Chapter Four

Project Preparation
 Phases of the project cycle – UNIDO manual
Phase 1 – Pre-investment

Opportunity Prefeasibility Feasibility Appraisal &

study study Study Decisions

Phase 2 – Investment

Construction Commissioning
Negotiation and Engineering & Manpower
Contracting Design & start up
training

Phase 3 – Operation

Phase 4 – Evaluation
Project pre-feasibility study
• A Pre-feasibility study is conducted to obtain an overview of the
problem and to roughly assess whether feasible solutions exists prior to
committing substantial resources to a project, or even before spending a
lot of money for the feasibility study itself.
• Reasons are
• Detailed feasibility study bearing high costs,
• Check for problems of substantive nature that could impair the project
implementation.
• To predetermine inputs origins.
• Initial conceptualization of the nature of the market in general, both for the
market of the product or availability of raw materials.
• Preliminary estimate of the size of investment required.
• Proceed to the detail feasibility study if you find positive results
Project feasibility study
• Misunderstandings on need for feasibility study
• Some argue that:
• ‘We know it is feasible, an existing business is already doing it.’
• Feasibility has been done a few years ago so there is no need to do
another one.
• Feasibility studies are just a way for consultants to make money.
• The business is too small for a feasibility study.
• The market analysis has already been done by the business that is
going to supply the equipment.
• By hiring a general manager, the study can be accomplished.
• Feasibility studies are a waste of time. Money is to be spent on
building, tie up the site and bid on the equipment; why spend money
on feasibility.
Project feasibility study
• Reasons for feasibility study
• Once decisions have been made about proceeding with a proposed
project, they are often very difficult to change.
• An entrepreneur may have to live with these decisions for a long time.
• Successful businesses thoroughly examine all of the issues and assess
the probability of business success first before going into it.
• Feasibility studies gives focus to the project and outline alternatives and
narrow project alternatives
• Feasibility studies bring to the fore new opportunities through the
investigative process.
• They enhance the probability of success by addressing and mitigating
factors earlier on that could affect the project.
Project feasibility study
• They identify reasons not to proceed.
• Feasibility studies provide quality information for decision-making.
• They help to increase likelihood of finding funds and investors for the
project.
• And provide documentation that the project idea was thoroughly
investigated.
Project feasibility study
• Project feasibility analysis is a method of presenting this choice between
competing uses of resources in a convenient and comprehensible
fashion.
• An evaluation and analysis of the potential of the proposed project that
is based on extensive investigations and research to give full comfort
making decisions based on the study
• It is a very detail and thorough investigation of the preliminarily feasible
ideas or opportunities
• In essence, project analysis assesses the benefits and costs of a project
and reduces them to a common denominator, in both business
(industrial projects) and public (development) projects.
• The result of a detail feasibility analysis indicates the worthiness of
individual project and implies the optimal choice of investment among
different projects.
Project feasibility study
• Feasibility study conducted at the project initiation phase before
significant expense are engaged.
• Feasibility study attempts to answer one main question: Whether the
project is Feasible OR Not
• Feasibility study should deal with correct facts, correct assumptions and
up to date financial data.
• Not a single person can conduct a feasibility study alone , feasibility study
is a product of a team of experts, can perform a set of studies (legal,
market, financial, profitability, technical, environmental, social, national,
regional, international ...etc.). The feasibility study takes a long time,
efforts and cost.
•Successful feasibility study must fulfill the following conditions:
• Setting and preparing should be prepared by experts in their
respective fields.
Project feasibility study
• Neutrality any dealing with data and information should be
objectively and impartially.
• Free of errors: in the preliminary examination we could allow some
