financial and economic analysis of education projects

Financial and Economic Analysis of Education Sector Projects Koji Fujimoto In determining whether to invest or not on a development project, we usually carry out a financial or an econom

Financial and Economic Analysis of Education Sector Projects

Koji Fujimoto

In determining whether to invest or not on a development project, we usually carry out

a financial or an economic analysis depending on the nature of the project Financial analysis is meant for private sector projects which yield revenue or profit, and economic analysis for public sector projects which often do not accrue revenue

These two basic analytical methods have long been established and applied to a vast number of projects undertaken, regardless of their sectors and characteristics In spite

of this fact, feasibility study reports by consultants and appraisal documents by multilateral development banks (hereinafter referred to as MDBs) such as the World Bank and the Asian Development Bank have not necessarily revealed truly practical and ready-to-use methods of analysis To a lesser or greater extend, some of the critical aspects of the analysis are hidden in black boxes within most of those reports Education sector projects are not an exception

This paper, therefore, primarily intends to explore and identify practical and ready-to-use mechanics of the analytical procedures that are applicable to real projects

To this end, a variety of hypothetical cases are introduced and analyzed hereafter

1 Definition

Generally speaking, the terms “financial analysis” and “economic analysis” are used

in the broad sense Namely, financial analysis and economic analysis cover such dimensions as if the investment project in question can secure its validity, viability and

“bankability” in totality.1 In this connection one may recall that feasibility study reports usually undertaken by consultants at the project preparation stage, and appraisal reports undertaken by the MDBs at the project appraisal stage right before loan approval, come together in what is known as the project cycle.２

In our present discussion, however, we define both analyses in a narrow sense, namely financial analysis will specifically imply “Cost-Profit Analysis” while economic analysis will reflect “Cost-Benefit Analysis”

2 Cost-Profit Analysis and Cost-Benefit Analysis

Cost-Profit Analysis and Cost-Benefit Analysis aim to measure the respective internal rate of return (hereinafter referred to as IRR) of a particular project by analyzing its cash flows Needless to say, IRR is a proxy of project profitability or “benefitability” and used as a critical factor to judge if the project is to be implemented

The IRR of Cost-Profit Analysis is called the Financial Internal Rate of Return (hereinafter referred to as FIRR) This analysis usually calculates FIRR only The IRR

of Cost-Benefit Analysis is called the Economic Internal Rate of Return (hereinafter referred to as EIRR) This analysis usually calculates not only EIRR but also the Net Present Value (hereinafter referred to as NPV) and the Benefit/Cost Ratio (hereinafter referred to as B/C Ratio) of the project

(1) Cost-Profit Analysis (Financial Analysis)

In the private business sector, investors do not aim to lose their investment They make it a rule to scrutinize carefully the validity and viability of every investment project before an actual investment decision takes place As FIRR is regarded as the most important criteria of investment, this analysis plays an indispensable role in pre-investment project study And when a FIRR is higher than the expected rate of return (say, a prevailing commercial interest rate), the investor will likely decide to invest

The method to obtain FIRR is well-known As defined, the internal rate of return is the rate of discount at which the present value of the profit stream is equal to the present value of the cost stream, or for which the present value of the net profit stream becomes zero It is equivalent to the discount rate r that satisfies the following relationship:

) 1 /(

P

0

0 ) /(

)

where Pt is the profit stream, Ct is the cost stream and n is the number of years of project life

(2) Cost-Benefit Analysis (Economic Analysis)

Cost-Benefit Analysis is primarily meant to apply to a public sector project, which does not accrue revenue/profit in the commercial sense In this analysis, therefore, we will identify (economic) costs and (economic) benefits, whose values are different from domestic market values The analysis, seeks to find the true values of additional costs and benefits borne by a project to the local/national economy To pursue this, it is a general practice to introduce a few particular conversion factors to change costs and

benefits from the domestic market values to the true economic values Against this background, the term “benefit” is employed in the economic analysis in place of “profit”

in the financial analysis

Similarly as in case (1) above, this analysis aims to obtain EIRR as well as NPV (the net present value) and B/C Ratio (the benefit-cost ratio) The EIRR is usually expected

to be larger than a certain level, say, 10~12 %, for investment decision-making; NPV is

to be positive at a given discount rate; and B/C Ratio is to be equal to or larger than 1 (one) at a given discount rate

