PPPUE: Tools for pro-poor municipal PPP: Mod 12/4-Financing (investments)

12.1 What are the objectives?

12.2 What are the key processes?

12.3 Who is involved?

12.4 What are the key steps?

12.5 What are the key issues?

12.6 What are the key issues relating pro-poor PPPs?

Module 12: Financing (investments)

12.4. What are the key steps?

...‘Reality check’
...Business valuation
...Investment projects feasibility analysis
...Investments programme design
...Approval and Realisation

1. Perform a "reality check"

“Reality check” implies the simplest kind of comparison if the potential benefits and costs of the project. The reality check is a benchmark scoring system that sets a baseline and establishes the strategic thinking and tactical work required to achieve the goal.
It is based on answering basic questions about the project, such as:

◊ Does the proposed project have a realistic chance of succeeding?

◊ Does the business concept to be based on a sound technical and business principles?

◊ Is there enough time between now and the date of the project results delivery?

◊ Are adequate financial resources available?

◊ Is there a political will? etc.

2. Perform business valuation

A business valuation is a formal opinion regarding the estimated value of an ownership interest in a business entity at a given point in time. There are a number of instances when there is a need to determine the market value of a company. Raising funds is one of them.
There are a wide range of factors that go into the process -- from the book value to a host of tangible and intangible elements. In general, the value of the business will rely on an analysis of the company's cash flow. In other words, it's ability to generate consistent profits will ultimately determine its worth in the marketplace. An accurate business valuation requires financial analysis as well as many other aspects of a business including:

◊ Management capabilities

◊ Company strengths, weaknesses and vulnerabilities

◊ The competitive environment

◊ Overall expectations for the marketplace

◊ Current and future economic prospects for the industry

This whole process of business valuation is one of those areas in business where hiring a professional to provide this service is essential.

3. Perform investment projects feasibility analysis

CBA provides a mean for systematically comparing the value of outcomes with the value of resources achieving the outcomes required. It measures the economic efficiency of the proposed technology or project. When all else is equal more efficient projects should be chosen over less efficient ones. When there are many options to consider during a decision-making task, it is useful to evaluate the options with a common metric. CBA refers to any type of structured method for evaluating decision options.
A CBA application includes the following stages:

1. General description of the project:
This part includes an explanation on the environment under which each analysis is done such as the objectives, the assumptions, the project/decision life etc.

2. List of alternative scenarios:
In order to decide which is the best option in the CBA we have to consider the costs and the benefits for each of these options. This section lists the options considered during the analysis.

3. Identify Benefits and Costs:
In this part, the application lists the exact benefits and costs met in each of the alternative scenarios. The application divides these into two kinds: The ones that are relatively straightforward to be measured and the ones that are not very easy to be measured. Many factors must be considered during the process of estimating the costs associated with competing alternatives in a CBA.

– All costs for the full system life cycle for each competing alternative must be included. The following factors must be addressed: Activities and Resources, Cost Categories, Personnel Costs, Direct and Indirect Costs (Overhead), Depreciation, and Annual Costs.
– Benefits are the services, capabilities, and qualities of each alternative system, and can be viewed as the return from an investment. To estimate benefits, first identify the benefits for both the customers and the organization that provides the service(s) to the customers.

4. Schedule Benefits and Costs:
For each of the alternatives defined in step 2, the user now identifies the value of each benefit and cost for each year through the life cycle of the decision beginning from Year 0, which is the start of the decision life. After the costs and benefits for each year of the system life cycle have been estimated, convert them to a common unit of measurement to properly compare competing alternatives. That is accomplished by discounting future values, which transforms future benefits and costs to their "present value." The present value (also referred to as the discounted value) of a future amount is calculated with the following formula:

P = F (1/(1+I)n), where P = Present Value, F = Future Value, I = Interest Rate, and n = number of years.

5. Comparison of alternatives:
In this part the application compares the alternative solutions. The comparison is illustrated with tables and graphs so as to facilitate decision making. When the costs and benefits for each competing alternative have been discounted, compare and rank the discounted net value (discounted benefit minus discounted cost) of the competing alternatives. When the alternative with the lowest discounted cost provides the highest discounted benefits, it is clearly the best alternative.

6. Sensitivity Analysis:
In this part the application helps the user define how sensitive the results are to changes in the costs and benefits. This sensitivity involves costs and benefits whose definition is not straightforward or is not easy to be exactly defined. Sensitivity analysis tests the sensitivity and reliability of the results obtained from the cost-benefit analysis. Since the CBA is normally the key document in the investment review process, reviewers want assurance that the analysis is reliable. Sensitivity analysis identifies those input parameters that have the greatest influence on the outcome, repeats the analysis with different input parameter values, and evaluates the results to determine which, if any, input parameters are sensitive. If a relatively small change in the value of an input parameter changes the alternative selected, then the analysis is considered to be sensitive to that parameter. If the value of a parameter has to be doubled before there is a change in the selected alternative, the analysis is not considered to be sensitive to that parameter. The estimates for sensitive input parameters should be re-examined to ensure that they are as accurate as possible.

4. Design capital investment programme

Capital investment program is a multi-year plan of capital projects listed in priority order by year with anticipated beginning and completion dates, annual estimation costs and proposed methods of financing. Annually, the program is reviewed, revised and projected one year.
There is a number of reasons for designing the investment program:

1. PPP projects require multi-year expenditures because they are expensive and may take more then one year to design and construct.

2. PPP projects often involve multiple sources of financing such as current funds, debts and grants, which must be accounted for separately.

3. Financial resources for capital projects are limited and therefore must be conspired and allocated in a systematic manner.

Capital investment program design is a dynamic process that involves several steps. The complexity of the process depends on the law, extend of central government regulation and local government size, organization structure, staff capability and financial conditions.