simple mistakes, but in the final feasibility study we do not allow any
error whatsoever small it is.
• Issues to be analyzed at this stage
• Legal –investment
• Institutional-Organisational-Managerial
• Commercial or Marketing or demand
• Technical
• Financial
• Economic
• Environmental or Ecological
Legal or Investment Analysis
• It is conducted by experts and specialists in the field of law and
legislation concerning investment and employment, insurance, taxes...
etc.
• It deals with
1. Analysis of investment environment(Customs, traditions and social
values; Economic and political system; Grants and subsidies)
2. Study of investment laws(Incentives and mechanisms to encourage
investment; Customs and tax laws; Commercial and economic laws)
3. Specifying the legal personality (sole proprietorship, partnership;
limited liability partnership(LLP), corporations, Limited liability
company(LLC))
Market or demand Analysis
• An investment project is developed for the purpose of producing goods
and services to be consumed in the economy.
• To simply assume that consumers exist who are willing and able to
purchase the project’s output is a road to disaster.
• A problem for the project designer is to identify the market - potential of
consumers: who they are? how many and where they can be found? what their
needs are? the proportion accessible to the project? how these needs can be
satisfied by the product design? and how they can be seen in regard to the ability
to pay?
• The commercial feasibility of a project represents the general demand
and market analysis about the project to see whether the project’s
products or services can be commercialized.
• Market analysis of a project indicates the demand potential of the output
of the project (i.e. it needs to ensure the existence of effective demand at
remunerative price)
Market or demand Analysis
• It is a systematic inquiry seeking to gain information about the whole
environment in which the project is expected to operate and to forecast
the future trends to which the project is expected to adapt.
• It provides basis for projecting marketing variables such as, sales
volume, price, distribution and promotion expenses.
• It examines the integrity and consistency of the marketing assumptions
to ensure sustainability of the project
• Market analysis basically addresses the following two questions:
• What would be the aggregate demand of the proposed product/service in
future?
• What would be the market share of the project under appraisal?
• It involves demand estimations, supply projection, determining the
market gap, targeted group, identification of price policy
Market or demand Analysis
• The goals of this analysis
• Determine the market structure and shape
• Determine exact demand for product.
• Identify the factors affecting the market demand and supply.
• Identify the micro and macro size of the market.
• Identify market targeted groups, and market segments.
• Selecting the price policy and the best price mechanism to sell the
products
• Data required
A.populations Data,
• Current population and its distribution(geographical, age, education...
etc.)
• The population growth rate.
Market or demand Analysis
B.Data related to individual and national income (National income
distribution over various sectors, national spending, per capita income,
Personal income distribution on individual consumption, Income
distribution at different population groups)
C.Data on transport and communications (transportation used within
different state)
D.Data on alternative and complementary goods
E.Data on exports and imports and quantity that include global demand
trends toward our country products with world price index
F. Any information on consumers (food preferences, favorable charges,
their motives ... purchasing habits ...).
Market or demand Analysis
• Hence, to answer the above two questions, the project analyst requires
a wide variety of information and need to use appropriate forecasting
methods. The kinds of information required include:-
• consumption trends in the past and present level;
• past and present supply positions;
• production possibilities and constraints;
• imports and exports;
• structure and competition;
• cost structure;
• elasticity of demand;
• consumer behavior, intentions, attitudes, preferences, and
requirements;
• distribution channels and marketing policies in use
Market or demand Analysis
• Generally market analysis seeks to clarify whether :
• the project can compete successfully in the market place over its
expected lifetime.
