1.4. Criteria for Optimal
Planning
33
If market prices exist to measure the benefits of flood control, irrigation
water, electric energy, and so on, then the market prices should be used to
estimate benefits. In the absence of a market price, the estimated cost of
the least costly alternative source that could be developed if the project
under consideration is not put into effect might be used as a basis for benefit measurement. This method is used extensively to calculate the benefits
from hydroelectric energy. The cheapest alternative, such as thermal or
nuclear power plants, that could provide comparable electric energy would
be used as the energy benefit from the development of the hydro project.
It should be noted, however, that this alternative-cost computation will
not be a correct measure of the benefits unless there is a real demand for
the energy produced and the market can absorb the electricity made available. To calculate agricultural benefits or irrigation water, the concept of
willingness to pay might be used if somewhat competitive markets are at
work. An alternative approach is to use the "with and without" principle
to estimate the agricultural benefits of a project; that is, the irrigation
benefits of the project are calculated by the difference between the rural
income with the project and without it.
A final consideration in establishing the criteria to be used once the
prices are established is how to reduce the monetary values attached to the
benefits and costs to a common point in time (the present) so that an evaluation of a project can be made. The usual method is to calculate the present
value of benefits and costs using a discounting factor. If the value of benefit
b at the period j is bj, then its present value would be &;/(l +
r)where
r is the discount or interest rate. Considerable controversy exists as to the
appropriate discount rate.J Most federal agencies in the United States
use the yield on the long-term federal bonds as the cost of capital and discount rate. If the market interest rate is employed as the correct measure
of the cost of capital, when a high interest rate in the market must be used
for the evaluation of projects, many of the projects will have a negative
present value for their net return.
The problem with regard to the level of the interest rate becomes very
significant in underdeveloped countries. Most of their public projects are
large scale and relatively capital-intensive, and have long economic life.
On the other hand, because of the scarcity of investment capital, interest
rates are very high—much higher than in the more developed countries.
The interest rate is even higher in the unorganized money market for the
majority of the underdeveloped countries where the weighted average rate
of interest is somewhere between 24 and 36% per annum [Meier, 1964].
t See, for example, the Fed. Regist. (1971) and de Neufville and Stafford (1971).
Planning
33
If market prices exist to measure the benefits of flood control, irrigation
water, electric energy, and so on, then the market prices should be used to
estimate benefits. In the absence of a market price, the estimated cost of
the least costly alternative source that could be developed if the project
under consideration is not put into effect might be used as a basis for benefit measurement. This method is used extensively to calculate the benefits
from hydroelectric energy. The cheapest alternative, such as thermal or
nuclear power plants, that could provide comparable electric energy would
be used as the energy benefit from the development of the hydro project.
It should be noted, however, that this alternative-cost computation will
not be a correct measure of the benefits unless there is a real demand for
the energy produced and the market can absorb the electricity made available. To calculate agricultural benefits or irrigation water, the concept of
willingness to pay might be used if somewhat competitive markets are at
work. An alternative approach is to use the "with and without" principle
to estimate the agricultural benefits of a project; that is, the irrigation
benefits of the project are calculated by the difference between the rural
income with the project and without it.
A final consideration in establishing the criteria to be used once the
prices are established is how to reduce the monetary values attached to the
benefits and costs to a common point in time (the present) so that an evaluation of a project can be made. The usual method is to calculate the present
value of benefits and costs using a discounting factor. If the value of benefit
b at the period j is bj, then its present value would be &;/(l +
r)where
r is the discount or interest rate. Considerable controversy exists as to the
appropriate discount rate.J Most federal agencies in the United States
use the yield on the long-term federal bonds as the cost of capital and discount rate. If the market interest rate is employed as the correct measure
of the cost of capital, when a high interest rate in the market must be used
for the evaluation of projects, many of the projects will have a negative
present value for their net return.
The problem with regard to the level of the interest rate becomes very
significant in underdeveloped countries. Most of their public projects are
large scale and relatively capital-intensive, and have long economic life.
On the other hand, because of the scarcity of investment capital, interest
rates are very high—much higher than in the more developed countries.
The interest rate is even higher in the unorganized money market for the
majority of the underdeveloped countries where the weighted average rate
of interest is somewhere between 24 and 36% per annum [Meier, 1964].
t See, for example, the Fed. Regist. (1971) and de Neufville and Stafford (1971).