are substantial health related expenditures which the poor households have to meet. Women also spend a lot of time taking care of sick family members. This prevents them from devoting more time to income generating activities and has again a negative impact on the household budget. When buying water from a private vendor customers have to spend as much as 25 times more than the regular tariff at water kiosks (a tariff 10 times higher than the Kiosk tariffs has been adopted in the calculation. It can be supposed, that water consumption decreases significantly, when customers only rely on alternate providers due to pressure on income). A high number of people cannot afford these tariffs at all and for most of the others it puts a heavy strain on the household budgetthereby leaving less money to spend on other activities (food, school fees etc.).The WSPs responsible for servicing the area do not have the resources to expand their services into the area. If this action were NOT taken the water supply and sanitation situation in these low-income areas would continue to deteriorate as population density is growing and the WSPs will not be able to address the problems with their limited resources. This means that the living conditions will also get worse as water supply would be very erratic.
Since the set-up costs for a standard water kiosk are too high to be recaptured, commercial utilities will not use them and consequently not serve the urban poor. Alternative options like connections are a lot more expensive in terms of initial investments and therefore completely out of reach for the WSPs and the poor. In addition, the service level would not be sustainable with the low income levels in these areas. It is reasonable to make the professional providers for servicing the poor in order not to discriminate against the poor in the first place. In the past systems which are purely community managed have often turned out to be unsustainable. Thus, without the project the current unsatisfactory WSS situation is likely to prevail and to deteriorate even further. WSPs bring professionalism and more institutional stability.For the financial analysis refer to Annex 3.
Situation with the project
The Action will contribute to the improvement of the living conditions of the urban poor through provision of sustainable water supply and sanitation. It will also play a bigger role towards the attainment of the Millennium Development Goals on water supply and sanitation. This is so because the majority or at least 50% of the urban poor in Kenya reside in these low-income areas. Outbreaks of waterborne diseases will be greatly reduced and therefore this would free resources spent on combating these diseases both at national and household level.These resources can be channelled to other sectors of the economy and hence contribute in reducing poverty. It can prevent a number of deaths of infants and small children caused by diarrhoea and other water borne diseases.In addition, the action will reduce the financial burden on the WSPs caused by the need to extend services to the unserved urban poor. This is definitely needed in these early years of the WSPs as their financial base is still not solid to carry on this responsibility on their own.
For astandard WSPwhich sets up seven water kiosks (average size ofWSTF project defined as standard) the present value of future cash flows would be reduced from EUR1,459,222 to EUR1,435,767 as shown in Annex 6. For the economic benefits realised through the project refer to Chapter 2 “Economic Analysis.
It follows that the incremental cash flow of the project is equal to the cash flow of a standard WSTF project of 7 water kiosk with a net present value of EUR-23454 and an IRR of –6% (see Annex 7).
Therefore, the required share of investment grant should be at least equal to net present value of a standard WSTF project to render the project financially viable.
II.3Sensitivity Analysis
The sensitivity analysis varies the key assumptions of the analysis of the water kiosk’s incremental cash flows and determines which may be driving the results. The following assumptions have been subjected to the sensitivity analysis: the number of customers per kiosk, the consumption per person per day, and total production cost/m³.
The sensitivity analysis arrives at the following conclusions(details are shown in Annexes 9 – 12):
- A variation in the number of customers per kiosk (+/-10%) does have an impact on the revenue side. More customers buy more water and the IRR increases by 1.55%-points from 2.75% to 4.3%. The opposite effect occurs when the number of customers is reduced. The IRR drops from 2.75 to – 1.11%. Looking at the NPV figures, however, reveals that the standard water kiosk remains deeply negative (EUR-2517 and EUR-4180 respectively) as the weight of initial investment costs is not altered at all (see Annex 9)
- A variation in the consumption per person per day (+/-5litre) does affect the revenue side as well. The impact is more significant because the absolute change of 5 litre represents a relative change of almost 50%. The IRR varies from 2.75% in the base case to 8.38% in the optimistic and –4.2% in the pessimistic case. NPV remains still negative with EUR-84 in the best case (see Annex 8 and 9).
- With regard to the cost side:a variation of the total production costs (+/-10%) confirms the previous result that the initial investment costs are the driving force behind the IRR and the NPV. Changes in other variable have only a marginal impact. The IRR increases from 2.75% to 4.5% when costs are lower and drops another percentage point to 0.85% when a rise occurs (see Annex 8 and 11).
II.4Scenario Analysis
The scenario analysis –depicted in Annexes 12 and 13 – confirms what has already been pointed out in the sensitivity analysis. The initial investment costs are the reason why a CU would not be willing to set up a water kiosk without any subsidy, because they are too high relative to future cash flows. Only in the most optimistic case, a positive NPV can be reached. Assuming that the number of households were 10% higher, that the consumption were at the same time 5 litre per person higher and the production costs were to drop by 10% as well, the NPV would only increase to EUR2550 and the IRR to 12.5%. The pessimistic scenario assumes the opposite and the results are a NPV of EUR-7644 and an IRR of –8.5%.
