Who needs to understand FEA and why?

While FEA is usually carried out by economists (e.g. . staff from government, IFIs FAO, and consultants), their close cooperation with the technical experts involved in project design, implementation and evaluation is key to meaningful FEA. Most importantly, decision-makers at various levels have to understand the implications of FEA outcomes to make informed decisions about project design and resource allocations.

What are the main elements of FEA?

FEA starts with analysis of the proposed project’s main objectives and targets that need to be reflected in the project’s logical framework. This is followed by the monetization of the relevant project benefits and of their associated costs (see Costing). FEA basically consists of two main steps: firstly, an assessment of the project’s financial profitability and sustainability in order to determine whether the farmers or other stakeholders will have sufficient incentive to participate in the project; and secondly, an assessment of its economic viability from the point of view of the national economy. FEA should also examine a project’s expected impact on the government budget to ensure its fiscal sustainability. Furthermore, FEA usually includes an assessment of a project’s impact on employment and poverty, as well as an analysis of the distribution of benefits.

What are the differences between FA and EA?

The basic principles for carrying out FA and EA are the same and both are required for project screening and selection. However, there is a difference in approach; FA deals with the cost and benefit flows from the point of view of the individual, firm or institution, while EA deals with the costs and benefits to society. EA takes a broader view of costs and benefits, and the methods of analysis differ in a number of important respects. An enterprise is interested in financial profitability and the sustainability of that profit, while society is concerned with wider objectives, such as food security, poverty alleviation, and net benefits to society as a whole. The main differences between FA and EA are that EA: (i) attempts to quantify “externalities” (i.e. negative or positive effects on specific groups in society without the project entity incurring a corresponding monetary cost or enjoying a monetary benefit. This includes both environmental and social impacts resulting from the project); (ii) removes transfer payments (i.e. subsidies and taxes); and (iii) makes use of “shadow prices” that might differ from the “market prices”, in order to eliminate market distortions and reflect the effective opportunity costs for the economy, thus achieving a proper valuation of economic costs and benefits from the perspective of the economy as a whole.

What are the main categories of FEA?

FEA usually belongs to one of two general categories: cost-benefit or cost-effectiveness. Cost-benefit analysis (CBA) monetizes all major benefits and all costs generated by the project and presents their streams over a given number of years (cash flow). Costs and benefits can then be directly compared with each other as well as with reasonable alternatives to the proposed project. A CBA is generally considered to be the most comprehensive approach and is the standard for FEA. In general, CBA provides two main indicators, the Net Present Value (NPV) and the Internal Rate of Return (IRR). Comparing the NPV of several possible investments allows for identifying the alternative which yields the highest result – for cases in which the alternatives are mutually exclusive. The IRR allows for ranking investment alternatives based on their return on the investment – when a number of projects can be financed – up to a certain maximum investment amount. As such, these indicators are important decision-making tools for national governments, as well as for IFIs and other donors. Cost-effectiveness analysis evaluates which project design options provide the desired results at the lowest cost. While it is similar to CBA in many important respects, it does not attempt to monetize all anticipated benefits deriving from a project or the alternatives considered. Consequently, it only allows for comparisons across project alternatives that deliver roughly similar bundles of outcomes and benefits.

For which types of investment projects should FEA be carried out?

FEA is primarily carried out for “production-oriented” projects that result in net production increases for which financial and economic benefits can be easily quantified. These projects typically include investments in areas such as technology development, extension services, input supply systems, productive infrastructures (e.g. irrigation and storage), rural finance and micro-enterprise development. There are also attempts to qutify the economic benefits generated through positive social and environmental externalities. One example is the estimation of economic benefits from reduced greenhouse gas impacts calculated by the EX-Ante Carbon-balance Tool (e.g. see IFAD 2016, Case studies). FEA should also be carried out for other types of projects that are not directly related to the improvement of production and productivity, although in many cases the financial/economic benefits of these projects are neither identified nor valued. Typical examples are: rural roads; natural resources conservation; community development; institutional strengthening; education and health. Although the identification and valuation of benefits for these kinds of investments is usually more difficult than for productive activities, they should still be outlined separately. The existing literature on FEA provides several approaches to the valuation of various types of projects.

What are the main steps in FEA?

Project FEA is concerned with the incremental costs and benefits of a project, i.e. its contribution to the present situation, and therefore it requires a comparison between the potential situations “with” and “without” the project. The first step is the description of both the baseline scenario before the project starts and the counterfactual scenario, which will usually be a forecast of the future scenario without the project. The second step is the formulation of the project’s expected outcomes in the future, including the investment and operating costs, and the monetized benefits. Because costs and benefits do not occur at the same time – with costs generally preceding and exceeding benefits during the first years of the project – the comparison is not straightforward and hence “discounting techniques” are applied. The third step is the determination of the project’s incremental net flows (financial and/or economic), which results from comparing the situation "with the project" with the situation "without the project". With these elements, it is possible to calculate the corresponding project profitability indicators. The FA evaluates how feasible and sustainable a project will be for the participants. Depending on the project objectives, the FA’s feasibility indicators may include: gross and net margins; profit; incremental family income; return to labour; job creation; and increase in assets, as well as the financial rate of return. When using a participatory approach to project design, these results are important to motivate potential beneficiaries to participate as well as to assess their interest in doing so. FA also informs decision-makers in governments, IFIs  and other donor institutions about how attractive the project is to its potential beneficiaries and informs possible project partners, such as credit institutions, of the feasibility and sustainability of the investments being proposed and hence of the pertinence and advantages of their participation. At the community, household and business level, simplified FAs can help explain the project’s objectives and provide a tool for discussions on its benefits with the participants.

