Ma Project (2015 Entry)

Ambo University Woliso Campus
Department of: Project Management (MA)
Course Title:
Project Feasibility Analysis & Evaluation
(MPM-751)
Course Instructors’ Name: Addisu G.(Ph.D.)
Email: addisugemeda2015@gmail.com
Tuesday, November 7, 2023 COMPILED BY: ADDISU G (PhD) 1

Course Description:
• This course deals with the techniques of generating project ideas
directed to the effective realization of project ideas which is expected
to solve meaningful social problem.
• As resources are generally scarce the ideas generated as a project
should be appraised first for their pre-feasibility and finally for their
feasibility in terms of various issues of importance.
• In this course, project idea generation, idea screening, technical
analysis, financial analysis, human resource analysis, market analysis,
economic analysis, ecological analysis etc. will be discussed

Objective:
• After completing this course students will be able to:
• Generate sound project ideas with a good prospect of feasibility
• Undertake feasibility of project ideas from various considerations
• Appraise and select projects ideas whose feasibility has been prima facie
confirmed
• Apply software packages for pre-feasibility, feasibility and appraisal passes of
project life cycle
Tuesday, November 7, 2023
COMPILED BY: ADDISU G (PhD) 3

Chapter One
Introduction

What Is a Feasibility Study?
• A feasibility study is an analysis that considers all of a project's

relevant factors—including economic, technical, legal, and
scheduling considerations—to ascertain the likelihood of completing
the project successfully.
• Whether a project is feasible or not can depend on several factors,
including the project's cost and return on investment, meaning
whether the project generated enough revenue or sales from
consumers.

KEY TAKEAWAYS
 A feasibility study assesses the practicality of a proposed plan or
project.
 A feasibility study considers many factors, including economic,
technical, legal, and scheduling to determine whether a project can
succeed.
 Whether a project is feasible or not can depend on the project's cost
and return on investment, which might include revenue from
consumers.
 A company may conduct a feasibility study to consider launching a
new business or adopting a new product line.
 It's a good idea to have a contingency plan in case of unforeseeable
circumstances or if the original project is not feasible.

Understanding a Feasibility Study
• A feasibility study is an assessment of the practicality of a proposed
plan or project.
• A feasibility study analyses the viability of a project to determine
whether the project or venture is likely to succeed.
• The study is also designed to identify potential issues and problems
that could arise from pursuing the project.
• As part of the feasibility study, project managers must determine
whether they have enough people, financial resources, and the
appropriate technology.

Cont’d…
 The study must also determine the return on investment, whether
it's measured as a financial gain or a benefit to society, as in the
case of a non-profit.
 In some cases, a feasibility study might include a significant change
in how a business operates, such as an acquisition of a competitor.
As a result, the feasibility study might include a cash flow analysis,
measuring the level of cash generated from revenue versus the
project's operating costs.
 A risk assessment must also be completed to determine whether
the return is enough to offset the level of risk of undergoing the
venture.

Benefits of a Feasibility Study
• There are several benefits to feasibility studies, including:
• Helping project managers discern the pros and cons of undertaking
a project before investing a significant amount of time and capital
into it.
• Feasibility studies can also provide a company's management team
with crucial information that could prevent them from entering into
a risky business venture.
• Feasibility studies also help companies with new business
development, including determining how it will operate, potential
obstacles, competition, market analysis, and the amount and source
of financing needed to grow the business.
• Feasibility studies aim for marketing strategies that could help
convince investors and banks that investing in a particular project or
business is a wise choice.

Tools for Conducting a Feasibility Study
Suggested steps in feasibility study
Although each project can have unique goals and needs, below are
some best practices for conducting a feasibility study:
1.Conduct a preliminary analysis, which involves getting feedback about
the new concept from the appropriate stakeholders; consider other
business scenarios and ideas
2.Analyse and ask questions about the data obtained in the early phase of
the study to make sure that it's solid
3.Conduct a market survey or market research to identify the market
demand and opportunity for pursuing the project or business

4. Write an organizational, operational, or business plan, including
identifying the amount of labor needed, at what cost, and for how long
5. Prepare a projected income statement, which includes revenue,

operating costs, and profit
6. Prepare an opening day balance sheet
7. Identify obstacles and any potential vulnerabilities, as well as how to deal

with them
8. Make an initial "go" or "no-go" decision about moving ahead with the
plan

Suggested Components of feasibility study report
 Once the initial due diligence has been completed, listed below are
several of the components that are typically found in a feasibility
study:
 Executive summary: Formulate a narrative describing details of the
project, product, service, plan, or business.
 Technological considerations: Ask what will it take. Do you have it? If
not, can you get it? What will it cost?
 Existing marketplace: Examine the local and broader markets for the
product, service, plan, or business.
 Marketing strategy: Describe it in detail.
 Required staffing (including an organizational chart): What are the
human capital needs for this project?
 Schedule and timeline: Include significant interim markers for the
project's completion date.
 Project financials.
 Findings and recommendations: Break down into subsets of
technology, marketing, organization, and financials.
Types of Feasibility Study
• Technical feasibility: is the process of figuring out how you're
going to produce your product or service to determine
whether it's possible for your company.
• Before launching your offerings, you must plan every part
of your operations, from first sourcing your production
materials all the way to tracking your sales. It includes:
• Technical: Hardware and software
• Existing or new technology
• Manpower
• Site analysis
• Transportation

 Market feasibility: is a study that identifies the success of a product in a
particular market.
It helps to identify the potential markets, market
competition, potential development in the market, and
market analysis to evaluate the business idea
Market feasibility is highly important for the companies who
are planning to start a business.
It helps the entrepreneurs to identify their target market,
analyse the market opportunity and the unmet customer
needs in the particular market segment.
It includes the study of:
Type of industry
Prevailing market
Future market growth
Competitors and potential customers
Projection of sales

• Financial feasibility focuses specifically on the financial aspects of the
study.
• It assesses the economical viability of a proposed venture
by evaluating the start-up costs, operating expenses, cash
flow and making a forecast of future performance.
• The results from a financial feasibility study determine
whether the proposed project is financially possible and
make a projection on the rate of return on invested capital.
• The preparation of a financial feasibility study has three
parts:
• Determining the start-up costs.
• Preparing a profit plan and making cash flow projections.
• Assessing the return on invested capital.

• Economic Feasibility: This assessment typically involves a cost/
benefits analysis of the project, helping organizations determine the
viability, cost, and benefits associated with a project before financial
resources are allocated.
• It also serves as an independent project assessment and enhances
project credibility—helping decision-makers determine the positive
economic benefits to the organization that the proposed project
will provide.
• During the economic feasibility step, the following activities must
be completed:
• Develop a financial analysis that identifies break-even scenarios
based upon unit prices, volume of sales, and costs
• Determine whether the business opportunity presents sufficient
profit margins to justify a business venture
• Assess the merits of licensing the opportunity compared to
venturing

Appraisal of Project by Lenders
What is Project Appraisal?
Assessing the viability or feasibility of a proposed project by the lending
institutions is called project appraisal.
Why is Project Appraisal necessary?
Generally, commercial banks cannot finance on a long term basis to
industries as most of their funds are short term in nature.
In the case of term loans, the bank provides them on the basis of the
purpose and they differ from short term loans.
Term loans are not only huge but they are given for a longer period and
there are greater risks involved.
But, the earnings of the banker will be more which compensates for the
loss.
The borrowing industry is able to utilize the term loans in a much better
manner and it improves their production capacity, earnings and utilization
of existing capacity.

 While providing term loans, the lending institutions will have to find that
the income received from the utilization of these loans by the borrower
firm is sufficiently large that they are able to repay the loan.
 A banker has to assess the project for which the loan is required.
 He must make sure that the project will provide enough contribution so
that the loan could be repaid. Hence project appraisal is necessary.
 An appraisal made by a banker on the viability of the project from the
point of repayment is known as project appraisal.
 It is here that the bank has to adopt a technique and go in for the
selection of a suitable project.
 Accordingly the four feasibility analysis types will be used as a criteria by
the banks like market, technical, financial and economic feasibility.

Chapter Two
Market Feasibility

o The first step in project analysis is to estimate the potential size of
the market and get an idea about the market share that is likely to
be captured.
o Market and demand analysis is concerned with two broad issues:
o What is the likely aggregate demand for the product/service?
o What share of the market will the proposed project enjoy?
o These are very important, yet difficult, questions in project
analysis.
o Intelligent and meaningful answers to them call for an in-depth
study and assessment of various factors like patterns of
consumption growth, income and price elasticity of demand,
composition of market, nature of competition, availability of
substitutes, reach of distribution channels, so on and so forth.

Market and Demand Analysis
The key steps involved in market and demand analysis are
organized into seven sections as follows.
1.Situational analysis and specification of objectives

2.Collection of secondary information
3.Conducting market survey
4.Characterization of the market
5.Demand forecasting
6.Uncertainties in demand forecasting
7.Market planning.

