ECON7740 Benefit-Cost Analysis Case Study Assignment
A Social Benefit and Cost Analysis of
Western Pacific Tuna Products’ Proposal
for Establishing a Tuna Cannery
in Papua New Guinea A Report to the Government of Papua New Guinea
October 2007
Prepared by:
Yasemin BARLAS OZER
Table of Contents
Executive Summary ................................................................................................................................ 1 1. Introduction...................................................................................................................................... 2 2. Methodology.................................................................................................................................... 2 2.1. Social Benefit and Cost Analysis ............................................................................................ 2 2.2. Variables ................................................................................................................................. 4 2.3. Assumptions............................................................................................................................ 4 3. Results ............................................................................................................................................ 5 3.1. Project Analysis....................................................................................................................... 6 3.2. Private Analysis....................................................................................................................... 6 3.3. Efficiency Analysis .................................................................................................................. 7 3.4. Referent Group Analysis ......................................................................................................... 7 4. Sensitivity and Risk Analysis........................................................................................................... 9 5. Conclusions and Recommendations ............................................................................................12 Appendix ...............................................................................................................................................14 Bibliography ..........................................................................................................................................14 Executive Summary
Western Pacific Tuna Products (WPTP) company, which is originally registered in the Philippines, has
submitted a proposal to set up a business for harvesting and processing tuna fish on the north coast
of Papua New Guinea (PNG). The project proposal’s significance arises from the potential
employment opportunities and thus benefits it may provide to the community living in this particular
region of PNG, where unemployment rate is very high; as well as from the potential benefits to the
Government of PNG through various import and business tax revenues it may be required to disburse
as a foreign company.
The aim of this report is to evaluate WPTP’s proposal in terms of prospective benefits and costs to the
Papua New Guinean society as a whole in light of the available information and provide
recommendations to the PNG Government. As WPTP has requested exemptions from certain taxes
and import duties from the Government, along with a permission for its vessels to be treated as
domestic, the report examines a number of alternative scenarios to assist the Government in the
decision making process.
In the appraisal ‘Social Benefit and Cost Analysis’ methodology is used, which facilitates the effects of
the proposal to be quantified and translated into benefits and costs that would be acquired by the
groups of interest, and also enables to account for the efficiency aspects in the relevant markets.
Under each scenario, net benefits to the referent groups of interest are provided for comparison
purposes.
While WPTP’s proposal appears to be a project that could highly contribute to the economic welfare
of the country under the current circumstances, it does not satisfy the required real rate of return on
equity by the company to invest in the Pacific Islands region. To this end, the alternative scenarios
might provide valuable insight for the negotiations between the Government and the company.
The appraisal of these nine options that could be considered by the Government are presented in
Section 3. The comparisons of the results show that, Option 3, based on the scenario that WPTP is
given an exemption from duties for its exports to the EU under the Lome Convention, maximizes the
net benefits to the Papua New Guinean society as a whole, however fails to provide the incentive for
WPTP to invest in the first place. On the other hand, granting all concessions to WPTP is clearly the
worst option from the PNG’s perspective. Examined under Option 9, this is the scenario that benefits
WPTP the most among all alternatives, yet performs poorest from the society’s standpoint. The
recommended scenario which offers the best outcome to Papua New Guinea is Option 8, under which
the Government grants WPTP exemptions from VAT on miscellaneous items along with an exemption
from EU duties, while the fleet is treated as domestic in the PNG waters. This option provides the
greatest net benefits to the Papua New Guinean society as a whole, provided that WPTP has just
enough incentives to invest. If WPTP cannot be convinced to accept its conditions during
negotiations, the second most favourable option from the perspective of the PNG society would be
Option 7, which treats WPTP as a domestic company for tax purposes and exempts it from EU duty
under Lome Convention.
The report also includes a sensitivity analysis for the recommended option, examining the impact of
possible variations in discount rate, opportunity cost of labour and external cost of pollution. The
findings confirm that the results are sensitive to changes in the discount rate and the opportunity cost
of labour. A risk analysis is also undertaken for the two key variables of the project, namely the
expected annual catch of the fleets and the price of canned tuna in Europe. While net benefits to PNG
remain positive, WPTP faces a risk of making losses in case of severe price and supply shocks.
