Part D - Technical notes

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This section of the manual attempts to fill in some of the technical detail touched upon in Part B where the various stages of the design process are outlined. To make these technical notes more useful a case study approach has been adopted, primarily using illustrative material drawn from FAO studies in Nepal, Thailand, Brazil and the Near East.

10. Project justification

The purpose of any market development programme is the promotion of an environmentally sustainable project, combining the provision of benefits to producers and consumers with profitability of market operations. To evaluate whether this is actually achievable a systematic and rigorous approach must be adopted in analysing a project.

The intention of this chapter is to amplify the discussion on project justification outlined in the description of project formulation and feasibility in Chapter 5. Further background to the subject of project economics and details of appraisal techniques are contained in the publications listed in the Bibliography.

Particular reference should be made to Price Gittinger, I (1972. Economic analysis of agricultural projects. Baltimore, The John Hopkins University Press); Abbott, J.C & Makcham, J.P. (1979. Agricultural economics and marketing in the tropics. Harlow, Longman); and Harrison, K. (1987. Improved food marketing and delivery Systems, in Elz, D. [ed.] Agricultural marketing strategy and pricing policy. Washington DC, World Bank).

Financial analysis assumptions

The first step in making a financial analysis (see Chapter 5) will be to phase the inputs of materials, equipment and labour required over the project's life and cost them, in present day prices, so that cash flow tabulations can be created. Assumptions that will need to be made in order to prepare cost estimates of the capital works, recurrent expenditure and anticipated revenues for the project, are described in the following section.

Table 10.1 Typical cost elements for site preparation works

Source: FAO Project TCP/THA/8958

Table 10.2 Typical cost elements for site infrastructure

Source: FAO Project TCP/THA/8958

Capital costs. Costs for civil works are usually developed on the basis of multiplying approximate quantities by global "unit rates" derived from an analysis of similar, recent contracts. The quantities are estimated from the projected schedule of accommodation and measured off the outline designs for buildings and infrastructure defined in the site master plan. For the purposes of this analysis the cost for buildings is usually estimated on a simple per square metre basis, whilst for other infrastructure costs more detailed estimates will need to be made. Typical items that might need to be included in infrastructure estimates, which are explained in detail in Chapter 14, are shown in Tables 10.1 and 10.2.

The costs of major materials might be assessed separately. These include the costs for stone, gravel and sand, which might be obtained directly from a number of local quarries. Because the fabrication of the main structure is also likely to be a major cost component, separate budget costs for this might also need to be obtained. In general, materials for building and infrastructure design should either be locally manufactured or easily available as imports from local suppliers. However, a guaranteed supply and substantial saving in steel work and cement costs can sometimes be obtained by a project if it uses imported materials in lieu of what is locally available. Equipment may also need to be imported and cost estimates for these items should cover, if appropriate, the complete supply (c.i.f. for the destination city), including labour and materials in installation, commissioning, maintenance and spares. Typical market equipment is shown in Table 10.3.

Table 10.3 Typical market equipment

Source: FAO Project GCP/NEP/043/SWI

The build-up of capital costs should include provision for technical assistance and professional fees of design and supervision consultants. This is usually estimated on a percentage basis (typically 10 percent overall) for both pre-contract services and site-supervision. Sometimes the local custom is for the site-supervision element of fees to be charged on a time basis, but using an overall percentage is adequate for financial analysis.

Civil works and equipment cost estimates should include a 10 - 20 percent physical contingency. Price contingencies for inflation should not. however, be included in cash flows (although they may form part of project budget estimates ) as the analysis is undertaken in current prices.

For furniture, fittings and minor equipment a dump sum estimate can be included, normally based on prevailing local prices for other construction projects or by applying a factor of around 5 percent to the capital costs.

Although a market site may already be owned by a market authority or government an allowance should he included in the cash flow for land purchase, again at current prices. Often there is a need for temporary rented accommodation for market offices or storage during the construction period and this should be included in the cash flow as an approximate lump sum.

It is also sometimes necessary to identify separately any items requiring a major foreign exchange component, particularly if this feature is going to be analysed in the economic analysis.

