INVESTMENT
COORDINATION COMMITTEE (ICC) RATIONALE, FUNCTIONS
I.
Rationale
This set of guidelines on project evaluation aims to provide standards
of procedures for the ICC in assessing development projects to ensure their
technical, financial, economic and social merits. The procedures are also formulated to achieve uniformity in and
set the basis for evaluation. An
appreciation of these procedures is deemed necessary in order for the proponents
to understand the various information requirements of the ICC as contained in
the ICC-PE forms and is envisioned to facilitate the processing of requests for
clearance.
These guidelines are
organized into eight (8) sections. The
first four (4) sections cover the procedures in undertaking the financial,
economic, technical and institutional evaluation of projects. Section VI provides the steps in undertaking
a sensitivity analysis of the selected parameters. The evaluation of technical assistance components of projects is
given in Section VII. Section VIII, on
the other hand, describes the procedures in conducting public consultations on
projects.
II.
Financial
Evaluation
These guidelines shall apply to revenue generating projects of
government agencies, government-owned and controlled corporations (GOCCs) and
private sector firms/entities whose projects qualify under the conditions set
for private sector access to ODA.
A special case of financial analysis is carried out for agricultural
projects where farm income analysis is undertaken. Please refer to Technical Annex A for specific guidelines.
A.
Objectives.
1.
To
assess the financial viability of a project and its ability to meet its
debt-service obligations, and
2.
To
determine, thru the GCMCC, the financial capability of government corporations
to finance their proposed projects.
B.
Procedures
1.
The
project proponents shall submit ICC-PE Forms 1 to 5, hereby attached as
Attachment 1.
2.
In
addition, the proponent, if a private enterprise, shall submit the following:
a.
projected
cash flow of the enterprise covering the entire project life including the year
prior to project implementation using the GCMCC format (Attachment 2) with the
addition of an account indicating the beginning cash balance; and
b.
the
audited financial statements covering a period of at least three (3) years
prior to implementation of the project, as applicable.
The major assumptions used
in the financial statements, (e.g., exchange rates, volume of sales, prices)
should be clearly stated.
3.
If
necessary and where applicable, the Secretariat may require the proponent to
submit a market study of the project.
This shall include a definition of the types and nature of the
products/services to be generated by the project, their specific and potential
markets, existing and projected demand and the resulting supply gaps.
4.
In
the financial analysis (using constant prices), contingency allowances may be
provided as follows:
a)
physical
contingency, which represents an allowance for increases in the quantity of
real goods and services utilized for the project;
b)
price
contingencies, for relative price changes, involving changes in the market
price structure for project inputs and outputs.
Physical contingencies are
usually estimated separately for each major cost component, and separately for
local and foreign costs. Normally, this
is 10% of direct cost, although higher allowance is possible for
complicated/lengthy works which are more vulnerable to design changes and
adverse external phenomena.
For price contingencies,
escalation rate is applied to major cost/benefit items, which is the projected
annual price change of the item net of the general inflation rate.
5.
For
local cost items, relative price changes can be projected from past trends in
the item’s price movement relative to inflation, or from forecast demand/supply
trends. For internationally traded
goods, price project can be sourced from international publications (especially
World Bank Commodity Price Projections or WBCPP).
Projections of relative
prices for local items need not extend beyond medium term (5 years). Local price relationships may be assumed
constant beyond the 2-year period.
Cash flows given in current
prices are converted to constant terms, thru the use of general price
deflators. The GNP Implicit Price Index
(IPIN) is the deflator for local costs, while the manufacturing unit value
(MUV) Index (IPIN) is the deflator for
local costs, while the manufacturing unit value (MUV) index (from the WBCPP) is
appropriate for foreign components.
6.
The
ICC-Secretariat shall determine the financial viability of projects from
either, or both, of the following viewpoints:
the “all capital” viewpoint and the “equity capital” viewpoint. The former looks at the discounted returns
to all real investment flows for the project as a whole, irrespective of
whether these come from equity or from loans.
The latter looks at the proponent’s (investor’s) equity contributions as
the investment, such that loans proceeds are treated as inflows, while loan
repayments are treated as outflows.
7.
In
both cases, the financial internal rate of return (FIRR) and the net present
value (NPV) shall be computed based on the validated submissions of the project
proponents of the benefit and cost streams.