The economic internal rate of return (EIRR) is equivalent to the discount rate r*

which satisfies the following relationship:

3 Cost-Profit Analysis of Education Sector Projects

Education sector projects can broadly be divided into two groups：those projects to which Cost-Profit Analysis is applicable and those to which Cost-Benefit analysis is applicable In the former case projects may be understood in analogy with private sector investment projects such as those projects in the shoe manufacturing, bakery, restaurant and the like, particularly from the viewpoint of owner-cum-investor, and are dealt with in this section The latter type of projects are mostly public investment projects undertaken by public authorities, which are, therefore, analyzed from the viewpoint of the local/national (macro) economy and are subsequently dealt with in

section 4 below

To illustrate the mechanics of Cost-Profit Analysis, three kinds of hypothetical case studies, which exhaust all the possibilities of this type of analysis in the education sector, are carried out in this section

(1) School Construction and Management Project

To illustrate the case clearly, the following assumptions are set forth

year (2032 or year 25) The project life is, thus, 26 years including the construction period

② Costs (Cash Out-flows)

From the viewpoint of the investor-cum-owner, investment costs could be divided into four components, namely:

i Buildings and facilities construction costs (including land acquisition,

designing and consulting services, equipment/materials, labor, physical contingencies and so on) of 12 million dollars are required in year one of the plan Within this year, all the university facilities are constructed and all the costs are paid to the contractors

ii Operation and maintenance (hereinafter referred to as O&M) costs per year are

estimated at 4% of the construction costs and start to accrue from the second year of the project up to the final year of project life

iii Salaries and other recurrent costs are projected to be 5 million dollars (US) per

annum The university is to pay this amount uniformly from 2008 through the last year of operation (2032) Staffing is completed by the beginning of

2008

iv The university as a private sector business entity is to pay tax out of its “profit

before tax” to the government And this is estimated at 0.3 million dollars per annum

③ Revenues/Profits (Cash In-flows)

i Entrance fee per student is set at 0.002 million dollars (2,000 dollars) and

tuition per student per annum at 0.006 million dollars (6,000 dollars) Subscription or contribution by graduated students is not assumed to accrue

ii The university is to receive a government subsidy of 0.0015 million dollars

(1,500 dollars) per student per annum

iii To avoid complexity, the scrap (salvage) value of the university buildings and

facilities including land is not counted That is, it is assumed to be zero at the end of project life

Before calculating FIRR based on cash flow analysis, it might be helpful to grasp the entire picture of the case in terms of stakeholders, cost/benefit items and directions of cash flows by figure presentation (Figure 1 below)

Figure1 Cash Flows among Stakeholders of the University

Construction/Management Project

Tuition/

EntranceFeeConstruc

Govern-Project Entity (Investor-Owner of University)

Students/GraduatedStudents/Parets/OthersSubsidy Subscription/Contribution

shows cash flow and its direction

Source: Author

④ Cash Flow Table

Against the background above, we can now prepare a cash flow table, in which cash flows of costs and revenues/profits are sorted out over the life of the project 26 years To prepare the cash flow table is not a difficult task Simply, a table format is filled in step by step in accordance with the assumptions given in

①, ② and ③ above

Project life spans the period from year 0 (2007) through year 25 (2032) Every

year, 250 students are enrolled in the university with the first term students entering the university in 2008 (students of 2008) In 2011, therefore, the total number of enrolled students becomes 1,000 The final term students (the 22nd

term students or students of 2029) are enrolled in 2029 Subsequently, the number of students decreases annually by 250 until reaching zero at the end of

2032

The 12 million dollar construction costs is paid to the contractor in 2007 and, from the second year, the university spends 0.48 million dollars (4% of 12 million dollars) per annum for the O&M of buildings and facilities until its closure year

As annual salaries and other recurrent costs are fixed in a lump sum at 5 million dollars, this amount is simply inserted in the table format The university usually offers student scholarships/grants, but, in our present case, this practice is excluded for the sake of simplification The final component of costs is tax The amount of tax is usually derived from “Income Statement” and varies from year

to year But, here, it is simply assumed that the university pays 0.3 million dollars annually to the government

