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Project analysis and Management
Chapter one: GENERAL INTRODUCTION

1.1. Meaning and Definitions of a Project
In General Speaking, the term project, long before has been conceived in different
dimensions. Projects are about work, actions, buildings, re–buildings, achievements,
deliverables and outcomes. Moreover, project may have also the following meaning. “a
sequence of connected events that are conducted over a defined and limited period of
time and are targeted towards generating a unique but well – defined outcome”.
According to Project Management Institute the term project can be defined as” a
temporary endeavor undertaken to create a unique product or service. Temporary means
that, every project has a definite end. Unique means that, the project or service is
different in some distinguishing way from all similar products or services.”
According to the scholar Turner, project is defined as “ an endeavor in which human (or
machine), material and financial resources are organized in novel way, to undertake
unique scope of work of given specification, with in the constraints of time and cost, so
as to deliver beneficial change defined by quantitative and qualitative objective.”
“A project is a one-shot, time-limited, goal-directed, major undertaking, requiring the

commitment of varied skills and resources”.
A project is “a unique endeavor to produce a set of deliverables within clearly specified
time, cost and quality constraints”.
A project is a problem scheduled for solution.
Project is an investment activity in which specific resources are committed within a given
time frame, to create capital assets over an extended period of time in expectation of
benefits that exceed the committed resource.
1.2. Primary Features of a Project

Traditionally, work in the construction industry and defense procurement were seen as
projects, but in recent times pro – active companies restructuring their work as projects
(management – by – projects). Projects range in size, scope, cost and time from mega
international projects to small domestic projects. To mention few examples:
 Designing and constructing a building, a house or a yacht.
 Launching a new product (advertising and marketing project).
 Planning and conducting an audit (quality management project).
 Disaster recovering (limiting the damages of fire, floods or any type of accident).
 Olympics (a sports project ).
 Going on holiday (a domestic project).
 Developing a new product or service
 Building a bridge, road, runway, or other structure
 Writing a software
 Installing a new manufacturing process
 Publishing a book
 Developing a new marketing plan
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 Obtaining an MBA degree
 Planting a garden
 A wedding plan
 Constructing a house
 Establishing a plant or designing a car or new machinery etc;
Generally, all projects are characterized by a certain features which may be common to
all. Thus, the following are typical features of a project:
 A start and finish. The start may have been crystallized over a period of time
and the end may by a slow phase out. This shows that every project has a
beginning and certain definite end. It is not like other ordinary course of business
activities which are having an indefinite term of existence – going – concern.
 Are Unique in nature. They do not involve repetitive processes. Every project
undertaken is different from the last, whereas operational activities often involve
undertaking repetitive (identical) processes.
 Involve an element of risk. Projects entail a level of uncertainty and therefore
carry business risk.
 Are multifunctional (i.e., cut across several functional lines)
 Achieve beneficial change. The purpose of a project, typically, is to improve an
organization through the implementation of business change.
 Have a specific objective to be completed within certain specifications
 Create capital assets: capital asset from which a long term benefit is consumed
may be created
 A life cycle. This means that, there will be a beginning and an end, with a
number of distinct phases in between.
 A budget. It is unthinkable to undertake any project without sufficient cash
flows. During the planning phase, adequate budget allocation is mandatory for
the smooth flow of all project related activities.
 Non – repetitive. As it was discussed in the definition part, all project activities
are essentially unique. The project activities are rare and new. In a project, once
a certain activity is completed it would not be repeated. Generally, projects may
found to be similar but no two projects are exactly a like.
 Use of resources. In a project undertaking, resources are quite necessary for
successful accomplishment of its activities. The resources i.e. material, human,
financial may be coordinated from various sources.
 A Single Point of Responsibility. All Projects have a well defined responsibility.
In general, the head or manager of the project ultimately takes the responsibility
of the project. Therefore, in the project, responsibility should be specifically
identifiable.
 Team Roles. A project is a team work activity of different professionals. In a
project, team roles and relationships that are subject to change need to be
developed, defined and established (team building).
Why projects are undertaken? /Benefits of projects
 Development or growth of a nation, region, city, village etc.