1
1. Introduction
WPTP has submitted a project proposal to the Government of Papua New Guinea to make an
investment in the country for catching tuna and constructing a processing plant to process the
harvested fish to be exported to the European Union countries and produce fishmeal as a by-product
to be sold in the domestic market. As a company policy, WPTP requires at least 20% real rate of
return on equity capital to invest in the Pacific Islands region. To this end, the company seeks
concessional terms that would enable it to undertake the investment, such as exemptions from certain
taxes and import duties, and permission for its vessels to be treated as if they were domestic. WPTP
also wants to be regarded as a domestic company for company tax purposes.
If the proposal is approved by the PNG Government, the project will be established within a year and
will have a life time of 20 years. The company projects an annual catch of 32000 metric tonnes in
PNG’s Exclusive Economic Zone from the 12 vessels it will operate. The report conducts the analysis
on the estimated values of prospective benefits and costs in 2007 US dollars.
To accommodate the negotiations between the Government and WPTP, following options have been
considered:
Option 1: No concessions
Option 2: Exemptions from import duties, export tax, fuel tax and VAT on miscellaneous items
Option 3: Exemption from EU duty under the Lome Convention
Option 4: Treatment as Domestic Company
Option 5: Treatment of Vessels as Domestic
Option 6: Treatment as Domestic Company and Treatment of Vessels as Domestic
Option 7: Treatment as Domestic Company and Exemption from EU duty under Lome Convention
Option 8: Treatment of Vessels as Domestic, Exemption from EU duty under Lome Convention and
VAT on Miscellaneous Items
Option 9: All concessions
Option 1 refers to the base scenario under which no concessions requested by the WPTP are
provided, whereas Option 9 considers the counter scenario under which WPTP is given all of the
concessions. Other options are constructed to enable assessment of not only all concessions
separately (Options 2 to 5), but also some different combinations of concessions together (Options 6
to 8).
2. Methodology
2.1.
Social Benefit and Cost Analysis
The Social Benefit and Cost Analysis (BCA) is a methodology designed to accurately measure and
quantify the benefits and costs associated with a project and provide information on the distribution of
these costs and benefits among all groups of interest. The effects of the project are translated into
positive and negative cash flows within the projects life using BCA principles, which are then used to
evaluate benefits and costs. BCA facilitates examining and comparing the net benefits to each
referent group, as well as enabling to account for the efficiency aspects in the relevant markets.
2
A BCA has four essential components, which appraise the project from the perspective of the varying
parties.
The Project BCA values project’s inputs and outputs at the market prices, i.e. without adjusting the
cash flows for taxes or duties, and assesses the efficiency of the project from the market perspective.
In Private BCA, the project is evaluated from the private investor’s viewpoint, such that company
taxes, interest and debt flows are net out from the cash flows to investigate the benefits and costs that
will be obtained by the private firm. The private analysis of each option demonstrate how likely the
firm would be to undertake the investment under the circumstances.
The Efficiency BCA is concerned with the overall benefits and costs that arise from the project,
irrespective of the groups that gain or lose. As it comprises all aspects of the project that affect
economic welfare, it provides decision makers information on whether a project perform well in
allocating scarce resources to their most efficient uses. More precisely, efficiency analysis accounts
for the market distortions and inefficiencies arising from market failures and attempts to accurately
value inputs and outputs whenever they exist or whenever the variable of interest has no market
value such as pollution. To this end, shadow prices reflecting the opportunity costs are used, rather
than market prices where applicable.
The Referent Group BCA shows how the benefits and costs from the project are distributed among
different parties. The stakeholders that are deemed to be relevant are referred to as the referent
group, while other parties affected from the project that are left out, are referred to as the non-referent
group. The investigation of the project from the view of the referent group is the most crucial part of
the analysis and plays the key role in decision-making.
For this project, the referent group can be broadly defined as PNG, yet is comprised of the
Government, labour and the community. The non-referent groups are WPTP, EU and the foreign
bank that finance WPTP, and are not discussed in this report.