Table 10.4 shows a compilation of capital costs for a the first phase of a medium-sized market development programme. The table incorporates all the construction costs, major equipment, technical assistance and physical contingencies.

Recurrent costs. The main operating expenditure of a market will be staff wages and salaries. These should ideally be built-up from detailed staffing establishment figures (see Chapter 7), using prevailing pay scales in the private sector. Bonus payments, based on formulas for market productivity, may also need to be included in the cost estimates.

Other items of recurrent expenditure should again ideally be estimated on the basis of data which may be available from similar markets in the region. Typical items of expenditure that should be included are shown in Table 10.5. An overall percentage basis may have to be used if insufficient detailed costs are available. A 10 percent physical contingency is usually added to the overall operating costs.

A sinking fund should also be included, calculated on a straight line or declining balance basis. Depreciation should assume a 25-years life for civil works, with a residual value equal to acquisition costs plus site preparation, a 10-years average life for equipment and 5 years for furniture and fittings. Most desk top calculators with financial functions or spreadsheet programmes have a facility for calculating depreciation.

Revenues. The revenues generated from wholesale markets are the most difficult components to estimate. Revenues for markets charging market fees directly on sales or operating an auction system are the easiest. In this case it is usual to assume as a "basic" case that revenues might be around 5 percent of the turnover, which is a fairly normal rate of commission levied in wholesale markets (see Chapter 8).

To prepare estimates of revenues on sales sensible assumptions will need to be made about the growth in turnover, as well as estimates of the average value of produce. The latter can be derived from a combination of roadside surveys of produce types and price data.

Table 10.4 Sansai Market Centre: construction costs (Bht '000)

Source: FAO Project TCP/HA/8958 Note: # constructed in later phase

Table 10.5 Typical market operating expediture

Source FAO Project GCP/NEP/043/SWI

Other revenues, from the monthly rental for stores, from market fines (a minimal amount) and from services such as washing, grading, packing and parking fees, can be estimated as 30 per cent of the amounts collected as market fees or as commission on auctions. A more refined method to estimate annual revenues (or when a market does not charge market fees or auction commission) is to use an assumed set of financial analysis parameters. Typical examples of such parameters are shown in Table 10.6 Unit rates extrapolated from actual market rates, where these are available (such as typical rental or parking charges), would be applied to these parameters to derive revenues.

Terms used in financial feasibility studies

Although there are many techniques for analysing projects, such as by the use of goals-achievement and social cost-benefit analyses, the preferred method for marketing investment projects is usually one that adopts an internal rate of return as the main criterion. This basic method for calculating financial and economic returns, using a desk-top calculator or spreadsheet, has already been outlined in Chapter 5. The following notes amplify a number of the technical stages that are used in such an analysis.

Table 10.6 Typical financial analysis parameters

Source: FAO Project GCP/NEP/043/SWI

Projected cash flows. Cash flows arc a means of representing in a tabular form all the costs and benefits of a project that have been discussed earlier in this chapter. Each year of a project's life is represented by a column in a cash flow table. The rows of the table represent the costs and benefits occurring in each year. An example of a project cash flow and the resulting financial analysis is shown in Table 10.7. The analysis is not taken beyond around 25 years as this will have little impact on a project's rate of return.

Discounted values. A market investment project is developed over a number of years and its costs must therefore be phased to reflect this. So that the financial analysis can be undertaken in present day prices, all these costs are converted into current prices by applying discount rates, usually of between 10 -20 percent. The spreadsheet programme or desktop calculator will normally allow this to be automatically calculated.

