The Kariba Dam
case study- Measuring Social impact
investing
Introduction
The Kariba dam project has not only
had an economical impact to Zambia and Zimbabwe; but has also had a social
impact to the two countries. As a result of its power generation, the
industrial sector of both countries has significantly grown over the last 50
years. In addition, the Kariba dam project has resulted in the development of
irrigation schemes, creation of employment, source of government revenue etc. Through
the analysis of the financial aspects of Kariba dam project; this essay therefore
aims at understanding social and environmental impact of development projects
into financial decision making.
Kariba dam Project Valuation
In order to estimate Kariba dam’s
project value; a combination of valuation models would be incorporated. This
includes: asset based valuation model, earning approach valuation model and the
market value approach valuation model.
Asset
based valuation model
In this model, the net value of all
assets should be accounted and the project’s liabilities subtracted from them.
This information can be easily availed through government data, or even the
project’s balance sheets. In addition, asset based valuation can also be
determined by accounting for the net cash received for the sale of the project
(privatization). For the Kariba dam project; this model would tend to attach
monetary value on the impacts of physical assets on social/economic growth. In
this regard, externalities created through the interaction of the project’s
assets with other factors in the economy would be addressed.
Earning
approach valuation model
This valuation model involves
prediction of future earnings by examining the previous records and trends in
the incomes from the project (Sweo, 2013). Hence, the valuator would be
required to assess the value of the impact of the project in regards to future
risks, uncertainties and its probable success.
However, in order to make this model more effective; the project
valuation team should be able to account for earnings resulting from the
externalities. This could be done through a comprehensive research study on the
nature of the externalities and their impacts on individual earnings.
Market
value approach model
This valuation model involves research
and analysis of similar projects in the region. Through research, the
stakeholders would be able to make relevant comparison of earnings, future
prospects and expansion strategies for the project hence they would be able to
make informed decisions (Richard, 2000). For example, in the case of Kariba
dam; an analysis of neighboring power plant projects in the Southern African
region would be made so as to determine the relative value of the impact of the
project to social/economic activities in the region. In addition, the market
value model should incorporate an analysis of the impacts of the project to
various externalities. This may be through market research and accounting for
inter-relationship between different industries in the market.
Positive
aspects of the combined valuation method
A combination of asset, earning
approach and market value approach valuation models; not only reveals the
project’s value but brings about an in depth understanding of its future
prospects. This is essential in financing expensive and long term projects which
are risky in nature. Also, the multi-facet approach would enable the valuators
to capture aspects that may have previously been ignored by the use of one
valuation model.
Moreover, by incorporating the market
valuation model; the valuators would be able to correct probable operational
mistakes and improve on the efficiency of the project. In this regard, the
interaction with other stakeholders in the industry may form the basis of new
ideas for the project development.
Negative
aspects of combined valuation method
Poor coordination of the combined
valuation models may lead to recording of inaccurate results of the project
value. This may be due to double considerations of factors that may appear on
both sides of the valuation models. In essence, inaccurate data may be misleading
to both investors and stakeholders of the project and hence may to unplanned
losses.
Reasons for the Kariba dam project
The main reason for the construction
of Kariba dam was to generate electricity and also to supply water for
irrigation.
Hydro-electric
generation
As a result on industrial revolution,
there was need for industrial power in both Zambia and Zimbabwe especially in
the region’s copper mines. The Zambezi River proved to be an essential asset
for the generation of hydro-electric power both for domestic and industrial
use. Due to its massive water reservoir, the dam is thus generates 1600MW of
electricity with an annual power of about 6400 GWh.
Irrigation
In order to boost the food security of
the Tonga people (natives of the Kariba region); the project was to provide
constant supply of water for irrigation. Through irrigation, the people would
not have to depend on the seasonal rains hence boosting their agricultural
activities. However, in recent years, the respective governments have
encouraged the locals in the Kariba region to invest in cash crop farming due
to their higher monetary income.
Control
flooding
The Zambezi River normally floods as a result
of heavy rains in the surrounding highland areas. By controlling the flow of
water in the Zambezi River; the project aimed at controlling flooding during
the rainy season. Hence, people would comfortably be able to settle downstream
in the flood plains without risks of flooding and loss property.
Has the project achieved its objectives?
Financial
objectives
The Kariba dam project has been able
to achieve its financial objectives over the past decades. The hydro-electric
generation plant has a constant demand of power from the surrounding
industries, cities and private homes hence enabling both governments to collect
large amounts of revenue.
In addition, through irrigation; the
surrounding regions have been able to grow important cash crops which generate
revenue through exports. Moreover, the project’s ability to control flow of the
Zambezi River may be viewed as a land reclamation method in the floodplains. In
this regard, the suitable agricultural and settlement land acquired from the
flood plains of Zambezi River have contributed to the project’s financial
objective. Therefore, in my opinion; the Kariba dam project has surpassed its
financial obligations by generating enough funds to the economy of both Zambia
and Zimbabwe.
