1. Benefit-Cost Analysis Course: Project & Private Analysis
Financial and Economic
Appraisal using Spreadsheets
Ch. 4: Project and Private
Benefit-Cost Analysis
© Harry Campbell & Richard Brown
School of Economics
The University of Queensland
© Harry Campbell & Richard Brown, School of Economics, University of Queensland, 2003

2. Private Benefit-Cost Analysis
Benefit-Cost Analysis Course: Project & Private Analysis
Private Benefit-Cost Analysis
Deriving ‘Project’ and ‘Private’ cash flows:
Project cash flow refers to cash flow for the overall project
At market prices
Irrespective of who gains or loses.
© Harry Campbell & Richard Brown, School of Economics, University of Queensland, 2003

3. Private Cash Flow
Private cash flow refers to cash flow to the individual investor engaged in project.
at market prices
after allowing for loan service costs
after payment of profits taxes

4. Deriving Private Cash Flow
To derive private cash flow, we begin by calculating overall project cash flow.
We then subtract from the project cash flow:
Debt/financing inflows and outflows to creditors
Taxes paid to government

5. Cash Flow on Equity
The private cash flow is the cash flow on the investor’s own funds or ‘equity’.
Project cash flow minus debt cash flow = cash flow on equity (before tax).
Cash flow on equity is the residual: what is left over after servicing debt.

6. Deriving Project Cash Flow
To derive project cash flow we need to be mindful of some important concepts and conventions:
Incremental rather than total cash flow: ‘with project’ less ‘without project’ cash flow. See table 4.2.
Inflation: usual to use constant prices with a real discount rate (otherwise, nominal prices with nominal interest rate). See table 4.1.

9. Deriving Project Cash Flow
Depreciation excluded from cost to avoid double counting. (See table 4.3)
Changes in working capital appear under investment costs at the beginning and end of the project. (See table 4.4)
Interest on debt excluded from cost to avoid double counting.

11. Debt Financing Cash Flow
To derive debt financing flow, for each period, from the borrower’s perspective, begin with project cash flow, then:
Add all loan receipts in each period
Subtract all interest payments in each period
Subtract all principal repayments in each period

12. Private Cash Flow (Equity)
To derive private cash flow, for each period, before tax:
Add debt financing flow to project cash flow.
(See table 4.5)

14. Project = Debt + Equity
Cash flow from the perspective of lenders and investors adds up to Project Cash Flow. (See table 4.6)

15. Deriving IRR on Equity
We can calculate IRR on each ‘component’ of cash flow: project, debt and equity.
First, calculate IRR on Project Cash Flow:
when NPV = 0
-5000 (1.0) (AF10) = 0
AF10 = 5000/1000
= 5
IRR = 15%

16. Deriving IRR on Equity
Second, calculate IRR on Debt Financing Cash Flow:
when NPV = 0
-3512(1.0) +500(AF10) = 0
AF10 = 3512/500 =
IRR = 7%

17. Deriving IRR on Equity Third, calculate IRR on Equity Cash Flow:
when NPV = 0
-1488(1.0) + 500(AF10) = 0
AF10 = 1488/500 =
IRR = 31%

18. Gearing and Debt: Equity Ratio
IRR on Equity + IRR on Debt = Project IRR
Project IRR minus IRR on Debt = IRR on Equity
By changing the ratio of debt to equity, you can change the
IRR on equity, given the Project IRR and IRR on debt.

19. An Example of Gearing Assume debt:equity is $60:$40
Assume Project IRR = 10%,
and, cost of debt = 5%
What is the IRR on equity?
HINT: IRR on Debt + IRR on Equity = Project IRR

20. An Example of Gearing IRR on project = 0.6(IRR on debt)
+ 0.4(IRR on equity)
10% = 0.6(5%) + 0.4(x%)
0.4(x%) = 10% - 3%
IRR on equity = x% = 7/0.4
= 17.5%

21. More Gearing IRR on project = 0.8(IRR on debt) + 0.2(IRR on equity)
10% = 0.8(5%) + 0.2(x%)
0.2(x%) = 10% - 4%
IRR on equity = x% = 6/0.2
= 30%

22. 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 might appear ‘bad’.

23. 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 through their effect on the project's taxable profits.
The analyst needs to prepare a separate statement to calculate the project's taxable profits.
The two items that are not part of the project’s cash flow that
enter into the calculation taxable profits are:
– depreciation
– interest on debt

24. Calculating After Tax Cash Flow
Benefit-Cost Analysis Course: Project & Private Analysis
Calculating After Tax Cash Flow
These should be added to the operating costs in the project cash flow for the purpose of calculating taxable profits.
Taxes due are then calculated as some % of taxable profits and are deducted from the private cash flow to derive the after tax private cash flow.
© Harry Campbell & Richard Brown, School of Economics, University of Queensland, 2003

25. Calculating Taxes
It should be noted that tax laws vary from one country or state to
another. In most cases, losses can be written off profits earned
elsewhere or of future profits.
This implies that there could be negative taxes in some project years.

26. To Summarise Project cash flow minus debt finance minus taxes
equals private cash flow
(on equity after tax)

27. Using Private BCA
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 stakeholder’s whose gains are part of the ‘Referent Group’ net benefits.
Because the policy maker needs to know what is ‘in it’ for the investor: need incentives or tax concessions? etc

28. Distribution of Net Benefits
The project net benefits (at market prices) can be disaggregated among three stakeholder groups:
equity holders (private or public sector)
lenders
recipients of taxes (government)

29. Shares of Project’s Capital

30. Shares of Project’s Net Benefits (hypothetical)

31. Distribution of Net Benefits
At a later stage we will be looking at the distribution of all project net benefits among stakeholders, including those not included in the project’s net benefits at market prices.
At this stage it is still useful to distinguish between
Referent Group and Non-Referent Group Net Benefits.

32. Distribution of Project Benefits

33. NFG Case Study: Project & Private