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1、管理资源吧（），提供海量管理资料免费下载！6. Economic Evaluation of Facility Investments6.1 Project Life Cycle and Economic FeasibilityFacility investment decisions represent major commitments of corporate resources and have serious consequences on the profitability and financial stability of a corporation. In the publi
2、c sector, such decisions also affect the viability of facility investment programs and the credibility of the agency in charge of the programs. It is important to evaluate facilities rationally with regard to both the economic feasibility of individual projects and the relative net benefits of alter
3、native and mutually exclusive projects. This chapter will present an overview of the decision process for economic evaluation of facilities with regard to the project life cycle. The cycle begins with the initial conception of the project and continues though planning, design, procurement, construct
4、ion, start-up, operation and maintenance. It ends with the disposal of a facility when it is no longer productive or useful. Four major aspects of economic evaluation will be examined: 1. The basic concepts of facility investment evaluation, including time preference for consumption, opportunity cos
5、t, minimum attractive rate of return, cash flows over the planning horizon and profit measures. 2. Methods of economic evaluation, including the net present value method, the equivalent uniform annual value method, the benefit-cost ratio method, and the internal rate of return method. 3. Factors aff
6、ecting cash flows, including depreciation and tax effects, price level changes, and treatment of risk and uncertainty. 4. Effects of different methods of financing on the selection of projects, including types of financing and risk, public policies on regulation and subsidies, the effects of project
7、 financial planning, and the interaction between operational and financial planning. It is important to distinguish between the economic evaluation of alternative physical facilities and the evaluation of alternative financing plans for a project. The former refers to the evaluation of the cash flow
8、 representing the benefits and costs associated with the acquisition and operation of the facility, and this cash flow over the planning horizon is referred to as the economic cash flow or the operating cash flow. The latter refers to the evaluation of the cash flow representing the incomes and expe
9、nditures as a result of adopting a specific financing plan for funding the project, and this cash flow over the planning horizon is referred to as the financial cash flow. In general, economic evaluation and financial evaluation are carried out by different groups in an organization since economic e
10、valuation is related to design, construction, operations and maintenance of the facility while financial evaluations require knowledge of financial assets such as equities, bonds, notes and mortgages. The separation of economic evaluation and financial evaluation does not necessarily mean one should
11、 ignore the interaction of different designs and financing requirements over time which may influence the relative desirability of specific design/financing combinations. All such combinations can be duly considered. In practice, however, the division of labor among two groups of specialists general
12、ly leads to sequential decisions without adequate communication for analyzing the interaction of various design/financing combinations because of the timing of separate analyses. As long as the significance of the interaction of design/financing combinations is understood, it is convenient first to
13、consider the economic evaluation and financial evaluation separately, and then combine the results of both evaluations to reach a final conclusion. Consequently, this chapter is devoted primarily to the economic evaluation of alternative physical facilities while the effects of a variety of financin
14、g mechanisms will be treated in the next chapter. Since the methods of analyzing economic cash flows are equally applicable to the analysis of financial cash flows, the techniques for evaluating financing plans and the combined effects of economic and financial cash flows for project selection are a
15、lso included in this chapter. Back to top 6.2 Basic Concepts of Economic EvaluationA systematic approach for economic evaluation of facilities consists of the following major steps: 1. Generate a set of projects or purchases for investment consideration. 2. Establish the planning horizon for economi
16、c analysis. 3. Estimate the cash flow profile for each project. 4. Specify the minimum attractive rate of return (MARR). 5. Establish the criterion for accepting or rejecting a proposal, or for selecting the best among a group of mutually exclusive proposals, on the basis of the objective of the inv
17、estment. 6. Perform sensitivity or uncertainty analysis. 7. Accept or reject a proposal on the basis of the established criterion. It is important to emphasize that many assumptions and policies, some implicit and some explicit, are introduced in economic evaluation by the decision maker. The decisi
18、on making process will be influenced by the subjective judgment of the management as much as by the result of systematic analysis. The period of time to which the management of a firm or agency wishes to look ahead is referred to as the planning horizon. Since the future is uncertain, the period of
19、time selected is limited by the ability to forecast with some degree of accuracy. For capital investment, the selection of the planning horizon is often influenced by the useful life of facilities, since the disposal of usable assets, once acquired, generally involves suffering financial losses. In
20、economic evaluations, project alternatives are represented by their cash flow profiles over the n years or periods in the planning horizon. Thus, the interest periods are normally assumed to be in years t = 0,1,2, .,n with t = 0 representing the present time. Let Bt,x be the annual benefit at the en
21、d of year t for a investment project x where x = 1, 2, . refer to projects No. 1, No. 2, etc., respectively. Let Ct,x be the annual cost at the end of year t for the same investment project x. The net annual cash flow is defined as the annual benefit in excess of the annual cost, and is denoted by A
22、t,x at the end of year t for an investment project x. Then, for t = 0,1, . . . ,n:(6.1)where At,x is positive, negative or zero depends on the values of Bt,x and Ct,x, both of which are defined as positive quantities. Once the management has committed funds to a specific project, it must forego othe
23、r investment opportunities which might have been undertaken by using the same funds. The opportunity cost reflects the return that can be earned from the best alternative investment opportunity foregone. The foregone opportunities may include not only capital projects but also financial investments
24、or other socially desirable programs. Management should invest in a proposed project only if it will yield a return at least equal to the minimum attractive rate of return (MARR) from foregone opportunities as envisioned by the organization. In general, the MARR specified by the top management in a
25、private firm reflects the opportunity cost of capital of the firm, the market interest rates for lending and borrowing, and the risks associated with investment opportunities. For public projects, the MARR is specified by a government agency, such as the Office of Management and Budget or the Congre