When should FEA be carried out during the project cycle?

FEA has an important role to play at each stage of the project cycle. The earlier the FEA is carried out, the more useful it is as a tool for making decisions about whether to invest at all and about the types of investment. At the project identification stage, a preliminary FEA will help to understand how the project will contribute to the country’s economic development, why the public sector should undertake or finance the project, and what is the value added of requesting IFI support. The initial analysis will provide the basis for determining what further analyses are required to substantiate justification of the project and for deciding on the form of FEA that needs to be carried out.

During project design and appraisal, FEA is primarily carried out to justify project investments and inform decisions on project resource allocation. For FEA to be meaningful, it should not be conducted at the end of the project design process, as it is often the case when FEA is seen merely as an exercise to satisfy institutional requirements. In fact, FEA carried out early in the project design stage will provide useful inputs in the following areas: 

• Logical framework (or results framework) design – the project’s objectives, as stated in the logical framework, need to be linked to the assumptions in the FEA. In this way, FEA helps to formulate clear results at impact and outcome levels and their corresponding indicators (e.g. increased incomes, increased productivity and prices, reduced losses);
• Component selection – FEA provides a tool for evaluating the efficient use of scarce project resources. Assessment of the financial and economic viability of different proposed project activities makes it possible to select activities and components that contribute most effectively to the project’s stated objectives and identify those that should be abandoned or revised;
• Risk assessment – FEA includes sensitivity analyses which test for identified risks to ascertain how they may undermine the financial and economic viability of a project. Sensitivity analyses should be directly linked to risk identification in the logical framework and to the design of risk mitigation measures. Switching value analysis is a particular type of sensitivity analysis used to identify for key variables their effect on project outcomes. The switching value of a variable is that value at which the project's NPV becomes zero or the IRR equals the discount rate;
• Distribution analysis and targeting – FEA makes it possible to assess the project’s impact on the various groups of beneficiaries and thereby to validate the project’s targeting approach. Where possible it is important to assess the fiscal impact of a project, i.e. changes in government revenues and expenditures to sustain its counterpart funds. While most development projects do not have a substantial fiscal impact, large infrastructure projects do call for a more thorough fiscal impact analysis.

During project implementation, FEA informs the government and financing institutions as to whether the project is producing the expected financial and economic results and helps identify opportunities for improvements in design and/or implementation processes. FEA should be an integral part of a project’s monitoring and evaluation (M&E) system, as the project design and the indicators in the project’s logical framework should have been informed by FEA. Specifically, FEA during project implementation will help to:

• ensure that resources are used for financially viable investments as a precondition for adoption and sustained use of technologies by beneficiaries. Typical cases for FA during implementation are business plans or proposals for extension interventions. In fact, in projects providing credit and/or matching grants, FA should be a core element of any microproject or enterprise development plan as a precondition for accessing project funds. FA should also be part of proposals for adaptive research;
• adapt project design to changing circumstances such as prices of outputs and inputs, production technologies, and institutional and policy changes, which may suggest different approaches and design adjustments. Activities that are not generating satisfactory financial results for the intended beneficiaries and the desired economic outcomes should be modified or terminated;
• understand and manage risks (see Risk Analysis). On the basis of the sensitivity analysis carried out during project design, FEA during project implementation provides a tool for quantifying the impact of actual changes in terms of key parameters (e.g. costs, benefits, outreach, adoption and pace of implementation) and for validating the assumptions incorporated in the project’s logical framework. FEA during implementation may identify new risks or adjust the assumptions made during design, and consequently help to identify risk-mitigating measures and any modifications to the project design and/or implementation arrangements that may be needed.

At the project completion stage, FEA is an important tool for the assessment of a project’s impact and efficiency. This requires revisiting the FEA carried out at appraisal (and ideally during implementation) and using updated reality-based information on project outcomes vis-à-vis costs, as well as on the sustainability of the promoted economic activities. This information and the lessons learned can be used in the formulation of future projects and policies. Calculation of ex-post economic and financial rates of return and NPV should be attempted, even if those calculations were not done at appraisal. If it is not possible to carry out these calculations due to lack of data, other measures should be used to assess project efficiency, such as cost per unit of output.

Application of FEA at  countrywide investment plan level

While national investment plans are rarely quantitatively assessed, as their scope is often too broad and encompassing and they usually do not detail specific investment activities, some country or regional investment plans may include project profiles with preliminary (“standard”) FEAs. It is at the project level that investments are clearly defined and where both the FA and the EA are essential for informed decision-making. One example where a FEA was carried out at country level in Rwanda under the Transformation of Agriculture Sector Program phase 3 Program for Results funded by the World Bank.