 Long term growth of company and resulting to increased welfare of employees
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 Improvement of income distribution
 Solving immediate problems
 Providing employment and transport facilities
 Increase in wealth of suppliers of resources including owners or shareholders
 Other social benefits like bringing change in society, accelerate the process of
elimination of poverty, socio-economic development etc.
Projects Vs programs
It is necessary to distinguish between projects and programs because there is
sometimes a tendency to use them interchangeably but they have different meanings.
A program is an ongoing development effort or plan which may not necessarily be
time bounded.
Definition: “a definite plan or scheme of any sequence of operations aimed at the
attainment of planned objectives.”
Example: Road development program, a health improvement program, continues
education program, distance education program, a nutritional improvement program,
a rural electrification program etc.
Major difference between a project and a program lies not in objectives but in scope,
the details and accuracy. Projects are subunits and bricks of programs. Programs
include one or several projects at various times.
Differences:
Projects Programs
Scope narrow wider
Objectives specific general
Beneficiary groups specific numerous
Financial resources clearly determined not clear and detailed
financial
and allotted funds resources
Time time bounded not time bounded
Similarities:
 Both have objectives as well as goals
 Require resources like financial, personnel, material and other
 Generate outputs of goods and services
 Serve as instruments for the execution of development and plans to develop
the economy of a nation.
Types and classification of projects:
1. Quantifiable and non- quantifiable projects:
Quantifiable projects are those in which a quantitative assessment of benefits can be
made.
Example: Industrial projects, power generation projects, mineral development projects
etc.
Non quantifiable projects are those where such assessment is not possible
Example: Health, education, defense projects etc.
2. Sect oral classification of projects:

Based on the usefulness of projects in resource allocation at macro level, they may be
classified into the following sectors:
 Agricultural and allied sector projects
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 Irrigation and power sector projects
 Industry and mining sector projects
 Transport and communication sector projects
 Social service sector projects
 Miscellaneous projects
3. Techno-Economic projects:
Based on their techno aspect, projects can be classified into three groups which are useful
in the process of feasibility appraisal and the techno-economic feasibility studies:
a. Factor intensity- oriented classification: Here projects may be classified as capital
intensive or labor intensive projects.
b. Causation- oriented classification: Here projects are classified as demand based or
resource based projects.
c. Magnitude- oriented classification: Here projects are classified on the basis of
investment as mega scale, large scale, medium-scale, or small scale projects.
4. Financial institutions based Classification:
Financial institutions classify projects according to the age, experience and pupose for
which the project is being taken up as follows:
 New projects
 Expansion projects
 Modernization projects
 Diversification projects
5. Service projects:
These are further classified as:
 Welfare or non commercial projects
 Commercial projects
 Research and development projects and
 Educational projects
6. Ownership and control based classification:
Under this projects are classified as
 Corporate projects
 Partnership projects
 Sole-proprietor projects
7. Technology based classification:
Based upon the technology applied, projects are classified as;
 High technology projects( most sophisticated technology)
 Conventional technology projects( out dated technology)
8. Risk based classification:
Under this classification, projects are classified into:
 High risk projects
 Medium risk projects
 Small risk projects
9. Country origin based classification;
 Domestic projects/national projects
 Foreign projects/international projects
10. Productivity based classification:
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Under this projects are classified into:
 Directly productive projects:
In directly productive projects, the benefits and cost of the projects are accrued to a single
large organization. This organization will be able to calculate the surplus.
 Indirectly Productive projects:

These are the projects where the benefits derived from a new project do not accrue to the
organization responsible for carrying out the costs. Hence, the resulting surplus is not
concentrated in the hands of a single organization. In case of indirectly productive
projects, the calculation of benefits is difficult.
Ex: roads, schools, health projects where the benefits accrue to the users.
The project Life cycle:
The different stages/phases through which a project passes is called the project life cycle.
The Project Life Cycle refers to a logical sequence of activities to accomplish the
project’s goals or objectives. Regardless of scope or complexity, any project goes through
a series of stages during its life. There is first an Initiation or
Birth phase, in which the outputs and critical success factors are defined, followed by a
Planning phase, characterized by breaking down the project into smaller parts/tasks, an
Execution phase, in which the project plan is executed, and lastly a Closure or Exit phase,
that marks the completion of the project.
The main features and elements of this process are information gathering, analysis and
decision making. The project cycle consist of various stages in which each stage, not only
is grown out of the preceding ones, but also leads into the subsequent ones.
