Evaluation of investment projects

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  • This paper was prepared for the purpose of presenting the methodology and uses of the Monte Carlo simulation technique as applied in the evaluation of investment projects to analyse and assess risk. The first part of the paper highlights the importance of risk analysis in investment appraisal. The second part presents the various stages in the application of the risk analysis process. The third part examines the interpretation of the re

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  • We have been assuming that if your income stream is Y1,Y2, your consumption stream must be the same. And if you invest, your consumption stream must be C1,C2. However, by lending or borrowing at the market rate of interest, you can choose any point on the net present value line through A (if you don’t invest), or through B (if you do invest).

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  • We have seen how in conducting efficiency benefit-cost analysis we often use market prices, either directly or indirectly, to value or cost project outputs or inputs. We use market prices directly when they are generated by perfectly competitive markets - markets that are not distorted by monopoly, monopsony, taxes or regulations.

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  • Although we use the term “cash flow”, the dollar values used might not be the same as the actual cash amounts. In some instances, actual ‘market prices’ do not reflect the true value of the project’s input or output.

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  • Measures the economic efficiency of the project: if net benefit is positive, the project is a more efficient allocation of resources than the alternative (the world “without” the project).

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  • When we do a benefit-cost analysis, we have to value a range of commodities which are either inputs to or outputs of the project. Some of these commodities are traded (i.e. can be bought or sold on international markets) and some are non-traded (are not bought or sold in international markets but are only traded domestically).

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  • To derive private cash flow, we begin by calculating overall project cash flow.The private cash flow is the cash flow on the investor’s own funds or ‘equity’.

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  • The observed market rate of interest is the sum of the utility discount factor (reflecting impatience) and the utility growth factor (reflecting diminishing marginal utility of consumption).

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  • Chapter 1 introduces the concept of capital budgeting, and sets out the structure of the book. The important points are: Capital budgeting is the most significant financial activity of the firm. Capital budgeting determines the core activities of the firm over a long term future. Capital budgeting decisions must be made carefully and rationally.

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  • 2. The computational inter-relationships between data types are complex: eg rainfall/soil type/location/species. A Generic model can evaluate a variety of separate investment projects for a variety of users.

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  • Where the possible values could have significant impact on project’s profitability, a decision will involve taking a risk. In some situations, degree of risk can be objectively determined. Estimating probability of an event usually involves subjectivity.

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  • The two projects have the same economic impact, in terms of generating income for factors of production and inducing additional expenditures, but the hospital has a higher net present value than the hole in the ground.

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  • The ideal investment decision making technique is Net Present Value. N P V measures the equivalent present wealth contributed by the investment. NPV is given in NPV -- relates directly to the firm’s goal of wealth maximization -- employs the time value of money -- can be used in all types of investments -- can be adjusted to incorporate risk.

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  • Analyzing project risks by making mechanical trial and error changes to forecast values of selected variables.Analyzing the risks of investment projects, by changing the values of forecasted variables. Finding the values of particular variables which give the project a Breakeven NPV of zero.

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  • - it is the group whose net benefits are relevant to the decision-maker who commissioned the SBCA. - all members of a social group, for example, pensioners, native peoples etc.

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  • The market prices of project inputs or outputs will NOT change if: - the inputs or outputs are TRADED ie. price is determined in world markets) - the project is SMALL relative to the size of the economy in which is undertaken

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  • Allocation of scarce resources; land, labour, capital, foreign exchange; present and future consumption, optimum use of taxes and subsidy. Public ownership and planning, relationship between plans and projects selection and investment programme; private sector projects, method of evaluation of private projects, social cost- benefit and switching values, uses and abuses of sensitivity analysis. Accounting prices for traded and non-traded goods, marginal social costs and marginal social benefits, financing of projects, impact of project outputs on production and consumption elsewhere.

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  • “A systematic framework for economic appraisal of proposed public and private projects from a public interest point of view” – based on Benefit-Cost Analysis: Financial and Economic Appraisal using Spreadsheets by H. Campbell & R. Brown (Cambridge University Press, 2003)

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  • In the preceding chapters we assumed that each $ of net benefits of same value irrespective of sub-referent group . Atemporal – how income (and income changes) distributed among individuals or groups at present; ie. within present generation

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  • This book is about how to model the behaviour of complex projects. It isn’t about how to manage projects—although you’ll be expected to know the basics of project management—and reading this won’t make you into a better project manager. This book is written for analysts and workers in project management who find themselves needing to model how a project behaves.

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