Chapter 2

Developing Business Plan

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Outlines
 Introduction
 Opportunity identification and evaluation
 Business idea development
 Concept of business plan
 Essential components of business plan
 Financial statement of feasibility analysis

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 Learning Objective
 After completing this chapter, students will be able to:
 Identify opportunities in the environment
 Evaluate the opportunities in the environment
 Generate business idea
 Explain the concept of business planning
 Identify components of the business plan
 Develop a business plan,

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 Questions
1. What is Plan?

2. What is “Business Plan" ?

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 Introduction
 Virtually to start any type of business or expand the existing one needs to work on opportunity
identification and evaluation, business idea development and then prepare business plan.

 Lack of proper opportunity identification and evaluation, idea development process and business
planning are the most often cited reasons for business failure.

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 Opportunity Identification and
Evaluation
 Most authors agree that the initial stage in the entrepreneurial process is the identification and
refinement of a viable economic opportunity that exists in the market

 The opportunity identification and evaluation stage can be divided into five main steps namely:

1. Getting the idea/scanning the environment

2. Identifying the opportunity

3. Developing the opportunity

4. Evaluating the opportunity

5. Evaluating the team

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1) Scanning the Environment/ Getting the Idea
 While scanning the environment it may be provide you with idea and business opportunities.
 opportunity is a favorable time or set of circumstances for doing something.
 A business opportunity is a gap left in a market by those who currently serve it, giving a chance to
others to add unrealized value by performing differently from and better than competitors in order to
create new possibilities
2) Opportunity Identification
 Opportunity identification is ability to see, to discover and exploit opportunities that others miss.
 It is the process of seeking out better ways of competing.
Question:
What is the difference between an idea and an opportunity?

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3) Opportunity Development
 Opportunity development is the process of combining resources to pursue a market opportunity
identified.
 This involves systematic research to refine the idea to the most promising high potential opportunity
that can be transformed into marketable items.

4. Opportunity Evaluation
 Opportunity screening and evaluation is a critical element of the entrepreneurial process.
 Opportunity screening and evaluation is perhaps the most critical element of the entrepreneurial process,
as it allows the entrepreneur to assess whether the specific product or service has the returns needed for
the resources required.
 Table 1 Team factors and questions for opportunity evaluation
Team factor Question for evaluation
Focus • Does the entrepreneur (or his team) have some experience (work or industry)?
• Do they really like this product/sector? Do they really want this?
• Can the team create products to suit that market need?
Selling • Does the team have the necessary selling and closing skills?
management • Does the team have the necessary management and technical skills?
• If the required skills are not available, can they be acquired at competitive rates?
ownership • Are the members committed to these?
• Does the owners have enough financial capital for required own contributions?

5) Assessment of the Entrepreneurial Team

 Regardless of how right the opportunity may seem to be, it will not make a successful
business unless it is developed by a team with strong skills

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Business Idea Development
A business idea is a short and precise description of the basic operation of an intended business. There are
three types of business ideas.
1. Old Idea : Here an individual copies an existing business idea from someone.
2. Old Idea with Modification: In this case the person accepts an old idea from someone and then
modifies it in some way to fit a potential customer’s demand.
3. A New Idea :This one involves the invention of something new for the first time.
Business Idea Identification
Your business idea will tell you:
Which need will your business fulfill for the customers and what kind of customers will you attract?
What good or service will your business sell? Who will your business sell to?
How is your business going to sell its goods or services?
How much will your business depend upon and impact the environment? A good business idea will
be compatible with the sustainable use of natural resources and will respect the social and natural
environment on which it depends.
Your business idea should be feasible by :
o Accessibility of potential customers or end users of your product/intended to be delivered services/
o Availability of required raw material or facilities
o Human capital and adaptability of new technologies and etc.
Methods for Generating Business Ideas
o Every business idea should be based on knowledge of the market and its needs.
o When you understand the market in your area, you might recognize many business ideas that you may
have previously ignored.
o It’s time to investigate and see if there is a business opportunity here.
Through the ff. approach, BI can be generated.
1: Learn from successful business owners
2: Draw From Experience
2.1: Your own Experience
2.2: Other People’s Experience
3: Research The Market
4: Scanning Your Environment
4. 1 Evaluate unused natural resources
5: Research the Competition
6: publications
10: Problem Inventory Analysis 12
Business Idea Screening
 Idea screening is the process to spot good ideas and eliminate poor one. To screen the business idea generated,
three approaches are discussed as follow:
1) Macro screening: is aimed screening down ideas to 10:
o Are my own competencies (see strength detector) sufficient?
o Can I finance it to a large extent with my own equity?
o Will people buy my product/service (i.e. is it needed and can people afford it)?
2) Micro Screening: is aimed screening down ideas into 3. The common criteria used for screening are:
o Solvent demand
o Availability of raw materials
o Availability of personal skills
o Availability of financial resources