There is no single way of devising the different phases of a project there are many
equally valid ways in which the project cycle may be divided. There are three basic
models of project life cycles they are:
1. The Baum project life cycle
2. UNIDO project life cycle
3. DEPSA project life cycle
The Baum project life cycle (World Bank procedures)

The first basic model of a project cycle was that of Baum developed in 1970, which has
been adopted by the World Bank and initially recognized four main stages, namely
1. Identification
2. Preparation
3. Appraisal and selection
4. Implementation
At a later stage in 1978 the author has added another stage called “Evaluation “thus
making the stages 5 in number.
1. Identification Phase:
The first stage in the project life cycle is to find potentially promising projects which are
worthwhile for investment. Some of the sources of such projects are listed below:
 Some projects are resource based and stem from the opportunity to make
profitable use of available resources.
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 Some may be market based arising from an identified demand in home or
overseas markets.
 Others may be need based and initiated to make available certain basic material
requirements and services to all people in an area at minimal amounts.
 Well informed technical specialists and local leaders are also common source of
projects. Technical specialists will identify many areas where they feel new
investment might be profitable, while local leaders may have suggestions about
where investment might be carried out.
 Ideas for new projects also come from proposals to extend existing program.
2. Preparation Phase:
Once projects are identified, there begins a process of progressively more detailed
analysis of the projects and preparation of the project plans. This phase of the project life
cycle which normally includes both the prefeasibility and feasibility study .this is the
stage at which the project is being seriously considered as a definite investment action.
Project preparation covers the establishment of all the technical, economic, social,
financial, institutional and environmental feasibility analyses. From the inferences of
such analysis, decisions have to be made on the scope of the project, location and site,
soil and hydrological requirements, project size etc. At this stage the project exists as
asset of tangible proposals.
3. Appraisal Phase (an assessment of the quality or value of something)
At this stage critical review of the project is to be conducted. This provides an
opportunity to re-examine every aspect of the project proposal (project plan) to assess
whether the proposal is appropriate and sound before large sums are invested. Generally
only internal institution/government staffs are used for this work. Projects are appraised
both in the field and at the desk level. Appraisals should cover at least seven aspects of
the project, each of which must have been given special consideration during the project
preparation stage. Those seven aspects are:
 Technical- here the appraisals concentrate on verifying whether the proposed
project will work in the way suggested or not.
 Financial- In this, the appraisals try to see whether requirements for money
needed by the project have been calculated properly, their sources are all
identified and reasonable plans for their repayment are made where necessary.
 Commercial-the way the necessary inputs for the project are conceived to be
supplied is examined here and also the arrangements for the disposal of the
products are verified.
 Incentive- the appraisals here will see into it whether things are arranged in such a
way that all those whose participation is required will find it in their interest to
take part in the project, at least to the extent envisaged in the plan.
 Economic- the appraisal here tries to see that what is proposed is good from the
view point of the national economic development interest when all project effects
(positive and negative0 are taken into account and check whether all are correctly
valued.
 Managerial- this aspect of the appraisal examines whether the capacity exists for
operating the project and the people who were assigned responsibilities can
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operate it satisfactorily or not. Moreover, it tries to see whether the responsible
persons are given sufficient power and scope to do what is required.
 Organizational- this appraisal examines the project if it is organized internally and
externally into units, contract policy institution, etc., to allow the proposals to be
carried out properly and to allow for change as the project develops.
The above issues are the subjects of specialized appraisal report. On the basis of this
report, financial decisions are made- whether to go ahead with the project or not. In
practice, there can be quite a sequence of project selection decisions. Following
appraisal, some projects may be discarded. If the project involves loan finance, the
lender will almost certainly wish to carry out his own appraisal before completing
negotiations with the borrower. Comments made at the appraisal stage frequently give
rise to alterations in the project plan.
4. Implementation Phase:
The clear objective of any effort in project planning and analysis is to have a project
that can be implemented to the benefit of the society. Thus implementation is perhaps
the most important part of the project cycle. In this stage, funds are actually disbursed
to get the project started and keep running. A major priority during this stage is to
ensure that the project is carried out in the way and within the period that was
planned. Problems frequently occur when the economic and financial environment at
implementation differs from the situation expected during appraisal.