For the project to be financially viable in the “all capital” invested
approach, the resulting FIRR should exceed the weighted average cost of capital
(WACC), while the NPV should be greater than zero using the same WACC as the
discount rate. The computation of the
WACC shall be described below.
Meanwhile, for the “equity
capital” approach, the resulting FIRR should exceed the cost of equity
contribution of the proponent while the NPV should be greater than zero using
cost of equity capital as discount rate.
8.
The
WACC is the weighted average of the yields net of tax on different sources of
funds of the proponents. This is
determined by calculating the relative weights of the capital resources and
multiplying them with the corresponding opportunity cost of capital for each of
the capital resource. The WACC is
mathematically represented in equation form by:
WACC = Pe X
Re / P1 X
R1
Where Pe = percentage of equity investment to
total
capital investment
Pc = percentage
of corporate funds
(i.e.,
internal cash generation
for
government corporation).
P1 = percentage
of loaned funds
Re = opportunity
cost of capital of equity funds
Rc = opportunity
cost of capital of
corporate
funds
R1 = effective
cost of loaned funds,
Pe +
Pc / P1 = 1
The use of
the WACC in financial analysis should be limited to cases where the project’s
risk is consistent with the overall
business risk of the company, and that the project will be financed from
a pool of funds with proportions indicated in the WACC.
Otherwise,
the equity capital approach is more appropriate, particularly
a.
when
capital markets are imperfect, where cost and availability of long term capital
is unpredictable, and prevailing financing sources are relied upon at any given
time; and
b.
when
the nature and scale of the project influences the sources and cost of
financing, such as in a case when foreign financing is tied to the project.
Conditions relevant to GOCCs
appear to warrant the application of the “equity capital” approach if the
sources of financing being considered come from abroad and may be viewed as
tied to the particular project at hand.
Since the “stockholder” of the GOCC is the economy-at-large, the cost of
equity capital is the opportunity cost of capital to the economy.
If the project involves
foreign sources of funds, the decision makers have to decide whether foreign
funds may be treated as tied to the project, in which case, the “equity
capital” viewpoint should be adopted.
Specific examples of the
appropriate approach to pursue are provided in Technical Annex B.
9.
The
proponent shall be guided by the projected foreign exchange rates as indicated
by the Secretariat, in converting foreign funds into their local currency
equivalent.
10.
Under
the “all capital” analysis, the foreign exchange risk can be captured by adjusting
the WACC. Projected annual movements in
the peso rate against relevant currencies will be converted by the Secretariat
into corresponding percentage points adjustments in the WACC.
Under an “equity” capital
approach, repayments for foreign loans as outflows should be converted to peso
equivalent using projected exchange rates.
11.
For
public sector proponents, the GCMCC shall evaluate the ability of the
corporation to finance the investment cost (local component) and meet the
debt-service requirements of the project.
GCMCC shall then submit a formal evaluation to the ICC, indicating therein its recommendations,
findings and the bases for favorable endorsement of the GOCC’s project to the
Technical Board.
For private sector
proponents, the ICC Secretariat shall appraise the private firm’s capability to
shoulder the investment cost and assess its repayment capacity. This will be undertaken through the
following:
a.
Ability
of the corporation to finance the local investment cost of the project.
This shall be
determined by subtracting the capital requirements of ongoing projects and the
corporate debt-service from the internal cash generation (ICG) and comparing
the net with the local cost component of the proposed project. A net ICG greater than the local cost
component indicates that the corporation may be able to finance the project;
otherwise, it can be expected that it will resort to borrowings.
b.
Ability
of the corporation to service its principal amortization and interest payment.
This requires a
projection of the financial position of the company when the project is already
operational and when it is already amortizing its loan.
To determine the
effect of the project on the corporation’s financial position, the ICG of the
corporation should be positive after deducting the project’s interest and
principal repayments, together with other obligations falling due. Otherwise, the corporation, based on its own
operations may not be able to service fully or in part the project’s debt
service requirements and may have to resort to external funding.
12.
For
both public and private proponents, cash flows should also capture tax payments
(i.e., corporate taxes) inasmuch as the cost of capital measure is on an
after-tax basis.
13.
For
private firms, the financial evaluation shall be complemented by the estimation
of relevant financial ratios, with and without the project, based on submitted
balance sheets and income statements.