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Cont.…
3) Scoring the Suitability of Business Idea: This approach is most appropriate when deciding on starting a business.
 When there are more than one possible business idea and one needs to decide which one to follow, we use score business
ideas (e.g., BI1, BI2, BI3) by assigning a rating from 1 to 3 for each question, with 3 being strongest.
 After we score the ideas we sum the total and select the idea with the highest score.

Notes: while to
answer the above
listed questions it is
important to conduct
survey.

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Con…
 While to answer the above questions, there are four important groups that you should talk to:
o Potential customers: Their views are essential to your understanding of whether or not your
proposed product is important to them and if you need to modify your idea to meet their needs.
o Competitors, suppliers, and entities with financial resources: Their views will reveal the
challenges of competition that you would face, as well as other issues related to your potential
business.
o Financial institutions: Find out the lending requirements to determine whether borrowing for a new
business is possible.
o Key informants and opinion leaders: These are people who would know a lot about the type and
field of business you want to go into and/or a lot about your potential customers.
 Their views would give you a lot to think about and could also give you a better insight into the
feasibility of your business idea.
 Then, if the above are OK!, you can go on to the next step to start your own business: Prepare a
business plan for the proposed business.
Concept of Business Plan
 Planning is the first and the most crucial step for starting a business.
 A carefully charted and meticulously designed business plan can convert a
simple idea/innovation into a successful business venture.
 A business plan is a road map for starting and running a business.
 A well-crafted business plan identifies opportunities, scans the external and
internal environment to assess the feasibility
 A business plan is the blueprint of the step-by-step procedure that would be
followed to convert a business idea into a successful business venture.
 BP first of all identifies an innovative idea, researches the external environment
to list the opportunities and threats, identifies internal strengths and weakness,
assesses the feasibility of the idea and then allocates resources
(production/operation, finance, human resources ) in the best possible manner to
make the plan successful:

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Cont.…
 The objectives of a business plan are to:
 Give directions to the vision formulated by entrepreneur.
 Objectively evaluate the prospects of business.
 Monitor the progress after implementing the plan.
 Persuade others to join the business.
 Seek loans from financial institutions.
 Visualize the concept in terms of market availability, organizational, operational and financial
feasibility.
 Guide the entrepreneur in the actual implementation of the plan.
 Identify the strengths and weakness of the plan.
 Identify challenges in terms of opportunities and threats
 Clarify ideas and identify gaps in management information about their business, competitors and
the market.
 Identify the resources that would be required to implement the plan.
 Document ownership arrangements, future prospects and projected growths of the business
venture.
 Developing a Business Plan
Business Planning Process
 As discussed above, the successful entrepreneur lays down a step-by-step plan that she/he follows in
starting a new business.
 This business plan acts as a guiding tool to the entrepreneur and is dynamic in nature – it needs
continuous review and updating so that the plan remains viable even in changing business situations.
 The various steps involved in business planning process are :
1) Preliminary Investigation: - Before preparing the plan entrepreneur should:
 Review available business plans (if any).
 Draw key business assumptions on which the plans will be based
 Scan the external and internal environment to assess SWOT
2) Opportunity Identification and Idea Generation:- Opportunity identification and business idea
generation is the first stage of business planning process.
 It involves generation of new concepts, ideas, products or services to satisfy demand.
 Cont.…
3) Environmental Scanning:
4) Feasibility Analysis:
Estimation of Financial needs
 This leads us to know our investment cost and operation cost.
 Fixed Investment, land and site preparation cost
 is done to find whether the proposed project (considering the above environmental scanning) would
be feasible or not.
 Environmental scanning is carried out to assess the external and internal environment of the
geographical area/areas where, entrepreneur intends to set up his business enterprise, whereas
feasibility study is carried out to assess the feasibility of the project itself in a particular environment
in greater detail.
 Cont.…
5) Report Preparation: After environmental scanning and feasibility analysis, a business plan report is
prepared. It is a written document that describes step-by-step, the strategies involved in starting and
running a business.