Social/economic
objectives
Apart from hydro-electric power
generation and irrigation; the Kariba dam project has contributed to various
sectors of the economy. First, the project has led to creation of employment in
areas such as environmental conservation, tourism, fishing, health, transport
etc. hence solving the problem of unemployment in the region. Secondly, project
has led to infrastructural development in the two countries. The revenues
generated from the project have helped to build roads, hospitals, schools etc
hence improving the leaving standards of the people in the Kariba dam region.
Therefore, the Kariba dam project has fulfilled its social/economic objectives.
Project finance as a tool for
development
The project finance model is used as a
tool for assessing the feasibility of the project. In this regard, a project
finance model should be able to analyze the variables needed for forecasting
revenues, variables for determining future expenses, capital expenditures and
finances. This would be able to determine the amount of cash the project would
be generating for the repayments of debts used to finance the project.
In cases where the required finance
involves a large amount of money; the investors may request to analyze the
project finance model. This would enable them to estimate their projected
returns and risks involved in the business venture.
Challenges
of incorporating external factors in the finance model
The finance model needs to be accurate
and precise in order for the relevant stakeholders to make necessary financial
assumptions and analysis. Incorporating external factors to the finance model
not only makes the calculation process complex; but introduces many errors and
assumptions due to absence of exact figures. In this regard, external factors
make it hard for the valuation of the debt service coverage ratio (DSCR).
Project enhancement
The project finance model can be
restructured in various ways so as to improve the returns on investments,
maximum positive socio-economic returns to the affected communities and
minimize negative externalities relating to the project.
Ways
of improving the project’s ROI
In every investment in a project; the investors
expect make a given amount of profit. In this regard, a project like Kariba dam
may increase its returns on investments through the following methods:
Diversification of the project
Even though the main purpose of Kariba
dam project was to generate hydro-electric power and provide water for irrigation
in the surrounding regions; the project can be diversified to encompass other
areas of the economy. In this regard, the authorities managing the water
project could introduce specific types of marine life which could act as a
tourist attraction hence generating more income. Also, Zambezi river authority
could build a larger fresh water supply and pumping unit that would hence
supply large amounts of fresh water to the nearby town for domestic and
industrial use.
Moreover, the irrigation project
initiated on the downstream of the dam has not been well developed due to lack
of funding and poor education of the local communities. In this regard, the
modernization of the irrigation schemes would help to generate more income
hence boosting the project’s returns on investments.
Improving the project’s management
Improving Kariba dam’s operation
efficiency would eliminate loses hence increasing the project’s returns on
investments. The efficiency could be improved through constant maintenance of
the power generating machines, overall maintenance of the dam, competent
employees, automation etc. Through proper management, problems facing the
project would be easily identified and solved thus resulting to increased
returns on investments (Pettinger, 2006).
Ways
to maximize social/economic benefits to the community
The success of the project largely
depends on the co-operation of the affected community. In order for the project
to have maximum community development; the Kariba dam project management team
should:
Invest in community infrastructure,
health and education
The project team should ensure that a
percentage of the generated revenues would be channeled into community
development projects. This would include funding the construction of roads,
construction of schools, free supply of clean water, construction of health
facilities etc. hence, contributing to socio/economic development.
Provision of employment opportunities
to the local community
The project can be an important source
of employment to the local community. People could be employed in the
maintenance of the power plant, in the irrigation projects, environmental
conservation projects, etc. In addition, by developing other supporting
industries such as fishing, tourism, and transport etc. the project would be
able to create additional sources of employment to the surrounding community.
Ways
to minimize negative externalities relating to the project
In the case of Kariba dam, negative
externalities may arise from forced evacuation of people due to the dam
construction, transmission of water borne illnesses as a result of the large
water body, negative environmental effects etc. Such negative externalities of
the project can be prevented through:
Proper compensation of displaced
persons
Since the dam construction required a
vast area of land, the relevant authorities should ensure that the displaced
persons receive the correct amount of compensation. This should not only
account for the property losses but also include the compensation through the
inconveniences of relocating. In addition, long term compensation strategies
should be emphasized. This may include giving jobs to the displaced persons so
that they could continue benefitting from the project.
Measures to curb water borne diseases
As a preventive measure for curbing
water-borne diseases in the region, the local communities would have to be
educated on the importance of maintaining higher levels of hygiene. In
addition, the provision of clean water to the public would facilitate the
prevention of water-borne diseases. Moreover, the dam project should be able to
fund local hospitals so as to subsidize the costs of treating water-borne
diseases in the region.
Environmental conservation
The development of the project would
ultimately lead to urbanization which in essence would contribute to environmental
pollution. The project management team should be able to come up with ways of
conserving the environment of the dam. This may include proper waste disposal
methods, tree planting, wildlife conservation etc (Kotler, & Lee, 2004).