KEY STEPS IN MARKET & DEMAND ANALYSIS & THEIR INTER-
RELATIONSHIPS
Collection of
Secondary Demand
Information Forecasting
Situational Analysis
Characterization
and Specification of
of the Market
Objectives
Conduct of Market
Market Survey Planning

1. SITUATIONAL ANALYSIS & SPECIFICATION OF OBJECTIVES
• Situational Analysis provides the current status of the key aspects

of the market and its participants.
• The aspects include:
• Customers: customer’s preferences & purchasing
power
• Competitors: strategies & actions of competitors, and
• Middlemen: practices of middlemen

• A situation analysis may generate data that will provide a vague
idea of the market and provide a basis for rough demand and
revenue projection.
• If the situation analysis points a promising picture for the
project,
• a formal market study is warranted to provide more accurate
and reliable data that can be used for investment decision
making.
• To carry out such a study it is necessary to specify the objectives
as clearly and as comprehensive as possible.

• A common approach to do this is to structure them in the form of
questions.
• Eg. suppose Sony Corporation developed technology to

produce superior plasma television set; and the
management wants to know where and how to market the
TVs.
• The objectives of the market and demand analysis may be to

answer the following questions:

a) Who are the buyers of the TVs?
b) What is the current demand of the TVs?
c) How is the demand distributed geographically and seasonally?
d) What is the component demand of TVs of various sizes?
e) What prices will the customers be willing to pay for the
superior TVs?
f) What price and warranty will ensure acceptance?
g) What distribution channels are the most suited for the TVs and
what margins will induce distributors to carry it?
h) What are the prospects for immediate sales? etc

2. Collection of Secondary Information
• Information may be obtained from secondary and /or primary
sources.
• Secondary information is information that has been gathered in
some other context and is already available.
• Primary information, on the other hand, represents information
that is collected for the first time to meet the specific purpose
on hand.
• Secondary information provides the base and the starting point
for the market and demand analysis.

3. Conduct of Market Survey
• Secondary information, though useful often, does not provide a
comprehensive basis for market and demand analysis.
• It needs to be supplemented with primary information gathered through a

market survey, specific to the project being appraised.
• Consequently primary information is sought through a market survey.
• The survey could be a census; where the entire population is covered or a

sample survey; only a proportion of the population is covered.

• Information sought in a market survey may cover one or
more of the following areas:
a) Total demand and rate of demand growth
b) Demand in different segments of the market
c) Income and price elasticity of demand
d) Motives for buying
e) Purchasing plans and intentions
f) Satisfaction with existing products
g) Unsatisfied needs
h) Attitude towards various products
i) Social economic characteristics of buyers
j) Customer preferences etc

• Steps in a sample survey:
• Typically, a sample survey consists of the following steps.
 Select the sampling scheme and sample size.
 Develop the questionnaire
 Recruit and train the field investigators
 Obtain information as per questionnaire from the sample
respondents
 Scrutinize the information gathered
 Analyze and interpret the information.

• The results of a market survey depend on the following:
 representativeness of the sample,
 precision and adequacy of the questions,
 comprehension of the questions by the respondents,
 honesty of the respondents in answering the questions,
 integrity of the investigators and
 appropriateness of data analysis methods

4. Characterization of Market
• Based on the information gathered from the secondary

information survey and the market survey, the market for a
product may be described in terms of the following:
• Effective Demand; Past and Present: In competitive markets
effective demand is the apparent consumption which is
defined as: production + imports – exports – changes in stock
level.
• Breakdown of Demand: Total / aggregate demand may be
broken in to different segments which may be defined by: nature
of product; consumer groups; geographical region etc

• Price: It may be wise to distinguish between the following
prices: manufacturer’s price; wholesaler’s price; retail price
etc.
• Methods of Distribution and Sales Promotion: Since
methods of distribution and sales promotion vary among
different products, it will be helpful to describe the foregoing
aspects for the product on hand
• Consumers: Consumers may be characterized
demographically using such attributes as age, income, sex etc
or attitudinally using such attributes as preferences, habits,
intentions etc

• Supply and Competition: The location, present production,
planned expansion, capacity utilization level of competitors is
crucial information.
• Substitutes and near substitutes should be noted too.
• Government Policy: The role of the government in influencing

the market and demand of a product may be significant; as such
government policies and legislations that have an impact on the
product should be spelt out.

5. Demand Forecasting
• After gathering information about the various aspects of the
market and demand from primary and secondary sources,
attempt may be made to estimate future demand.
• A wide range of forecasting method is available to the market

analyst.
• These methods can be grouped in three categories

A. Qualitative Methods
i. Jury of executive opinion method: under this method

opinions are sought from a group of managers on the expected
future sales they are then translated into sales estimates
ii. Delphi method: opinions are sought from a

group of experts who don’t know the identity of each other, any
divergent opinions are then mailed back to back for further
opinion until a consensus is obtained.

B. Time Series Projection Methods
i. Trend projection method: This involves (a) determining the trend of

consumption by analyzing past consumptions data and then (b) projecting future
consumption by extrapolating the trend.
• The most common method of extrapolation is the linear regression. This is given
by the expression
• Yt = a+ bT , where;
• Yt =demand for years t; T= time variable
• a = Y intercept; given by the expression
• b is the slope of the relationship; given by the expression

• where n = No. of Observation
• Illustration: Assume the following are the demand figures (Y)

for the past six years (T)
T 1 2 3 4 5 6 ∑T=21 Tbar= 3.5
Y 23 22 24 24 25 27 ∑Y= 145 Ybar= 24.17
TY 23 44 72 96 125 162 ∑TY= 522
T2 1 4 9 16 25 36 ∑T2= 91
b = 522-507.57 14.43 =0.825

91-73.5 17.5
a= 24.17- 0.825(3.5) = 21.2825
•The forecasted demand 3 years from now, which will be year 9
from our analysis will be:
•Y9=
Tuesday, November 7, 2023
a+ bT = 21.2825 + 0.825(9) = 28.71
COMPILED BY: ADDISU G (PhD) 39
ii. Exponential Smoothing Method: the forecasts from the
preceding method may be modified by exponential smoothing if
large deviations of the forecasts from actual values are noted.
• If the forecasts value for year t, (Ft), is less than the actual
value for year t, (St), the forecast for year t+1 (Ft+1), is set higher
than Ft.
• If Ft >St, Ft+1 is set lower than Ft.
• In general , Ft 1   et where;  =smoothing

Ft
parameter chosen so as to minimize the deviation (error) and
ranging from 0 to 1, and et = deviation (error) in the forecast
for year t, given by St - Ft.
• To illustrate the use of the moving average technique, consider
the following time series.

• If n is set equal to 4 (n has to be specified by the forecaster), the
forecast for period 5 will be equal to
• (It may be noted that if n is equal to 4, the first forecast can be made
only for period 5.)
• The forecast for period 6 is equal to
• Other forecasts follow as shown

6. Uncertainties in demand forecasting
• Demand forecasting is subjected to error and uncertainly that
arise from three main sources
i. Data about past and present market: lack of standardization,
few observations, influence of abnormal factors etc.
ii. Methods of forecasting: inability to handle unquantifiable
factors, unrealistic assumption, excessive data requirement
etc.
iii. Environmental changes: shift in government policy,
international development, discovery of new sources of raw
materials.

7. Market planning
• The following are the steps followed in market planning
a) Current marketing situation. This deals with:
i. Market situation e.g. size growth rate etc.
ii. Competitive situation e.g. the competitors objectives strategies
strengths etc.
iii.Distribution situation e.g. distribution capabilities of competitors
iv.Macro-environment e.g. social, political economic technological
variables etc.

b) Opportunity and issue analysis. In this section SWOT analysis is
conducted
c) Objectives. Objectives which have to be clear, specific and
achievable are spelt out
d) Marketing strategy. The marketing strategy covers the following:
• Target segment, positioning, product line, price, distribution,
sales force, sales promotion and advertising.
e) Action program. This entails operationalising the strategy in to
time phased activities.

Chapter Three
Technical Feasibility

 Analysis of technical and engineering aspects is done continually
when a project is being examined and formulated.
 Other types of analyses are closely intertwined with technical
analysis.
 The broad purpose of technical analysis is
(a)to ensure that the project is technically feasible in the sense
that all the inputs required to set up the project are available
and
(b)to facilitate the most optimal formulation of the project in
terms of technology, size, location, and so on.

3.1. Raw Materials and Supplies Study
• The selection of raw material and supplies depends primarily on
the:
• technical requirements of the project and
• the analysis of supply markets.
• Important determinants for the selection of raw materials and
factory supplies are:
 environmental factors such as resource depletion
and population concerns, as well as
 criteria related to project strategies for example, the
minimization of supply risks and the cost of materials
inputs.

• In order to keep the cost of the supply low, key aspects are to
be identified and analyzed in terms of:
 requirements availability
 cost and
 risks which may be significant for the feasibility of a project.
• The approach taken in this respect is:
 first to classify the raw materials and supplies
 then to specify the requirement,
 check there availability and then estimate their cost.