There are two essential criteria used in the appraisal of a project. The first is the Net Present Value
(NPV), which is calculated by discounting the future values of a cash flow using a specified discount
rate, so that all benefits and costs from the perspective of the individual being considered are
represented by a single net present value. While a positive NPV indicates that the project leads to
total net benefits and thus the individual is better off with the project, a negative NPV signifies that the
project’s costs outweigh its benefits and thus the individual is worse off with the project. According to
the decision rule, when comparing two or more alternatives, the project with the highest NPV is
preferable, as it leads to greater benefits.
The second criterion is the Internal Rate of Return (IRR) of a project, which is defined as the
discount rate that equalizes the NPV of the project to zero. In decision making, an IRR that is greater
than the relevant cost of capital implies that the project’s benefits outweigh the costs, leading to a
positive NPV, thus the project could be accepted. IRR has the advantage of providing information on
how profitable the project may be, however, it is worth mentioning that it is safer to use NPV for
comparison purposes, as IRR may sometimes be misleading in this regard.
3
2.2.
Variables
The key variables used in the analysis of the proposed project are presented in Appendix A1. This
table includes prices of all project inputs and outputs, variables relevant to WPTP’s revenue
calculations such as capacity utilization rates, depreciation and replacement schedules for capital
costs, estimated volume of annual tuna catch, etc., along with information on prevailing conditions in
the country such as current import tariffs, company tax rates, income taxes, and so on.
It is important to note however that valuations of all items identified within this project are based on
numerous assumptions (which are detailed in the next subsection) and may indeed be subject to
changes over the 20 year life of the project. The reader needs to be aware of the fact that, these may
not be 100% accurate as future estimations involve uncertainty to a large extent, but they reflect the
best information available at the time of the analysis.
2.3.
Assumptions
This section summarises the assumptions made for the analysis of the project proposal. It is worth
mentioning that are these assumptions are open to the analyst's interpretation and discretion and may
be modified to improve the representativeness of the course of the project if required, as new
information becomes available.
Capacity Utilization
In accordance with the information provided by the company itself, WPTP is assumed to operate at
30% capacity in the first year and at 70% capacity in the second year of the project, until it reaches a
100% production capacity in 2010.
Operating Costs
WPTP's operating costs are assumed to remain constant over the life of the project. Yet, in the first
two years they are subject to variation (excluding insurance) due to the changing capacity utilization
rates.
Depreciation
For calculating the depreciation of relevant assets for tax purposes, a straight-line method based on
the life of the asset is used. The information on asset lives applicable is included in the Variables
Table (Appendix A1). Although the straight-line method may not be the actual practice of the
accounting authority in PNG, the assumption is likely to reflect the net cash flows to be faced by
WPTP and thus can be considered as adequate to provide decision makers with sufficient information
to proceed for initial negotiations.
Shadow Prices
The opportunity cost of local labour represented by the shadow wage is assumed to be 50% of the
pre-tax wage in the coastal region of PNG, in light of the estimates of a recent study.
The project is also expected to cause significant water, air and noise pollution due to WPTP’s
business activities. While it is difficult to place an exact figure on the cost of pollution to the
community, it is assumed to be $20 per metric tonnes of tuna processed, as suggested by an expert
in the field.
A sensitivity analysis is also undertaken to account for changes in these variables, realizing the fact
that - without a market value like normal commodities - they are by no means easy to evaluate.
4
Taxes, Duties and Taxes on Income
Value added tax on miscellaneous items, fuel tax, import duties, as well as company taxes and
income taxes for labour are all assumed to remain unchanged for the length of the project. As
Government policies on tax collection change, the estimated rates may also change.
Interest on Loan
WPTP intends to finance 60% of its capital costs through foreign credit. While the credit conditions
may be subject to change, it is assumed that the loan from the foreign bank is to be repaid over 10
years at a real interest rate of 12%.
Annual Tuna Catch
WPTP’s estimated annual tuna catch is assumed to remain the same throughout the life of the
project, while the 30% and 70% capacity utilization rates in the first two years respectively apply.
While this assumption is a strong one, a risk analysis is also undertaken to account for changes in this
variable.