It is during implementation stage that many of the real problems of projects are first
identified. Because of this feedback effect on the discovery and design of new
projects, and the deficiencies in the capabilities of the project action can be revealed.
Therefore to allow the management to become aware of the difficulties that might
arise, in recording, monitoring and progress reporting are important activities during
the implementation stage.
5. Evaluation Phase:
At later stage that is in 1978, BAUM has added an additional stage called Evaluation
which usually closes the project life cycle. Once a project has been carried out, it is
often useful, to look back over what took place, to compare actual progress with the
plans, to judge whether the decisions and actions taken were corrective, to see
whether the results obtained are optimal in a sense that the resources are efficiently
utilized and whether the project’s goals and objectives are effectively achieved. The
extent to which the objectives of a project are being realized provides the primary
criterion for an evaluation. The analysts look systematically at the elements of
success and failure in the project experience to obtain insights about how to plan
more productive projects in future.
Evaluation is not limited only to completed projects. It is the most important
managerial tool in ongoing projects and rather formalized evaluation may take place
at several times in the life of project. Evaluation may be undertaken when a project is
in trouble, as the first step in a re-planning effort. Careful evaluation of the project
should precede any effort to plan follow-up projects. Finally, evaluation should be
undertaken when a project is terminated or as well in routine operation. Different
people may do evaluation like:
 Project management will be continuously evaluating its experience as
implementation proceeds.
 The sponsoring agency, the operating ministry, the planning agency or an
external assistance agency may undertake evaluation.
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 In large and innovative projects, the project’s administrative structure may
provide a separate evaluation until responsible for monitoring the projects
implementation and for bringing problems to the attention of the project’s
management.
Evaluation can help not only in the management of the project after the initial phase but
also in the planning of the future projects.
The UNIDO model:
The United Nations Industrial Development organization (UNIDO) is the most devoted
institution towards the development and the standardization of the concept, context and
content(CCC)of industrial project management system. According to the UNIDO
approach documented in the UNIDO manual, the project development cycle comprises
three distinct phases, they are:
1. Pre- investment phase

2. Investment phase and
3. Operational phase
Each of these three phases is divided into several stages, some of which constitute
important consultancy, engineering and industrial activities as shown below:
1. Pre- investment phase
 Opportunity study( identification of project ideas)
 Pre-feasibility study (preliminary project formulation , selection of alternatives)
 Feasibility study (techno-economical project back ground, final project
formulation stage)
 Evaluation report ( decision making about project availability)
2. Investment phase
 Project design stage
 Construction stage
 Pre-production marketing stage
 Training
 Start-up stage
3. Operational phase
 Replacement of equipment
 Development, invasion or liquidation
Before dealing with pre –investment phase, the various stages of the investment and
operational phases are considered since these impacts on the nature and scope of pre-
investment studies. The project investment or implementation phase for a large industrial
business project will be different as compared to that of a small non- industrial project.
Assuming that a projected industrial activity involves the construction of a factory and
the installation of machinery and equipment, the project investment phase could be
divided in to the following stages:
 Project engineering designs
 Negotiations and contracting
 Construction and training and
 Plant start up
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An adequate importance should be given to the pre investment phase, because the success
or failure of an industrial project ultimately depends upon the marketing, technical,
financial and economic feasibility study findings and their interpretation. To reduce
wastage of scarce resources, a clear comprehension of the sequence of events is required
when developing an investment proposal from the conceptual stage by way of active
promotional efforts to the operational stage.
A. Pre-investment stage
It is a usual practice, project ideas must be elaborated in a more detailed study.
However, formulation of the detail techno-economic feasibility study, that enables a
definite decision to be made on the project, is a costly and time consuming task.