1. Classification of Raw Materials and Supplies
a) Raw Materials (Unprocessed and Semi Processed).
i.Agricultural Products
ii.Livestock and Forest product
iii.Marine Product:
Availability of marine products may not only depend on ecological
factors but also on national policy & bilateral & multilateral
arguments

iv. Mineral products:
•Detailed information on the proposed exploitable deposit is
essential.
•Unless the reserves are known to be very extensive, the study
should give details of the:
 viability open cast or underground mining,
 the location,
 size,
 depth
 quality of deposit and
 the composition of the ore with other elements i.e.
impurities.

• A detailed analysis of :
 physical,
 chemical and
 other properties of the subject are to be processed
and the results ought to be incorporate in the
feasibility report.

b) processed industrial materials
semi processed materials relating to a wide variety of
industries in different sectors and manufactured parts,
components and subassemblies for assembly- type industries,
including a number of durable consumer goods and engineering
goods industry.
In all these cases, it is necessary to define requirements
availability and costs in some detail to ensure that the
specification in the case of the two latter categories suit the
production programs envisaged for the projects.

c) Factory supplies
i. Auxiliary Materials and Utilities
•A part from basic raw materials and processed industrial materials and
components all manufacturing projects require various auxiliary
materials and utilities, usually subsumed as factory supplies.
•A detailed assessment of the utilities required (electricity, water, steam,

compressed air, fuel, effluent disposal) can only be the made after
analysis and selection of location, technology and plant capacity, but a
general assessment of these is a necessary part of the input study.

ii) Packaging materials and containers:
•All types of containers and packaging materials serve in
principle the following two purposes:
 physical holding and protection of a product (semi-
finished) and
 achieving the marketing objectives defined in the
marketing concept.
d) Recycled Waste
•The issue of waste disposal is assuming increasing importance
in developing countries, depending on the type of production
process.

• Waste combustion of high-risk waste is technically feasible
provided adequate measures are taken and appropriate
technologies are applied.
• The disposal of effluents is technically feasible provided the
appropriate installations have been selected.
e) Spare Parts: In spite of regular maintenance all machinery and
equipment will finally break down after a certain lifetime.
• Various spare parts will be required to keep a plant in operation.

• The importance of
 correctly identifying essential spare parts,
 the quantities required and
 available suppliers
• cannot be overemphasized because interruption of production
owning to lack of essential spare parts is often the reason for
projects failure.

f) Supplies for Social and External Needs
• A remote location or some other reason might require the
project (or the company) to provide and pay for
 foodstuffs,
 medicine,
 clothing,
 education and training materials etc.
• for the employees and perhaps also their families. Sometimes it
may be necessary for the investing company to take
responsibility for maintenance of external infrastructure.

2. Specification of Requirements
• In order to estimate the requirement of materials and supplies
during the future operation of the plant, such requirements should
be identified, analyzed and specified in the study both
quantitatively and qualitatively.
• A number of factors could have a strong influence on the type,

quantities, and qualities of the project inputs in particular the
following:
i. Socio- economic factors:
ii. Commercial and financial (business) factors

iii. Technical factors

Availability and Supply
• The source and the constant availability of basic production materials
are crucial to the determination of the technical and economic
viability as well as the size of most industrial projects.
• A feasibility study must show how the materials and inputs required
will be provided.
• General availability, data about :
• materials potential users, and
• supply sources and programs
• will have to be analyzed and described.

• A final assessment of input requirement can be made on only
after the plant capacity as well as the technology and
equipment to be used are defined.
• If a basic input is available within a country, its location and

the area of supplies, whether concentrated or dispersed
should be determined.
• The alternative uses likely to be made of such materials and

the consequent impact on availability should be assessed for the
project in question

• The question of transportability and transport costs should be
carefully analyzed.
• When the basic material has to be imported either in whole or in
part, the implication of such imports should be fully assessed.
 First the sources of imported inputs have to be determined.
 Secondly, the uncertainly of inputs should be sated.
 Thirdly, the implication of domestic production of basic
materials that was being imported should be analyzed.

Input Alternatives
• In many projects different raw materials can be used for the same
production.
• When this is the case, the raw materials must be analyzed to

determine which is most suitable taking all relevant factors in to
consideration.
• If alternative materials are used, discussion should be also include

an assessment of the eenvironmental impact of each material.

4. SUPPLY MARKETING AND SUPPLY PROGRAM
• Supply marketing : The objectives of supply marketing are

basically :
 cost minimization,
 risk minimization (reliability of supplies) and
 the cultivation of relation with supplier.
• Supply Program: The overall purpose of the outline of a

supply program in the feasibility study is to show how
supplies of materials and inputs will be secured.
• Cost estimates should be based on the supply program presented.
• A supply program should deal with the following:
 Identification of Supplying Sources and Suppliers
 Agreement and Regulations
 Means of Transport
 Storage
 Risk Assessment

• A distinction should be made between external and internal
project risks factors, including:
 failure of suppliers to meet their obligations,
 delayed consignments,
 supply shortages,
 quality defects,
 transport breakdown,
 utility malfunctions,
 strikes,
 climate variations,
 changed import regulations and
 shortages of foreign exchange for imports.

5. Costs of Raw Materials and Suppliers
a) Unit Costs
•Not only the availability but also the unit costs of basic materials
and factory supplies have to be analyzed in detail as this is a critical
factor for determine project economies.
•The cost of alternative means of transport should also be

considered.

• For imported materials and inputs CIF prices (including costs,
insurance and freight) should be invariably be adopted together
with clearing charges (including loading and unloading) port
charges, tariffs, local insurance and taxes, and costs of internal
transport to the plant.
b) Annual Costs
• Estimates of annual operating costs for materials and supplies are

to be made.

• It should be made clear whether the cost estimates refer
 to a hypothetical level of production at full capacity

utilization during the operation phase
 or to the first year (or some other year) of operation phase

according to the time schedule for project implementation.
• Some costs vary with the production level the plant in question,
while others are more or less fixed.

• Taking into consideration the expected variations in the proposed
plant, it is advisable to divided cost item into variable and fixed
costs.
• In order to arrive at the total operating costs by product as well

as by total costs per year, the estimated costs per unit are
multiplied by the total number of unit to be produced.

c) Overhead Costs of Supplies
•When estimating material and input requirements of the project,
the project planner has to plan not only for the level of production
cost center but also at the level of service, administration and sales
cost centers.

3.2. LOCATION, SITE AND ENVIRONMENTAL
IMPACT ASSESSMENT
• Location and site are often used synonymously but must be

distinguished.
• The choice of location should be made from a fairly wide

geographical area, within which several alternatives sites can
be considered.
• For each project alternatives the environmental impact of

erecting and operating the industrial plant should be assessed.

• The main criteria or key requirements for selecting proper
locations & sites should always be identified at an early stage of
the study.
Location Analysis
• Location analysis has to identify a location suitable for the
industrial project under consideration.
• The feasibility study should also indicate on what grounds
alternatives locations have been identified and give reasons for
leaving out other locations that were suitable but not selected.

• Traditional approach to industrial location focused, on the
proximity of raw materials and marketing’s, mainly with a
view to minimizing transport costs.
• The modern view requires consideration of commercial,

technical and financial factors, but also of the social and
environment impact a project might have.
Key Factors in Location Analysis includes:
1. Natural environment, geographical conditions and project

requirements.

2. Ecological impact of the project, environmental impact
assessment
3. Socio-economic policies, incentives and restrictions and

government plans and policies
4. Infrastructural service, conditions and requirements, such as

the existing industrial infrastructure, the economic and social
infrastructure the institutional framework, urbanization and
literacy.

The Natural Environment
• Climatic conditions a part from the direct impact on project costs
of such factors as dehumanization, air conditioning, refrigeration
or special drainage, the environmental effects may be significant.
• Information should be collected on temperature, rainfall,

flooding, dust, times and other factors for different locations.
• Climatic conditions are relevant in different ways; means of

transport may become less reliable for products to distant
markets.

• The construction, operation and management of the plant may be
less efficient or more expensive if adequately skilled labor force
is reluctant to work in areas with extreme climate conditions.
• Climate conditions can be specified in term of air temperature,

humidity, sunshine hours, winds, precipitation hurricane, risk etc.
• aspects are in general more relevant for the selection of suitable

sites.

• There include soil, water levels, and a number of special site
hazard such as earthquakes and susceptibility to flooding all of
which extend over grater areas.
• Ecological requirements: some projects may not have a negative

environmental impact themselves but rather be sensitive to such
effects.
• Management and workers may be reluctant to work in a factory

located in a polluted area with health risks.

Environment Impact Assessment
• The site environment impact analysis will cover the impact of the
project and the alternatives (in terms of size, technology etc) on
the surrounding area, including its population, flora and fauna.
• This analysis should be integrative and interdisciplinary,

assessing the overall impact which taking into account the
synergetic effects of inter-linked systems.
• Environmental benefits or costs of a project are usually

externalities or side effects that affect the society in whole or in
part.

• Environment Conflicts
• Environmental conflicts might also lead to:
 compensation claims,
 substantial costs for purification equipment, and
 possibly a risk that the plant will have to be closed down.
• The potential risks related to the location of projects that have

negative environmental impact must be seriously considered in
the feasibility study.