Question: what is the major difference between a feasibility study and a business plan?
 Essential Components of Business Plan
I) Cover Sheet: Cover sheet is like the cover page of the book. It mentions the name of the project,
address of the headquarters (if any) and name and address of the promoters
II) Executive Summary: It is the summary of all the key sections of the business plan and should work as
a separate, stand-alone document. Interested parties will read this section first and often use this in
conjunction with a glance at the financial section in deciding whether or not the read the rest of the plan.
Key points to remember include
 Write this document after the business plan completed
 While the executive summary is written last, it is presented first
 The executive summary should be no more than one and half page long.
III) The Business Model: This will give details about the business concept such as objective of the
business, a brief history about the past performance of the company etc.
IV) Funding Requirement: Since the investors and financial institutions are one of the key bodies
examining the business plan report
V) The Product or Services:
 Describe the company’s product or service in lay terms. Give product mix if the company will
initially be focusing on more than one product
 Describe how customers would use and buy the product or service.
 Describe key components or raw materials that will be used in the product
VI) The Plan
1. Marketing Plan;
2. Technical and operational plan;
3. Organization plan
4. Financial and economical plan;
 Feasibility study
 A feasibility study is an analysis of the viability of an idea through a disciplined and documented
process.

 A feasibility study provides an investigating function that helps answer “Should we proceed with
the proposed project idea? Is it a viable business venture?”

A feasibility study of an idea is mainly conducted at three levels.

 Market Feasibility

 Technical & Operational Feasibility

 Financial & Economic Feasibility

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Based on property and perception of Gondar people,
 what type of business you will do & why?
 At which location?

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 1) Marketing (plan) Feasibility
This answers the question “will it be accepted & sold?”

In market feasibility you have to describe in detail the following issues.

 Product or service description
What makes your product or service unique (features, size, color,
shape, texture, use and benefits.)
 Competitors
use tables to list out the competitors, their business size, their product
or service features, their market share and price.
 Location
where will the business located and what are the criteria's and factors
considered. 25
 Marketing area
which area will your products or services cover?
 Main customers
 Market share
what will be your market share in the marketing area?
 Pricing strategy
what type of pricing strategy you will use:
 Cost-oriented pricing
 Demand and supply oriented pricing (market will bear method)
 Competition-oriented pricing (comparative method)
 New product pricing (Skimming pricing, Penetration pricing)
 Product mix pricing (geographical, bundle, Price lining )
 Promotional pricing (Loss leader pricing, Special-event pricing) 26
 Promotional measures:
promotion generally divided into advertising, selling & publicity.
 free sample free trail
 sponsoring local shows, festivals and events
 volume discount
 Participate in trade fairs & exhibitions
 Special credit facilities to regular customers
 Posters, social media boosting, billboards
 Radio & television advertise, newspaper, trade journals
 Buy one take two
 Raffles & coupons.
All the above activities cost you many so you have to asses the sales added by each
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promotional measure.
 Sales forecast
how many products will you sell per week, month, year, etc. based
on the market share you will have. In addition how many of the
products will returned from or replaced to customers.
 Sales strategy
what type of sales strategies you will be used (push, pull)
you should interview & ask question in addition to setting
criteria's to select wholesalers, distributors, & retailors.
For example : How many of the products do you will sell in a year?
How many competitors do you have in your neighbor?
For customers: why do you buy this product?
would you like to see any changes or improvements? 28
 2) Technical & Operational Feasibility
This answers the question “will it be built & work?”

 Machines and tools:

Machines From Where are Price Production Power Size
and tools whom the suppliers Capacity & usage (l*w*h)
name & would you & their service life
model buy address

 Input materials & availability, packaging, transport, & working

area (land) with their cost source.
 Production type (continuous, mass, job-shop)
 Production layout, relation of activities & departments (draw
r/ship Diagrams)
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What quality control procedures will you use?
How will you manage inventory levels & how will you receive order? (consider ordering,
holding cost )
 Maintenance & repairs
 what will be your future capacity
 labor skill & availability
 utility requirements, availability & cost.
3) Organizational Plan: The organizational plan indicates the pattern of flow of
responsibilities and duties amongst people in the organization.

