Evaluating Project Economics

 

Evaluating project economics is part and parcel of business development and deal origination. For capital to be allocated, decision makers need assurance that all material factors have been accurately accounted for, and what the deal returns look like. Here are some items to consider in evaluating your deals.

INCREMENTAL POST-TAX CASHFLOWS

To evaluate project investment value, it is vital to consider the incremental after-tax cashflows net to the shareholder from doing the deal as opposed to not doing the deal. Assessing whether to pursue greenfield projects is fairly straightforward, as the incremental cashflows = the project cashflows as the alternative is to do nothing. For brownfield projects, project cashflows should be assessed against cashflows in a minimum stay in business scenario where future capital expenditure is limited to non-discretionary capex.

INFLATION AND CURRENCY

In project economic evaluation, it is best practice to consider nominal (money of the day) cashflows which accounts for inflation effects for each line item. This is particularly important in investments in emerging or frontier markets where the inflation rate for costs can vary wildly from that of revenues. For instance, a crude oil producer in Indonesia sells oil in US Dollars (USD) which inflates at USD inflation rates, but incurs costs in Indonesian Rupiah (IDR) that are subject to IDR inflation rates. For modelling purposes, cash costs and revenue receipts should be modelled in the currency that they are expected to be incurred or received in, respectively. That means matching currency specific inflation rates to each cashflow and thereafter converting them to the model functional currency.