• Including potential conflicts with existing and future
neighboring industries, urban settlements and other elements
should be identified and analyzed in so far as they may affect the
investment decisions.
Objectives of Environmental Impact Assessment
• The general objective of environmental impact assessment in

project analysis is to ensure that development projects are
environmental sound.
• The specific objectives of environmental impact assessment are as

follows:
 To promote a comprehensive, interdisciplinary investigation of
environmental consequences of the project and its alternatives
for the affected natural and cultural human habitat.
 To develop an understanding of the scope and magnitude of

incremental environmental impacts (with and without the
project) of the proposed projects for each of the alternatives
project designs.
 To incorporate in the designed any existing regulatory

requirements

 To identify measures for mitigation of adverse environmental
impacts and for possible enhancement of beneficial impacts.
 To identify critical environmental problems requiring further

investigation
 To assess environmental impact quantitatively and qualitatively,

as required, for the purpose of determining the overall
environmental merit of each alternative.

Socio-Economic Policies
Role of Public Policies
•Government regulations and restrictions may be critical for the

location of project.
•Project with certain characteristics may be allowed only in certain

regions.
•Investment in export processing zones and other specified regions

are sometimes exempted from taxes or would benefit from other
types of subsidy

Fiscal and Legal Aspects
•The legal, regulations, and procedures applicable for alternatives

locations should be defined.
•The corporate and individual income taxes, exercise duties,

purchase taxes and other national or local taxes should be
ascertained for different locations together with the incentives and
concessions available for new industries.

Infrastructural Conditions
a) Infrastructure dependence
 Technical infrastructure
 Transport and communication
b) Factory supplies
 Effluent and Water
 Electricity
 Fuel
c) Human resources
d) Infrastructural service
e) waste disposal

Resources or Market Orientation
• Criteria to location selection is the impact on a particular project
of factors such as:
 the availability of raw material and inputs
 the proximately of centers of consumption and
 the existence of basic infrastructure facilities.
• Project based on specific raw materials are for obviously

reasons located at the source.
• The simplest location model is to calculate the transport,

production and distribution costs at alternative locations
determined principled by the availability of raw materials and
principal mkt
• For projects that are not unduly resources or market-oriented,
optimum location could well combine reasonable :
 proximately to raw material and markets,
 favorable environmental condition,
 a good pool of labor,
 adequately power and fuel at reasonable cost,
 equitable taxes,
 good transports,
 adequate water supply and
 facilities for waste disposal.

Assessment of Location
• As far as the financial feasibility of alternative locations is

concerned, the following data, as well as related financial risks,
should be assessed
 production costs (including environmental protection costs)
 Marketing costs
 Investment costs (including environmental protection)
 Revenues
 Taxes, subsides, grants and allowances
 Net cash flows

Site Selection
• Once the location is decided upon, a specific project site and, if
available, site alternative should be defined in the feasibility
study.
• The structure of site analysis is basically the same for location

analysis and the key requirement, identified for the project give
guidance also for site selection.
• For sites available within the selected are the following

requirements and conditions are to be assessed.
 Ecological condition on site (soil, site hazards climate etc.)
 Environmental impact (restrictions, standards, guidelines,)
 Social-economic conditions (restrictions, incentives,
requirements)
 Local infrastructure at site location (existing, industrial,
infrastructure economic and social infrastructure,
availability of critical project impact such as labor and
factory supplies)
 Strategies aspects (corporate strategies regarding possible
future extension, supply and marketing policies.

 Cost of land
 Site preparation and development, requirement and costs
Requirements and Relevant Factors
• Site Requirement
• A project may depend on particular site condition, which
should be identified and described in the feasibility study.
i. Cost of land
ii. Construction requirements
iii.Local conditions-infrastructure

• The availability and cost of electricity is common for most sites
within a given location.
• Transport is very important when comparing the suitability of

different sites.
• Where water is requirement for the manufacturing processes

such assessment is more important and the source and cost of the
water supply has to be estimated at alternatives sites.
iv. Effluent and waste disposal

• The disposal of effluent may be a problem for many industries.
• The possibilities for effluent disposal at different sites should be
carefully studied bearing in mind the type of effluent.
v. Human resources
• Recruitment of managerial staff and labor may be a critical
factor for the viability of a project.
• The study must therefore pay carefully attention to the
question of labor availability, conditions related to recruitment
and facilities for training.

• It may be necessary to develop a social
infrastructure next to the envisaged site like:
 housing,
 primarily school,
 medical and
 social centers to attract the requirement staff and
labor force.

3.3. Production Program and Plant Capacity
Production program
•Production program consist of the whole range of project activities

and requirement, including production levels to be achieved under the
technical, ecological, social and economic constraints.
•This necessitates identifying the principal products or products range

including by-products, determining the volume of production, &
relating production capacity, to the flow of materials and
performance of services at the selected site.

• Determination of the production program
a)Market requirements and marketing concept

• The range and volume of products to be produced depends
primarily on the market requirements and the proposed marketing
strategies.
• A production program should define the levels of output to be

achieved during specified period and from this viewpoint, it
should be directly related to the specific sales forecasts.

• It would be prudent to recognize that full production may not be
practicable for most projects during the initial production
operations.
• Owing to various technological, production operations, and
commercial difficulties most projects experiences initial
problems that can take the form of :
 a gradual growth of sales & market penetration on the one
hand and,
 a wide range of production problems such as the adjustment
of labor & equipment to the technology selected on the other.

• Even if full production were to be achieved in the first year,
marketing and sales might prove to be a bottleneck.
• Depending on the nature of the industry production & sales target

of 40-50% of overall capacity for the first year should be
considered reasonably.
• Once a production program defines the levels of outputs in terms

of end products & possible of intermediate products & the
interrelation b/n various production lines & processes, the specific
requirements of materials & labor should be quantified for each
stage.
b) Technology and know-how
•An important factor in determining the production program and

plant capacity is the technology and know-how to be utilized in
the project.
•Specific processes are often related to certain levels of

production or become technically and economically feasible only
at such levels.
•The nature of technology choice and usage constitutes a key

factor in the determination of plant capacity.

• Each technically possible alternative must in
addition consider:
social,
ecological,
economic and
financial conditions,
• because production programs and plant
capacity are functions of various interrelated
socio- economic strategic and technical factors.
Plant capacity
• Plant capacity (also referred to as production
capacity) refers to the volume or number of
units that can be manufactured during a given
period.
• Plant capacity may be defined in two ways:
 feasible normal capacity and
 nominal maximum capacity.
• Feasible normal capacity refers to the capacity
attainable under normal working conditions.

• This may be established on the basis of:
 the installed capacity,
 technical conditions of the plant,
 normal stoppages, & downtime for maintenance,
 holidays, and
 shift patterns.
• The nominal maximum capacity is the capacity
which is technically attainable and this often
corresponds to the installed capacity
guaranteed by the supplier of the plant.

• Plant capacity is influenced by the following factors:
i. Technological requirement
• For many industrial projects, particularly in process
type industries, there is a certain minimum
economic size determined by the technological
factor.
• For example, a cement plant should have a capacity
of at least 300 tons per day in order to use to rotary
kiln method: otherwise; it has to employ the
vertical shaft method which is suitable for lower
capacity.
ii. Input constraints
•In developing countries, there may be constraints
on the availability of certain inputs.
 Power supply may be limited,
 basic raw materials may be scarce;
 foreign exchange available for imports may be
inadequate.
•Constraints of these kinds should be borne in
mind while choosing the plant capacity.

iii. Investment cost
•When serious input constraints do not exist, the
relationship between capacity and investment
cost is an important consideration.
•Typically, the investment cost per unit of capacity
decrease as the plant capacity increase.
•This relationship may be expressed as follows:

• Where C1 = derived cost for Q1 units of capacity
• C2 = known cost for Q2 units of capacity
a = a factor reflecting capacity -cost relationship. This is usually
between 0.2 and 0.9.
• Illustration: suppose the known investment cost for 5,000 units
of capacity for the manufacturer of a certain item is Br.
1,000,000.
• What will be the investment cost for 10,000 units of capacity if
the capacity-cost factor is 0.6?
• The derived investment cost for 10,000 units of capacity may be
obtained as follows:

iv. Market conditions
•The anticipated market for the product/service
has an important bearing on the plant capacity.
• If the market for the product is likely to be
very strong, a plant of higher capacity is
preferable.
•If the market is likely to be uncertain, it might be
advantageous to start with a smaller capacity.

v. Resources of the firm
•The resources, both managerial and financial
available to a firm define a limit on its capacity
decision.
•Obviously, a firm cannot choose a scale of
operations beyond its financial resources and
managerial capability.
vi. Government policy
•The capacity level may be influenced by the
policy of the government.
• Traditionally, the policy of developing countries
was to distribute the additional capacity to be
created in a certain industry among several
firms regardless of economics of scale.
• This policy has been substantially modified in
recent years and the concept of ‘minimum
economic capacity’ has been adopted in
several
industries.

vii. Economic of scale
•While production costs undoubtedly fall with
increasing volumes of production, the economic,
technical and ecological effects vary from country
to country and industry to industry.
•Therefore plant capacity must be related to
economies of scale.

viii. Minimum economic size and equipment
constraints
• The concept of minimum economic size is
applicable to most industries and projects but is
of varying significance for different types of
industries.
• A cement plant of less than 300 tons per day is
for instance not considered economical.

