Project Evaluation

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Project Evaluation

Project
Any developmental / investment activity undertaken to increase or enhance the productive capacity of the source is known as a project.
Evaluation
To determine the practical, technical and economical viability of the project.
            A private owner is always interested in profit and various techniques are available to work out the profitability of a project. A few of these are:
1). Payback method
2). Undiscounted returned
3). Net present value (NPV),
4) Internal Rate of return (IRR)
5). Cost-benefit analysis.

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1). Payback method
This method refers to the period of time over which the initial outlay/cost of the project is recovered/ recouped. 
e.g., we purchase machinery for Rs.10,000/- and recovery during the first year is to 6,000/- and in the 2nd year amounted to Rs. 4,000/-. In other words, we have used the machinery in two years or the payback period is 2 years. 
How this method helps in project evaluation?
In each business or industry, the payback period is fixed before hand keeping in view past experiences. In saw-milling, the period is 2 years. If the pay-back period is less than the conventional or accepted pay-back period then the project is feasible otherwise not.
Merits: i) simple, ii). No calculations are involved.

Demerits:
1) it does not take in to account the benefits to be derived after the payback period 
e.g.
           Project         A                                 B
Pay back period 2yrs                                2 yrs
Profitable upto  5yrs                                 10 yrs.
            But according to the above method both the projects are feasible/profitable.
2).       We do not know the ranking of the project and we can not give priority to the project of depend upon this method.
3). Never sure about the magnitude of the profitability.
            In forestry the pay-back period is fairly long. So if we compare forestry with other projects with the help of this method, we are at greater disadvantage. 

So this method is not fit for the evaluation of the forestry projects. 

It is generally confined to business and industry and even here its use is negligible.

2) Undiscounted return method
In this method we will have to make a year wise cash flow statement. This statement should contain how much amount is spent as a cost, how much received back as a return e.g. poplar plantation, rotation 10 years.
Years
Operation Establishment
Cost statement
operation
Rev.Statement
1
5000/-
2
1000/-
3
500/-
4
500/-
5
500/-
6
500/-
7
500/-
8
500/-
9
500/-
10
500/-
Felling
50,000/-
10,000/-
50,000/-
            The above statement of cash flow will give us complete picture of money. How much money has gone or spent and how much money has come or received so far? 
Difference between sum total of expenses or costs and other revenue give us the undiscounted revenue, i.e.,
Undiscounted Net revenue  =    Total revenue – total cost
                                                = 50,000 – 10,000 = 40,000/-
annual average revenue   = 40,
If the undiscounted rate of return is greater than the present rate of interest then the project is feasible otherwise not.
Demerit. It does not take into account the time value of money. So this method is not used for the evaluation of projects.
           
The remaining three methods are based on discounted revenue.

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3). Net present value
            Net present value = Net present revenue – Net present cost.
            NNPV = NPR – NPC. Both these are discounted.
            
If net present value is greater than zero then the project is economically viable. If less then zero the project is not economically feasible.
4). Internal rate of return (IRR)
The term financial yield is used in much of the English literature on forest economics is equivalent to the term Internal Rate of Return used in economics generally. 
Another name given to the concept is the marginal efficiency of capital. Because financial may be used in other senses, for example to indicate the cash profit from a project, use of the term internal rate of return seems preferable.
–          The internal rate of return is that interest which if applied to expenditure incurred at different time gives a compounded sum equal to revenues compounded at the same rate.
–          The IRR can also be defined as the rate of discount which reduces the net resent value (NPV) of the project to zero.
–          It will make the discounted value of a cost equal to discounted value of the revenue from the project . In other words we can say that
OR sum of discounted value of cost- sum of discounted value of revenue = zero.
            
The examples will illustrate the concept. 
A project costing Rs.100/- in the Ist year to install and yielding Rs.121/- to year later has an internal rate of return.
In other words future value (F.V) of 121 has present value equal to Rs. 1000/00 which becomes to zero or rate which where used in discounting makes discounting revenue equal to discounted expenditure. 
Formulation of cash flow statement which includes yearly estimates of cost and revenue. Apply different discount rates and try to find out that rate of interest which brings present work of the project equal to zero. This process is also known as reiteration.
If discounted value of revenue is grater than the discounted value of costs then IRR is greater than the discounting rate we applied.
            Now we apply 25% rate of discounting we find that cost =4240.78
Revenue = 3443.35 =4240.78 – 3543.35 = 697.43
            
Now the discounted value of cost is greater than IRR is loser than rate we applied. So reiteration discounting rate is between 10%  & 25% NPV = PNPC – NPV.
We plot both values i.e., values of NPV for 10% and 25% discounting rate. We will get two points and join these two points. Where these intersects the ox line that will be the desired discount rate which will given us the required zero value.
IRR = lower discount rate + Difference between two discount rate.

IRR is actually the rate of return earned by the investment of the project. IRR is grater than the current rate of interest then the in viable/feasible/ profitable otherwise not.

5. Cost benefit ratio method
It was first used in water resources . It is also used in large sale social problem. It can new also be applied to open project particularly which are suitable for forestry.
This method not only determines the feasibility of the project but also establishes the priority of different project. It gives social costs and social benefit. After listing all social costs and social benefit, the ratio is worked out.
e.g. cost  = 100, Benefit = 121
It is difficult to translate social benefit in terms of money. By enlisting the costs and benefit, the profit can be enumerated.

Cost               Benefit
1.                     1.        Employment
2.                    2.        Communication
3.                    3.        Conservation of soil
                        4.        Erosion control
                        5.        Nursery plants etc.
Then determine the present work.

If ratio is 1, Benefit desired is equal to costs. If benefit would more than. I the project is feasible.


Demerits

1.     Assumption of benefit arbitrarily is not correct. Arbitrary value.
2.    Impossible to quantity the benefit.
The evaluator will be biased to evaluate the project.
3.  Rate of interest: less present value note shed are – higher risk involved . If interest is higher then the project will not be feasible.

Merit

1. It was difficult to evaluate such project which was oriented on social benefit with the help of any method already discussed. 
This method facilitates to use arbitrary value for benefits evaluation instead of market price. Those projects which cannot be evaluated in the past or at present not only formulated or evaluated with the help of this method but also this procedure is internationally accepted. Particularly for those projects which are related with water resources. 
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For correction and improvements please use the comments section below.

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