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					                                                       TA 4106 –IND: Kerala Sustainable Urban Development Project
                                                                                               Project Preparation


transferred from KWA to the MCs, it is proposed that a 40% sewerage surcharge be included in the
MC water bill.

With this surcharge of 40% on prevailing water tariff, it is envisaged that there will be full recovery of
O & M cost thus requiring no State support in the form of operating subsidies post project
implementation. The Project includes sewer house connections as part of the sewerage component to
ensure connection and utilization of the new investment. The current fee for future connections (post
project) is assumed to remain the same to make it affordable and encourage connection to the system.

On-Site Sanitation. With the acquisition of desludging equipments, it is proposed that as part of the
FIAP a fee of Rs.600 (Rs.588 at 2004 price) be collected for every septic tank that will be cleaned of
sludge. The fee is projected to increase every 3 years by 20% to achieve sustainability.

Solid Waste. At present, no fees are collected by the MCs from residents in whose areas the MCs are
collecting solid waste. With low service coverage by the MCs, households in areas not served by the
MCs spend about Rs.30 a month for the collection and disposal of their wastes by private groups or
they dump their waste in open areas nearby or burn them on their premises.

With the proposed subprojects, it is envisaged that service coverage will cover the whole MC area.
However, the subproject will not be sustainable without the collection of minimal user charge. As part
of the FIAP, it is proposed therefore that a solid waste fee of Rs.30 per month for domestic, Rs.150
for shops, restaurants etc. and Rs.300 per month for large establishments like hospitals, hotels etc. be
collected starting FY 2006-07. It is projected that the fee will increase every 3 years by 20% to
achieve sustainability.

15.4       Financial Internal Rate of Return
The financial viability of a subproject is assessed by comparing the subproject’s Financial Internal Rate of
Return (FIRR) with the Financial Opportunity Cost of Capital (FOCC). As proxy for the FOCC, the
Weighted Average Cost of Capital (WACC) of the subprojects in real terms is used. FIRR is the discount
rate that equalizes the present values of costs and revenues over the subproject life while the WACC
represents the cost incurred by the MCs to implement the subprojects.

The WACC of the subprojects is 4% (real terms). The calculation of the WACC is shown in the table
that follows.

Table 15-1: Weighted Average Cost of Capital

                    Particulars                    Grant                  Equity                  Total
 Weight (%)                                        70.00%                 30.00%                  100.0%
 Nominal Cost (%)                                   0.00%                 10.00%
 Tax Rate (%)                                       0.00%                  0.00%
 Tax Adjusted Nominal Cost (%)                      0.00%                 10.00%
 Inflation Rate (%)                                 6.00%                  6.00%
 Real Cost (%)                                      0.00%                  3.77%
 Minimum Rate Test (%)                              4.00%                  4.00%
 Weighted Component of WACC (%)                     2.80%                  1.20%
 Weighted Average Cost of Capital (Real)                                                           4.00%



FR Volume 1 – Main Report                                                                                 PAGE 132
                                                       TA 4106 –IND: Kerala Sustainable Urban Development Project
                                                                                               Project Preparation


FIRR was calculated for each of the revenue generating subprojects. The assumptions and approach
used in the calculation of the FIRR include: (i) all revenues and costs are stated at constant November
2004 prices; (ii) all revenues and costs are calculated on an incremental basis, i.e. difference between
“with project” and “without project” situations; (iii) subproject capital expenditures are recognized at
the time they are incurred; and (iv) equipment replacement costs have been included every 10 years
for water supply and sewerage and every 5 years for on-site sanitation and solid waste management.

Sensitivity analyses were also carried out to determine the possible effects of adverse changes on the
subprojects. The adverse changes are: (i) 10% increase in capital costs; (ii) 10% increase in O&M
costs; (iii) 10% decrease in revenues; and (iv) one year delay in benefits. For water supply sub-
projects, additional sensitivity analyses were done for the following adverse conditions: (i) NRW
assumption higher by 10%; (ii) water demand assumption lower by 10%; and (iii) tariff increase
assumption lower by 50%.

The results of the FIRR calculation and sensitivity analyses are summarized in the table below. The
details of the calculation and analyses for each city are in Volume 2 – City Reports.