• enough revenues can be generated to offset the costs
• the market is large enough;
• the products of the project can be expected to expand the
existing market or accelerate its growth;
• there is threat of competition now and during the life of the
project;
• there exists management's capability to respond to such threats
or to take advantage of opportunities along the way;
• marketing expenses have to be incurred to optimize long term
revenue and costs.
Technical Analysis
•Technical analysis details of how you will deliver a product or service (i.e.,
materials, labor, transportation, where your business will be located,
technology needed, etc.).
•It is the logistical or tactical plan of how your business will produce, store,
deliver, and track its products or services.
• Technical analysis seeks to determine whether the prerequisites for the
successful commissioning of the project have been considered and
reasonably good choices have been made with respect to Materials and
Supplies, location and site, engineering and technology & human
resource, etc.
• It is from this aspect of analysis that all physical quantity of inputs and
outputs will be determined for the estimation of costs and benefits.
• Analysis of the technical and engineering aspects is done continually
when a project is being examined and formulated.
Technical Analysis
• With this regard, the major aspects of the technical analysis include:
• Manufacturing process/technology
• Raw Materials and supplies
• Plant capacity
• Product mix
• Location and site selection
• Machineries and equipment
• Structures and civil works
• Project charts and layouts
• Project implementation schedule
Institutional/organizational Analysis
• This relates to the analysis of project owner, its organization,
management, staffing, policies, and procedures, but also the whole
array of government policies that conditions the environment in which
the project is expected to operate.
• Experience indicate that insufficient attention to these aspects of a
project leads to problems during its implementation and operation
• The host of questions related to this analysis include:
• whether the project is properly organized and its management
adequate to do the job
• whether local capabilities and initiative are being used effectively
and
• whether policy or institutional changes are required outside the
entity to achieve project objectives
Institutional/organizational Analysis
• The important issues to be addressed are:
• How does the proposed project relate to the various levels of
power as well as the existing institutions?
• What are the links of the projects and team with existing
government departments and organizations considered here?
• Within the project, what are the lines of authority, delegation, line
of reporting, and organisational procedures?
• Will the project keep and operate its own accounts?
• Assessment of availability of staff to manage the project; if there is
a gap will there be the need to train or hire others locally or for
expatriate staff?
• Are the target groups equipped to use the product or adopt the
technology or innovation being introduced?
Financial Analysis
• Financial feasibility analysis seeks to ascertain whether the proposed
project will be financially viable in the sense of being able to meet the
burden of servicing debt and whether the proposed project will satisfy
the return expectations of those who provide the equity capital.
• The financial returns of a project must be determined and compared to
the costs of the project.
• There must be clear evidence that the project will have a net gain if it
has to be feasible.
• This analysis will become the basis for evaluating the project
profitability.
• Project profitability depends on a comparison of costs versus revenues
using realistic market prices of materials, labor and outputs.
Financial Analysis
• Source of information for projecting receipts and payments is the
market, technical analysis and others
• The aspects, which have to be looked into while conducting financial
appraisal are:
investment outlay and costs of the project;
means of financing, source of finance, credit terms, interest rates,
etc;
cost of capital ;
projected profitability;
break-even point;
cash flows of the project;
projected financial position and
level of financial risk.
 The framework for financial costs and benefits analysis
Time
Liquid
(Economic Life Converted
resources
of the project) into fixed &
mobilized Utilization Results
Current
0 from Investors
assets
of Assets
1 & Lenders