On the revenues/profits side, entrance fee, tuition and subsidy are calculated annually and are inserted in the table format, while subscriptions/contributions and scrap/salvage values are assumed zero The total entrance fee amounts to 0.5 (0.002×250) million dollars from 2008 through 2029, and becomes zero for the remaining 3 years The total tuition amounts to 1.5 (0.006×250) million dollars

in 2008 and reaches 6 (0.006×1,000) million dollars in 2011 which remains a constant until 2029, and towards the closure year of 2032, the amount of tuition contrarily decreases each year The total government subsidy amounts to 0.375 (0.0015×250) million dollars in 2008 and reaches 1.5 (0.0015×1,000) million dollars in 2011 remaining constant until 2029, and towards the end of project life, the amount of subsidy decreases As subscriptions or contributions from the graduated students are not assumed, related cash in-flows are not added The scrap (salvage) value of the project is normally regarded as cash in-flow, but it is assumed zero in this case

In accordance with the values given above, all cash flows are itemized and sorted out chronologically, resulting in the final cash flow table, shown as Table 1 hereunder

⑤ FIRR

The FIRR is then calculated by utilizing data in the first column on the right, “Net Revenues/Profits” An IRR calculation program is included within Microsoft Excel

software.3 In our present case, the FIRR is 0.0787 or 7.9%

The FIRR of 7.9% may not be as high as the investor would have expected

Whether or not the project is undertaken is a matter of judgment

Table 1 Cash Flows of the University Construction/Management Project

( U n i t : m i l l i o n d o l l a r s )

(2) Life-long Education Project

Similar to the above (1), a hypothetical case entitled “Life-long Education Project” for

an individual is set forth below

① Project Description

Almost all children, as he/she grows older, receive formal and informal education

Mr and Mrs Takushoku are determined to give their son, Taro (7 years old) who is

about to be enrolled in an elementary school, a good formal education from

primary through higher (tertiary) by sending him to private schools Their country

has long instituted the 6-3-3-4 education system; namely, 6 years of elementary school, 3 years of junior high school, 3 years of senior high school and 4 years of university Immediately before Taro’s primary education starts, Taro’s parents ask themselves if Taro’s education of 16 years will pay off or not In an attempt to find

an answer to this question, they decided to regard Taro’s life-time formal education as an investment project and apply the method of cost-profit analysis to determine its profitability

② Costs (Cash Out-flows)

i Tuitions and entrance fees are major costs of the project During the elementary school from age 7 to 12, Taro’s parents pay 6,000 dollars per annum on an average, during junior high school from age 13 to 15, 7,000 dollars, during senior high school from age 16 to 18, 8,500 dollars and during university from age 19 to

22, 10,000 dollars

ii Other education related direct costs such as uniforms, transportation, books and

so forth are excluded from the analysis for simplification

③ Revenues/Profits (Cash In-flows)

i Taro starts working right after his graduation from the university at the age of

23 with a starting annual salary of 20,000 dollars He can expect an annual salary increase of 5% throughout his career to the retirement age of 60 His salary streams are deemed “after tax” as the salaried man’s income tax in the country of the example is pre-deducted (taxation at the source) In the final year, Taro receives 200,000 dollars as retirement severance pay

ii Student grants/scholarships as well as part-time income are assumed to be zero

for the sake of simplification

In order to understand the above discussion illustratively, Figure 2 is shown in terms of stakeholders, directions of cash flows and related items

Figure 2 Cash Flows among Stakeholders of the Life-long Education Project

Dir Costs

Part-time SalaryTuition

Tax

Mr and Mrs Takushoku (Parents) (Project Entity) Taro (Son)

Private Sector (Shops/Firms/Others)Scholarship

Source: Author

④ Cash Flow Table

Based on ①, ② and ③ above, a cash flow table is completed as Table 2 below

Table 2 Cash Flows of the Life-long Education Project

Total Costs

Salary after Tax

ment Pay

Retire- ships

Scholar- time Income

Part-Total Rev./

⑤ FIRR

Microsoft Excel software is used to calculate the private rate of return (FIRR) for Taro In this case, we obtain a FIRR at 0.114 or 11.4% The result may suggest that Mr and Mrs Takushoku would be pleased with their educational investment on Taro as it has a fairly satisfactory return