Therefore, before assigning large funds for such a study, a preliminary assessment of
the project idea must be made in a pre-feasibility study. This is just seeing that
whether:
 All possible project alternatives are examined
 The project concept justifies the detail study
 All aspects are critical and need in-depth investigation
 The project idea is viable and attractive or not
According to the UNIDO manual, the main stages of the pre-investment phase are as
follows:
 Identification of investment opportunities (opportunity studies)
 Analysis of project alternatives and preliminary project selection
 Project preparation( pre-feasibility and feasibility studies ) and
 Project appraisal and investment decision (appraisal report)
These stages assist a potential investor in the decision making process and provide the
base for project decision and implementation.
a. opportunities studies
Identification of investment opportunities is the starting point in a series of investment
related activities when potential investors (private or public) are interested in obtaining
information on newly identified viable investment opportunities. The main instrument
used to quantify the parameters, information and data required to develop a project idea
into a proposal is the opportunity study. An opportunity study should identify investment
opportunities or project ideas by analyzing the following factors in detail:
 Natural resources with high potential for processing and manufacture:
 Existing agricultural pattern that serves as a basis for agro-based industries:
 The future demand for certain consumer goods or for newly developed goods:
 Imports in order to identify areas for import substitution:
 Cost and availability of production factors:
 Possible expansion of existing industrial capacity to attain economies of scale
and
 Export possibilities.
b. Pre-feasibility studies
A Pre-feasibility study should be viewed as an intermediate stage between a project
opportunity study and a detailed feasibility study. The main difference between the
prefeasibility study and the actual feasibility study is the degree of the detailness of the
information obtained and the intensity with which project alternatives are examined. The
structure of a prefeasibility study should be the same as that of the detailed feasibility
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study. These two studies basically compile the information on the justification of the
project. In a practical sense, the main components of the project feasibility report are:
 Executive summary
 Project back ground and history
 Market and plant capacity
 Location and site
 Project engineering works
 Factory, administrative and sale overheads
 Man power
 Project implementation
 Financial analysis and
 Project risk analysis
c. Support (Functional) studies
Support of functional studies cover some aspects of an investment project, and are
required as prerequisites for, or in support of pre-feasibility and feasibility studies of
particularly large scale investment proposals. The various aspects in support or functional
studies include:
 Market studies of to be manufactured
 Raw materials inputs and factory supply studies laboratory tests location studies
 Environ mental impact assessment
 Economies of scale studies
 Equipment and technological selection studies
The contents of the support study vary, depending on the type and nature of the projects.
However, as it relates to a vital aspect of the project, the conclusions could be clear
enough to give directions to the subsequent stage of the project preparation. In most
cases, a support study when undertaken either before or together with a feasibility study,
from an integral part of the latter and lessen its burden and cost.
d. feasibility studies
A feasibility study should provide all data necessary for making the investment decision.
The commercial, technical, financial, economic and environment prerequisites for an
investment project should therefore be defined and critically examined on the basis of
alternative solutions already reviewed in the pre-feasibility study. The results of these
efforts strengthen a project whose back ground conditions and aims have been clearly
defined, in terms of its control objective and possible marketing strategies, the possible
market share that can be achieved, the corresponding production capacities, the plant
location existing raw materials, appropriate technology and mechanical equipment and,
location, existing raw materials, appropriate technology and mechanical equipment and if
required an environmental impact assessment.
The financial part of the study covers the scope of the investment, including the net
working capital, the production and marketing costs, sales revenue and the return on
capital invested. The final estimates on investment and production costs and its
subsequent calculations of financial and economic profitability are only meaningful if the
scope of the project is defined in order not to omit any essential part and its related cost.
However, there is no uniform approach or pattern to cover all industrial projects of
whatever type, size or category. The emphasis on the components varies from project to
project. For most industrial projects, however, there is a broad format of general
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application-bearing in mind the larger the project the more complex will be the
information required.
e. Appraisal Report
When a feasibility study is completed, the various parties will carry out their own
appraisal of the investment project in accordance with their individual objectives and
evaluation of expected risks, costs and gain. Large investment and development finance
institutions usually have formalized project appraisal procedures and usually prepare an
appraisal report. This is the reason why project appraisal should be considered an
independent stage of the pre-investment phase, marked by the final investment and
financing decisions taken by the project promoters.
The appraisal report will prove whether the pre production expenditures spent since the
initiation of the project idea were well spent or not. Project appraisal, as carried out by
financial institutions concentrates on the health of the company to be financed, the returns
to be obtained by equity holders and the protection of its creditors. The techniques
applied to appraise projects in line with these criteria center around technical,
commercial, market, managerial, organizational, financial and if possible economic
aspects a
B. Investment (implementation) phase
The investment or implementation phase of a project provides a wide scope for
consultancy and engineering work, first and foremost, in the field of project management.