2 P Generation
3 Cost of r of cash
Capital o inflows
4 over time –
5 j committed
6 e resources

7 c
8
COSTS t BENEFITS
Total Investment System
Net cash flows +
9 + expected
10 service charges. ≤ Residual value of
assets
Financial Analysis
• The cash flow statement of a project is a listing of all anticipated sources of cash
(receipts) and uses of cash (expenditures) by the business over the life of the
project.
• It is usually negative in the beginning of a project’s life when the investment is
being made and positive when revenues from sales of output become larger than
expenditures
• The cash flows of a given project are of three types
– Initial investment or Capital or investment cash flows
– Operating cash flows
– Terminal or liquidation cash flows
• Basic characteristics of relevant project cash flows(initial, operating or terminal)
• Cash (not accounting income) flows
• Operating (not financing) flows
• After-tax flows
• Incremental flows
The Components of Cash Flow Analysis
(+)
Benefits Less Costs

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
Year of Project Life

(-)
Initial Investment Operating cash flow
Liquidation

Project Life
Financial Analysis
• Initial investment or capital or investment cash flows
• This includes the total investment cost spend to make the facility ready
for operation
1. Investment in fixed assets(land purchase, site preparation and
improvements; building and civil works; plant machinery and
equipment, including auxiliary equipment; certain incorporated fixed
assets such as industrial property rights and lump-sum payments for
know-how and patent; transport, custom duties, sale of existing asset
and other related costs) plus pre-production expenditures (preliminary
capital issues expenditures like legal fees; expenditure on preparatory
studies(identification, pre-feasibility and feasibility costs); travel costs
pre-production marketing costs; installation etc.)
2. Net working capital ( inventories, A/R, cash, A/P)
3. Sale of existing assets and tax implication
Financial Analysis
• Initial investment or capital or investment cash flows
• Example
• The following expenditures were made
• (1) Cost of Building =Br. 200, 000,000
• (2) Duty tax & insurance on building = Br. 2,000,000
• (3) Purchase of equipment= Br. 15,000,000
• (4) Shipping and installation cost =Br. 500,000
• (5) Increase in Net Operating Working Capital =Br. 2,000,000
• (6) Proceed from sale of old asset net of tax =Br. 5,000,000
• Initial investment = 1+2+3+4+5-6
• Initial investment =200,000,000+ 2,000,000+15,000,000+
500,000+2,000,000-5,000,000
=214,500,000
Financial Analysis
• Operating cash flows/annual cash flows
• This includes cash inflows from sales, cash outflows for marketing and
advertising, payments for wages, utilities, raw materials
• The net cash flow statement is calculated as the difference between
total receipts (not total income) and total expenditures (not total
expenses).
• Important considerations
• Sales has to be adjusted for A/R and A/P to determine cash flows (One has to
differentiate sales from receipts and purchases from expenditures)
• Depreciation expense or capital cost allowance is not a cash outflow. It
should not be included in the financial cash flow of the project as an outflow.
• Income taxes paid by the project should be included as an outflow in the
cash flow statement.
Financial Analysis
• Operating cash flows/annual cash flows
• Example

Annual cash flows during project’s life – years 1 - 10

Sales Revenue Br. 60,000,000,000
Less Operating Costs Br -50,000,000,000
Less Depreciation Br. - 1,746,000,000
EBIT Br. 8,254,000,000
Less Taxes (0.40) - 3,301,600,000
NOPAT 4,952,400,000
Plus Depreciation 1,746,000,000
OCF 6,698,400,000
Less increase in NWC - 120,000,000
Net Cash Flow Birr 6,578,400,000
Financial Analysis
• Terminal or liquidation cash flows
• Terminal cash flows include
• Inflows, proceeds from sale, salvage value of the asset net of
tax, recovery of remaining working capital
• Outflows, cost of asset disposal, environmental rehabilitation,
redundancy payment to employees
Example – end of 10 year
• Recapture of NWC: 6,367,000,000
• Total after-tax salvage values 10,607,000,000
• Total terminal cash flow 16,974,000,000
Financial Analysis
• Principles that must be adhered in estimating cash flows(initial,
operating or terminal)
• Ignore sunk costs/historical costs(financial obligations of
the existing facility should not be included in the
incremental benefits and costs of the new project)
• Include opportunity costs(costs resulting from using a
resource in a project is the forgone benefit for not using it
in another activity)
• Include project-driven changes in working capital net of
spontaneous changes in current liabilities
• Include effects of inflation
Financial Analysis
• Principles that must be adhered in estimating cash flows(initial,
operating or terminal)
• Ignore sunk costs/historical costs(financial obligations of
the existing facility should not be included in the
incremental benefits and costs of the new project)
• Include opportunity costs(costs resulting from using a
resource in a project is the forgone benefit for not using it
in another activity)
• Include project-driven changes in working capital net of
spontaneous changes in current liabilities
• Include effects of inflation
More on cash flow
estimation
Cash flow estimation
• Estimating cash flows is the most important, but also the most difficult
step in project .
• Relate to uncertain future period involving various risk factors
• Costs and revenue accrue at different time periods.
• It involves many people and numerous variables and prone to errors in
forecasting.
• A sales forecast leads to an estimate of cash inflows from customers
• A cost/expense projection leads to a pattern of outflows to employees
and vendors
• An equipment plan leads to a series of outflows for capital assets
• Guidelines for estimating cash flows
1. Use free cash flows, not accounting profits
2. Think Incrementally
3. Beware of cash flows diverted from existing products
Cash flow estimation
4. Look for incidental or synergistic effects
5. Work in working-capital requirements
6. Consider incremental expenses
7. Sunk costs are not incremental cash flows
8. Account for opportunity costs
9. Decide if overhead costs are truly incremental cash flows
10. Ignore interest payments and financing flows

