Financial Analysis Module
Financial Analysis
is concerned with determining the
income that the project would
generate for the project-operating
entity; and if there is no income, how
to finance and sustain its operation
(i.e., water supply and road projects)
Economic Analysis
is directed towards establishing the
net returns that the project would
generate for the economy/society as
a whole. Because of this, revenues,
costs and profits (benefits) would tend
to differ in the two analyses.
Why financial analysis for public
sector project?

To ensure financial sustainability
- availability of funds to finance
investment up to operation stage
- projects with high economic returns
may still fail when funds to finance
its operation is not enough (water
supply, irrigation, and public
transport)
Why financial analysis for public
sector project?

To determine its financial profitability
- gov’t. approaches a project like a
private sector does, especially when
privatization is considered
- to estimate true value of a project
- to know if project is profitable or not
Weighted average cost of
capital (WACC)


Cost of borrowing, for borrowed capital
(i.e., interest rate of loan)
The yield of alternative opportunities,
for equity capital (i.e., interest rate of
savings, other investments)
Weighted average cost of
capital (WACC)
Example:
Total project cost
– P200,000
Fund 1: (Loan-60%) - 120,000
Cost of capital (15%)
Fund 2: (Equity-40%)
- P80,000
Cost of capital (8%)
WACC = (60%x15%)+(40%x8%)
= (0.09)+(0.032) = 12.2%
Weighted average cost of
capital (WACC)
Example:
Total project cost
– P 500,000
Fund 1: (Loan-50%)
- P 250,000
Cost of capital (15%)
Fund 2: (loan-40%)
- P 200,000
Cost of capital (18%)
Fund 3: (Equity-10%)
- P 50,000
Cost of capital (10%)
WACC = (50%x15%)+(40%x18%)+(10%x10%)
= (0.075)+(0.072)+(0.01) = 15.7%
Time Value of Money (TVM)
The essence of this concept is that
money received or consumed at a
particular time has greater value than
the same money received or consumed
at some future time.
Explanations/Reasons:



Normal preference for present versus
future consumption
Resources on hand may be invested
during the intervening period to
generate income or earn interest
Risk of uncertainty factor of the future
Concept of Discounting
is a process of translating future values
into their present worth
Ao = An x 1/(1+r)n , where
Ao = present value of An
An = expected amount at year n
r = discount rate
n = no. of years between year 0 and
year n, i.e., discounting period
Example: A revenue of P85 is
expected 2 years from now.
Assuming a discount rate (WACC) of
10 percent, the present value is:
Ao = 85 x 1/(1+0.10)2
= 85 x 1/(1.21)
= 85 (0.826)
= 70.2
Net Present Value (NPV)
- the difference between the present
values of project benefits and project
costs
n
n
NPV = ∑ bi /(1+r)i - ∑ ci /(1+r)i
i =0
i=0
where bi= benefits in period i
ci= costs in period i
r = discount rate
n= discounting period
NPV Decision Rule:
Accept projects with NPV greater than
or equal to 0, and reject if otherwise.
In case of competing projects, select
the project with the highest NPV.
NPV > or = 0
Benefit-Cost Ratio (BCR)
- the ratio of the present value of gross
benefits to the present value of gross
costs:
n
n
BCR = ∑ bi /(1+r)1 / ∑ ci /(1+r)1
i=0
i=0
Benefit-Cost Ratio (BCR)
Decision rule:
- Accept projects with BCR greater or equal
to 1; reject if otherwise.
- In case of competing
projects, select
project with the highest BCR.
Exercises: Compute and compare the BCR, NPV,
and IRR using 15% discount factor and
recommend the better project.


Project A
Year
1
2
3
4
5
Project B
1
2
3
4
5
Costs
1,700
200
200
200
200
1,700
200
200
200
200
Benefits
900
800
700
600
500
500
600
700
800
900
Computations: (Project A)
Year
1
2
3
4
5
Costs
1,700
200
200
200
200
Benefits
900
800
700
600
500
DF (15%)
.870
.756
.658
.572
.497
PVc
1,479
151
132
114
99
PVb
783
605
461
343
249
Total = 1,975
2,441
NPV = PVb – PVc = 2,441 – 1,975 = P 466
BCR = PVb / PVc = 2,441/1,975 = 1.24
Analysis: Project A
NPV = PVb – PVc = 2,441 – 1,975 = P 466
Per rule, accept project with NPV greater than or equal
to 0, reject if otherwise. In case of competing projects,
select the one with the highest NPV.
BCR = PVb / PVc = 2,441/1,975 = 1.24
Per rule, accept project with BCR greater than or equal
to 1, reject if otherwise. In case of competing projects,
select the one with the highest BCR.
IRR Computations:)
rb – r* =
NPVb
rb – ra
NPVb – NPVa
60 – r* =
- 53
60 – 15
-53 – 466
60 – r* =
- 53
45
519
(519)(60- r*)
= (-53) (45)
519(60) – 519r* = -2385
31,140 – 519r* = -2385
519r* = 31140 - 2385
519r* = 28755
r* = 28755/519 = 55%
Computations: (Project B)
Year
1
2
3
4
5
Costs
1,700
200
200
200
200
Benefits
500
600
700
800
900
DF (15%)
.870
.756
.658
.572
.497
PVc
1,479
151
132
114
99
PVb
435
453
461
458
447
Total = 1,975
2,254
NPV = PVb – PVc = 2,254 – 1,975 = P 279
BCR = PVb / PVc = 2,254/1,975 = 1.14
Exercises: Compute and compare the BCR and
NPV using 15% discount factor and recommend
the better project.


Project A
Year
1
2
3
4
5
Project B
1
2
3
4
5
Costs
1,700
200
200
200
200
1,700
200
200
200
200
Benefits BCR NPV
900
1.24 446
800
700
600
500
500
600
700
800
900
1.14 279