The ratios are contained in Technical Annex C.
III.
Economic
Evaluation
A.
Objective
To ascertain the project’s
desirability in terms of its net contribution to the economic and social
welfare of the country as a whole.
B.
Procedures
1.
Documents
submitted by proponent agencies for financial analysis shall be the take-off
point for economic analysis.
2.
The
steps involved in economic evaluation are as follows:
a. Identification of project costs and benefits. Since projects are usually evaluated in
terms of their effect on national income, costs and benefits identified must
necessarily reflect the additions to and reductions from national income as a
result of project implementation.
i.
Economic
Costs[1]. The basic guidelines in identifying the
costs of a project stems from the definition of cost itself, or activities that
involve use of real resources. Cost items
are usually classified into two (2) types:
capital costs and operating and maintenance costs which may include the
following:
Capital Costs –
land, detailed engineering and design; preparatory installation work; cost of
equipment; raw materials and supplies for construction; cost of buildings and
auxiliary installations; engineering and administrative cost during
construction, organization cost;;
Operating and
Maintenance Costs – raw materials and other supplies; energy and fuels; labor;
rent and insurance; depletion of natural resources.
ii.
Benefits. A benefit constitutes an increase in output
or savings in resource use. In the case
of transport projects for instance, the set of benefits may include: reduced vehicle operating costs; lower
maintenance costs; fewer accidents, savings in time for passenger and freight;
and in the case of developmental transport infrastructure, production
increases. Of these cases, only the
first two benefits and the last are easily quantifiable. However, to the extent possible, the effects
of other benefits on national income should be quantified (e.g., value of each
human life saved in terms of the capacity to earn during productive life).
iii.
Externalities
and Secondary Benefits. In several
cases, project effects – positive or negative – go beyond the limits of the
project, but are not reflected in the financial accounts of the project. If these effects, known as “externalities,”
involve a significant economic cost or confer a significant economic benefit,
these should be taken into account in estimating the overall economic impact of
the project.
The external economic impact
on the cost side may include increased pollution resulting from cement or a
chemical plant, or the adverse effects of an irrigation scheme on health and
fisheries. External economic benefits
may include improved recreational or tourist facilities provided by a water
storage dam. While it may not be
possible to measure all such effects, an attempt should be made to identify
them, and if they appear to be significant, to evaluate them.
Secondary benefits, on the
other hand, refer to the beneficial effects on activities which are
technologically linked to the project’s direct users, either forward as
consumers, or backward prove to be significant, they should, whenever possible,
be incorporated into the analysis.
b. Valuation of costs and benefits in
terms of economic prices. This
procedure involves adjustment of the financial prices of goods and services of
both costs and benefits to reflect economic values. Market prices may not be an acceptable measure of the true costs
and benefits due to distortions (i.e., taxes, subsidies, quotas, regulatory
measures, or monopolistic practices).
To deal with this problem, shadow prices are employed to measure the
value of a commodity from the economy’s viewpoint. Technical Annex D provides techniques for adjusting inputs from
financial statements to conform with concepts in economic evaluation.
The valuation of project costs and benefits should be in constant
prices at the current year’s level. In
the case of projects where price levels are not in current year’s levels,
appropriate price indices shall be applied to inflate or deflate prices
accordingly.
i.
Valuation
of Costs. Estimation of project costs
involves an analysis of the supply-demand situation of the project inputs and,
in the case of major projects, the corresponding price changes resulting from
the project’s implementation. General
procedures are as follows:
-
The
entire set of project inputs must be differentiated between those inputs that
reduce the supply to other users, and those inputs that would be supplied from
increased production.
-
For
inputs resulting in reduced supply to other users, the shadow price is the
market selling price appropriately adjusted for the value of rationed
components, the effect of monopoly power in buying or selling and the actual
price impact of the supply reduction.
-
If
the supply of inputs is obtained from
expanded production, the relevant cost estimate is the actual cost of
production.
-
If
some of the inputs are imported or are substitutes for exports, the foreign
exchange cost involved, corrected by the shadow price of foreign exchange,
should be estimated and any transport costs and trade service margin should be
added.
ii.
Valuation
of Benefits. Estimation of direct
benefits involves the following steps:
-
For
outputs leading to additional supply or reducing the output of other local
producers, the shadow price is the market price, corrected for the following: effects of any rationing, monopoly power of
some buyers, and actual price impact based on the size of the additional
supply.