• Use free cash flows

• Free cash flow accurately reflects the timing of benefits and costs—
when money is received, when it can be reinvested, and when it must
be paid out.
• Accounting profits do not reflect actual money in hand(example on
next slide )
Difference between accounting and cash flow approach
Items Accounting approach Cash flow approach
Revenue 55,000 55,000
Cost of good sold 31,000 31,000
materials 18,000 18,000
Labor 8,000 8,000
overhead 5,000 5,000
Gross profit 24,000 24,000
Administrative expenses
other 4,000 4,000
depreciation 10,000 -----------
EBIT 10,000 20,000
Tax @30% 3,000 6,000
Net earning/cash flow after tax 7,000 14,000
Cash flow estimation
• Incremental cash flows
• After-tax free cash flows must be measured incrementally.
• Determining incremental free cash flow involves determining the cash
flows with and without the project. Incremental is the “additional cash
flows” (inflows or outflows) that occur due to the project.
• Not all incremental free cash flow is relevant.
• Thus new product sales achieved at the cost of losing sales from
existing product line are not considered a benefit(incidental cost)
• However, if the new product captures sales from competitors or
prevents loss of sales to new competing products, it would be a
relevant incremental free cash flows.
• Although some projects may take sales away from a firm’s current
projects, in other cases new products may add sales to the existing
line. This is called synergistic effect and is a relevant cash flow.
Cash flow estimation
• Principles to be followed: incremental, separation, after-tax and
consistency
A. Incremental principle
• The cash flow of a project must be measured in incremental terms.
• To ascertain a project’s incremental cash flow one has to look at what
happens to the cash flows of the firm with the project and without the
project.
• The difference between the two reflects the incremental cash flows
attributable to the project
• Pay attention to the following in estimating incremental cash flows
• Consider all incidental and synergistic effects
• Ignore sunk costs.
• Include opportunity costs.
• Question the allocation of overhead costs.
• Estimate working capital properly
Cash flow estimation
• In addition to the direct cash flows of the project, all its incidental and
synergistic effects on the rest of the firm must be considered
• The project may enhance the profitability of some of the existing
activities of the firm because it has a complimentary
relationship(synegry) or it may detract from the profitability of some of
the existing activities of the firm because it has a competitive
relationship(incidental)
• Example
• A company introduce a new car model which caused a decrease in the
sale of another model.
• The decreased cash flow per year on other lines would be a cost to this
project. This is an incidental effect to the project.
• If it has increased sales of the old model, it is a benefit( CF) & hence a
synergistic effect
Cash flow estimation
• A sunk cost refers to an outlay already incurred in the past or already
committed irrevocably.
• So it is not affected by the acceptance or rejection of the project under
consideration.
• Example
• A company is debating whether it should invest in a project. The
company has already spent Br.10,000 for preliminary work meant to
generate information useful for this decision. This Br.10,000 represents
a sunk cost as it cannot be recovered irrespective of whether the
project is accepted or not.
• There is plan to produce a new car model using a technology you
bought last year for Br. 50,000.
• Should this cost be included in the project cash outflow?
Cash flow estimation
• If a project uses resources already available with the firm, there is a
potential for an opportunity cost.