Table 15-2: Summary of Financial Evaluation

  City / Component          NPV @ 4%      FIRR, SI   Base      Capital      O&M         Revenues      Benefits
                            Rs. Million     & SV     Case      Costs +     Costs +       – 10%        Delay by
                                                                10%         10%                       One Year
Thiruvananthapuram
Sewerage                       (897.66)   FIRR (%)   (11.6)%    (12.1)%     (13.9)%        (14.8)%       (12.3)%
                                                SI
                                            SV (%)
Kollam
Water Supply                    259.14    FIRR (%)     8.7%        7.8%         8.5%          7.5%          7.6%
                                                SI                  1.18         0.25          1.66
                                            SV (%)                 85%         403%            60%
Sewerage                       (374.09)   FIRR (%)    (3.8)%     (4.4)%       (4.5)%        (5.1)%        (4.3)%
                                                SI
                                            SV (%)
Water & Sewerage                (23.50)   FIRR (%)     3.8%       3.0%         3.5%          2.6%           3.0%
                                                SI                 2.55         0.91          4.56
                                            SV (%)               39.3%       110.3%         21.9%
Solid Waste                      62.78    FIRR (%)     9.4%      8.00%        8.10%         6.50%         7.00%
                                                SI                 1.76         1.68          4.59
                                            SV (%)                 57%          60%           22%
Kochi
Water Supply                     835.6    FIRR (%)   12.92%     11.90%       12.70%        11.60%        11.40%
                                                SI                 0.85         0.14          1.11
                                            SV (%)                118%         733%           90%
Sewerage                        (961.4)   FIRR (%)   (11.6)%    (12.1)%     (13.8)%        (14.7)%       (12.4)%
                                                SI
                                            SV (%)
Water & Sewerage                (125.8)   FIRR (%)     3.4%       2.7%         3.0%          2.3%           2.6%
                                                SI                 2.63         1.02          4.90
                                            SV (%)               38.0%        98.4%         20.4%




FR Volume 1 – Main Report                                                                                 PAGE 133
                                                                 TA 4106 –IND: Kerala Sustainable Urban Development Project
                                                                                                         Project Preparation


  City / Component           NPV @ 4%         FIRR, SI        Base       Capital        O&M             Revenues    Benefits
                             Rs. Million        & SV          Case       Costs +       Costs +           – 10%      Delay by
                                                                          10%           10%                         One Year
Solid Waste                        155.1       FIRR (%)        10.7%          9.3%          9.4%            7.8%        8.2%
                                                       SI                      1.47         1.41            3.65
                                                 SV (%)                     68.2%         71.1%            27.4%
Thrissur
Water Supply                      158.90       FIRR (%)         5.9%          5.1%          5.7%            4.8%        5.0%
                                                       SI                      1.47         0.41            2.26
                                                 SV (%)                     67.9%        242.8%            44.3%
Sanitation                         13.87       FIRR (%)        13.1%        10.8%         10.2%             7.6%        8.1%
                                                       SI                      2.10         2.84            7.16
                                                 SV (%)                     47.7%         35.2%            14.0%
Solid Waste                       217.29       FIRR (%)        25.3%        22.5%         23.8%            20.8%       18.3%
                                                       SI                      1.24         0.63            2.17
                                                 SV (%)                     80.6%        159.5%            46.0%
Kozhikode
Sewerage                        (549.84)      FIRR (%)        (7.8)%        (8.3)%        (9.5)%         (10.2)%      (8.5)%
                                                       SI
                                                 SV (%)
Solid Waste                        53.18       FIRR (%)         8.4%          7.0%          7.0%            5.4%        6.1%
                                                       SI                      2.04         2.04            5.74
                                                 SV (%)                     48.9%         49.0%            17.4%
Additional Sensitivity Analysis
                                                                                                          Tariff
                            NPV @ 4%          FIRR, SI        Base         NRW         Demand
      Component                                                                                         Increase
                            Rs. Million         & SV          Case         + 10%        - 10%
                                                                                                          - 50%
Kollam Water Supply               259.14       FIRR (%)         8.7%          7.7%          7.2%            1.7%
                                                       SI                      1.36          2.04           8.20
                                                 SV (%)                     73.3%         49.0%            12.2%
Kochi Water Supply                 835.6       FIRR (%)      12.92%         12.0%           9.4%            4.6%
                                                       SI                      0.80          3.68           3.67
                                                 SV (%)                    125.2%         27.2%            27.2%
Thrissur Water
                                  158.90       FIRR (%)         5.9%          4.7%          4.2%         negative
Supply
                                                       SI                      2.62          4.09
                                                 SV (%)                     38.2%         24.5%
NPV = Net Present Value
SI = Sensitivity Indicator (ratio of percentage change in NPV to the percentage change in a variable)
SV = Switching Value (percentage change in a variable required for the NPV to become zero)