Output Prices
The output prices, namely the price of canned tuna in Europe and fishmeal in PNG, are assumed to
remain constant over the life of the project. However, the assumption that the prices will remain
constant over 10-year life of the project is also a pretty strong one. To this end, a risk analysis is also
conducted for the price of tuna, as tuna exports to EU region comprises a greater portion of the
WPTP’s revenues.
Discount Rate
The analysis is undertaken using a discount rate of 5%. Although this rate is the Government’s
benchmark for decision making, and the report also presents the results of all analysis undertaken for
each option at 3% and 8% in Appendix, for inspecting the responsiveness of the results to varying
discount rates (See Appendix A7). Yet, the sensitivity of results of the recommended option is
discussed in Section 4.
Changes in related markets
As the project size can be regarded as relatively small, the prospective impact of the project on other
market prices are assumed not to be significant.
3. Results
In this section the four components of Social Benefit and Cost Analysis are examined separately for
each option and results are summarized at the PNG Government's preferred discount rate of 5%. The
corresponding NPV and IRR values of each option are reported in the relevant subsections for
ranking purposes. The details of cash flows derived for the base scenario with no concessions
(Option 1) are contained in spreadsheets appended to the report and can be found in Appendix
Tables A2 to A5. Moreover, the analysis results of all considered options in this section are available
in the Appendix in Table A7, which further includes NPV’s at 3% and 8% discount rates.
5
3.1.
Project Analysis
From the market perspective, all considered options yield to a positive NPV at 5% real discount rate
with IRR values higher than 5% (See Table 1). This implies that the benefits outweigh the costs for all
options. As can be seen from Table 1, both NPV and IRR criteria provide the same ranking of
alternative options. Option 9 is preferred over the other options, while Option 8 is the second
favourable option.
Table 1: Project Analysis
NPV
(at 5% discount rate, in
2007 million US dollars)
Rank
IRR
(%)
Rank
Option 1
1.09
6
5.31
6
Option 2
67.23
3
21.06
3
Option 3
65.63
4
20.25
4
Option 4
1.09
6
5.31
6
Option 5
16.17
5
9.33
5
Option 6
16.17
5
9.33
5
Option 7
65.63
4
20.25
4
Option 8
85.41
2
24.06
2
Option 9
146.84
1
35.64
1
3.2.
Private Analysis
The private analysis essentially provides information on how much WPTP stands to make or lose
from the different options under consideration. The two decision criteria (NPV and IRR) again give
consistent rankings of the options (See Table 2). Not to surprise, Option 9 which provides all
concessions to WPTP is by far the best outcome from the firm’s standpoint. On the other hand,
Option 1 is the least preferable of all options (which is a reflection of the current situation), as WPTP
does not get any concessions from the Government at all. It is also worth noting that Options 7 and 8
lead to IRR values just over the WPTP’s 20% required rate of return, and are the second and third
preferred options respectively.
Table 2: Private Analysis
NPV
(at 5% discount rate, in
2007 million US dollars)
Rank
IRR
(%)
Rank
Option 1
-7.69
9
1.42
9
Option 2
27.29
4
17.87
4
Option 3
25.87
5
16.44
5
Option 4
-7.05
8
2.15
8
Option 5
0.15
7
5.07
7
Option 6
4.26
6
6.71
6
Option 7
41.35
2
21.29
2
Option 8
36.15
3
20.80
3
Option 9
102.57
1
46.37
1
6
3.3.
Efficiency Analysis
Efficiency analysis reveals that the proposed project is very beneficial from a social point of view, with
significantly high NPV and IRR values (See Table 3). Thus, the project yields very high positive net
gains to PNG community as a whole, indicating that it performs well in allocating scarce resources to
their most efficient uses. All of the options considered have the same net impact on efficiency
outcomes, as this analysis is based on the opportunity costs of variables.
Table 3: Efficiency Analysis
NPV
All Options
3.4.
(at 5% discount rate, in
million US dollars in 2007)
IRR
(%)
165.27
38.70
Referent Group Analysis
Referent group analysis considers the distributional effects of the project. Table 4 illustrates that all
options lead to positive net benefits to PNG, which can be disaggregated into separate groups of
interest as the Government, labour and the community. The IRR values are not applicable because all
values in the cash flows are positive and there is no change of sign in the stream (i.e. no roots).