• The opportunity cost of a resource is the benefit that can be derived from
it by putting it to its best alternative use.
• Opportunity cost refers to cash flows that are lost because of accepting
the current project.
• For example, if a project uses a vacant factory building owned by the firm,
the revenue that can be derived from renting out this building represents
the opportunity cost.
• A firm needing a new warehouse could: Lease warehouse space or Buy a
warehouse
• Build warehouse on land it already owns which might be sold for
$1,000,000
 the opportunity cost of the land is $1,000,000
 It isn’t free even though there was no immediate need for it
Cash flow estimation
• Costs which are only indirectly related to a product (or service) are
referred to as overhead costs.
• They include items like general administrative expenses, managerial
salaries, legal expenses, rent and so on.
• When a new project is proposed, a portion of the overhead costs of the
firm is usually allocated to it.
• Thus, we must include incremental overhead costs or costs that were
incurred as a result of the project and relevant to the project.
• However, not all overhead costs may be relevant
• For example, utilities bill may have been the same with or without the
project
Cash flow estimation
• Estimate working capital properly: Outlays on working capital have to
be properly considered while forecasting the project cash flows.
• In this context the following points must be noted:
• Working capital is defined as “Current Assets – Current Liabilities”
• The requirement of working capital is likely to change over time as the
output of the project changes
• Working capital is renewed periodically and hence is not subject to
depreciation.
• New projects require infusion of working capital (such as inventory to
stock the shelves), which would be an outflow.
• Generally, when the project terminates, working capital is recovered
and there is an inflow of working capital.
• Therefore, the working capital at the end of the project life is assumed
to have a salvage value equal to its book value.
Cash flow estimation
B. Separation principle
• The accounting equation
Assets Owners equity ( Liability + capital )
Investing Financing
• The cash flows associated with these sides should be separated.
• Interest payments and other financing cash flows that might result from
raising funds to finance a project are not relevant cash flows.
• Reason: Required rate of return implicitly accounts for the cost of raising
funds to finance a new project.
• Cash flow should be measured on an after-tax basis
• This is used to bring out the project cash flows with accuracy.
Cash flow estimation
Initial Investment(outlay or outflow)
• Initial investment =
a. Purchase price of “new” assets
b. + Capitalized expenditure(Freight , set-up and installation, Insurance,
Transportation, Training of manpower to use the machine etc
c. + Opportunity costs incurred.. eg own land/house used for the project
d.+ (-) Increase (decrease) = Net Working Capital
e.- Net proceeds from sale of “old” Assets ,if replacement
f. + (-) Taxes (savings) due to the sale of ‘old ‘machines/assets
• Sale of old asset=book value --- no tax effect
• Sale > book value(but < cost) recapture depr.---taxed as regular income
• Sale > book value(but > cost) capital gain – tax as capital gain the rest as a
regular income
• Sale < book value--- capital loss- tax saving
Initial Investment(outlay or outflow)
• Example: An old machine is to be replaced. It was bought 4 years ago for
$ 120,000 and now sold as salvage for $ 10,000. The accumulated
depreciation amounts to $ 112,000. The cost of the new machine is
$200,000. The installation costs amount to $ 4000 and training costs $
5,000. The increase in net working capital amounts to $3,000.Tax rate is
30%. Cost of new machine 200,000