-
For
goods that substitute for imports or add to exports, foreign exchange earnings
or savings involved are estimated and corrected by shadow price of foreign
exchange.
-
For
goods/services that are supplied freely, the value placed by users on the
facilities should be estimated, i.e., what they would pay if they were to
purchase the facilities. This would
likely involve some value judgment.[2]
c.
Measurement
of economic desirability, sensitivity analysis and selection of projects based
on economic feasibility indicators.
The indicator to be used for
estimating the economic desirability of projects shall be the economic internal
rate of return (EIRR), defined as the discount rate which equates the net
present social value (NPSV) of the benefits and costs of the project such that
the NPSV is zero and the benefit cost ratio (BCR) is one. The NPSV is the discounted net economic
benefit accruing to the project. The
decision rule is to accept projects where the NPV is greater than zero.
3.
The
ICC Secretariat shall provide the following parameters for estimating the
economic stream of costs and benefits:
a.
Shadow
Exchange Rate
The shadow exchange rate (SER) is applied to
correct the distortion in the prevailing exchange rate due to balance of
payments disequilibrium and the projection structure. The SER currently adopted is 1.20 of the prevailing exchange
rate, and shall be applied to all direct and indirect foreign exchange costs of
a project and those benefits which may expressed in foreign exchange,
particularly in the case of exports and/or import substitutes or savings.
b.
Shadow
Wage Rate
The
shadow wage rate (SWR) is used to reflect the true economic value of labor
employed in a project. The SWR is
applicable only to the unskilled labor component of wages paid and is currently
estimated at 60 percent of legislated wage rates.
c.
Shadow
Discount Rate
The
social discount rate (SDR) shall be used to discount the stream of economic
costs and benefits to their present values.
It is the rate at which the social value of project costs and benefits
decline over time. The SDR shall
likewise be used as the hurdle rate for a project’s EIRR. SDR currently used is 15 percent.
4.
In
addition to the EIRR, the ICC Secretariat shall compute for the domestic
resource cost (DRC) of tradeable goods as the output of the project, where
relevant. This will indicate the amount
of domestic resources used for every foreign exchange earned or saved from
production. The DRC shall apply in
projects that involve production of tradeable goods (e.g., coal, steel, sugar,
etc.)
IV.
Technical
Evaluation
A.
Objectives
1.
To
determine if the project is technically feasible, workable and that its
operations and maintenance can be locally sustained;
2.
To
ascertain if the proposed technology is cost effective; and
3.
To
ensure that the project does not adversely affect the environment and/or that
appropriate measures are taken to protect the environment.
B.
Procedures
1.
The
ICC Secretariat shall evaluate the technical aspects of the project, and may
consult with DOST in cases when the proposed technologies are untried, new, or
old/obsolete. Inputs or comments from
other experts, consultants from industry or academe may also be solicited as
necessary. The technical evaluation
shall cover, among others, the following:
a.
Issues
of technical design such as size, location, timing and technology package
proposed for the project (Refer to Technical Annex E for details);
b.
Advantages
and limitations of the technology used by the project;
c.
If
a new technology is applied; success rate in other countries;
d.
Applicability
of the new technology to Philippine conditions particularly to the proposed
project area;
e.
Environmental
impact that would arise out of using the proposed design of the project; and
V.
Social
Analysis
A.
Objective
To determine if the proposed
project is responsive to national objectives of poverty alleviation, employment
generation and income redistribution.
B.
Procedures
The ICC Secretariat shall,
whenever possible, take into consideration project benefits beyond those that
are simply financial and economic. If
the project is of interest mainly because of its social benefit, this section takes
on added importance. The Secretariat
should devote considerable attention to the analysis of socially desirable but
financially unviable projects. This
will be especially true for private non-profit firms whose projects may be
eligible for access to ODA.
The following aspects may be
considered in the qualitative assessment of the social benefits of the project:
1.
Income
Distribution. The extent to which the
income of the poorest sector o the rural population is improved as a result of
the project may be quantified.
Reference must be made to the relative improvement in comparison with
other groups in the country.
2.
Employment. The extent to which the project reduces
underemployment may be assessed. This
may be quantified in terms of work years created by the project, with
distinction made between permanent employment and employment during the
investment or construction phase. The
number of jobs created may be compared with the expected increase in the labor
force of the project area.