3.4. Technology and Engineering Study
• Definition of technology
• Technology is defined as the application of
scientific knowledge for productive
purposes.
• This entails the use of science to produce
products, services or processes.

Assessment of technology required
• The primary goals of technology assessment are to determine

and evaluate the
1. impacts of different technologies on the society and national
economy, such as
 cost-benefits analysis,
 employment and income effects,
 satisfaction of human needs etc,
2. impacts on the environment (environmental impact
assessment) and
3. techno-economic feasibility assessed from the point of view of
the enterprise

• To allow the careful assessment of the
suitability of the technological alternatives a
logical sequence should be followed:
i. Problem identification,
ii. technology description and project layout,
iii. technology market and alternatives,
iv. assessment of availability,
v. technology forecast,
vi. assessment of the local integration,
vii. description of the social economic impact,
viii. environmental impact assessment
Selection of Technology
• The choice of technology is influenced by variety considerations
this are:
 plant capacity: To meet a given capacity requirement
perhaps only a certain production technology may be viable.
 principal inputs: For example, the quality of limestone
determines whether the wet or dry process should be used for
a cement plant.
 investment outlay and production cost: The effect of
alternative technologies on investment outlay and production
cost over a period of time should be carefully assessed.

 used by other units: The technology adopted must
be proven by successful use by other units,
preferably in the specific country
 product mix: The technology chosen must be judged
in terms of the total product-mix generated by it,
including saleable by-products.
 latest developments: The technology adoption must
be based on the latest developments in order to
ensure that the likelihood of technological
obsolescence in the near future at least, is
minimized.

 ease of absorption: The ease with which a particular
technology can be absorbed can influence the choice
of technology.
• Sometimes a high level technology may be beyond
the absorptive capacity of a developing country
which may lack trained personnel to handle that
technology
 ecological and environmental impact

Appropriateness of technology
• Appropriate technology refers to those methods of production
which are suitable to local economic, social and cultural
conditions.
• The advocates of appropriate technology should be evaluated in
terms of the following questions:
i. Whether the technology utilizes local raw materials?
ii. Whether the technology utilizes local man power?
iii. Whether the goods and services produced cater to the
basic needs?
iv. Whether the technology protects ecological balance?
v. Whether the technology is harmonious with social and
cultural conditions?

Means of Technology Acquisition
• When technology has to be obtained from some other enterprises,
the means of acquisition have to be determined.
• These can take the form of:
 technology licensing,
 outright purchase of technology or
 a joint venture involving participation in ownership by the
technology supplier.
• The implications of these methods of acquisition should be
analyzed.

Civil Works
• Structures and civil works may be divided into
three categories: site preparation and
development, buildings and structures and,
outdoor works.

Site preparation and development
• This covers the following
(i)grading and leveling of the site,
(ii)demolition and removal of existing structures
(iii) relocation of existing pipelines, cables,
roads, power lines, etc;
(iv) reclamation of swamps and draining and
removal of standing water,

(v)connections for the following utilities from
the site to the site to the public network:
 electric power (high tension and low tension),
 water for drinking and other purposes,
 communications (telephone telex, internet
etc,)
 roads, railway sidings and
(vi)other site preparation and development
work.

Building and structures
• Buildings and structures may be divided in to:
(i)factory or process buildings,
(ii)ancillary buildings required for stores,
warehouses, laboratories, utility supply centers,
maintenance services, and others
(iii)administrative buildings
(iv) staff welfare buildings cafeteria and medical
service buildings and
(v)residual buildings.

Outdoor works
• Outdoor works cover
(i) supply and distribution of utilities (water, electric power,
communication, steam, and gas)
(ii)handling and treatment of emission, wastages and effluents
(iii)transportation and traffic signals;
(iv)outdoor lighting
(v)landscaping and
(vi) enclosure and supervision (boundary wall, fencing, barriers,
gates, doors, security posts etc,)

3.5. Human Resource and Organization
• The human resources requirement at various levels and during

different stages of the project must be defined as well as their
availability and cost.
• On the basis of the quantitative human resource requirement of

the project, the availability of personnel and training needs, the
cost estimates for wages, salaries other personnel-related
expenses and training are prepared for the financial analysis of
the project.

Categories and Functions
• Human resources as required for the implementation and

operation, industrial project need to be defined by categories
such as
 management as supervision personnel and
 skilled and unskilled workers and
• By functions such as
 general management,
 production management and supervision,
 administration (accounting, purchase etc.)
 production control,
 machine operation and transport

• The numbers, skills and experiences required
depend on:
 the type of industry,
 the technology used,
 plant size,
 the cultural and socio-economic environment of the
project,
 location as well as proposed organization of the
enterprise

Timing of requirements
i. Pre -production phase:
•During the pre-production phase, it may be assumed that labor
requirements occur mainly in conjunction with preparatory measures
needed to start the operational phase.
•Thus the managerial staff, supervisors, some foremen, and special

machine operators have to be recruited in advance, not only to be
trained, but also to attend to the construction of building and the
installation of equipment that they will later be operating.

ii. Operational phase:
•Requirements during the operating phase may vary over time.
•capacity utilization is usually improved gradually and additional

shifts may be introduced bringing about production and possibly
additional requirements in certain personnel categories.
•A distinction should be made between variable and fixed wage

and salary costs as well between the local and foreign lab our
components.

Organizational Set-Up
• Organization is the means by which the operational functions &

activities of the enterprises are structured and assigned to
organizational units represented by managerial staff, supervisors
and workforce,
• with the objective of coordinating and controlling the

performance of the enterprises and the achievement of its
business targets.

• Human resource requirements will obviously also depend on:
 the management structure,
 organizational layout,
 operating plan and other factors related to the financial and

commercial features of the project.
• The organizational structure of an enterprise indicates the

delegation of responsibilities to the various functional units of
the company and is normally shown in a diagram.

• Usually, the organization is designed primarily in line with the
different functions in the enterprise such as finance, marketing,
purchasing, and manufacturing.
• However, there is no unique organization pattern.
• It is also possible to base organizational structures on products or

productions lines (for instance profit or cost centers) or on
geographical areas or markets; the latter are typical for
marketing organizations.

Organizational Design
• The organization design for both the construction and the
operating phase depends on internal and external project
requirements and conditions.
• It is prepared for the following two reasons:
 First, the organization of the project and enterprises should aim

at the optimal coordination and control of all project inputs,
which make it possible to implement the project strategic
economically.

 Secondly, the organizational set up serves to structure the
investment and production costs and to determine the costs
linked with the corresponding organization units.
• The design of the organization usually includes the following
steps:
i. The goals and objectives for the business are stated;

ii. The functions that are necessary to achieve the goals
are identified;
iii. The necessary functions are grouped or related;

iv.The organizational framework or structure is designed;
v. All key jobs are analyzed designed and described,
vi.A recruitment and training program is prepared.
• The organizational planner will then have to consider

some of fundamental aspects of optimal organization.
These may include:
i. The span of control that is the numbers of employees

reporting to supervisor.
ii. The number of organization levels

iii.A subdivision of activities by functions, process,
equipments, location, product or classes of customers.
iv.The distribution of responsibilities and authority.

Training Plan
• Since the lack of experienced and skilled personnel can
constitute a significant bottleneck for project implementation
and operation in developing countries, extensive training
programmers should be designed and carried out as part of the
implementation process of investment projects.
• Training can be provided at the factory by managerial and

technical personnel and others, by specially recruited experts or
by expatriate personnel.

• The timing of training programs is of crucial importance since
personnel should be sufficiently trained to be able to take up their
positions as and when required.
• Training requirements should be defined separately for the

preproduction and for the operation phase in order to provide
adequately for production and operational training costs.

Cost Estimates
• The manning tables prepared for each department can be used

for estimating labor costs.
• When estimating the total wage and salary costs provision
should be made for the following personnel overhead costs.
 Social security, fringe benefits, and welfare costs
 Installation grant, subsistence payment and similar costs
that occur in connection with recruitment and employment
 Annual deposits to pension funds
 Direct and indirect costs of training
 Payroll taxes

Chapter Four
Financial Estimates and
Projections

• There are three basic questions to be answered in a project appraisal
exercise:
• Can we produce the goods or services?
• Can we sell the goods or services?
• Can we earn a satisfactory return on the investment made in the project?
• For answering these questions we have to do a technical appraisal, a
market and demand appraisal, and a financial appraisal.
• The previous two chapters covered technical appraisal and market and
demand appraisal.
• This chapter begins the discussion on financial appraisal

• In this chapter we will discuss the estimates and projections required
for financial appraisal.
• This exercise culminates in developing projections for three financial
statements, viz., profit and loss statement, cash flow statement, and
balance sheet.

