Chapter 4: Market & Private CBA Flashcards Preview

ECON3220 Final Exam > Chapter 4: Market & Private CBA > Flashcards

Flashcards in Chapter 4: Market & Private CBA Deck (12):
1

Market cash flow

Cash flow for the overall project at market prices, irrespective of who the gainers and losers are

2

Private cash flow

Cash flow to the individual investor engaged in the project at market prices, after allowing for loan service costs and after payment of profit taxes

3

Deriving private cash flow

Calculate overall market cash flow, then subtract:
- debt/financing inflows and outflows to creditors
- taxes paid to government

4

Cash flow on equity

The private cash flow is the cash flow on the investors own funds or "equity"
- market cash flow minus debt cash flow = cash flow on equity (before tax)
- cash flow on equity is what is left over after servicing debt

5

Deriving market cash flow: concepts to be mindful of

- Inflation: usual to see constant prices with a real discount rate (otherwise, nominal prices with nominal interest rate)
- Incremental rather than total cash flow ("with" vs "without")
- Depreciation: excluded from cost to avoid double counting. But "scrap value" or "salvage" is added to cash flow in the last year
- Changes in working capital appear under investment costs at beginning and end of project
- Interest on debt excluded from cost to avoid double counting

6

Deriving debt financing cash flow

To derive debt financing flow from the borrower's perspective, begin with market cash flows, then:
- add all loan receipts in each period
- subtract all interest payments in each period
- subtract all principal repayments in each period

7

Deriving IRR on equity

1. Calculate IRR on market cash flow
2. Calculate IRR on debt financing cash flow
3. Calculate IRR on equity cash flow

8

Gearing and debt: equity ratio (IRR)

IRR on equity + IRR on debt = Market IRR

9

Implications of gearing

If an investor can borrow on concessional terms a "bad" project can appear "good"
If an investor borrows on unfavourable terms a "good" project can appear "bad"

10

Calculating after-tax cash flow

Some items of project cost that do not enter into a project's cash flow directly, affect the net cash flow indirectly though their effect on the project's taxable profits:
- depreciation
- interest on debt
These should be added to the operating costs in the market cash flow for the purpose of calculating taxable profits
Taxes are then calculated as some % of taxable profits and are deducted from the private cash flow to derive the after tax private cash flow

11

Using private CBA: why would the project analyst who is concerned with the wider public or social interest be concerned with the return on private equity?

- When the private investor is one of the stakeholders' whose gains are part of the Referent Group net benefits
- Because the policy maker needs to know what's in it for the investor: need incentives? tax concessions? etc.

12

Distribution of net benefits

The market net benefits (at market prices) can be disaggregated among three stakeholder groups:
- equity holders (private/public sector)
- lenders
- recipients of taxes (government)