Financial evaluation is the process to assess the rationality of an investment. For example, comparing the financial benefits of a project or a project financial metrics, as indicated by
the financial internal rate of return (IRR) with the financial cost as indicated by the weighted average cost of capital (WACC).
To achieve goal of cost-effective allocation of capital, investors use different methods.From the point of view of the time factor, techniques profitability of investment projects are divided into:
- static methods, (also known as simple: a view of a single typical period) and
- dynamic methods (so called the discount cash flow analysis - DCF: calculating the cash flows for each period).
This APP calculates the cash flows for each period using index or with absolute values, and the key metrics to help the users in the financial project analysis.
A key indicator is the NPV (net present value), which is the sum of the present values of the differences between cash inflows and outflows in each time period. A discount rate is required to bring future values into the present. Both methods,using the Weighted Average Cost of Capital (WACC) and the investor's opportunity rate, can be used to calculate Net Present Value (NPV) in financial analysis. The choice between the two methods depends on the context and the specific scenario being analyzed.
WACC (Weighted Average Cost of Capital): WACC is a calculation that represents the average cost of financing a company's operations. It considers the cost of debt and the cost of equity, weighted by their respective proportions in the capital structure. WACC is commonly used as the discount rate for NPV calculations. It's a standardized approach and is useful for evaluating projects that are like the company's overall operations. WACC assumes reinvestment at the company's cost of capital.
Remember that the Opportunity Rate of the Investor refers to the rate of return an investor could earn from an alternative investment of similar risk. Using the investor's opportunity rate is more individualized and considers the specific rate of return the investor expects or could achieve elsewhere with a similar level of risk. This method might be preferred when evaluating an investment from the perspective of an individual or a small group of investors.
In some cases, a company might use WACC to evaluate projects as it represents the cost of the company's funds. However, an individual investor might use their opportunity rate as the discount rate for NPV calculations because it better reflects their cost of capital or their next best alternative investment opportunity.
Both approaches have their merits, but they cater to different perspectives. WACC is more standardized and often used in corporate finance for project evaluations, while the opportunity rate of the investor is more personalized and specific to the individual or a smaller entity. The choice between these methods ultimately depends on the context, the nature of the investment, and whose perspective is being considered in the evaluation, whether it's the company as a whole or an individual investor.
The Internal Rate of Return (IRR) is a crucial financial metric used in discounted cash flow (DCF) analysis to evaluate the profitability of an investment or project. It represents the discount rate at which the net present value (NPV) of cash flows becomes zero.
On the other hand, the Modified Internal Rate of Return (MIRR) considers that positive cash flows can be invested at the Investor Opportunity Rate, instead of at the same Internal Rate of Return of the project.
Return on investment (ROI) is a metric used to denote how much profit has been generated from an investment that's been made.
In the case of a business, return on investment comes in two primary forms, depending on when it's calculated: anticipated ROI and actual ROI.
The Benefit-Cost Ratio (B/C ratio) is a financial metric used in discounted cash flow analysis to determine the feasibility and profitability of a project by comparing the present value of its benefits to the present value of its costs. Also, can be calculated using the Investor Opportunity Rate or the WACC.
The Levelized Cost of Energy (LCOE) is a crucial metric used in the energy industry to evaluate the cost of generating electricity from different sources. It represents the per-unit cost of electricity over the expected lifetime of an energy project.
Sources:
- https://online.hbs.edu/blog/post/how-to-calculate-roi-for-a-project
- https://ceopedia.org/index.php/Project_evaluation_methods
- https://www.adb.org/sites/default/files/institutional-document/535126/financial-analysis-evaluation-guidance-note.pdf
Financial evaluation of projects has been well documented through a lot of books and papers since 1950 in each type of industry.
For example, in Renewable Energy: https://www.nrel.gov/docs/legosti/old/5173.pdf
In general:
- https://people.duke.edu/~charvey/classes/ba350/project/project.htm
- https://faculty.washington.edu/toths/ESRM461/Lectures/Week1_Lecture2.pdf
- https://pdf.usaid.gov/pdf_docs/pnadq164.pdf
- Others, referenced by: https://ceopedia.org/index.php/Project_evaluation_methods
- Copeland, T. E., Weston, J. F., & Shastri, K. (1983). Financial theory and corporate policy (Vol. 3). Reading, MA: Addison-Wesley.