From the PNG society’s perspective, Option 3 is the most preferred option that maximizes the net
benefits. However it can be seen from Table 3 that this option unfortunately does not satisfy the 20%
required rate of return on investment for WPTP, and therefore would not be undertaken under the
defined circumstances. The reason that this scenario under which WPTP is given an exemption from
duties for its exports to the EU under the Lome Convention, performs better than all the other
alternatives is because this concession is not placing any burden on the PNG Government. Moreover,
while PNG Government does not lose any revenue from Lome Convention, the option is performing
considerably well from WPTP’s perspective in terms of yielding an internal rate of return that is close
to the required level for investment (from Table 2).
Table 4: Referent Group Analysis
NPV
(at 5% discount rate, in
million US dollars in 2007)
Rank
Option 1
100.98
5
Option 2
66.00
8
Option 3
131.96
1
Option 4
100.34
4
Option 5
93.15
6
Option 6
89.04
7
Option 7
116.48
3
Option 8
121.67
2
Option 9
55.26
9
An important point to note for negotiations is that, the PNG government as the decision maker needs
to maximize the net benefits to the society as a whole, under the condition that WPTP has given
enough incentives to invest. With this constraint in mind, it can be concluded that WPTP would only
7
be willing to participate, if it were to be offered either of Options 7, 8 or 9, which yield internal rate of
returns greater than 20% (See Table 2).
When we look at the corresponding NPVs of these three options in the referent group analysis, Option
9 is clearly the worst alternative from the PNG society’s perspective, as the NPV of the referent group
is minimized under this scenario. But frankly, it can be argued that even under this least preferable
option, PNG still benefits from the project. In other words, providing all concessions to WPTP still
leads to a positive NPV.
On the contrary, the option that provides the highest net benefits to the referent group is Option 8.
The Government could recognize that in addition to providing exemption from EU duty under Lome
Convention, introducing treatment of WPTP’s vessels as domestic, and granting exemption on VAT
on miscellaneous items would not significantly reduce its revenues, however would provide just
enough incentives for WPTP to invest (with an IRR of 20.80%).
Thus, Option 8 is the most favourable option from the PNG society’s point of view. While this is the
recommended option, if WPTP is not to agree on its conditions during negotiations, PNG Government
might also consider Option 7 as the second best alternative. Option 7, under which WPTP is treated
as a domestic company for tax purposes and granted exemption from EU duty under Lome
Convention, is ranked in the third place from the WPTP’s standpoint and has an internal rate of return
of 21.29%.
Table 5 presents the net benefits that Option 7 and Option 8 would provide the relevant groups of
interest at the disaggregated level, along with the base scenario (Option 1). It is worth underlining how
PNG Government is likely to benefit from acclaiming either Option 7 or Option 8, when compared to
the base scenario.
Table 5: Disaggregated Referent Group Analysis *
Option 1
Option 7
Option 8
$100.98
$116.48
$121.67
$6.47
$21.96
$46.95
Indirect Taxes
$66.14
$66.14
$61.43
Access Fees
$15.49
$15.49
$0.41
Employment Benefits
$35.75
$35.75
$35.75
-$15.49
-$15.49
-$15.49
-$7.37
-$7.37
-$7.37
Government
$72.61
$88.10
$93.30
Labour
$35.75
$35.75
$35.75
Community
-$7.37
-$7.37
-$7.37
Total Referent Group
Type of Net Benefit
Direct Taxes
Opportunity Cost of Catch
External Cost
Stakeholder Group
“* NPV (at 5% discount rate, in million US dollars in 2007)
As can be seen from the above table, the Government is to receive the highest net benefits from the
proposed project. Although it stands to lose some revenue as reflected by the opportunity cost of
catch, the revenues from the direct and indirect taxes as well as access fees it would collect outweigh
these costs. Labour also earns an appreciable amount of employment benefits as a result of the
project, since the business is to be established in the coastal region of PNG where unemployment is
widespread. Nevertheless, there are some negative external costs to the PNG society in terms of
water, air and noise pollution which would arise from the WPTP’s operations.