1. COST OF PROJECT
• Conceptually, the cost of project represents the total of all items of
outlay associated with a project which are supported by long-term
funds.
• It is the sum of the outlays on the following:
• Land and site development
• Buildings and civil works
• Plant and machinery
• Technical know-how and engineering fees

• Expenses on foreign technicians
• Miscellaneous fixed assets
• Preliminary and capital issue expenses
• Pre-operative expenses
• Margin money for working capital
• Initial cash losses

Land and Site Development
The cost of land and site development is the sum of the following:
Basic cost of land including conveyance and other allied charges
Premium payable on leasehold and conveyance charges
Cost of levelling and development
Cost of laying approach roads and internal roads
Cost of compound wall and gates
Cost of tube wells

Buildings and Civil Works
Buildings and civil works cover the following:
Buildings for the main plant and equipment
Buildings for auxiliary services like steam supply,
workshops, laboratory, water supply, etc
Godowns, warehouses, and open yard facilities
Non-factory buildings like canteen, guest houses,
time office, excise house, etc
Quarters for essential staff
Silos, tanks, wells, chests, basins, cisterns,
hoopers, bins, and other structures necessary for
installation of the plant and equipment
Garages
Sewers, drainage, etc.
Other civil engineering works
Plant and Machinery
The cost of the plant and machinery, typically the most significant
component of the project cost, consists of the following:
 Cost of imported machinery: This is the sum of (i) FOB (free on board) value, (ii)
shipping, freight, and insurance cost, (iii) import duty, and (iv) clearing, loading,
unloading, and transportation charges.
 Cost of indigenous machinery: This consists of (i) FOR (free on rail) cost, (ii)
sales tax, and other taxes, if any, and (iii) railway freight and transport charges
to the site.
 Cost of stores and spares.
 Foundation and installation charges.

Technical Know-how and Engineering Fees
Often it is necessary to engage technical consultants or collaborators
for advice and help in various technical matters like
 preparation of the project report,
 choice of technology,
 selection of the plant and machinery,
 Detailed engineering, and so on.

Miscellaneous Fixed Assets
Fixed assets and machinery which are not part of the direct
manufacturing process may be referred to as miscellaneous fixed assets.
They include items like
 furniture, office machinery and equipment,
 tools, vehicles, railway siding, diesel generating sets, transformers, boilers,
 piping systems, laboratory equipment, workshop equipment, effluent
treatment
 plants, fire fighting equipment, and so on.

Preliminary and Capital Issue Expenses
Expenses incurred for identifying the project, conducting the market
survey, preparing the feasibility report, drafting the memorandum and
articles of association, and incorporating the company are referred to
as preliminary expenses.

Pre-operative Expenses
Expenses of the following types incurred till the commencement of
commercial production are referred to as pre-operative expenses:
(i) establishment expenses,
(ii) rent, rates, and taxes,
(iii) Travelling expenses,
(iv) interest and commitment charges on borrowings,
(v) Insurance charges,
(vi) mortgage expenses,
(vii) interest on deferred payments,
(viii) Start-up expenses, and
(ix) miscellaneous expenses.

Provision for Contingencies
A provision for contingencies is made to
provide for certain unforeseen expenses and price
increases over and above the normal inflation
rate which is already incorporated in the cost
estimates.
To estimate the provision for contingencies the
following procedure may be followed:
(i)Divide the project cost items into two
categories, viz., 'firm' cost items and 'non-firm'
cost items (firm cost items are those which have
already been acquired or for which definite
arrangements have been made).
(ii)Set the provision for contingencies at 5 to 10
percent of the estimated cost of non-firm cost
items.
Margin Money for Working Capital
The principal support for working capital is provided by commercial
banks and trade creditors.
However, a certain part of the working capital requirement has to come
from long-term sources of finance.
The margin money for working capital is sometimes utilised for meeting
over-runs in capital cost.
To mitigate this problem, financial institutions stipulate that a portion
of the loan amount, equal to the margin money for working capital, be
blocked initially so that it can be released when the project is completed.

Initial Cash Losses
Most of the projects incur cash losses in the initial years.
Yet, promoters typically do not disclose the initial cash losses because
they want the project to appear attractive to the financial institutions and
the investing public.
Failure to make a provision for such cash losses in the project cost
generally affects the liquidity position and impairs the operations.

2. MEANS OF FINANCE
• To meet the cost of the project the following means of finance are
available:
• Share capital
• Term loans
• Debenture capital
• Deferred credit
• Incentive sources
• Miscellaneous sources

Planning the Means of Finance
We have described the various means of finance that can be tapped for
a project.
How should you go about determining the specific means of finance for
a given project?
The guidelines and considerations that should be borne in mind for this
purpose are as follows:
 Norms of regulatory bodies and financial institutions
 Key business considerations

3. ESTIMATES OF SALES AND PRODUCTION
 Typically, the starting point for profitability projections is the forecast of

sales revenues.
 In estimating sales revenues, the following considerations should be borne
in mind:
1. It is not advisable to assume a high capacity utilisation level in the first year
of operation.
 A reasonable assumption with respect to capacity utilisation is as follows:
40-50 percent of the installed capacity in the first year, 50-80 percent in the
second year, and 80-90 percent from the third year onwards.

2. It is not necessary to make adjustments for stocks of finished goods.
For practical purposes, it may be assumed that production would be equal
to sales.
3. The selling price considered should be the price realisable by the
company
4. The selling price used may be the present selling price - it is generally
assumed that changes in selling price will be matched by proportionate
changes in cost of production

4. COST OF PRODUCTION
• Given the estimated production, the cost of production may be

worked out. The major components of cost of production are:
• Material cost
• Utilities cost
• Labour cost
• Factory overhead cost

5. WORKING CAPITAL REQUIREMENT AND ITS
FINANCING
 In estimating the working capital requirement and planning for its
financing, the following points have to be borne in mind:
1. The working capital requirement consists of the following:
(i) raw materials and components (indigenous as well as imported),
(ii) stocks of goods-in-process (also referred to as work-in-process),
(iii) stocks of finished goods,
(iv) debtors,
(v) operating expenses and
(vi) Consumable stores

2. The principal sources of working capital finance are:
(i)working capital advances provided by commercial banks,
(ii)trade credit,
(iii)accruals and provisions, and
(iv)long term sources of financing.

6. PROFITABILITY PROJECTIONS (OR ESTIMATES
OF WORKING RESULTS)
• Given the estimates of sales revenues and cost of production, the

next step is to prepare the profitability projections.
• The estimates of profitability projections may be prepared along the
following lines:

A. Cost of production
B. Total administrative expenses
C. Total sales expenses
D. Royalty and know-how payable
E. Total cost of production (A+ B + C + D)
F. Expected sales
G. Gross profit before interest
H. Total financial expenses
I. Depreciation
J. Operating Profit (G- H - I)
K. Other income
L. Preliminary expenses written off
M. Profit/loss before taxation (J + K - 1)
N. Provision for taxation
O. Profit after tax (M - N)
Less Dividend on
- Preference capital
- Equity capital
P. Retained profit
Q. Net cash accrual (P +I + L)
7. PROJECTED CASH FLOW
STATEMENT
• The cash flow statement shows the movement of cash into and out
of the firm and its net impact on the cash balance within the firm.
• Typical operational cash flows for a project are shown below.
• Operational cash outflows
 Increase in fixed assets (investment)
 Increase in net working capital
 Operating costs (less depreciation)
 Marketing expenses
 Production and distribution costs
 Corporate (income taxes)
•

• Operational cash inflows
 Revenues from selling of fixed assets
 Recovery of salvage value (end of project)
 Revenues from decrease of net working Capital
 Sales revenues
 Other income due to plant operations

8. PROJECTED BALANCE SHEET
• The balance sheet, showing the balances in various asset and liability
accounts, reflects the financial condition of the firm at a given point
of time.

• For preparing the projected balance sheet at the end of yearn+ 1, we
need information about the following:
• the balance sheet at the end of year n
• the projected income statement and the distribution of earnings for the yearn+
1
• the sources of external financing proposed to be tapped in the year n + 1
• the proposed repayment of debt capital (long-term, intermediate term, and
short-term) during the year n + 1
• the outlays and the disposal of fixed assets during the year n + 1
• the changes in the level of current assets during the year n + 1
• the changes in other assets and certain outlays like preoperative and preliminary
expenses (which are capitalised) during the yearn+ 1
• the cash balance at the end of year n + 1.