Installation cost +4,000

Training +5,000

Increase in working capital +3,000

Proceeds from sale of old asset -10,000

Tax on the recaptured depreciation (10,000-8000)* 0.3 = + 600

Initial investment 202,600

Operating cash flows
• Operating cash flows =
a. Revenue
b. - cost of good sold(variable and fixed costs) or operating costs
c. - administrative expenses (depreciation, interest on long term loan)
d. = profit before tax
e. - tax
f. = Profit after tax
g. + Depreciation + Other noncash charges + Interest on long-term
borrowings (1-tax rate)
Operating cash flows
• Operating cash flows =
Revenue (100,000 @ $ 6/unit) $ 600,000
Variable cost(100,000 @ $ 3/unit) - 300,000
Fixed cost - 90,000
EBITDA = 210,000
Depreciation (200,000 / 5 years) - 40,000
Interest on long term loan - 10,000
Earning before tax 160,000
Tax (@ 34%) 54,400
Net income 105,600
Depreciation +40,000
Interest on long term loan (1-Tax) +6,600
Operating cash flows 152,200
Terminal cash flows
• Terminal cash flows =
a. Salvage value of assets
b. - (+) taxes (tax saving) from sale of asset
c. + recovery of working capital
• Example
• A machine purchased for a project has fully depreciated but sold for $
10,000 at the end of the project. Working capital increased by $ 5,000 at
the beginning. Tax rate is 40%.
• Salvage value - 10,000
• Tax (10,000*0.4) - 4,000
• Recovery of WC + 5,000
• Terminal cash flow = 11,000
Terminal cash flows
• General illustration
• Magnum Technologies Limited is evaluating an electronics project for which the following
information has been assembled.
• The total outlay on the project is expected to be 50 million. This consists of 30 million of fixed assets
and 20 million of current assets.
• The total outlay of 50 million is proposed to be financed as follows: 15 million of equity, 20 million of
term loans,10 million of bank finance for working capital and 5 million of trade credit.
• The term loan is repayable in five equal installments of 4 million each. The first installment will be
due at the end of the first year and the last installment at the end of the fifth year. The levels of bank
finance for working capital and trade credit will remain at 10 million and 5 million till they are paid
back or retired at the end of five years.
• The interest rates on the term loan and bank finance for working capital will be 15 percent and 18
percent respectively.
• The expected revenues from the project will be 60 million per year. The operating costs, excluding
depreciation, will be 42 million. The depreciation rate on the fixed assets will be 33 and 1/3 percent
as per the written down value method.
• The net salvage value of fixed assets and current assets at the end of year 5 will be 5 million and 20
million respectively
• Tax rate is 50%
Terminal cash flows
•i
Economic Analysis
• The economic aspect is primarily concerned with the committing of
scarce resources, by justifying the significance of the project from the
whole economy point of view (the society as a whole)
• In such evaluation, the focus is on the social costs and benefits of a
project, which may often be different from its monetary or financial
costs and benefits.
• While financial analysis views the project from the participants (or
owners) point of view, the economic analysis is made from the society’s
point of view and is basically concerned with issues such as:
How to identify effects of a project on the society;
Quantifications of effects of the proposed projects and
Pricing of costs and benefits to reflect their values to society
Economic Analysis
• To reflect the real value of a project to society, we must consider the
impact of the project on society
• When we evaluate a project from the view point of the society (or
economy) as a whole, it is called Economic Analysis or Social Cost
Benefit Analysis (SCBA)
• The main focus of economic analysis is to determine the impact of the
project on
• society in terms of economic benefits and costs as valued using economic
prices
• the level of savings and investments in the society
• the distribution of income in the society
• its contribution towards the fulfillment of certain merit wants (self-sufficiency,
employment etc.)
Economic Analysis
• Comparison of FA and EA
Criteria of comparison FA EA
Point of view Private National
Pricing of costs & Market (Actual ) Shadow prices (true
benefits economic)
Measurement of costs Commercial costs and Resources used and
& benefits revenues made available
Externalities Not considered Accounted for
Acceptance Immediate return to the Conformance to social
investor policy
Economic Analysis
• Moving from FA to EA requires three adjustments
1. transfers (taxes, subsidies) have to be removed;
• Transfers in the form of grants, subsidies, taxes etc are included for
financial analysis purposes providing an artificial positive outcomes
2. All positive and negative external effects have to be included
• External effects (or externalities) constitute adverse or beneficial
impacts of a project on the welfare of society
3. Market prices of goods and services have to be replaced by economic
prices
• Shadow or accounting prices are prices indicating the intrinsic or true
value of a factor or product in the sense of equilibrium prices
• Market imperfections and distortions lead to distorted prices
Environmental Analysis
• Environmental appraisal is the term used to describe the assessment of
the environmental consequences of proposed policies, plans, programs,
or projects
• The objective of environmental appraisal is to determine and evaluate
the environmental implications of development and thus, ensuring
sustainable development through the integration of environmental,
social and economic objectives into the policy and planning process.
• Projects (especially the industrial projects) that are likely to
emit/release pollutants to the environment are increasingly being
required to show how pollutants with effects on human, animal and
plant life can be minimized or eliminated.
• Unfortunately, in the past, many projects around the world were started
without much consideration of the environment, and had caused
serious damage to the global system.
Environmental Analysis
• Recently, environmental concerns have been given greater
consideration.
• Consequently, some developed countries have set strict criteria which
projects must meet to prevent their projects from causing adverse
effects on the environment
Reporting of the feasibility study
1. General Information
2. Preliminary Description
3. Project Description
4. Market plan
5. Capital Requirements
6. Operating Requirements and Costs
7. Financial Analysis
8. Economic and Social Analysis
9. Environmental Impact Assessment