- Dasgupta, P., Sen, A., & Marglin, S. (1972). Guidelines for project evaluation. In UNIDO.
- Project Formulation and Evaluation (Vol. 2). United Nations. UNIDO.
- Devarajan, S., Squire, L., & Suthiwart-Narueput, S. (1997). Beyond rate of return: reorienting project appraisal.
- The World Bank Research Observer, 12(1), 35-46.
- Frechtling, J. (2002). The 2002 User-Friendly Handbook for Project Evaluation
When to socialize a project?
Some believe that too soon could lead to the attraction of artificial groups seeking only financial gain. Although this has some basis, delaying socialization too much carries the risk of generating discontent in the true community, simply by not being considered. Furthermore, it is no longer enough to gather the community in an assembly hall to make a presentation with a projector and take a photograph for the record.
- Starting by knowing and understanding is essential, but as in physics, no one can approach a community without having prepared some answers; It is a process that is reciprocal from the beginning.
- We could list some relevant aspects that need to be identified as part of social management:
- Know the background of social and political risks in the territory of influence of your project.
- Learn about citizen mobilizations and what issues they are related to in the territory of influence of your project.
- Learn about the background of other infrastructure projects in the territory and the impacts of social, environmental and property management.
- Learn about the media's perception of the project, similar projects, and other infrastructure projects in the territory of influence.
- Learn about the perception of the authorities about the project, similar projects, and other infrastructure projects in the territory of influence.
- Learn about the perception of communities and social organizations about the project, similar projects, and other infrastructure projects in the territory of influence.
- Learn about the models with which other projects and companies have carried out infrastructure works in the territory of influence.
- It has an evaluation of risks derived from the relational impacts of other actors and projects in the management of infrastructure works that affect the vulnerability of your company and project.
- Know the balances or social debts of other actors in the territory that may constitute a risk for the social viability of your project and company in the territory.
- Know what type and level of risk your project and company represent for other actors in the territory of influence.
What to do with all this?
With due evaluation by specialists, it is possible to define with what intensity and opportunity the following aspects are monitored and acted upon:
- Baseline of risks and expectations
- Map of actors with impact on the project and company in the territory Territorial risk monitoring by actors, places, social, economic and political sectors
- Direct management of relationships with key and critical audiences.
- Management of differentiated content and media according to priorities of key audiences and critics of the territory.
- Strengthening local capacities
The acceptance of projects in the development or feasibility stage is increasingly delayed, due to the lack of insurance on real estate issues. It is recommended to establish the affected areas with sufficient clearance, for example, the slopes that must be formed according to the permitted slope, since they expand the previously defined areas. Avoid isolating strips or areas of the owner that would cause loss of value.
For the buyer, it is usually the same to negotiate a complete lot or a fraction of it. It is recommended to identify land ownership early in unconventional situations such as succession processes, restitution, holders without titles or extinction of ownership in which cases the insurance will take longer.
If the project acquires the attribute of public interest or national interest, it may expedite the delivery of the properties before a judge, but it is recommended to first exhaust all possible avenues of negotiation with the owners.
Like project phases, stages can be identified in this process. It is recommended to consider the following activities classified into several phases:
Phase 1 - Exploration:
- Marking of the required properties, by the engineering manager, on plans or satellite images.
- Compilation of cadastral information with secondary sources
- Preliminary preparation of cadastral records.
Phase 2 - Visit and analysis:
- Tour of the land and identification of the existing use.
- Compilation of cadastral information with site sources.
- Cadastral records update
- Technical study of the property
- Title study
Phase 3 Evaluation:
- Property appraisals
- Evaluation of the use or impact of the property that will not be acquired
- Definition of the type of insurance required: purchase, acquisition of easement or rental
- Definition of value ranges for trading.
Phase 4 - Getting closer:
- Visits to the owners.