II.5Impact on Main Stakeholders
5.1Financial Impact on the Households
AssumptionsNo. of People per household / 6
Consumption / 11 / l/c/d
Household Consumption / 66 / l/day
Household Consumption / 24.09 / m3/year
Tariff / 1.07 / EUR/m3
Average annual income/household / 807
Annual household expense for water / 25.77
Average Household low-income in urban areas (KfW Feasibility Study 2003)
Per Household/month / 7200 / KES / 67 / EUR
Per Household/year / 86400 / KES / 807 / EUR
Total household income / 100% / 807
Income spent on water / 3.2% / 25.77
This calculation shows that the requested maximum of 5% of household income is feasible for household incomes as low as 807 EUR per year which is far below the line of extreme poverty. It can therefore be ensured that almost all the poor, including the extremely poor, will be able to buy adequate amounts of safe drinking water from the kiosks. Even including future tariff adjustments, the maximum expenditure reaches 4,10% in year 13, and is afterwards declining again (average projected expenditure is 3,62%.
5.2.1Financial Impact on the water vendor
The financial impact on the water vendor is shown in Annex 14.
IIIEconomic Analysis
III.1Economic Efficiency
1.1Water Supply
Cost per Kiosk10,000 EUR
The figure reflects the average costs of a water kiosk as observed in the pilot projects. The costs include the construction of the kiosk, the connection to the main network as well as a provision for necessary measures to upgrade the systems. Also included are the consultancies for social and technical tasks.
Cost per beneficiary
2006 / 2016Cost per kiosk / 10.000 / EUR / 10.000 / EUR
Beneficiaries per kiosk / 1.000 / 1500
Cost per beneficiary / 10 / EUR / 6.67 / EUR
A water kiosk is initially planned for 1,000 customers. Through continued urbanisation in particular in areas with good infrastructure it can be realistically assumed that the customers will increase to 1,500 per kiosk in ten years time; thereby reducing the investment costs of EUR 10.00 per beneficiary even further to EUR 6.67 per beneficiary.
1.2Sanitation
It shall be noted that the figures presented here for sanitation are only estimates. The detailed approach will be determined with the first implementation projects (Component 2).
Cost per sanitation facility150 EUR
This includes physical investment as well as consultancies. As a consequence of the demand driven approach, only one third of the costs will be funded within the framework of the action while two thirds will be requested as contribution from the households.
Cost per beneficiary
Cost per sanitation facility / 150 / EURNo of users per facility / 10 / EUR
Cost per user / 15 / EUR
III.2Overall Economic Impact
2.1Economic Costs
The following table shows the discounted net cash flows of a standard project consisting of seven water kiosks. The result (EUR 23,454) is clearly negative.
Year / Discounted Net Cash Flow Kiosk 1 / Discounted Net Cash Flow Kiosk 2 / Discounted Net Cash Flow Kiosk 3 / Discounted Net Cash Flow Kiosk 4 / Discounted Net Cash Flow Kiosk 5 / Discounted Net Cash Flow Kiosk 6 / Discounted Net Cash Flow Kiosk 7 / Discounted Net Cash Flow Standard Project1 / -9,539 / -9,539 / -9,539 / -9,539 / -9,539 / -9,539 / -9,539 / -66,773
2 / 425 / 425 / 425 / 425 / 425 / 425 / 425 / 2,975
3 / 447 / 447 / 447 / 447 / 447 / 447 / 447 / 3,129
4 / 384 / 384 / 384 / 384 / 384 / 384 / 384 / 2,688
5 / 471 / 471 / 471 / 471 / 471 / 471 / 471 / 3,297
6 / 485 / 485 / 485 / 485 / 485 / 485 / 485 / 3,395
7 / 494 / 494 / 494 / 494 / 494 / 494 / 494 / 3,458
8 / 455 / 455 / 455 / 455 / 455 / 455 / 455 / 3,185
9 / 398 / 398 / 398 / 398 / 398 / 398 / 398 / 2,786
10 / 402 / 402 / 402 / 402 / 402 / 402 / 402 / 2,814
11 / 459 / 459 / 459 / 459 / 459 / 459 / 459 / 3,213
12 / 461 / 461 / 461 / 461 / 461 / 461 / 461 / 3,227
13 / 460 / 460 / 460 / 460 / 460 / 460 / 460 / 3,220
14 / 424 / 424 / 424 / 424 / 424 / 424 / 424 / 2,968
15 / 423 / 423 / 423 / 423 / 423 / 423 / 423 / 2,961
-23,454
2.2Economic Benefits
In order to assess the economic benefits monetary values have been allocated to the some benefits while others which can only be defined in quantitative terms will be discussed at the end of the chapter.
Benefits of the households
The following assumptions have been made:
- the average low-income in poor urban is
KES / EUR
Per Household in low income urban areas/year / 86400 / 807
- Household incomes increase by 2% in real terms per year
- Base scenario for water consumption (see Annex 1)
- Private water vendors charge a constant rate of 1,000 KES/m3 (10.70 EUR/m3) in real terms over the projected period
- In the situation without the project, households have to spend 5% of their income on health related expenditures
- In the situation with the project, households spend only 2% of their income on health related expenditures
The monetary benefits from the household’s point of view when taking into account the following aspects
- Savings on water expenses
- Savings on health related expenses
have been calculated in Annex 15. They result in overall savings of EUR 581,406 (NPV).
Savings for households per kioskEUR
Total Savings per household / 2836.13
No of Households per kiosk / 205
Total Savings for households per kiosk / 581,406
Benefits of the water vendor
The water vendors benefits from the action in terms of additional income through the sale of water (NPV).
EUR
Incremental Income through kiosk / 40,551The detailed calculation is shown in Annex 16.