Methods of Financial Evaluation
(a) Net Present Value (NPV)
Method C n
NPV  I t
t
(1 t o
1
K)
• Where; Ct = cash flow at the end of period t
K = required rate of
return
n = useful life of project
Io = initial cost of project
• NPV = present value of cash flow – present
value of initial cost
• Decision criteria for NPV
• NPV > 0, Accept the project – it maximizes investors
wealth
• NPV < 0, Reject the project
• NPV = 0, Indifferent
Illustration:
• A firm is considering investing in a project which costs
6,000 Br and has the following cash flows
Year 1 2 3 4
• The cost of capital
Cash flow 1500 is 3000
10% and
2000the project
2500 has no
salvage value. Using the NPV method advise the firm,
whether to invest in the project.

solution
Year Cash Flow PVIF(10%) PV
1 1500 0.9091 1363.65

2 3000 0.8264 2479.20
3 2000 0.7513 1502.60
4 2500 0.6830 1707.50
Total PV 7053.00
Less Project Costs (6000.00)
NPV = 1053.00
• Decision: Accept the project since NPV >0

• Advantages of NPV
 Considers time value of money
 Gives a decision criteria
 Recognizes uncertainty of cash flow by discounting
 Uses all project cash flows
• Disadvantages of NPV
 Gives absolute values which cannot be used to
compare project of different sizes
 There is difficulty in selecting the discount rate to use
 It does not show the exact profitability of the project

b) Internal Rate of Return (IRR)
•IRR is the discount rate that equates the NPV of a
project to zero.
•It is the project rate of return (Yield)
n
Ct
 (1
 Io 
t
1
0
R)t
• Where; R = IRR
• It should be noted that IRR is computed using a
trial and error method.
• However, financial calculators are
programmed to compute IRR
• Steps in the IRR trial and error calculation
method
 Compute the NPV of the project using an arbitrary
selected discount rate.
 If the NPV so computed is positive then try a higher
rate and if negative try a lower rate.
 Continue this process until the NPV of the project is
equal to zero
 Use linear interpolation to determine the exact rate
• Linear interpolation is given by

LR  (HR  LR) NPVLR  0 
NPV  NPV  LR HR 
• Where; LR = Lower rate and HR = higher rate

• Illustration:
• A project has the following cash flows
Year 1 2 3 4
Cash 300 400 700 900
Flow
• The cost of the project is 1500 Br.
• Determine whether project is acceptable if the cost
of capital is 18% using the IRR method.
Solution
• We first select an arbitrary discount rate say 9% and
compute the NPV
Year Cash Flow PVIF (9%) PV
1 300 0.9174 275.22

2 400 0.8417 336.68
3 700 0.7722 540.54
4 900 0.7084 637.56
PV 1790.00
Less Cost (1500)
NPV at 290.00
9%
• since, NPV at 9% is positive and large we select another

discount rate larger than 9%, say 15%
1 300 0.8696 260.88

2 400 0.7561 302.44
3 700 0.6575 460.25
4 900 0.5718 514.62
PV 1538.19
Less Cost (1500)
NPV at 15% 38.19
• since, NPV at 15% is positive but not large, we

select a slightly higher rate, say, 18%.
1 300 0.8475 254.25

2 400 0.7182 287.28
3 700 0.6086 426.02
4 900 0.5158 462.22
PV 1431.77
Less Cost (1500)
NPV at 18% -68.23
• Since NPV at 18 % is negative, IRR, therefore lies

between 15% and 18%, and since zero NPV will be
between 38.19 and -68.23, to get the correct (exact)
IRR we have to interpolate between 15% and 18%
using interpolation formula
38.19 
IRR  15  (18 
0 
 38.19 

15) 16.08%

• Decision: Reject the project since IRR is less than
(68.23
the required rate of return (cost of capital)
• Advantages of IRR
 Can be used to compare projects of different sizes
 Indicates the exact profitability of the project
 Uses project cash flows

• Disadvantages of IRR
 Some project have multiple IRRs if their NPV
profile crosses the x-axis more than once
(project cash flow signs change several time)
 Assumes re-investment of cash flows occurs at
project’s IRR which could be exorbitantly
high
 Doesn’t provide a decision criteria
 Not conclusive for mutually exclusive projects

c) Profitability Index (PI)/ present value index
(PVI)/ benefit-cost ratio
• It is the relative measure of project’s
profitability and can be used to compare
project of different sizes
• PI = present value of cash flows/Initial cost
• Decision criteria:
• If, PI >1, Accept project
PI < 1, Reject project
PI = 1, Indifferent
• Illustration: A project has the following
cash flows
Year 1 2 3 4
Cash Flow 300 400 700 900
• If the required rate of return is 9% and the

project initial cost is 1500 Br, calculate the PI
of the project and advice if the project is
acceptable

Solution
1 300 0.9174 275.52
2 400 0.8417 336.68
3 700 0.7722 540.54
4 900 0.7084 637.46
Total PV = 1790
PVofC.F 1790
PI  Initial cost  1500 1.193
• Decision: The project is acceptable since PI > 1

• Advantages of PI
 Recognized time value of money
 Compares projects of different sizes
 Gives a decision criteria
• Disadvantages of PI
 Does not indicate the risk

d) Discounted payback period
•This is the number of year taken to recover the
original (initial) investment from annual cash flows.
•The lower the payback period the better the project
is
•Illustration:
•Assume a company wants to invest in two mutually
exclusive projects of 1000 Br each generating the
following cash flows.
•If the required rate of return is 10%. Which of
the projects should the company invest in?
Year 1 2 3 4 5 6
A 500 400 300 400 0 0
B 100 200 300 400 500 600
Year DCF of Cum F of DCF of Cum F of

A A B B
1 454.51 454.51 90.91 90.91
2 330.58 785.09 165.29 256.20
3 225.40 1010.49 225.40 481.60
4 273.21 1283.70 273.21 754.81
5 1283.70 310.46 1065.46
6 1283.70 338.68 1403.95

• Pay back for A = 2 
214.91
  2.95years
225.40

• Pay back for B = 4  

245.19 
 4.79 years
310.46 
• The management should undertake project A since
it has a lower pay bock period.
• Advantages of pay back method
 Useful in assessing risk and liquidity of the project
• Disadvantages of pay back method
 Does not use all project cash flows
 Does not consider the performance of the project after
the payback period
e) Accounting (average) rate of return (ARR)
Average, annual, profits
ARR= 100
Average, investiments
•Where average investment = ½ (cost of project +
negative Terminal value)
•Illustration:
•Assume 90,000 Br is invested in a project with the
following after tax net profits.
Year 1 2 3
Net Profit 20,000 10,000 30,000

• The life of the project is 3 years and no
salvage value, compute ARR of the project.
20,000  10,000  30,000
Average_ profits   20,000
3
•Average investment = ½ (90,000 +0) = 45,000
20,000
ARR  100  44%
45,00
0
• Advantages of ARR
 Easy to compute and use
 Computed from readily available accounting
information
• Disadvantages of ARR
 Ignores time value of money
 Ignores uncertainty of cash flows and there is no
consideration of risk in calculation
 Uses accounting profits rather than cash flows
 Doesn’t give a decision criteria
 Not consistent with investor’s wealth maximization

CHAPTER FIVE
ECONOMIC ANALYSIS OF
PROJECTS

Introduction
• Social cost benefit analysis (SCBA) also called economic analysis is a
methodology developed for evaluating investment project from the
point of view of the society (or economy) as a whole.
• Used primarily for evaluating public investments (though it can be
applied to both private and public investments)
• Economic analysis has received increasing emphasis in recent years in
view of the growing importance of public investments in many
countries, particularly in developing countries, where governments are
playing a significant role in economic development.

Social cost-benefit analysis
 is a technique of evaluating projects from

social/economic perspectives.
 primarily used in evaluating public sector
projects

Why social cost-benefit analysis?
1. Market Imperfections
 market prices do not reflect social values
2. Externalities
 are beneficial or harmful effects of a project to
the society
 benefits generated by the project and the
damages inflicted on the society are ignored in
financial analysis
Tuesday, November 7, 2023 COMPILED BY: ADDISU G (PhD)

198
3. Taxes and subsidies

 are irrelevant from social point of view as they
merely represent transfer payments
4. Concerns for Savings
 a project may have a consumption and saving
effect, and savings are more preferred as they
lead to investment

199
5.Concern for redistribution

 fair distribution of income among different
groups of the society is a concern in SCBA
6. Merit goods
are preferences and goals not expressed in
terms of market prices. Eg. Adult education
program

200
UNIDO Approach
It involves the following steps
1.Calculate financial feasibility based on market
prices
2.Obtain net benefits measured in
economic(efficiency) prices
3.Adjust for impact on savings and investment
4.Adjust for impact on income distribution
5.Adjust for impact on merit and demerit goods

201
UNIDO Approach
Net benefits in terms of economic(efficiency) prices

 economic (efficiency) prices are also called Shadow prices.
Issues related to shadow prices
 Numeraire-unit of account in which value of inputs and outputs are expressed
 Tradability of goods-measured using international price

202
UNIDO Approach
Net benefits in terms of economic(efficiency) prices

Sources of shadow price
Impact of a project Source of shadow price
Consumption Consumer willingness to pay
Production Production cost
International trade Foreign exchange value

203
UNIDO Approach
Net benefits in terms of economic(efficiency) prices…

Shadow pricing for specific goods
(a) Tradable inputs and outputs
 are goods for which increase in consumption results in increase in import and a decrease
in export, and increase in production leads to increase in export and decrease in import
 shadow price is border price in local currency translated at market exchange rate

