2. Economic Analysis
Introduction:
[*]The economic analysis demonstrates:-
(1)Economic merits behind a project.
(2)Optimal utilization of resources.
Various tools of economic analysis help to determine the economic
and fiscal impact of the project, including the impact on society and
the major stakeholders involved, as well as the projectâs risks and
sustainability.
[*]Economic and financial analysis of Hydropower Project:- Kurt Goldsmith.
4. Economic Analysis Tools
⢠Time Frame: The useful life of a hydro power projects are commonly
very high compare to thermal pants. For example a SHP life span may
be in excess of 5o years(in some cases up to 75 years) ,whereas
financial period is limited ,may be up to 5o years. At this point
significant repair or maintenance is required.
⢠Interest Rate: The interest is the fee that must be paid by the user for
the lenderâs capital to amortize the loan. The rate is set in the capital
markets and it fluctuates with changes in health of economy and
governmentâs fiscal policies.
5. ContinueâŚâŚ.
⢠Discount Rate: The discount rate is used for determining economic
feasibility whereas the interest rate is used ascertain financial
feasibility.
⢠Discounted Cash Flow: A Discounted Cash Flow or DCF is one of the
most important tool used to evaluate a company. A DCF is carried out
by estimating the total value of all future cash flows (both inflowing
and outflowing), and then discounting them to find a present value of
that cash.
6. Project Parameters in an SHP Project
Installed
Capacity
Annual Energy
Production
Load Factor Capital Cost
O&M Cost
Expected
Interest Rate
Discount Rate
Construction
Period
Financing
Period
Value of
Energy
Cost of
Distribution
System
Quantifiable
Community
Benefits
9. Payback method
⢠The payback method determines the number of years required for the
invested capital to be offset by resulting benefits.
⢠The required number of years is termed the payback, recovery, or
break-even period.
đđđŚđđđđ đđđđđđ =
đźđđŁđđ đĄđđđđĄ đśđđ đĄ
đđđĄ đ´đđđ˘đđ đ đđŁđđđ˘đ
10. Advantages and Disadvantages
of
Payback Methods
Advantages:
⢠It is the simplest method to identify the basic feasibility of a project.
⢠Under the payback method of analysis, projects with shorter
payback periods rank higher than those with longer paybacks do.
Because the theory suggests the idea of âhigher liquidity means lesser
riskâ.
Disadvantages:
⢠Payback method usually neglects opportunity cost.
11. ContinuedâŚ..
⢠This method does not consider cash flows beyond the payback
period and thus does not measure the efficiency of the investment
over its entire life.
⢠Payback period method doesnât give idea about salvage value of a
project.
12. Return On Investment[ROI]
⢠The return on investment (ROI) calculates average annual benefits,
net of yearly costs, such as depreciation, as a percentage of the
original book value of the investment.
The calculation is as follows:
đ đđź =
đđđĄ đ´đđđ˘đđ đ đđŁđđđ˘đ â đˇđđđđđđđđĄđđđ
đźđđŁđđ đĄđđđđĄ đśđđ đĄ
Ă 100.
For purposes of this formula, depreciation is calculated very simply,
using the straight-line method:
14. Advantages &Disadvantages of ROI Method
Advantages:
⢠Using ROI can give a quick estimate of the project's net profits, and
can provide a basis for comparing several different projects.
⢠Under this method of analysis, the project's entire useful life are
considered (unlike the payback period method, which considers only
the period that it takes to recoup the original investment).
Disadvantages:
⢠ROI method uses income data rather than cash flow and it completely
ignores the time value of money.
15. Net Present Value(NPV) Method:
⢠NPV is a method of ranking investment proposals.
Net present value is the difference between the present value of cash inflows and the
present value of cash outflows that occur as a result of undertaking an investment
project.
NPV may be positive, zero or negative.
⢠Positive NPV:
If present value of cash inflows is greater than the present value of the cash outflows, the
net present value is said to be positive and the investment proposal is considered to be
acceptable.
⢠Zero NPV:
If present value of cash inflow is equal to present value of cash outflow, the net present
value is said to be zero and the investment proposal is considered to be acceptable.
16. ContinuedâŚ.
⢠Negative NPV:
If present value of cash inflow is less than present value of cash outflow,
the net present value is said to be negative and the investment proposal
is rejected.
The formula for calculating NPV:
đđđ = đ đĽ =
đ=1
đ=đ
đ đ â đźđ + đđ + đđ
(1 + đ)đ
+ đđ .
17. ContinuedâŚâŚ
Where:
Ii = Investment in period i.
Ri =Revenues in period i.
Oi =Operating cost in period i.
Mi =Maintenance cost in period i.
Vr =Residual value of investment over its lifetime , where equipment .
lifetime exceeds plant working life.
r= Periodic discount rate.
n= Number of lifetime period.
18. Benefit-Cost Ratio
⢠The benefit-cost method compares the present value of the plant
benefits and investment on a ratio basis.
⢠It compares the revenue flows with the expenses flow.
⢠Projects with a ratio of less than 1 are generally discarded.
⢠Mathematically the Rb/c is as follows:
19. Internal Rate of return Method
[$]Definition: The annual discount rate at which the present worth of
two streams of cash-flow are equal. This rate gives the return, in % per
annum, on the asset having higher investment costs.
⢠IRR computations usually require an intensive procedure and the
results can also be used as a ranking or screening tool of a project.
⢠The essential element is to reject the project which has an internal
rate of return less the opportunity cost of capital.
[$] Economic and financial analysis of Hydropower Project:- Kurt Goldsmith.
20. Advantages of IRR
⢠This is the most important alternative to NPV.
⢠It is a simple way to communicate the value of a project to someone
who doesnât know all the estimation details.
⢠If the IRR is high enough, you may not need to estimate a required
return, which is often a difficult task.
⢠It is based entirely on the estimated cash flows and is independent of
interest rates.
21. A Typical Economic Analysis
Of
a Hydro-Project:
⢠Installed capacity: 4929 kW
⢠Estimated annual output 15750 MWh
⢠First year annual revenue: âš1005320
⢠It is assumed that the price of the electricity will increase every year one point less
than the inflation rate.
⢠The estimated cost of the project in (Rupee)âšis as follows:
⢠1. Feasibility study:6100
⢠2. Project design and management: 151975
⢠3. Civil works: 2884500
⢠4. Electromechanical equipment: 2686930
⢠5. Installation: 686930
⢠Sub-Total: 6416435
⢠Unforeseen expenses (3%): 192493
22. ContinueâŚ
⢠The estimated cost of the project in âŹis as follows:
⢠Total investment (âŹ) 6608928
⢠The investment cost per installed kW would be:
6608928/4929 = 1 341 âŹ/kW
⢠The investment cost per annual MWh produced is: 420 âŹ/MWh
⢠The operation and maintenance cost per year, estimated at 4% of
the total investment, is: âŹ264 357.
⢠NPV obtained is:âŹ444 803 (using r = 8%).
⢠Rb/c = 1.061.
23. Bibliography
⢠Small and Mini Hydro-Power Systems
by-Jack J.Fritz.
⢠Economic and Financial Analysis of Hydropower Projects
By-Kurt Goldsmith.
⢠Guide on How to Develop a Small Hydropower Plant
-European Small Hydropower Association(ESHA).
⢠Economic Times.