8
4. Sensitivity and Risk Analysis
This section presents the sensitivity of the analysis results to changes in selected key variables and
the responsiveness of the outcomes when some assumptions are weakened. Risk analysis
essentially concerns with the impact of supply and price shocks on the distribution of both the referent
group net benefits and WPTP’s private net benefits.
At this stage of the investigation, only Option 8 (the recommended scenario) has been examined for
sensitivity and against risk. The reason for this is because the base scenario (Option 1) which does
not provide any concessions to WPTP is not likely to be accepted by the company and therefore
analysing an option that is attractive from both parties’ perspective is more sensible.
Discount Rate
A sensitivity analysis is undertaken to analyse the sensitivity of results to a range of discount rates
(3%, 5%, 8%). Discounting the net cash flows at a rate higher than the Government's preferred rate of
5% has the effect of adding a 'risk premium' to the discount rate, while discounting at a lower rate
lowers the perceived risk associated with the project.
Table 6 shows that NPVs are sensitive to changes in discount rate. Lower discount rate of 3% results
in considerably higher NPVs, whereas higher discount rate of 8% results in considerably lower NPVs.
Nonetheless, the NPVs always stay positive.
Table 6: Sensitivity of Results to Discount Rate
NPV at 3% discount rate
NPV at 5% discount rate
NPV at 8% discount rate
(in million US dollars 2007)
(in million US dollars 2007)
(in million US dollars 2007)
Project Analysis
111.30
85.41
57.57
Private Analysis
48.88
36.15
22.85
Efficiency Analysis
207.44
165.27
119.64
Referent Group Analysis
148.21
121.67
92.98
Opportunity Cost of Labour
The high unemployment rates in the coastal region of PNG have always been prone to concerns.
While the opportunity cost of local labour is assumed to be 50% of the pre-tax wage in this project, a
sensitivity test on this shadow price is also undertaken to examine how employment benefits are
affected.
Table 7 illustrates the extent to which Efficiency and Referent Group Analysis results change when
different percentages are assumed for shadow wage. Project and Private Analysis results are not
reported, since they are not affected.
Table 7: Sensitivity of Results to Opportunity Cost of Labour *
10%
30%
50%
70%
90%
Efficiency Analysis
195.69
180.48
165.27
150.06
134.85
Referent Group Analysis
152.09
136.88
121.67
106.46
91.25
Employment Benefits
66.17
50.96
35.75
20.53
5.32
“* NPV (at 5% discount rate, in million US dollars in 2007)
When the shadow wage is assumed to be a higher percentage of the pre-tax wage than 50%, the
employment benefits naturally decrease. On the other hand, when the shadow wage is assumed to
be a lower percentage of the pre-tax wage like 10% or 30%, the employment benefits increase
dramatically. This implies that when the value of the subsistence activities which labour may engage
9
in is lower, the labour is significantly better off with the project, which is a plausible argument when
the high unemployment rate is considered.
External cost
As measuring the cost of pollution is a challenging task due to lack of a market value for pollution, the
assumed external cost may involve some error. To this end, a sensitivity analysis is undertaken to
analyse the sensitivity of results to a range of values for external cost. However, the results show that
even when a 50% higher or lower value than the assumed $20 per metric tonnes is used in the
project, the referent group NPV only slightly differ (See Table 8). And thus we can conclude that the
referent group’s net benefits are not very sensitive to the external cost of pollution.
Table 8: Sensitivity of Results to External Cost
$10 per mt
$20 per mt
$30 per mt
125.36
121.67
117.98
Referent Group Analysis
“* NPV (at 5% discount rate, in million US dollars in 2007)
Annual catch
As mentioned earlier, the assumption that the expected annual tuna catch of WPTP’s fleet would
remain at a constant level of 32,000 metric tonnes is a fairly strong one. To this end, a risk analysis is
undertaken to examine the impact of changes in the amount of annual catch on results using the
@Risk software.
The analysis confirms that the referent group NPV remains at positive levels when the annual catch is
let to vary within 25% below and above the expected level (See Appendix A8). As Figure 1 illustrates,
in the best outcome, i.e. when the annual catch is 25% above the expected level, the referent group
NPV reaches a maximum of $198.7 million. On the other hand, when the annual catch is 25% below
the expected level, the referent group NPV declines to a minimum of $46.0 million. Overall, there is a
90% chance that the referent group benefits would be higher than $78.0 million.
