Project Profitability from Society’s Point of View

Abstract

Profitability depends on how efficiently scarce resources are utilised. The relevant easure of efficiency depends on the economic objective. In a private company, the objective is to maximise its contribution to the income and wealth of the owners in the short or long term. The eco- nomic profit in each period is given by the maximum distribution to the owners, without reducing the firm’s market value. The value concept is forward-looking, in the sense that the market value of the company is the present value of the future cash flow that it is expected to generate for the owners. A positive present value means that the enterprise is yield- ing an average rate of the return on invested capital that is at least as large as the owners could have achieved by reinvesting the financial cap- ital in the external financial market, assuming this to be the alternative investment opportunity. Hence, profitability is defined in relation to the external rate of return opportunity for the capital required to operate the company.

This chapter deals with project profitability to society and how it is related to market-based commercial profitability. The first part discusses the sources of divergence between profitability to pri- vate companies and to society as a whole and how commercial assessments can be modified in order to find the social surplus. The second part deals with the role of information and risk for project assessments. It shows how the social cost of risk-bearing can be derived from the pricing of risk in private risk markets. The value of choosing flexible project concepts in order to adapt to new information about important risk factors is demonstrated in various contexts.