Net present value. A project's capital and recurrent costs, and gross returns can be directly related in the cash flow to obtain its annual net revenues, which arc the balance of revenues over expenditure (whether positive or negative). With the application of discount rates, these can be converted into a single figure, the net present value, which represents the total value (or worth) of a project in present day terms. This figure is equivalent to the sum that would be required to go out and purchase such a market

Table 10. 7 Sansai Market Centre: financial analysis (Bht. million)

ANALYSIS:
Internal financial rate of return = 19.34 percent
Net present value = 159.34 million Bht. at a 10 per cent compound discount rate

Source FAO Project TCP/HA/8958

Internal rate of return. The return on any investment can be expressed as a percentage; the internal rate of return. This represents the average earning power on the investment over its life, in which the total of the discounted costs and benefits (the net present value) are zero. The calculation can be applied to the financial returns on a project or to the adjusted economic returns (see Chapter 5).

If this calculation is undertaken manually it has to be by series of approximate calculations (iterations), whilst a computer or financial calculator will automatically produce a single value. To input data into the spreadsheet or calculator it is only necessary to specify the following: the amount of the initial (first year) net investment;

· each successive net cash flow amount, for the remaining 24 years; and
· a discount rate equivalent to the opportunity cost of capital (in this case taken as 10 percent).

An internal rate of zero will mean that a project has covered its capital and operating costs. A higher rate will mean that it has made a profit. A
rate of return of between 15 - 18 percent is usually found acceptable in less-developed countries.

Specilalist analysis

In some cases a different approach will need to be taken in the financial and economic analysis from that discussed in Chapter 5. Examples might include:

· integrated projects, with widely varying benefits, where the wholesale market is only a component of a larger programme, which might also include assembly markets, storage facilities, market extension and training, collection centres and rural roads;
· partial market-improvement programmes, where only a limited investment is undertaken and the impact is confined to only a part of the market's operation. An example of this might be the introduction of a traffic management scheme, where the benefits could be assessed by reference to reduced transport costs; or
· the provision of specialist facilities at a market, such as large-scale grain drying and silo storage facilities, abattoirs and cold storage.

These problems are outside the scope of this manual and should be subjected to a separate detailed justification. Because, however, cold storage is often included as part of a comprehensive market development programme the following notes amplify the types of problems that such infrastructure might create.

Justification for cold storage. The justification for cold storage must be thoroughly examined before entering into costly investment decisions, which frequently turn-out to be "white elephants". In general, it is better if gluts are prevented by using production planning to allow staggered harvesting times.

There are, however, cases when refrigerated cold storage can help the market situation. This can particularly apply with imported fruits, such as apples, where they are being sold through the wholesale market. It can also apply to local produce at harvest time, when a large crop of a particular produce is being harvested and a farmer becomes aware that the volume being sent to market cannot be absorbed without causing a serious over-supply. Through refrigerated cold storage some tones of produce can be loaded into store within hours of harvest and maintained in sound condition until supplies begin to tail off and prices improve.

Although this may justify the use of cold storage, the site does not have to be in the market and it is often more appropriately located in the production areas. Market cold stores are needed:

· to hold imported fruit;
· to hold truck loads coming from the off-market cold stores for sale at the market; and
· to provide temporary storage for small quantities to prepare for main market days or for holding temporary surpluses.

As a basis for evaluating the need for cold storage the types and quantities of crops that can be stored should be thoroughly reviewed, by looking at the supply situation and the practicality of storing that type of produce. In general, the vegetable crops that may safely be cold stored are potato, onion and carrot. No attempt should be made to store other more delicate vegetable crops until practical experience in cold storage management has been gained. Of the fruits, orange, lemon and apple are the most practical for cold storage.

Cost estimates for cold storage. Budget prices for refrigeration and cooling equipment are difficult to estimate and assistance should be obtained from suppliers in determining the appropriate capacity (specified in metric tons) and equipment needed. The following items should typically be included in a budget estimate:

· Supply and installation of refrigeration machinery, typically comprising ammonia reciprocating compressor, atmospheric condensers (1 standby), blowers, accumulator, defrosting equipment, liquid receiver, oil separator, pipework, fittings and electrical equipment (compressor motor, air handling motors, re-circulating pumping set, 3 phase electrical supply);
· Supply and installation of ice making plant;
· Supply and installation of stand-by diesel generator;
· Supply and installation of ducting;
· Freight and insurance;
· Labour and materials in installation; and
· Commissioning, I years maintenance and spares.

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