Project Appraisal - a Methodology

Project Appraisal - a Methodology


Appraisal involves a careful checking of the basic data, assumptions and methodology used in project preparation, an in-depth review of the work plan, cost estimates and proposed financing, an assessment of the project's organizational and management aspects, and finally the viability of project .

It is mandatory for the Project Authorities to undertake project appraisal or atleast give details of financial, economic and social benefits and suitably incorporate it in the PC-I. These projects are examined in the Planning and Development Division from the technical, institutional/organizational/managerial, financial and economic point of view depending on nature of the project. On the basis of such an assessment, a judgement is reached as to whether the project is technically sound, financially justified and viable from the point of view of the economy as a whole.

In the Planning and Development Division, there is a division of labour in the appraisal of projects prepared by the concerned Executing Agencies. The concerned Technical Section in consultation with other technical sections i.e; Physical Planning & Housing, Manpower, Governance and Environment sections undertake the technical appraisal, wherever necessary. This covers engineering, commercial, organizational and managerial aspects, while the Economic Appraisal Section carries out the pre-sanction appraisal of the development projects from the financial and economic points of view. Economic appraisal of a project is concerned with the desirability of carrying out the project from the standpoint of its contribution to the development of the national economy. Whereas financial analysis deals with only costs and returns to project participants, economic analysis deals with costs and returns to society as a whole. The rationale behind the project appraisal is to provide the decision-makers with financial and economic yardsticks for the selection/rejection of projects from among competing alternative proposals for investment.

The techniques of project appraisal can be divided under two heads viz (i) undiscounted and (ii) discounted. Undiscounted techniques include (a) Pay back period, and (b) Profit & Loss account. Discounted techniques take into account the time value of money and include (a) Net Present Value (NPV), (b) Benefit Cost Ratio (BCR), (c) Internal Rate of Return (IRR) (d) Sensitivity Analysis (treatment of uncertainty) (e) and Domestic Resource Cost (Modified Bruno Ratio). Different investment appraisal criteria are given at Appendix-I.

Economic viability of the project is invariably judged at 12 percent discount rate/opportunity cost of capital. However, in case of financial analysis, the actual rate of interest i.e. the rate at which capital is obtained is used. For the government-funded projects, the discount rate is fixed by the Budget Wing of the Finance Division for development loans and advances on yearly basis. The provisional rate of mark-up fixed by the Finance Division for the current year (2005-06) is 8.22%. In case the project is funded by more than one source, the financial analysis is carried out on the weighted average cost of capital (WACC) for each project. If the project is financed through foreign grants, the financial analysis is undertaken at zero discount rate. However, the economic analysis is undertaken at 12% discount rate.

Many investment projects are addition to existing facilities/activities and thus benefits and costs relevant to the new project are those that are incremental to what would have occurred if the new project had not been added. During the operating life of a project, it is very important to measure all costs and benefits as the difference between what these variables would be if no project (without project) were undertaken and what they will be should the project be implemented (with project). It is very common error to assume that all costs and benefits are incremental to the new project when, in fact, they are not. Hence, considerable care must be taken in defining a “ base case” which realistically sets out the profile of costs and benefits expected if no additional investment is undertaken.

Forpractical examples please refer to Appendix-II (Production Sector),Appendix-III (Infrastructure Sector) and Appendix- IV (Social Sector)