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4) Financial Plan
The financial plan is usually drawn for two to five years for an existing company. For a new organization the
following projections are drawn:
1. Financing Plan and Loan Requirement
2. Projected Sales
3. Projected Income and Expenditure Statement
4. Projected Break-even Point
5. Projected Profit and Loss Statement
6. Projected Balance Sheet
7. Projected Cash Flows
8. Projected Funds Flow
9. Payback period
10. Projected Ratios
 In this part you show a budget for your business
 Explain how much you intend to raise to get started
 What are your projected expenses and revenues
 In what period do you expect to be profitable and show a return to your investors?
 Start-Up Capital
Estimation of start-up capital Amount
INVESTMENT
Land
Building
License
Equipment
Other
Total Investment
WORKING CAPITAL
____ months of staff costs
____ months of operational costs
Over head expense
Other
Total working capital
TOTAL START-UP CAPITAL

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1. Sources of Start-Up Capital
Type Source Conditions Amount
(duration/interest)
Equity capital Own savings
Partner
Loan 1 Family
Friends
Money lender
Loan 2 Credit cooperative
Government scheme
Bank loan
TOTAL FUNDING

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List fixed assets needed and their cost
No. Item Quantity Amount
1
2
3
4
5
Total

List of raw materials needed

No Raw materials DIMENSION QUANTITY UNIT TOTAL COST
needed per COST
month
1
2
3
4
Total cost
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MONTHLY OVERHEADS
ITEMS COSTS
Rent ?

Water & Electricity ?

Material/Stock ?
Salaries ?
Transport ?
Maintenance on vehicle ?
Marketing & Promotion ?
Telephone/ Cell ?
Stationary & miscellaneous ?
Depreciation ( ) ?
Bank Charges ?
Loan Repayment ?
TOTAL ?
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 2. Projected Sales
 It’s an intimidating task, looking into the future. Sales forecasting is the process of estimating future
sales with the goal of better informing your decisions.
 A forecast is typically based on any combination of past sales data, industry benchmarks, or economic
trends.
 It’s a method designed to help you better manage your workforce, cash flow, and any other resources
that may affect revenue and sales
 Why is sales forecasting important?
 Your sales forecast is the foundation of the financial story that you are creating for your business.
Once you have your sales forecast complete, you’ll be able to easily create your profit and loss
statement, cash flow statement, and balance sheet.
Which forecasting model is best?
Ans. For new business, the Top-Down Model
 How to create a sales forecast
o Keep in mind that your sales forecast is an estimate of the number of goods and services you believe
you can sell over a period of time. This will also include the cost to produce and sell those goods and
services, as well as the estimated profit you’ll come away with.
o We’ll dive into specific methods, assumptions, and questions you’ll need to ask in order to build a
viable sales forecast. But to start, here are the general steps you’ll need to take to create a sales forecast:
1.List out the goods and services you sell
2.Estimate how much of each you expect to sell
3.Define the unit price or dollar value of each good or service sold
4.Multiply the number sold by the price
5.Determine how much it will cost to produce and sell each good or service
6.Multiply this cost by the estimated sales volume
7.Subtract the total cost from the total sales
 As a further example, the following table and chart showing shorter term projections for 4 product groups were copied and
pasted directly from Exl-Plan's built-in Textual Summary Report.
 3. Projected Income and Expenditure Statement
 This section relates to the Pro Forma Income Sheet in the
template.
 The purpose of the Income Statement Forecast is to project the
revenues and expenses of your business over a given period of
time usually one year.
 Other terms for this are budgeted income statement or pro
forma income statement.
 There are three things that need to be predicted to forecast
your income statement: the sales projection, the cost of goods
projection and the overhead projection.
Break-even Analysis
 Break-even analysis is a tool to determine the level of production/ sales at which the business will cover both
fixed and variable costs
 It indicates the minimum amount of revenue that a business must earn in order to cover the total cost incurred so
that it does not incur any loss
 Total sales are at least equal to total cost
 The point of equality of total revenue and total costs is a point of zero profits and zero losses.
Uses of break- even analysis
It enables a business organization to:
Measure profit and loss at different levels of production and sales
To predict the effect of changes in price of sales
To analyse the relationship between fixed cost and variable cost
To predict the effect on profitability if changes in cost and efficiency
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The fundamental accounting related equation can be used in Financial viability analysis in the
process of Business plan
Profit = Revenues - Costs
Revenue = SP*units sold ,SP = selling price
Costs = FC + VC(units manufactured) when
FC = fixed cost and VC = unit variable costs.
We are assuming that units manufactured equal units sold
how much product we must sell to break even?
The breakeven point : is the point where profit is zero,
so Profit /Loss = 0 = Revenue - Cost
= SP*units sold - FC - VC*units sold
= (SP - VC)*units sold - FC
units sold = FC/(SP - VC)
We will call units sold at Profit /Loss = 0: BEunits
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Breakeven Revenue
 it is equal to Breakeven units (BEunits) * SP, or SP * BEunits = SP*(FC/CM)
Breakeven revenue = FC/(CM/SP)
 Contribution margin (CM) = Revenue - Variable costs when Some variable costs are manufacturing
costs, but some may be non-manufacturing costs and None are fixed costs.

