PREVNEXTSUBMITMenuResourcesGlossaryNotesClear and return to MenuSearch ResultsFilterSlide TextNotesSearch in:Check to includeSearch...TermsDefinitionFINISHfinishdefinitionresourcessearchpauseplayreplaysubmitnextpreviousvolumeSUBMIT ALLsubmit allQuestion ListMore infoSend an emailCloseBioExit decision criteria and cba jerrod masondecember 4, 2013 session motivation what questions about our projects can cba help us answer more effectively?will my project be beneficial for farmers or other stakeholders?will my project have positive impacts on the economy as a whole?which project alternative will yield the highest benefits for society?given an existing set of activities, where is the best place to invest additional funds? 2 review of project evaluation metrics review of project evaluation metrics session outline review of metrics review of metrics decision criteria for a single project alternative decision criteria decision criteria mutually exclusive projects mutually exclusive projects constrained investment constrained investment nested alternatives nested alternatives decision criteria for nested alternatives decision criteria for mutually exclusive projects decision criteria for constrained investment the sum of future costs and benefits of a project, discounted to a single time period (usually the present). formally: 𝑁𝑃𝑉= 𝑡=0 𝑛 𝑁𝐶𝐹 𝑡 1+𝑟 𝑡 where: 𝑁𝐶𝐹 𝑡 is the net cash flows (benefits minus costs) in time period tr is the discount raten is the number of periods of costs and benefits being analyzed net present value 4 decision criterion: if npv > 0, accept the project limitations of the npv sensitive to choice of discount ratesensitive to timeframe of analysis and length of projectdoes not always provide a ready “marginal decision” framework 5 internal rate of return the “investor’s return”—the measure of what the project would return if it were a financial investment, also the maximum interest rate that could be paid on the investment costs and still break even.technically, the irr is that discount rate which causes the net present value of a stream of cash flows to be equal to zero. 6 decision criterion: if irr > r, accept the project limitations of the irr for beneficial projects, can be positive, negative, undefined, or positive and negativedoes not give information about the scale of benefitssensitive to time frame of analysis and length of project 7 8 limitations of the irr limitations of the irr for beneficial projects, can be positive, negative, undefined, or positive and negativedoes not give information about the scale of benefitssensitive to time frame of analysis and length of project 9 irr vs. mirr irr assumes that positive net cash flows are reinvested at project ratein reality, investment opportunities are not unlimited, high-return investments may not be availablemirr allows analyst to choose an investment & reinvestment rate that make sense 10 npv vs. irr 11 npv vs. irr 12 benefit-cost ratio different benefit-cost ratios used in project evaluation. most useful is the net benefit-cost ratio (net benefit to investment ratio): net present value of cash flows divided by net present value of investment. 13 decision criterion: if b/c ratio > 1, accept the project limitations of the b/c ratio does not give information about the scale of benefitssensitive to choice of discount ratesensitive to categorization of costs & benefits 14 limitations of the b/c ratio 15 general decision criteria: is the project worthwhile? if the question is whether or not to undertake a project, any metric will give the correct answer.*r = discount rate accept project reject project accept project reject project accept project reject project bc ratio > 1 npv > 0 irr > r* yes no yes no yes no accept project reject project accept project reject project accept project reject project bc ratio > 1 npv > 0 irr > r* yes no yes no yes no 16 decision criteria for mutually exclusive projects review of metrics review of metrics decision criteria decision criteria mutually exclusive projects mutually exclusive projects constrained investment constrained investment nested alternatives nested alternatives decision criteria for mutually exclusive projects decision criteria for mutually exclusive alternatives 18 decision criteria for mutually exclusive alternatives 19 decision criteria for constrained investment review of metrics review of metrics decision criteria decision criteria mutually exclusive projects mutually exclusive projects constrained investment constrained investment nested alternatives nested alternatives decision criteria for constrained investment decision criteria for constrained investment initial situation: mission portfolio contains the following four projects 21 decision criteria for constrained investment question: where should the mission invest $5 million more? 22 decision criteria for constrained investment solution: find the incremental npv of expanding each project 23 decision criteria for nested alternatives review of metrics review of metrics decision criteria decision criteria mutually exclusive projects mutually exclusive projects constrained investment constrained investment nested alternatives nested alternatives decision criteria for nested alternatives decision criteria for nested alternatives problem: choose the “best” set of roads projects possible given a $30 million budget. 25 decision criteria for nested alternatives what decision criteria should we use to choose the best set of roads? 26 decision criteria for nested alternatives 27 decision criteria for nested alternatives belli – analyst must undertake 3 project appraisal steps: each component separatelyeach possible combination of componentsthe entire project, including all of the components, as a packagejenkins and harberger propose a similar analysis for multiple-component projects.but—six road segments with four options each (dirt, gravel, paved and no road) is 4^6 = 4096 different potential alternatives! 28 decision criteria for nested alternatives maximum project npv is $26.07 million, from an initial investment of $30 million 29 summary if npv>0, project is worthwhilefor mutually exclusive alternatives, choose the project with the largest npvif investment is constrained, find the incremental npv of each possible incremental investmentif choosing between nested alternatives, create mutually exclusive alternatives and find the largest npv 30 a final note confusion over which decision criterion is appropriate is generally due to improper framing of the decision—the most important question is “what are the alternatives?”all of these rules essentially boil down to creating a set of mutually exclusive alternatives, then finding the npv of each alternative.irrs, bc ratios and other figures (repayment period, dscr/llcr, etc.) are useful as supplementary, illustrative metrics, but npv should be the (only) criterion for decision making! 31 decision criteria and cba jerrod masondecember 4, 2013 <html><p align='left'><textformat leading='1' tabstops='[48, 96]' leftmargin='0' indent='0'><font face='Microsoft Sans Serif' size='10.9933pt' color='#000000'><br></font></textformat></p></html><html><p align='left'><textformat leading='1' tabstops='[48, 96]' leftmargin='0' indent='0'><font face='Microsoft Sans Serif' size='10.9933pt' color='#000000'><br></font></textformat></p></html><p align='left'><textformat leading='3'><font face='Articulate' size='12' color='#444444'><b>Jerrod Mason</b></font></p><p align='left'><textformat leading='3'><font face='Articulate' size='12' color='#444444'>Economist, USAID Economic Policy</font></p><p><textformat leading='-5'></p><p align='left'><textformat leading='3'><font face='Articulate' size='11' color='#999999'>Jerrod Mason joined USAID’s Economic Growth, Agriculture and Trade bureau as a Presidential Management Fellow in August 2011, and comes from an academic background in economics and public policy and a professional background in national security focusing on the Middle East. Jerrod served six years in the US Navy as an Arabic linguist, spending about half of that time overseas in the Persian Gulf region, with additional time spent in the Mediterranean region and the Horn of Africa as well. </font></p>