Figure 1: Risk Analysis of Annual Tuna Catch
on Referent Group NPV
Figure 2: Risk Analysis of Annual Tuna Catch
on WPTP’s Private NPV
Distribution
Referent
Group
Distri
bution forfor
Referent
Group
NPV
Distribution for WPTP’s Private NPV
NPV/B28
Distribution for Private NPV/B28
1.000
1.000
Mean=36.15454
Mean=121.6705
0.800
0.800
0.600
0.600
@RISK Student Version
For Academic Use Only
0.400
@RISK Student Version
For Academic Use Only
0.400
0.200
0.200
0.000
40
80
5%
120
90%
67.72
160
5%
175.3594
200
0.000
-60
-30
5%
0
30
90%
-20.5476
60
90
120
5%
92.5818
10
From the WPTP’s perspective, a 25% higher annual catch is likely to increase the NPV of private net
benefits to $117.1 million, while a 25% lower annual catch is likely to result in a negative NPV of
$43.4 million (See Appendix A9). In other words, in case of 25% reduction in the estimated annual
tuna catch, private costs to WPTP would outweigh the benefits to a large extent. All in all, the
likelihood of WPTP’s net benefits to be higher than $11.8 million is 75%, nevertheless there is a 20%
chance that the project would result in a negative NPV for WPTP (See Figure 2).
Price of tuna
Similar to the previous discussion, as it is quite common to have price fluctuations, the assumption
that the price of canned tuna in Europe would remain constant throughout the 20 year life of the
project is again a fairly strong one. It is possible to examine the impact of price variations on analysis
results by loosening this assumption and extending the limits applicable to price by 25% above and
below.
According to the risk analysis performed using @Risk software, when the price of tuna is let to
fluctuate within 25% below and above the assumed level of $35, the referent group NPV always
remains at positive levels (See Appendix A10). In the worst possible outcome, the referent group NPV
would drop to $41.4 million, yet would peak to $201.2 million in the best case. The likelihood that the
referent group would get a net benefit of at least $76.4 million is 90% (See Figure 3).
Figure 3: Risk Analysis of Price of Tuna
on Referent Group NPV
Figure 4: Risk Analysis of Price of Tuna
on WPTP’s Private NPV
Distribution
Distribution
forfor
Referent
Referent
Group
Group
NPV
Distribution for WPTP’s Private NPV
NPV/B28
Distribution for Private NPV/B28
1.000
1.000
Mean=36.14925
Mean=121.6651
0.800
0.800
0.600
0.600
@RISK Student Version
For Academic Use Only
0.400
@RISK Student Version
For Academic Use Only
0.400
0.200
0.200
0.000
40
100
5%
65.6618
160
90%
220
5%
177.2584
0.000
-60
-30
5%
0
30
90%
-18.5259
60
90
120
5%
90.4241
From the WPTP’s perspective, a 25% higher annual catch is likely to increase the NPV of private net
benefits to $113.8 million, however a 25% lower annual catch is likely to reduce the NPV of private
net benefits to a negative $42.2 million (See Appendix A11). This means that WPTP would have to
bear the risk of acquiring higher costs than benefits when price of tuna in Europe fluctuates. To be
exact, there is a 15% chance that the project would result in a negative NPV for WPTP (See Figure
4). Even so, it is worth to note that the likelihood of WPTP’s private NPV to be higher than $6.8 million
is 80%.
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5. Conclusions and Recommendations
The WPTP’s proposed project is a beneficial one from the PNG’s point of view. However, without any
concessions provided (Option 1), the company would not be willing to undertake the investment, as
the business would be subject to numerous taxes and thus would not be able to earn a satisfactory
rate of return on its equity capital. Nonetheless, providing all concessions to WPTP (Option 9)
generates the least favourable outcome for the PNG society as a whole, and thus should not be
approved. Instead, the Government should seek alternative scenarios under which both the net
benefits to the referent group are maximized and the WPTP’s required rate of return is satisfied. To
this end, the Government should consider the options that provide just enough incentives for WPTP to
invest in order for the country’s resources not to be exploited too much by the company.