204
UNIDO Approach

(b) Non-tradable inputs and outputs
 are goods for which import price exceeds domestic cost of production and export prices is
less than domestic cost of production.
 shadow price is determined based on consumers willingness to pay or cost of production

205
UNIDO Approach

(c) Externalities
 are goods that are not deliberatly created, are beyond the control of persons affected,
and are not traded in the market.
 value is determined indirectly

206
UNIDO Approach

(d) Labor inputs
 by hiring labor a project can have impact on the rest of the economy in the following
THREE ways
i) may take labor from other employments
ii) may induce production of new labor
iii) may involve import of workers

207
UNIDO Approach

(d) Labor inputs
 Shadow price is as follows
If labor is taken from other employments
 rate others are willing to pay
If production of new labor is induced
 marginal product of labor in previous employment
 value of liesure time
 additional consumption of food when working

208
UNIDO Approach
(e) Capital inputs

 investment in capital goods involves conversion of
financial resources into physical assets and a reduction in
national savings that could have been used for financing
other projects
 shadow price therefore includes shadow price of physical
assets and the opportunity cost of a project given up

209
UNIDO Approach
Measurement of the impact on distribution

 first, income gained or lost by individual groups within the society is determined
 income gained or lost is the difference between shadow price and market price
Example: Suppose that people in Gilgel Gibe area get 10mill kwh of
electricity from Gilgel Gibe II hydroelectric power generation
plant at Br 0.55 per Kwh. They were actually willing to pay Br
0.75 per kwh. The income gain is therefore calculated as follows:
= Br 2mill (10mill kwh x (Br 0.75-Br 0.55)

210
UNIDO Approach
Saving impacts and its value

Two important questions
1. given its impact on income distribution, what would be effects of a project on savings?
2. value of the savings to the society
IMPACT ON SAVING
equals to
where Yi change in income as a result of the project
MPSi is marginal propensity to save of group i

211
UNIDO Approach
IMPACT ON SAVING
Example: Consider the following data
Group Gain/loss MPS

A Br 250,000 0.40
B 150,000 0.20
C -100,000 0.30
D 200,000 0.25
E -350,000 0.10
Impact on savings equals to Br 115,000

212
UNIDO Approach
Value of Saving
 is the present value of additional consumption produced when a saving is invested at the
margin.
 additional consumption generated by investment depends on marginal productivity of
capital and rate of investment from additional income.

213
UNIDO Approach
Income distribution Impact

 involves weighing the net gain/loss by each
group to reflect value of income for different
groups and summing them.
 Weights are determined as follows
w = (b/ci) n i
where wi =weight attached to income at ci level

b = base level of income that has a weight of 1
n = elasticity of the marginal utility of income

214
UNIDO Approach
Adjustment for merit and demerit goods

 merit goods have more social value than economic value eg.
Production of Oil
 demerit goods have more economic value than social value eg.
Production of Cigarette.
 the difference between social value and economic value is
adjusted by (i) estimating economic value (ii) calculating
adjustment factor as the difference between the ratio of SV to EV
and one (iii) multiplying economic value by the adjustment
factor(iv) add the value in (iii) to NPV

215
UNIDO Approach
Adjustment for merit and demerit goods...

Example
Suppose the present economic value of a project is Br 15mill and the ratio of SV to EV is
1.30.
Adjustment factor = 0.30 (1.30-1)
Adjustment = Br 4.5 million (0.30 x Br 15million)
Adjusted Economic value = Br 19.5mill(15mill+4.5mill)

216
Little-Mirrlees Approach
Differences with UNIDO approach

 UNIDO approach measures costs and benefits in domestic prices whereas L-M approach
measures them using international prices
 UNIDO approach measures costs and benefits in terms of consumption whereas L-M
approach measures them in terms of uncommitted capital
 the step-by-step analysis in the UNIDO approach focuses on efficiency, savings and
redistribution in different stages whereas L-M approach views them together

217
Shadow price of traded goods

 border price because it represents the correct
social opportunity costs or benefits of using or
producing a traded good
 if a good is exported, its FOB price
 if imported, its CIF price

218
Shadow price of non-traded goods

 is defined in terms of marginal social cost and
marginal social benefit.
 MSC is the value in terms of accounting prices of
the resource required to produce extra unit of
the good
 MSB is value of extra unit of the good from
social point of view

219
Shadow wage rate

 is determined based on
i.Marginal productivity of labor
ii. cost associated with urbanization
iii. the cost of having an additional amount
committed to consumption when consumption
of a worker increases due to employment

220
221

Ma Project (2015 Entry)

Uploaded by

Document Information

Original Description:

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Ma Project (2015 Entry)

Uploaded by

Copyright:

Available Formats

Ambo University Woliso Campus

Department of: Project Management (MA)

Tuesday, November 7, 2023 COMPILED BY: ADDISU G (PhD) 1

Tuesday, November 7, 2023 COMPILED BY: ADDISU G (PhD) 2

Tuesday, November 7, 2023

COMPILED BY: ADDISU G (PhD) 3

Tuesday, November 7, 2023 COMPILED BY: ADDISU G (PhD) 4

• A feasibility study is an analysis that considers all of a project's

Tuesday, November 7, 2023 COMPILED BY: ADDISU G (PhD) 5

Tuesday, November 7, 2023 COMPILED BY: ADDISU G (PhD) 6

Tuesday, November 7, 2023 COMPILED BY: ADDISU G (PhD) 7

Tuesday, November 7, 2023 COMPILED BY: ADDISU G (PhD) 8

Tuesday, November 7, 2023 COMPILED BY: ADDISU G (PhD) 9

Tuesday, November 7, 2023 COMPILED BY: ADDISU G (PhD) 10

5. Prepare a projected income statement, which includes revenue,

6. Prepare an opening day balance sheet

7. Identify obstacles and any potential vulnerabilities, as well as how to deal

Tuesday, November 7, 2023 COMPILED BY: ADDISU G (PhD) 11

Tuesday, November 7, 2023 COMPILED BY: ADDISU G (PhD) 13

Tuesday, November 7, 2023 COMPILED BY: ADDISU G (PhD) 14

Tuesday, November 7, 2023 COMPILED BY: ADDISU G (PhD) 15

Tuesday, November 7, 2023 COMPILED BY: ADDISU G (PhD) 16

Tuesday, November 7, 2023 COMPILED BY: ADDISU G (PhD) 17

Tuesday, November 7, 2023 COMPILED BY: ADDISU G (PhD) 18

Tuesday, November 7, 2023 COMPILED BY: ADDISU G (PhD) 20

Tuesday, November 7, 2023 COMPILED BY: ADDISU G (PhD) 21

1.Situational analysis and specification of objectives

Tuesday, November 7, 2023 COMPILED BY: ADDISU G (PhD) 22

Tuesday, November 7, 2023 COMPILED BY: ADDISU G (PhD) 23

• Situational Analysis provides the current status of the key aspects

Tuesday, November 7, 2023 COMPILED BY: ADDISU G (PhD) 24

Tuesday, November 7, 2023 COMPILED BY: ADDISU G (PhD) 25

• Eg. suppose Sony Corporation developed technology to

• The objectives of the market and demand analysis may be to

Tuesday, November 7, 2023 COMPILED BY: ADDISU G (PhD) 26

Tuesday, November 7, 2023 COMPILED BY: ADDISU G (PhD) 27

Tuesday, November 7, 2023 COMPILED BY: ADDISU G (PhD) 28

• It needs to be supplemented with primary information gathered through a

• Consequently primary information is sought through a market survey.

• The survey could be a census; where the entire population is covered or a

Tuesday, November 7, 2023 COMPILED BY: ADDISU G (PhD) 29

Tuesday, November 7, 2023 COMPILED BY: ADDISU G (PhD) 30

Tuesday, November 7, 2023 COMPILED BY: ADDISU G (PhD) 31

Tuesday, November 7, 2023 COMPILED BY: ADDISU G (PhD) 32

• Based on the information gathered from the secondary

Tuesday, November 7, 2023 COMPILED BY: ADDISU G (PhD) 33

Tuesday, November 7, 2023 COMPILED BY: ADDISU G (PhD) 34

• Substitutes and near substitutes should be noted too.

• Government Policy: The role of the government in influencing

Tuesday, November 7, 2023 COMPILED BY: ADDISU G (PhD) 35

• A wide range of forecasting method is available to the market

• These methods can be grouped in three categories

Tuesday, November 7, 2023 COMPILED BY: ADDISU G (PhD) 36

i. Jury of executive opinion method: under this method

ii. Delphi method: opinions are sought from a

Tuesday, November 7, 2023 COMPILED BY: ADDISU G (PhD) 37

i. Trend projection method: This involves (a) determining the trend of

• Yt =demand for years t; T= time variable

• a = Y intercept; given by the expression

• b is the slope of the relationship; given by the expression

Tuesday, November 7, 2023 COMPILED BY: ADDISU G (PhD) 38

• Illustration: Assume the following are the demand figures (Y)

b = 522-507.57 14.43 =0.825