(3) University Student Project

The case above deals with life-long formal education But if we segregate the university education for an individual student from the system and ask ourselves what is the economic justification for university education, how can we answer? One

of the quantifiable methods of analysis is the cost-profit analysis which aims to measure its profitability in terms of FIRR To analyze this case, the following assumptions are set forth

① Project Description

Hanako, the daughter of Mr and Mrs Takushoku plans to study at a Japanese university Hanako as well as her parents think that university education is a worthwhile investment project from an individual point of view They believe that all the private expenses on Hanako’s university education can be more than compensated by her future earnings This project is, thus, similar to the second project above The only difference, and a kind of difficulty, is how to realize some of costs and revenues/profits

② Costs (Cash Out-flows)4

i Tuition and entrance fee are major items of expenses which are generally borne

by the parents According to a UFJ bank (a Japanese bank) survey, the average entrance fee of a Japanese private university in 2003 is 400 thousand yen with

an annual tuition of 1,310 thousand yen

ii Foregone earnings, which are equivalent to the 4-year earnings earned by a high

school graduate who did not attend university, are regarded as cost or the opportunity cost of university education According to the Japan Statistics Year Book (2002), the average female high school graduate earns 1,908 thousand yen per annum at age 19, 1,980 thousand yen at age 20, 2,052 thousand yen at age

21 and 2124 thousand yen at age 22 (Here, we are applying the well-known notion of “with- and without-project” analysis.5) Income taxes on forgone earnings as well as on Hanako’s future earnings are costs However, as far as the figures above are concerned, they are treated as net of tax Figure 3 below helps to understand where the forgone earnings stand

iii Other direct expenses related to university education such as uniforms,

transportation, books and so on are also counted as costs In this case, however, they are negated for simplification of analysis

③ Revenues/Profits (Cash In-flows)

i Incremental earnings, the difference between the earnings of a university

graduate and those of a high school graduate illustratively shown in Figure 3, are counted as revenues/profits, which implies another “with- and without-project” analysis Statistical data on earnings of female high school and university graduates are readily available from the same statistical yearbook quoted above At age 23, for example, the former earns 2,196 thousand yen per annum and the latter 2,388 thousand yen, resulting in the difference of 192 thousand yen

Besides, an incremental retirement severance pay is assumed to be 1,500

thousand yen

ii Student scholarships/grants and other assistance can also be treated as

revenues/profits And, here again, they are assumed zero

Age 22

Figure 3 With-University Project and Without-University Project

Earnings of Hi School Graduate Earnings of Univ Graduate

Source: Mingat and Tan (1988) and Author

④ Cash Flow Table

The discussion on ①, ② and ③ above induces a cash flow table (Table 3), which simultaneously contains earnings of high school and university graduates as well as costs and revenues/profits

Table 3 Cash Flows of the University Student Project (Female Case)

Entrance Fee/ Tuition (Private Univ.)

Forgone Earnings

Direct Costs

Total Costs

Increment -al Earnings due to Univ.

Education

Incement -al Retire- ment Pay

Student Scholar- ships/

Grants

Total Revenues /Profits

⑤ FIRR

Whether Hanako’s university education is justifiable or not can be determined by the FIRR derived from the column entitled, “Net Revenues/Profits” within Table 3

We can calculate the FIRR of the project with Microsoft’s IRR software The FIRR

is 0.011 or 1.1% This rate is by all means too low to justify economically university education Therefore, whether the parents send her to the university or not is again a matter of judgment However, it should be reminded that the real value of university education can only be judged and recognized by taking into account a variety of externalities which are often and extensively discussed elsewhere.4

Incidentally, in case of the male student, the entire picture is quite different The FIRR of a male student is 0.051 or 5.1% which is calculated from Table A-1, Appendix A, whose data are also obtained from the same statistical yearbook The rate is relatively high and proves, at least in terms of FIRR, that university education for male is a better investment than that for female

4 Cost-Benefit Analysis of Education Sector Projects

We now proceed to the Cost-Benefit Analysis As we have pointed out, this analysis

is meant for the public sector project whose main concern is to estimate the impact on the economic growth for the country as a whole The education project to which this analysis is applicable, therefore, identifies its impacts on consumption and production

of wealth of the national economy as a whole, not from the private point of view but from the public/government point of view Take benefit, for example Benefit is required to measure actual economic productivity increase rather than sheer incremental earnings With this fundamental understanding in mind, the following case studies illustrate the specific mechanics of the analysis