The appropriate strategy for negotiations with WPTP could be to provide those concessions that do
not result in a substantial revenue loss to the PNG Government as well as not hurting the people of
PNG. Among the options that examine the requested concessions by WPTP separately (Options 2 to
6), Option 3 is the most favourable one from the referent group’s perspective. Clearly, requesting an
exemption from EU duty under the Lome Convention for WPTP’s sales to be classified as originated
from a developing country has no adverse effects on Government’s revenues or on other referent
group net benefits. On the contrary, granting WPTP exemptions from import duties, export tax, fuel
tax and VAT on miscellaneous items (Option 2) results in a substantial tax revenue reduction and
therefore should not be preferred by the PNG Government.
On the basis of the analysis, the option that maximizes the net benefits to the referent group, provided
that WPTP’s internal rate of return is above the required 20% is Option 8. Under this scenario,
WPTP’s fleet is treated as domestic and the company is granted an exemption on VAT on
miscellaneous items in addition to the exemption from EU duty under Lome Convention. The
accompanying concessions to Lome Convention do not significantly reduce government revenues,
and provides most favourable outcome to the PNG society as a whole, yet WPTP gets an internal rate
of return of 20.80%, which is slightly higher than the required rate and its second best alternative.
While Option 8 is the recommended option, if WPTP cannot be convinced to accept its conditions
during negotiations, PNG Government might also consider Option 7. This scenario is the second most
favourable option from the perspective of the PNG society, and third from the WPTP’s standpoint.
The sensitivity and risk analysis results shed light on the important parameters that play a key role in
the appraisal of the project. The sensitivity analysis undertaken based on the recommended option
(Option 8) reveals that the results are sensitive to changes in the discount rate. As a reflection of
perceived risk of a project, an increase in the discount rate is likely to erode the referent group net
benefits considerably. To this end, the Government may wish to consider undertaking a further
financial analysis to assess the risk involved in the project.
The results are also sensitive to estimates of different opportunity costs of labour. The lower is the
value of the activities that labour engages in when it is unemployed; the higher would be the
employment benefits from the proposed project. Another recommendation stemming from this
analysis is thus to undertake a detailed research to evaluate labour’s subsistence activities in the
coastal region of PNG. Given the sensitivity of results, incorrect shadow wage assumptions may be
misleading for the appraisal of the project.
Moreover, the risk analysis highlights the importance of possible variations in the annual tuna catch
and fluctuations in the price of tuna in Europe on project outcomes. Both reductions in the estimated
annual tuna catch and downward price shocks might have adverse affects on the net benefits of the
PNG society, yet it is certain that the net benefits would always remain positive. On the contrary, the
depressing changes in these two variables might be quite hazardous for WPTP and erode the
12
company’s profits substantially. Frankly, the possibility that the company might receive negative net
benefits as a result of these fluctuations is not to be neglected.
As a final point, it is worth mentioning that the associated cost of providing concessions to WPTP is
ignored in this report, although legal transaction costs definitely exist in practice. As these indirect
costs are only known to the PNG Government, we do not have any information on whether
introduction of some concessions would be more costly to the Government compared to others.
Therefore, it is strongly recommended that the Government considers this type of costs involved in
the decision making process.
13
Appendix
The following MS Excel worksheets are included as an appendix to this report:
A1: Variables
A2: Project Analysis
A3: Private Analysis
A4: Efficiency Analysis
A5: Referent Group Analysis
A6: Summary Sheet
A7: Sensitivity Analysis on Discount Rate
A8: Risk Analysis of Annual Tuna Catch on Referent Group NPV
A9: Risk Analysis of Annual Tuna Catch on WPTP’s Private NPV
A10: Risk Analysis of Price of Tuna in Europe on Referent Group NPV
A11: Risk Analysis of Price of Tuna in Europe on WPTP’s Private NPV
A12: Tables in Report
Bibliography
Campbell, Harry F. and Brown, Richard P.C. (2003) Benefit-Cost Analysis: Financial and Economic
Appraisal using Spreadsheets, Cambridge University Press, Cambridge.
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