The water supply, on-site sanitation and solid waste management subprojects are financially viable
with FIRRs higher than the WACC. The sewerage subprojects, however, have negative FIRRs due to
high investment costs and low sewerage charge. The combined water supply and sewerage
subprojects have positive FIRRs higher than the WACC.

Sensitivity tests indicate that the subprojects’ viability is most sensitive to decreased revenues and
benefits delayed by one year. Periodic revisions of user charges as described in the cost recovery




FR Volume 1 – Main Report                                                                                             PAGE 134
                                                    TA 4106 –IND: Kerala Sustainable Urban Development Project
                                                                                            Project Preparation


proposals and prompt completion of the subprojects are therefore very vital to the subprojects’
financial viability.

15.5       Average Incremental Financial Cost and Subsidy
In setting the tariff, the appropriate target level to achieve subproject financial adequacy and
sustainability is the long run marginal (LRM) cost, which includes both the incremental investment,
and O&M costs. The Average Incremental Financial Cost (AIFC) is regarded as an approximation of
the LRM cost. The AIFC for each subproject was calculated by dividing the present value of the
incremental subproject costs streams (capital and O&M) by the present value of the incremental
quantity streams (volume of water consumed in the case of water supply, volume of wastewater flow
in the case of sewerage and metric tons of garbage collected and disposed in the case of solid waste
management). The costs and quantity streams were both discounted at the WACC of 4%.

The following table summarizes the calculation of the AIFC, its relation with the average tariff and
the resultant financial subsidy.

Table 15-3: Average Incremental Financial Cost
                 City / Particulars           Water          Sewerage &      Water Supply          Solid
                                              Supply          Sanitation     & Sewerage            Waste

 Thiruvananthapuram
 PV of Project Costs @ 4% (Rs. Million)                         1,771.78
 PV of Project Revenues @ 4% (Rs. Million)                        462.50
 PV of Quantity* @ 4%                                              90.93
 AIFC**                                                            19.49
 AIFC (Rs./KL) for O&M                                               3.21
 Average Tariff**                                                    5.09
 Financial Surplus (Subsidy)**                                     -14.40
 AIFC Recovery (%)                                                 26.1%
 Kollam
 PV of Project Costs @ 4% (Rs. Million)           705.2            759.4             1,464.7           293.3
 PV of Project Revenues @ 4% (Rs. Million)       1,055.9           433.5             1,624.9           356.1
 PV of Quantity* @ 4%                             199.9              78.6              184.8        297,419
 AIFC**                                                3.5            9.7                 7.9          986.1
 AIFC (Rs./KL) for O&M only                         1.45              3.1
 Average Tariff**                                      5.3            5.5                 8.8        1,197.2
 Financial Surplus (Subsidy)**                         1.8          (4.1)                 0.9          211.1
 AIFC Recovery (%)                                150%               57%               111%            121%
 Kochi
 PV of Project Costs @ 4% (Rs. Million)           715.6           1,408.6            2,124.2           543.8
 PV of Project Revenues @ 4% (Rs. Million)       1,587.0           503.1             2,247.9           698.9
 PV of Quantity* @ 4%                             312.8              81.3              289.2      483,916.2
 AIFC**                                                2.3           17.3                 7.3        1,123.7
 AIFC (Rs./KL) Only O&M                                0.6            5.7
 Average Tariff**                                      5.1            6.2                 7.8        1,444.2
 Financial Surplus (Subsidy)**                         2.8          -11.1                 0.4          320.5
 AIFC Recovery (%)                               221.8%            35.7%             105.8%          128.5%




FR Volume 1 – Main Report                                                                              PAGE 135

				
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