There are two kinds of cost-benefit analysis: at financial prices (hereinafter referred

to as Financial Cost-Benefit Analysis or FCBA) and at economic prices (hereinafter referred to as Economic Cost-Benefit Analysis or ECBA) The difference between the two is that the former is carried out in terms of financial prices, namely the prevailing market prices within the domestic market, and the latter in terms of economic prices, namely the true-value-reflected prices such as international prices, border prices, willingness-to-pay prices and so on Public investment projects undergo FCBA first and, then, ECBA in sequence through the conversion processes Within the framework of the cost-benefit analysis, FCBA is called “Financial Analysis” as a means to distinguish FCBA from ECBA, which is a little misleading We should always keep in mind that the true financial analysis is the Cost-Profit Analysis

discussed above Needless to say, costs and benefits to be included in this analysis differ substantially from costs and revenues/profits in the cost-profit analysis

To illustrate the specific mechanics of the analyses, a hypothetical university project

is formulated

(1) Financial Cost-Benefit Analysis (FCBA) of the Bintang University Project

The planned Bintang University Project is to be implemented under the following assumptions

① Project Description

The government of an upper-middle-income developing country7 plans to establish a new national university, called Bintang University This university will specialize in socio-economic development studies and will educate future leaders of the country

The university construction takes the first full year and actual teaching starts in the following year The university accommodates 1,000 students with a throughput of 250 graduates a year in the steady state The university begins to hire its teaching and office staffs at the end of the first year and continues hiring

as the intake of students rises The student population increases from 250 in the project’s second year and reaches 1,000 in its fifth and fully operational year The project life is 31 years including the construction period, which means that the university is closed at the end of the 31st year

② Costs (Cash Out-flows)

The physical construction costs, which occupy the main share of the project’s investment, are broken down into several items in accordance with their respective markets such as goods, services, labor, land and so on These items are, then, individually divided into a traded goods/services (or foreign currency) component and a non-traded goods/services (or local currency) component This practice is indispensable in converting financial costs/benefits in FCBA into economic costs/benefits in ECBA

i Construction Costs

ⓐ Equipment and materials cost are 5 million dollars, of which 2 million

dollars represent the foreign currency component (traded goods) and 3 million dollars the local currency component (non-traded goods)

ⓑ Labor costs count for 900 thousand dollars, of which 300 thousand dollars

represents the foreign currency component (trained labor) and 600 thousand dollars the local currency component (untrained labor)

ⓒ Land costs 600 thousand dollars (local currency component)

ⓓ Consulting services cost 250 thousand dollars, of which 100 thousand

dollars represents costs for foreign consultants and 150 thousand dollars for the local consultants

ⓔ Taxes amount to 200 thousand dollars, of which 80 thousand dollars is paid

by foreign companies and 120 thousand dollars is paid by the local companies

ⓕ Base Costs are the sum of ⓐ, ⓑ, ⓒ, ⓓ and ⓔ above, which represents

the sub-total

ⓖ Physical contingency is equal to 5% of the base costs or the subtotal above ⓗ Total costs except price contingency are the sum of the base costs (ⓕ

above) and the physical contingency (ⓖ above)

ⓘ Price contingency is a construction cost item and is usually calculated on

the basis of annual costs allocation and inflationary trend during the construction period from a few to several years Usually inflation rates are separately set for the foreign currency components (3%, for example) and local currency components (8%, for example) In our present case, as the construction completes within a year, this calculation is not necessary Price contingency is not used for IRR calculation, but it is included in

the total costs of construction for the sake of determining real needs of funds and the loan amount

ⓙ The grand total costs are the sum of ⓗ and ⓘ

ii Salaries and Other Recurrent Costs

In the first teaching year, the university is operated with a total of 20 teaching and office staffs From the third year, 10 staffs are added every year until the total number reaches 50 at the beginning of the fifth year Total staff cost for the university is 50 thousand dollars per person per annum All 50 staffs remain employed until the end of the 31st year

iii Forgone Earnings

While attending the university each student forgoes 11 thousand dollars

potential annual earnings In the fourth year of the project, for example, when the university has 750 students, the aggregate cost in forgone earnings amounts to 8.25 (11,000×750) million dollars

iv Private University-related Expenses

For the sake of simplification, these expenses (uniforms, transportation, books

and the like) are assumed as not accruing

v Operation and Maintenance (O&M) Costs

From the second year of the project, 3% of the total costs excluding price

contingency (“ i-ⓗ” above) are spent on O&M of buildings and facilities annually through to the 31st year (year 30) of the project