Kariba dam financial valuation model
In the first phase of the project
(1955-1958), about $135 million USD was used. The project was later upgraded in
1977 so as to provide more electric power at a cost of about $480 million USD.
In the creation of a valuation model, several assumptions can be made:
Assumptions:
Ø
The
cash inflow from the project is uneven
Ø
The
assets of the project have minimal depreciation rates
Ø
The
project has minimal long term stoppages due to maintenance
Ø
Total
initial investment= 135million + 480million
=$615
million USD
Net
present value (NPV)
In the analysis of the cash inflow of
the project for a period of 4 years; the following values can be assumed
Cash inflow of year 1= $250 million USD
Cash inflow of year 2= $255 million
USD
Cash inflow of year 3= $252 million
USD
Cash inflow of year 4= $260 million
USD
Assuming 18% rate of returns
NPV= {[Y1/(1+i)1
+ Y2/(1+i)2 + Y3/(1+i)3 + Y4/(1+i)4]
– initial investment}
Where;
i- The target rate of returns per
period
Y1- 1st period
net cash inflow
Y2- 2nd period
net cash inflow
Y3- 3rd period
net cash inflow
Y4- 4th period
net cash inflow
|
|
Year 1
|
Year 2
|
Year 3
|
Year 4
|
|
Net cash inflow (Million USD)
|
250
|
255
|
252
|
260
|
|
Salvage value (net inflow ÷ (1+i)n)
|
[250 ÷ (1+0.18)1]
|
[255÷ (1+0.18)2]
|
[252 ÷ (1+0.18)3]
|
[260 ÷ (1+0.18)4]
|
|
Present value of cash flow
|
211.86
|
183.14
|
153.37
|
134.11
|
Total present values of inflows (TPV)
211.86 + 183.14 + 153.37 + 134.11
=682.48
Net present value= Total present value
– initial investment
=
682.48 – 615
= 67.48 million USD
Hence, it can be deduced that the
project is sufficiently viable due to its reasonable NPV value.
Weighted
average cost of capital (WACC)
WACC is used to determine the rate at
which the project would pay its financers. In this regard, it stipulates the
minimum amount of cash that the project should generate in order to satisfy the
project owners, shareholders, and the financers of stock etc. WACC can be
calculated through:
WACC= (E/V) x Re + (D/V) x Rd (1-Tc)
Where;
E- Market value for the project’s
equity
D- The project’s debt market value
Re- Cost of equity
Rd- Cost of debt
V= total value of the project (E+D)
And Tc- Tax rates as required by the
authorities
Assumptions:
·
Market
value of the project’s equity= $500 million USD
·
Market
value of the project’s debt = $115 million USD
·
Cost
of equity= 0.6
·
Cost
of debt= 0.5
·
Tax
rate of 20 %
Hence
Total value of the project = 115 + 500
=615
million USD
Therefore;
WACC= (E/V) x Re + (D/V) x Rd (1-Tc)
=
(500/615) x 0.6 + (115/615) x 0.5 x (1- 0.20)
=0.56
Analysis:
This implies that for every dollar
invested into the capital; 0.56% of the returns would be used to pay off the
financers of the project. Through calculations of WACC, the project management
may be able to vary project financing from equity or debt in order to achieve
minimal payment rates to its financers.
Social
and environmental risk factors
As a result of minimal technological
advancement in the 1950’s, the Kariba dam project was manually planned hence
the analysis of the social/economic and environmental factors was not
comprehensive. First, the project failed to fully analyze the effect of the
large water body on the surrounding eco-system. As a result, tropical diseases
often affect the inhabitants of the region.
Secondly, the project lacked a clear
financial strategy in the irrigation sector. Due to lack of financial planning,
the project faced a risk of not meeting its objective. Such a plan would have
enabled maximum utilization of the project hence higher ROI from the project.
On the other hand, the planning of the
project did not encompass environmental risk factors such as flooding or
mechanical failure of the dam. In recent years, studies have shown that Kariba
dam’s strength has tremendously weakened hence it’s faced with a risk of
collapsing. This exposes the community leaving around to unexpected loss of
property and may also lead to climatic change in the region.
Conclusion
In conclusion, the valuation of the
Kariba dam project can be critically analyzed through a combination of asset,
earning approach and market approach valuation models. Even though the project
was initially formed for power generation and water irrigation; its
diversification and proper management may be able to increase its ROI. In
addition, the project should be involved in community development and environmental
conservation measures. Finally, analysis of the project’s financial model by
considering the NPV and the WACC is essential for determining its overall
viability.
Reference
list
Kotler, P,. & Lee,. N. 2004.
‘Corporate social responsibility’ New York: Wiley Publishers. Pp 86
Pettinger, R (2006) Introduction to
management. London: Palgrave Macmillan.
Print
Richard, E.,R. 2000. ‘Developing
strategic alliances’ Mississauga: Crisp learning publishers. Pp 23
Sweo, R. (2013). International
business: a practical approach. New York: Create Space independent publishing.
Print