3.
Access
to Land. If the project includes a land
settlement or land reform element, the distribution of land rights with and
without the project should be demonstrated.
4.
Internal
Migration. It may be useful to note the
possible effect of the project on rural-urban migration.
5.
Nutrition
and Health. If the project is located
in an area where serious nutrition or health problems exist, or if the project
is directed toward groups with nutrition and health deficiencies, the expected
effects of the project on these problems might be mentioned. In some cases, the effect on nutrition may
be quantified in the daily intake of calories in protein that is expected as a
result of the project.
6.
Other
Indicators of the Quality of Life. Some
projects may have a significant effect on the quality of rural life through
improvements in access to domestic water supplies, electricity, schools, and
other facilities. These may be
mentioned and the quantities of the new amenities noted.
Technical Annex F presents some pointers for
social analysis for reference.
VI.
Institutional
Evaluation
A.
Objectives
1.
To
review and recommend improvement/revisions on the institutional arrangements
and linkages in order to ensure a more efficient implementation of the project.
2.
To
ascertain the ability of the project proponent(s) to implement the project as
proposed and scheduled.
B.
Procedures
1.
The
ICC Secretariat shall assess the capability of the project proponent(s) to
implement the project, per the proposed activities and as scheduled,
considering the following:
a.
The
internal arrangements within the project organization/implementing agency and
the external arrangements among the project proponent(s) or concerned agencies;
b.
The
feasibility of proceeding as scheduled based on the preparedness of all
concerned agencies; and
c.
When
relevant, the arrangements made to address the concern of those who may oppose
the project (e.g., environmental conservation groups and those who may be
relocated).
The above shall be
complemented with a review of the past performance of the proponent(s) on
related/similar projects.
2.
The
ICC shall recommend possible measures to improve the program of implementation.
VII.
Sensitivity
Analysis in Project Evaluation
A.
Objective
To
determine whether the project will remain feasible if changes in the assumptions
used in the calculation/projections were to take place according to the degree
in which they are likely to vary from the estimated or projected values.
B.
Procedures
1.
Financial
Evaluation
Case I : Increase
in projected costs by 10% and 20%
Case II : Decrease
in revenues by 10% and 20%
Case III : Combination
of Cases I and II
2.
Economic
Evaluation
The sensitivity parameters
above shall likewise be applied in the economic evaluation of projects. The basis will be the cost-benefit flows
(adjusted to economic terms).
Probability weights for the
above sensitivity analysis may later be assigned as validated by the
Secretariat.
3.
Sensitivity
analysis, when constant prices are used, involves testing of relative price
changes. Price contingencies should not
be applied to items for which sensitivity analysis will be performed.
VIII.
Evaluation
of Technical Assistance Components
A.
Objective
To determine/evaluate
project components that may be eligible for separate technical assistance (TA)
funding.
B.
Procedures
1.
The
ICC Secretariat shall determine which components of the project may be
considered for separate technical assistance financing.
2.
In
general, financing for technical assistance involving pre-feasibility or
feasibility studies, project identification, sector survey, institution
building activities including training, shall be sourced from grants. On the other hand, consultancy/advisory
services related to construction activities, including detailed engineering,
shall be considered as part of the project capital cost and may be financed by
the project loan.
3.
Section
10 of E.O. 182 (Rationalizing Public Works Measures, Appropriating Funds for
Public Works, and for Other Purposes; dated 3 June 1987) which sets the
guidelines on the Use of Consultancy Services, shall be considered in the
review of the estimated amounts for hiring of consultants for the conduct of
feasibility studies, detailed engineering, and construction supervision.
a)
Farm
Enterprise Profit. The objective of
farm enterprise analysis is to determine the profitability of the individual
production activities or enterprises.
As such, it provides useful information for decision-making on which
activities to pursue, which to emphasize, and which to discard altogether. It also helps determine whether and how a
particular enterprise may be made more viable.
In terms of definition,
enterprise profit is simply the difference between gross value of production
and total cost of production.
b) Farm Enterprise Gross Value of Production. Gross Value of Production. Gross value of production is a measure of the value of output produced by the enterprise, whether the output is sold, consumed on the farm, or stored for consumption or sale in future accounting periods. All outputs are valued at th