③ Benefits (Cash In-flows)

i Productivity Increase

It is expected that university education increases graduates’ productivity over

their entire lifetime To measure the incremental productivity, the difference between the earnings of university graduates (namely, in the case of

“with-project”) and those of high school graduates (in the case of

“without-project”), as shown in Figure 3, is used as a proxy.8

Generally speaking, the difference in earnings gradually grows and hits a ceiling towards the end of their work career But in our present case, we simply fix it at 6,000 dollars per person per annum through to the retirement age of 65 Besides, every university graduate receives an incremental retirement severance pay of 75 thousand dollars

ii Scrap/Salvage Value

When the university is closed, it retains certain valuable assets The only valued

asset left, in this case, is the land Its market value is 600 thousand dollars, which is the same at the time of the initial investment

④ Cash Flow Table

In preparing the cash flow table, a step-by-step approach is utilized In other words, an individual cash flow table for every item of costs and benefits listed above is prepared and, then, all the tables are integrated into one final cash flow table

The eight individual tables, whose headings are listed below, are tabulated as shown in the Appendix B

Table B-1: Construction Costs

Table B-2: Salaries and Other Recurrent Costs

Table B-3: Forgone Earnings

Table B-4: Other Private University-related Expenses

Table B-5: Operation and Maintenance Costs

Table B-6: Productivity Increase (Annual Earnings)

Table B-7: Productivity Increase (Retirement Pay)

Table B-8: Scrap/Salvage Value

Those tables are merged into one final cash flow table, Table 4-1 shown below ⑤ Net Present Value (NPV) and Benefit/Cost Ratio (B/C Ratio) Table

To determine the “benefitability” of the project from two different angles other than IRR values, NPVs and B/C Ratios are also calculated from the NPV and B/C Ratio table (Table 4-2) at the given discount rates of 8% and 10%

⑥ EIRR, NPV and B/C Ratio

The FCBA of the Bintang university project produces three kinds of values: EIRR, NPV and B/C Ratio The EIRR can easily be calculated from the “Net Benefits” summarized in the right edge column of Table 4-1 Utilizing the Microsoft Excel IRR program, we obtain the EIRR value of 0.0897 or 8.97% Table 4-2 tabulates the present values of costs and benefits and, for this reason, the discount factors are inserted until the last batch of graduates completes their work career over a

73 year period At the given discount rate of 8%, we then obtain: 1) the NPV of 19.99 million dollars by adding all the present values in the seventh column (“Net Present Value”), and 2) the B/C Ratio of 1.14 by calculating the ratio between the total of present values of costs in the fifth column (“Present Value of Costs”) and the total of present values of benefits in the sixth column (“Present Value of Benefits”) Similarly, we can obtain, at the given discount rate of 10%, a NPV of

－(minus)14.37 million dollars and a B/C Ratio of 0.88

Whether or not these values are high enough to make an investment decision is

a matter of judgment However, what needs to be reiterated more importantly here is the fact that FCBA is a preparatory stage to ECBA, and FCBA is carried out at the financial prices and ECBA is carried out at the economic prices This may raise the question concerning validity of FCBA In other words, if ECBA is the final goal, what is the use of FCBA? FCBA does, however, have its own advantages One of them is derived from the fact that financial prices are the market prices that we perceive in our daily life They are readily available and easy to quote for analysis Therefore, we can quickly obtain EIRR, NPV and B/C Ratio On the other hand, economic prices are converted and computed prices whose calculation is often difficult which hamper practical execution of analytical works Another advantage of financial prices is that they are equally recognized

by anyone and, therefore, have proved to be an acceptable and non-deniable aspect of FCBA The analytical results obtained above, thus, can be of valuable help in making a decision on the Bintang university project

