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):

Market cash flow

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


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


Deriving private cash flow

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


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


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


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


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


Gearing and debt: equity ratio (IRR)

IRR on equity + IRR on debt = Market IRR


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"


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


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.


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)