The investment phase can be divided into the following stages:
 Technological acquisition and transfer
 Detailed engineering design and contract, including tendering, evaluation of bids
and negotiations
 Acquisition of land, construction work and installation
 Pre-production marketing, including the securing of suppliers and setting up the
administration of the firm
 Recruitment and training of personnel and
 Plant commissioning and start-up
Detailed engineering design comprises preparatory work for site preparation, the final
selection of construction planning and time scheduling of factory construction, as well as
the preparation of flow charts, scale drawing and a wide variety of layouts. During the
stage of tendering and evaluation of bids, it is chiefly important to receive comprehensive
tenders for goods and services for the project from a sufficiently large number of national
and international supplies of proven efficiency and with good delivery capacity.
This stage covers the signing of contracts between the investor on the one hand, and the
financing institutions, consultants, architects and supplies of raw materials and required
inputs on the other.
The construction stage involves site preparation, construction of buildings and other civil
works, together with the erection and installation of equipment in accordance with proper
programming and scheduling. The personnel recruitment and training stage, which should
proceed simultaneously with the construction stage, may prove very crucial for the
expected growth of productivity and efficiency in plant operations. Plant commissioning
and start up is usually a brief, but technically critical span in project implementation.
C. Operational Phase
The problem of the operational phase needs to be considered from both short and long
term view points. The short term view relates to the initial or commencement of
production when a number of problems may arise concerning such matters as the
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application of production techniques, operation of equipment or inadequate labor
productivity owing to lack of qualified staff and labor. Most of the problems have their
origin in the implementation phase. The long term view relates to chosen strategies and
the associated production and marketing costs as well as sales revenues. These have a
direct relationship with the productions made at the pre-investment phase. If such
strategies and projections prove faulty and remedial measures will not only be difficult,
but may prove highly expensive.
The DEPSA Model

In Ethiopia, Development Project Studies Authority (DEPSA) made certain efforts and
developed a model for Project life cycle which is known as DEPSA’s Project life cycle.
This life cycle comprises three major phases. They are:
1. Pre-investment phase
2. Investment and
3. Operation
Each of these three phases may be divided into different stages.
The following is the summary of this classification of the project life cycle.
1. Pre- investment Phase

a. Identification Stage
b. Formulation Stage
 Pre-feasibility study
 Feasibility study
c. Appraisal
 Appraisal
 Decision
2. Investment Phase
 Implementation
 Tendering negotiation and contractual
 Detailed engineering design
 Construction, erection and commissioning
3. Operation Phase
 Operation
 Ex-post evaluation
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Chapter Two:
Generation and screening of Project Ideas (Project Identification)
2.1. Generation of Project Ideas
The search for viable project ideas is the prime step towards establishing a successful
venture. The key to success lies in getting into the right business in the right time. The
objective is to identify investment opportunities which are feasible and promising.
Searching opportunities requires imagination, sensitivity to environmental changes, and
realistic assessment of firm’s performance. This task is partly structured, partly
unstructured; partly dependent on convergent thinking, partly dependent on divergent
thinking; partly requiring objective analysis of quantifiable factors, partly requiring
subjective evaluation of qualitative factors; partly amenable to control, & partly
dependent on fortuitous circumstances.
Many of the most important projects in developing countries emerged from the political
commitments of national leaders, as response to crisis, emergencies and external threats
or a foreign governments policies assistance agency priorities, etc.
A project is not a product or commodity to be purchased. It has a promise as well as a

risk.
Stimulating the Flow of Ideas
Often firms adopt a somewhat casual and haphazard approach to generation of project
ideas. To stimulate the flow of ideas, the following are helpful:
SWOT Analysis: SWOT is an abbreviation for strengths, weaknesses, opportunities and
threats. SWOT analysis symbolizes a conscious, deliberate, and a systematic effort by an
organization to determine opportunities that can be profitably exploited by it. Periodic
SWOT analysis facilitates the generation of ideas.
Clear Articulation of Objectives: The operational objectives of a firm may be planned
to be one or more of the following:
 Cost reduction
 Productivity improvement
 Increase in capacity utilization
 Improvement in contribution margin
 Expansion into promising fields
A clear articulation and prioritization of objectives are helpful in gilding the efforts of
employees and encourage them to think more imaginatively.