26、ss of the United States. The public MARR thus specified reflects social and economic welfare considerations, and is referred to as the social rate of discount. Regardless of how the MARR is determined by an organization, the MARR specified for the economic evaluation of investment proposals is criti
27、cally important in determining whether any investment proposal is worthwhile from the standpoint of the organization. Since the MARR of an organization often cannot be determined accurately, it is advisable to use several values of the MARR to assess the sensitivity of the potential of the project t
28、o variations of the MARR value. Back to top 6.3 Costs and Benefits of a Constructed FacilityThe basic principle in assessing the economic costs and benefits of new facility investments is to find the aggregate of individual changes in the welfare of all parties affected by the proposed projects. The
29、 changes in welfare are generally measured in monetary terms, but there are exceptions, since some effects cannot be measured directly by cash receipts and disbursements. Examples include the value of human lives saved through safety improvements or the cost of environmental degradation. The difficu
30、lties in estimating future costs and benefits lie not only in uncertainties and reliability of measurement, but also on the social costs and benefits generated as side effects. Furthermore, proceeds and expenditures related to financial transactions, such as interest and subsidies, must also be cons
31、idered by private firms and by public agencies. To obtain an accurate estimate of costs in the cash flow profile for the acquisition and operation of a project, it is necessary to specify the resources required to construct and operate the proposed physical facility, given the available technology a
32、nd operating policy. Typically, each of the labor and material resources required by the facility is multiplied by its price, and the products are then summed to obtain the total costs. Private corporations generally ignore external social costs unless required by law to do so. In the public sector,
33、 externalities often must be properly accounted for. An example is the cost of property damage caused by air pollution from a new plant. In any case, the measurement of external costs is extremely difficult and somewhat subjective for lack of a market mechanism to provide even approximate answers to
34、 the appropriate value. In the private sector, the benefits derived from a facility investment are often measured by the revenues generated from the operation of the facility. Revenues are estimated by the total of price times quantity purchased. The depreciation allowances and taxes on revenues mus
35、t be deducted according to the prevailing tax laws. In the public sector, income may also be accrued to a public agency from the operation of the facility. However, several other categories of benefits may also be included in the evaluation of public projects. First, private benefits can be received
36、 by users of a facility or service in excess of costs such as user charges or price charged. After all, individuals only use a service or facility if their private benefit exceeds their cost. These private benefits or consumer surplus represent a direct benefit to members of the public. In many publ
37、ic projects, it is difficult, impossible or impractical to charge for services received, so direct revenues equal zero and all user benefits appear as consumers surplus. Examples are a park or roadways for which entrance is free. As a second special category of public benefit, there may be external
38、or secondary beneficiaries of public projects, such as new jobs created and profits to private suppliers. Estimating these secondary benefits is extremely difficult since resources devoted to public projects might simply be displaced from private employment and thus represent no net benefit. Back to
39、 top 6.4 Interest Rates and the Costs of CapitalConstructed facilities are inherently long-term investments with a deferred pay-off. The cost of capital or MARR depends on the real interest rate (i.e., market interest rate less the inflation rate) over the period of investment. As the cost of capita
40、l rises, it becomes less and less attractive to invest in a large facility because of the opportunities foregone over a long period of time. In Figure 6-1, the changes in the cost of capital from 1955 to 1985 are illustrated. This figure presents the market interest rate on a 20-year treasury bond,
41、and the corresponding real interest rate over this period. The real interest rate is calculated as the market interest rate less the general rate of inflation. During the last decade in this figure, the real interest rate has varied substantially, ranging from 10% to -4%. The exceptional nature of t
42、he 1980 to 1985 years is dramatically evident: the real rate of interest reached remarkably high historic levels. Figure 6-1 Nominal and Real Interest Rates on U.S. Bonds, 1955-1985(Reprinted by permission of the Wall Street Journal, Dow Jones & Company, Inc. 1985. All rights reserved.) With these v
43、olatile interest rates, interest charges and the ultimate cost of projects are uncertain. Organizations and institutional arrangements capable of dealing with this uncertainty and able to respond to interest rate changes effectively would be quite valuable. For example, banks offer both fixed rate a
44、nd variable rate mortgages. An owner who wants to limit its own risk may choose to take a fixed rate mortgage even though the ultimate interest charges may be higher. On the other hand, an owner who chooses a variable rate mortgage will have to adjust its annual interest charges according to the mar
45、ket interest rates. In economic evaluation, a constant value of MARR over the planning horizon is often used to simplify the calculations. The use of a constant value for MARR is justified on the ground of long-term average of the cost of capital over the period of investment. If the benefits and co
46、sts over time are expressed in constant dollars, the constant value for MARR represents the average real interest rate anticipated over the planning horizon; if the benefits and costs over time are expressed in then-current dollars, the constant value for MARR reflects the average market interest ra
47、te anticipated over the planning horizon. Back to top 6.5 Investment Profit MeasuresA profit measure is defined as an indicator of the desirability of a project from the standpoint of a decision maker. A profit measure may or may not be used as the basis for project selection. Since various profit m
48、easures are used by decision makers for different purposes, the advantages and restrictions for using these profit measures should be fully understood. There are several profit measures that are commonly used by decision makers in both private corporations and public agencies. Each of these measures
49、 is intended to be an indicator of profit or net benefit for a project under consideration. Some of these measures indicate the size of the profit at a specific point in time; others give the rate of return per period when the capital is in use or when reinvestments of the early profits are also included. If a decision maker understands clearly the meaning of the various profit measures for a given project, there is no reason why one cannot use all of them for the restrictive