FCBA is, thus, fundamentally the economic analysis and, therefore, its IRR has

to be called EIRR or more precisely EIRR at financial prices Within the framework of cost-benefit analysis, however, FCBA is often treated as the Financial Analysis and its IRR is called FIRR The logic behind this may be that

the analysis deals with the prevailing domestic market prices and all transfer items are not necessarily excluded, which resembles cost-profit analysis slightly

We should be reminded once again that the terms, “financial analysis” and

“FIRR”, referred here are definitely different from those of the true financial analysis, namely, the cost-profit analysis discussed in the previous section,“3 Cost-Profit Analysis of Education Sector Projects”

Table 4-1 Cash Flows of the Bintang University Project at Financial Prices

Forgone Eranings

Private Expenses

O&M Costs (3% of Initial Investment)

Total Costs

tivity Increase (Earnings)

tivity Increase (Retire- ment Pay)

Scrap/

Salvage Value

Total Benefits

(Unit: thousand dollars)

Discount Factor 1/(1+0.08)^

Present Value of Costs

Present Value of Benefits

Net Present Value

Discount Factor 1/(1+0.1)^

Present Value of Costs

Present Value of Benefits

Net Present Value

Discount Rate: 8% Discount Rate: 10%

(Unit: thousand dollars)

(2) Economic Cost-Benefit Analysis (ECBA) of the Bintang University Project

We are now in a position to analyze the Bintang university project from the economic point of view The major task here is to change the financial prices into economic prices

① Steps to Convert Financial Cash Flows into Economic Cash Flows

In general, there are three steps to obtain economic cash flows, namely:

i To eliminate transfer items such as tax and subsidy from the flows, as they are

not related with actual consumption or production of the economy; they are sheer transfers from someone’s hand to someone else’s hand

ii To adjust the domestic market prices of traded goods and services into the

international prices

iii To adjust the domestic market prices of non-traded goods and services into

economic prices by applying such coefficients as conversion factors9, willingness-to-pay prices and long-term marginal costs

② Economic Costs (Cash Out-flows)

i Construction Costs

ⓐ With regards to the 5 million dollars of equipment and materials costs, 2

million dollars (foreign currency component or traded goods/services) are counted as economic costs as they are spent on internationally traded goods/services The remaining 3 million dollars (local currency component

or non-traded goods/services) are spent on domestically traded goods/services and are thus converted into economic costs with a conversion factor of 0.9

ⓑ Similarly as above, out of the labor costs of 900 thousand dollars, 300

thousand dollars (foreign currency component or traded goods/services) are treated as economic costs and the remaining 600 thousand dollars (local currency component or non-traded goods/services) are converted into economic costs with a conversion factor of 0.6

ⓒ The land costs 600 thousand dollars (local currency component or non-traded goods/services) in the domestic market This land, however, can

be used alternatively as agricultural land, whose opportunity cost is worth

500 thousand dollars, in present value terms, of agricultural products to be harvested over the 30 years of the project

ⓓ Out of 250 thousand dollars of consulting services, 100 thousand dollars (foreign currency component or traded goods/services) are spent on foreign consultants and regarded as economic costs The remaining 150 thousand dollars (local currency component or non-traded goods/services) for local consultants are converted into economic costs with a conversion factor of 0.9

ⓔ Taxes belong to the transfer item and, therefore, is simply eliminated from the table

ⓕ Base costs are then the sum of ⓐ,ⓑ,ⓒ and ⓓ above, which is usually captioned as the sub-total They are to be separately summed in both the

“Foreign Currency or Traded Goods/Services” and “Local Currency Component or Non-traded Goods/Services” columns The transfer item ⓔ

is not logically included

ⓖ Physical contingency is calculated on the basis of 5% of the base costs ⓕ above

ⓗ As the grand total economic costs, the base costs and the physical contingency are added

ii Salaries and Other Recurrent Costs

As teaching and office staffs are recruited from the fairly competitive domestic

as well as international market, the financial costs are regarded equal to the economic costs In other words, a conversion factor of 1 (one) is applied

iii Forgone Earnings

The salary level of the high school graduate is valued higher than its real

value Therefore, a conversion factor of 0.9 is applied to revaluate the real forgone earnings which are the economic costs In the forth year of the project, for example, when the university has 750 students, aggregate cost in forgone earnings amounts to 7,425 (11,000×0.9×750) thousand dollars