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DIAGRAMATIC PRESENTATION

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Example 1
• ABC company is working in the following business environment
Maximum Capacity= 25,000 units per year
Total Fixed Cost = ETB 30,000
Sales Price =ETB 10
Variable Cost = ETB 7
Contribution =Sales Price - Variable Cost = 10-7=3
Calculate the break even point in
a) Volume of Production
b) Sale revenue
c) Capacity utilization
d) Minimum acceptable price

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Solution
a) Volume of Production

BEP =

= = 10,000 units . This means , you need to sell 10,000 units to break even
b) sales revenue
sales revenue = Production units X Sales price

= 10,000 units X 10 ETB= 100,000 ETB OR = X unit price = X 10 = 100,000 ETB

The result can also be calculated based on the equation that at break even sales revenue and all costs (fixed and
variable) are the same, i.e. Sales revenue = total fixed cost + total variable costs

= 30,000 ETB + (10,000 X 7) = 100,000 ETB

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C) Capacity Utilization
a) Capacity Utilization = = = 40 %

oThis is the most popular method of expressing break-even.

oIn this example, if you are able to make use of at least 40% of your theoretical production capacities ( and
sell the products), then you are break even.
oIf you produce more, you make a profit. It is a quick indicator for steering your business.
oIn this case the margin of safety is 60 % (100%-40%) .
oThe wider the margin, the broader is the scope of operation beyond the break-even point.

oBut be careful: keep production & sales in a sound relation.

oDo not over produce products that later might be unsellable, but also do not under produce and have
difficulties to deliver.

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D) Minimum acceptable price
• The break-even analysis can also be utilized for guiding the minimum acceptable price to a
business at a particular level of production.
• Using the same data give above, ABC plans to produce and sell 15,000 units and wishes to
know the minimum price below which it should not sell his product.
• It can be calculated as follows:

• Price = =

• = = 9.00 ETB

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The minimum price will be lower if production is more, say 20,000 units

i.e. = 8.50 ETB

The reason for reduction in the break-even price is that the fixed costs are spread over a large number
of units; hence the cost per unit goes down.

Thus, the higher the safety margin, sales price being the same, the higher will be the scope of profit.

This analysis allows you to determine objectively the viability of your business.

If you discover that a business will have to operate at 70% to 80% capacity for break-even, you might
conclude that the business may not cover its costs.

If the analysis shows that the business would break-even at 30% to 50% of capacity, the chances are
much greater that the business will be viable.
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Exercise
A small street side café offers fresh traditional coffee to the general public. Total variable cost per coffee
(including coffee beans, water fire wood, sugar) amount to be ETB 1.60 per cup. The selling price is ETB
4.00. The café has fixed costs per week of ETB 360.00, being the rental of the place. Capacity = 300 units
Calculate:-
1. Volume of production at break-even point
2. Sales at break-even point
3. Capacity Utilization (%)
4. What is the minimum acceptable price, if the café plans to produce 250 cups.
5. diagrammatic presentation of the break – even analysis