- Definition of the communications channel
- Negotiation with owners or holders
- Identification, measurement and joint marking of the required properties.
Phase 5 Ensure the acquisition of rights:
- Joint preparation of the sales promise.
- Sign sales promise
- Advance payment if applicable
- Perfecting the legal act or business
- Payment to owners and/or holders
Phase 6 Sustainability:
- Addressing complaints related to property management
Consider implementing tracking on a technology platform. There are already several solutions that allow integration with BIM.
How much does engineering cost?
The first thing that is acquired in the development of infrastructure projects is recognition for good engineering, regardless of whether it represents 3 or 6% of the entire investment; In addition to having a sufficient level of detail according to the phase in which the project is, when starting construction it must have the attribute of constructability, that is, its design considers the access limitations of people, materials, machinery and equipment. , and consider its use according to the site and the ease of handling in the field and the future operation of the installation.
Performance engineering
Performance engineering, which seeks to be optimal from the point of view of the budget, in addition to meeting the standards and functionality expected by the project and the client, will be based on identifying which are the lowest costs according to the site or country. . Although in some places access to labor is feasible and there is trained personnel, in addition to privileging local employment, in other places due to its scarcity, savings can be prioritized by opting for an increase in materials or machinery or even the acquisition and transportation of prefabricated elements to other locations. The engineering developed can adhere to some standardization of the client or the union, in order to reduce costs during the operation of the asset or reduction of construction time, although it would generate higher costs compared to specific solutions that are theoretically optimal.
BIM
The incorporation of BIM (Building Information Modeling) has become a standard in some sectors while in others it barely advances in isolated initiatives. There are considerable advantages to investing in designing through a digital twin: the reduction of errors, the agility of coordination between disciplines and the incorporation of other dimensions such as budget management, time management and technical construction consultations, in addition to allowing digital access to document management, energy efficiency management, the future operation of the facility, security management during construction or access to assets.
There are various institutions that have worked hard on the BIM issue, providing order and methods to work flows, providing tools and platforms for review, communication and process control. It is spoken in other terms and concepts.
Levels or scopes of Engineering
Here is a proposal that aims to integrate different terminology, new and old, depending on the phase of the project:
|
Id |
Type of engineering |
Eng. % |
LOD* |
Project Stage |
Purposes |
Description |
Detail of the deliverable or model |
|
1 |
Conceptual Engineering |
5% |
LOD 100 |
Ideation |
Informative |
They are generic schematics, sketches, or graphs with geometries without calculations. |
Symbols, annotations, lines, polygons, or other generic representations of information. |
|
2 |
Basic Engineering |
30% |
LOD 200 |
Pre-feasibility |
Cost Estimation and Investor Approval |
It incorporates the expertise of specialists into the designs, with preliminary calculations and secondary site information. |
Shapes with approximate size, perimeter or volume, location, or orientation consistent with preliminary calculations and similar to final shapes. |
|
3 |
Advanced Basic Engineering |
50% |
LOD300 |
Feasibility |
Licensing, budgeting and acquisition of equipment |
It incorporates preliminary soil studies and preliminary topography into the designs, delivering geometries and compliance with standards. |
It includes specific objects that can be measured in the model; It has a representation of the element's size, location and orientation, volume, and includes information such as name and allowable loads. |
|
4 |
Detailed engineering |
75% |
LOD350 |
Contracting |
Specifications for the contracting of services. |
It incorporates soil studies, detailed topography, and other field studies and simulations into the designs. |
Ditto plus construction specifications not alterable by the final drawings of the equipment |
|
5 |
Construction Engineering |
95% |
LOD400 |
Construction |
Construction & Assembly |
It incorporates the final drawings of the acquired equipment into the designs, providing construction details. |
Elements are modeled with sufficient detail and accuracy; For example, it would include conditions of joining beams, plaster, stucco, paint color, baseboard, reinforcement figuration, etc. |
|
6 |
Engineering as Built (AS BUILD) |
100% |
LOD500 |
Operation, reconstruction, or replication |
Operation, reconstruction, or replication |
It incorporates into the designs the changes that were necessary during construction. |
Idem |
