Investment decisions, with special reference to social and developmental projects, should be justified by economic analysis in order to test the projects' real contribution to the welfare of the society. Accordingly, two types of economic studies could be conducted:
Economic Viability Studies (Cost-Benefit Analysis);
Economic Impact Studies.
It aims at identifying and quantifying the economic benefits (direct and indirect) of the underlying project, to be weighed against the economic costs for such project (including the mitigation cost to prevent the negative environmental impacts). In this respect, the economic viability (national profitability) is concerned with the contribution of the underlying project to the national economy, in order to justify the investment decisions taken on behalf of the society.
All inputs and outputs are valued at their economic prices (i.e. shadow prices) in order to compensate for any price distortion. Both benefit and cost items, as well as foreign exchange rate and social discount rate, are based on constant prices of the base year.
All future values are discounted at the social opportunity cost of capital, which is expressed as the Social Discount Rate (SDR). The interest rate on long term loans at which the country can actually borrow capital from the relevant international market is taken as an appropriate basis for estimation of the social discount rate. The interest rate is then adjusted to take into account the prevailing economic and political conditions of the country.
In this respect, basic economic indicators are adopted to test the economic viability of the underlying project:
Economic Rate of Return (ERR), which reflects the discount rate that reduces the present value of the future stream of net benefits from a project to zero. The project is economically viable if ERR is greater than the Social Opportunity Cost of Capital.
Present Value of Net Benefits, where the net benefits generated by the project over its expected life is discounted at the social discount rate to arrive at a present value, which can be compared with the present value of the investment cost to test the economic viability of the project. Economic viability implies that present value exceeds investment cost, i.e. positive net present value.
2. Economic Impact Studies:
Economic impact is carefully investigated to test the impact of the project on the society, through measuring the direct and indirect (including induced) effects of three basic macro parameters:
National Value Added (NVA) Effect, i.e. contribution to the national income;-This includes estimating Relative Efficiency Test (RET), i.e. impact of investing 1 LE or USD in the project on value added.
Employment Effect, i.e. job creation, as well as cost of creating one job;
Foreign Exchange Effect, either through foreign direct investment, export generation, savings or import substitution.
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