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Projected Balance Sheet
The Balance Sheet is a snap shot of the business at any point in time. In the case of a business start-up, it is
often the starting balance sheet. A balance sheet is made up of three parts.
Assets: Things a business owns
Liabilities: Debts a business owes
Equity: The owners’ investment and re-investment in the business
Everything that the business owns (its assets) must be paid for; free of debt owing. Therefore we get the
following formula:
Assets = Liabilities + Equity
Cont.…
o This is extremely important as it gives the reader a picture of how the business is being financed
through the owners’ money (equity) or through the creditors’ money (liabilities).

o In a business start-up you should look at the assets required to get the business started – and then ask
yourself how you will finance that start-up.

o If you do not have the money to invest into the business, you will have to borrow the remainder
 How to Do a Balance Sheet for a Business
Start-up
 The start-up balance sheet is simple if you know how to make and sort a list. You need to make two
lists to get started.
 The first list is your list of current assets.
 These are assets (things your business owns) which will be used up within the first year of doing
business.
 The second list is the capital assets. These are items you purchase with the intention of keeping them
and using them to run the business. For example, if you purchase a vehicle to use in the business, it is a
capital asset
 Sometimes there is a third asset list.
 These are known as Intangible Assets and are things such as franchise fees, goodwill, quotas, licenses,
patents and trademarks.
Forecasting Your Assets

 Your second step is to determine how you are going to finance this total. What combination of Debt and
Equity will allow you to get your business started?
 Using the information discussed above you can create the
Example
Cash Flow
The cash flow statement makes adjustments to the information
recorded on your income statement, so you see your net cash
flow—the precise amount of cash you have on hand for that time
period.
A lack of cash can arise for a number of reasons, including:
 unplanned payments, which are to be made (e.g. maintenance);
poor profit margins (e.g. large overhead cost structure);
 over-trading / growing too fast;
ineffective debt collection;
carrying too much raw materials / work in progress / finished
goods stock.

56
How does cash flow out of your business?
Cash is spent buying things we mean to keep running the businesses. E.g. buying fixed
assets

Cash is spent making things to sell. E.g. buying raw materials, payment for workers

Cash is spent on covering business expenses e.g. rent, interest, utility, etc

Drawings by the owner of the business: E.g. pay school fees, feed your family, maintain
your lifestyle, etc

Cash is spent paying taxes

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Cash flowing through a business as the below cycle

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Example:
Suppose you are the owner of hollow blocks manufacturing enterprise. Hollow blocks are sold for ETB
850 per 100 blocks. The monthly cost structure of your enterprise looks the following

Salaries ETB 3000 per month

Production labor ETB 50 per 100 blocks
Rent ETB 3000 per month
cement, sand and stone ETB 500 per 100 blocks
Machine credit payment ETB 1000 per month
Delivery costs ETB 50 per 100 blocks
Telephone/communication ETB 500 per month

59
 Con’t…..
oPrepare a Cash flow forecasts and profit forecasts for Your Hollow concrete enterprise
oThe enterprise fix budget to produce and sell the following quantities of bricks:

September October November

Blocks 5000 6500 7000

oThere is lower production in September due to weather conditions and lower demand.

