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APPRAISAL AND APPROVAL

This chapter is in two parts - part I, which gives the theoretical framework, and part II, which presents the appraisal and approval process in Pakistan.

PART I - THE THEORETICAL FRAMEWORK

11.1 Introduction

Project appraisal is also referred to as project analysis and is. undertaken to guide the decision-maker in accepting or rejecting an investment proposal through well laid Out decision criteria. The most important function of project appraisal is to evaluate the project’s ability to meet its avowed objectives and its ability to contribute towards the long term development and growth of the national economy.

One of the main reasons for undertaking appraisal is to prevent waste or misallocation of limited resources which have to be allocated between competing claims/projects. It is thus necessary in principle to define and value costs and benefits and, measure their impact on the development objectives. In some cases, it may be helpful to place a project in the sectoral context.

Project appraisal needs to answer two main questions

“Will the project as designed meet its own objectives as well as the larger needs of its location and the national economy?”

�How does the project compare with other projects competing for the same funds?”

This becomes relevant when there is a budget constraint and many projects compete for the same limited funds.

Project appraisal requires analytical interpretation. It is more than just a set of techniques that can be applied to obtain ready made answers (This is important since resources are allocated in scenario where market prices do not equate the MSC and .MSV

the commodities.) In order to handle this problem, project analysis makes use of shadow pricing and cost-benefit analysis with imputed values. These reflect the real economic values of costs and bend its, while the market prices are employed for calculating

private /commercial profitability.

While carrying out project appraisal, the accompanying feasibility study needs to be

viewed from technical through to the aspects. Often a project fails to reach its goal where

the socio-political impacts were overlooked. Similarly a project may fall through

where there was too much emphasis on any one aspect the exclusion of the other aspects. These problems can be overcome if the project is appraised thoroughly from all aspects.

11.2 Types of Appraisal

project may he appraised from 3 different points of view:

Financial Economic and Social.

Financial analysis/appraisal attempts to measure the financial viability of the project and thus complements the economic analysis in accepting or rejecting the project.

Both the financial and economic appraisals try to predict the profitability of a project by comparing the expected project Costs with the expected benefits Where the benefits exceed the costs, the project is accepted. The difference between the two approaches lies in their methods of calculating future costs and returns of the project and their perspective Of the meaning of the term �profitable”. The financial appraisal looks at the project from the point of view of the returns to the project itself. while the economic appraisal estimates the returns from the project to the economy as a whole.

This gives rise to three very important distinctions:

Firstly, under economic analysis taxes and subsidies are treated as transfer payments and are not shown in the cost and benefit stream of the project hut of the society, while for financial analysis they are shown as the cost and benefit of the project entity..

Secondly, in financial analysis, market prices are generally used to express the costs and benefits but in economic analysis adjustments are made to the market prices to. reflect the opportunity costs and thus the shadow or accounting prices are used to reflect the costs and benefits. These are in effect hypothetical prices and they .aim at covering the total impact of the project on the national economy.

Thirdly, economic analysis does not separate interest on capital, which is deducted from the gross return since it is a part of the total return to capital that is available to the society. But under financial analysis, interest paid to external suppliers of credit is deducted from the benefit stream. However imputed interest paid to the entity (under consideration for financial analysis) is not shown in the cost stream.

11.2.1 Financial Appraisal

Where a project has many different beneficiaries and participating agencies, the financial analysis should be done separately in order to determine the financial impact. This may be done at the entrepreneurs’ level, the beneficiaries’ level and the government’s level.

The important objectives at the entrepreneurs’ level are the following :

i. Assessing the incentive aspects of the project. Here, the main question to ask and answer is: will the assets created by the project provide sufficient additional revenue after

debt services to act as an incentive to undertake the activities stipulated by the project?

ii. Assessing the viability of the project at the various stages. This is important in integrated operations where outputs at one stage become inputs or raw materials in the next stage. Financial analysis needs to look at the prices to determine whether it will be sufficient for the output suppliers at the first stage to sell to the factory, and whether it would he . viable to operate the plant at this price level.

iii. Assessing the borrowers’ repayment capacity and the terms and conditions of the lenders. The financial analysis should be able to show the lenders the project’s capacity to meet amortization and interest payments on the debts incurred. Income and expenditure projections can be used to deter- mine the appropriate scheduling for loan repayments and grace period.

At. the beneficiaries’