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Payback period
 It Considers the length of time required to payback (recapture) the original investment from the annual
cash inflow produced. Payback is usually measured in years.
𝑎𝑚𝑜𝑢𝑛𝑡 𝑖𝑛𝑣𝑒𝑠𝑡𝑒𝑑
 1st method: Payback period for uniform flow =
𝑛𝑒𝑡 𝑎𝑛𝑛𝑢𝑎𝑙 𝑐𝑎𝑠ℎ 𝑖𝑛𝑓𝑙𝑜𝑤
Example 1: Amount Invested =15,000 Br & Expected Net Annual Cash Inflow=4500 Br.
Payback period= 15000/4500= 3.33years
 2nd method: 𝑃𝑎𝑦 𝑏𝑎𝑐𝑘 𝑝𝑒𝑟𝑖𝑜𝑑 𝑓𝑜𝑟 un𝑒𝑣𝑒𝑛 𝑐𝑎𝑠ℎ (non uniform) 𝑖𝑛𝑓𝑙𝑜𝑤
𝑢𝑛𝑟𝑒𝑐𝑜𝑣𝑒𝑟𝑒𝑑 𝑐𝑜𝑠𝑡 𝑎𝑡 𝑡ℎ𝑒
𝑠𝑡𝑎𝑟𝑡 𝑜𝑓 𝑡ℎ𝑒 𝑦𝑒𝑎𝑟
= 𝑦𝑒𝑎𝑟𝑠 𝑏𝑒𝑓𝑜𝑟𝑒 𝑓𝑢𝑙𝑙 𝑟𝑒𝑐𝑜𝑣𝑒𝑟𝑦 +
𝑐𝑎𝑠ℎ 𝑖𝑛𝑓𝑙𝑜𝑤 𝑖𝑛 𝑡ℎ𝑒 𝑛𝑒𝑥𝑡 𝑦𝑒𝑎𝑟
It is better than the 1st one N.B: Net Cash. is found from investment cash flow statement
Example 2: Net cash of year 1, 2, 3 and 4 are 3000, 4000, 5000, and 6000 respectively for TG furniture
industries. However, At the end of 3rd year,12000br will have been paid. The additional 3000br. can be
paid before 4th year, when 6000 is expected. Thus it will take(3+3000/6000)=3.5 years to pay the
original investment.
Cont.…
 In the case of uneven net annual cash flows, the company determines the cash payback period when the
cumulative net cash flows from the investment equal the cost of the investment.
Example 2
XY Company proposes an investment in a new website that is estimated to cost $300,000.

 Cash payback should not be the only basis for the capital budgeting decision as it ignores the expected
profitability of the project.
Exercise
1. Assume XYZ the Paper Corporation is considering adding another machine for the manufacture of
corrugated cardboard. The machine would cost $900,000. It would have an estimated life of 6 years
and no salvage value. The company estimates that annual cash inflows would increase by $400,000
and that annual cash outflows would increase by $190,000.
a. Compute the cash payback period.
b. What is your suggestion on the proposed expansion plan of the XYZ company?
Net Present Value (NPV)
 NPV is realistically used to predict the future cash flows
 It used to discounts future cash flows at an appropriate industry’s discount rate , this discount rate is
project’s opportunity cost of capital
 NPV is the sum of all discounted cash flows
 If NPV is > 0, the proposed investment or project can be accepted, the greater the NPV, the better the
project financial benefits
 Mathematically, NPV can be evaluated by the following formula:
 NPV = “Present Value of Cash Inflows” – “Present Value of Cash Outflows”
Worked Example

Formula for calculating present value =P= 𝐹/(1 + 𝑖)𝑛 OR

Where i or K = interest rate , n= service life , P = present value and F = future value
 Internal Rate of Return (IRR)
 Investments are undertaken with the expectation of a return in the form of future earnings.
 It is a discount rate at which NPV become zero. In other word, IRR is an opportunity cost at which the
NPV is zero.
 It tells ho much rate of return are getting from the new launched or invested project.
Why e use IRR?
o It used to rank different projects. i.e. the higher IRR, the more feasible or desirable to be
undertake.
o If all other factors are same for d/t project, analyst can consider project with highest IRR.
o Note:
o For constant cash inflow for every year, IRR can be computed with the help of formula.
o For uneven cash inflows for every year, IRR can be calculated Little’s and Error adjustments.
 Profitability Index (PI)
 Profitability index can be calculated as present value of all future cash inflows divided initial cash
outflows
 Profitability Index = PV of all future cash inflows /Initial cash outflows
 Project acceptance criteria:
 Accept the project when p1>1
 Reject the project when p1<1
 May accept the project when p1 =1
Generally, higher the PI, the project can be better
Cont.…
VII) Critical Risks: The investors are interested in knowing the tentative risks to evaluate the viability of
the business and to measure the risks involved in the business.
VIII) Exit Strategy: The exit strategies would provide details about how the organization would be
dissolved, what would be the share of each stakeholder in case of winding-up of the organization. It further
helps in measuring the risks involved in investing.
IX) Appendix: The appendix can provide information about the curriculum vitae of the owners, ownership
agreement and the like.
Exercise
1. What is business plan ?
2. Try to at least generate about 5 up to 8 Business Idea and using BI screening process, select the opportunity
that can be realized with feasible scenarios
3. Discuss the Components of Business Plan.
4. Discuss the steps or procedures of Feasibility Analysis
Project : formulate a group with 8 member in a single group and develop business plan considering essential
elements of business plan which is seen in this chapter 20%?

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