Fostering a Conducive Climate: To tap the creativity of people and to harness their
entrepreneurial urges, a conducive organizational climate has to be fostered.
An idea regarding a required intervention in a specific area to address identified problem

is formed and developed. This idea is usually hatched through discussions by specialists
and local leaders in a community need based on issues and turned into a proposal.
The project idea selection is selection of project idea from available alternatives which
is to be best suited to the entrepreneurs’ capacity, competence and willingness. The
project Selection criteria may include;
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 Profitability
 Feasibility
 Resoursability
 Acceptability
The basic criterion for selection of a project could be existence of a favorable cost-
benefit relationship.
People would like to select a project which requires a minimum investment, low degree
of competence, completed in the shortest time, and which has the highest return potential.
2.2. Monitoring the Business Environment
Fundamentally a promising investment idea enables a firm or an entrepreneur to take
advantage of opportunities in the environment by drawing on its competitive strengths.
Thus, the firm must systematically monitor the business environment and assess its
competitive abilities. The important aspects in monitoring the key sectors of the
environment are as follows:
o Economic Sector
 State of the economy
 Overall rate of growth
 Growth rate of primary, secondary, and tertiary sectors
 Cyclical fluctuations
 Linkage with the world economy
 Trade surplus /deficits
 Balance of Payment situation
o Governmental Sector
 Industrial Policy
 Government programmes and projects
 Tax framework
 Subsidies, incentives, and concessions
 Import and export policies
 Financing norms
 Lending conditions of financial institutions and commercial banks
o Technological Sector
 Emergence of new technologies
 Access to technical know – how, foreign as well as indigenous
 Receptiveness on the part of industry
o Socio – demographic Sector
 Population trends
 Age shifts in population
 Income distribution
 Educational profile
 Employment of women
 Attitudes toward consumption and investment
o Competition Sector
 Number of firms in the industry and the market share of the top few
 Degree of homogeneity and differentiation among products
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 Comparison with substitutes in terms of quality, price, appeal, and
functional performance.
 Marketing policies and practices
o Supplier Sector
 Availability and cost of raw materials and sub – assemblies
 Availability and cost of energy
 Availability and cost of money
Governmental
Socio-
economic
Technological
Competitor
Geographic
Supplier
FIGURE – 1 BUISNESS ENVIRONMENT

2.3: Corporate Appraisal
A realistic appraisal of corporate strengths and weaknesses is desirable for identifying
investment opportunities which can be profitability exploited.
The broad areas of corporate appraisal and the important aspects to be considered under
them are as follows:
o Marketing and Distribution
 Market image
 Product line
 Market share
 Distribution network
 Customer loyalty
 Marketing and distribution costs
o Production and Operations
 Condition and Capacity of Plant Capacity
 Availability of raw materials, Sub – assemblies, and power
 Degree of vertical integration
 Locational advantage
 Cost Structure
o Research and Development
 Research capabilities of the firm
 Track record of new product developments
 Laboratories and testing facilities
 Coordination between research and operations
o Corporate Resources and Personnel
 Corporate image
 Clout with governmental and regulatory agencies
 Dynamism of top management
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 Competence and commitment of employees
 State of industrial relations
o Finance and Accounting
 Financial leverage and borrowing capacity
 Cost of capital
 Tax situation
 Relations with shareholders and creditors
 Accounting and control system
 Cash flows and liquidity
2.4: Scouting for Project Ideas
In scouting or searching for project ideas, there are wide varieties of sources which need
to be tapped to identify them. The following are some of the suggestions:
To have a wide range of options, the sources of project ideas can be categorized into two.
They are:
A) Micro level sources
B) Macro level sources
Micro level sources:
Analyze the Performance of Existing Industries. Promising investment opportunities
which are profitable and relatively risk – free can be reached through the study of
existing industries in terms of their profitability and capacity utilization.
Examine the Impute and Outputs of Various Industries. An analysis of the inputs
required for various industries may throw up project ideas. Opportunities exist when (i)
materials, purchased parts, or supplies are presently being procured from distant sources
with attendant time lag and transportation cost, and (ii) several firms produce internally
some components /parts which can be supplied at a lower cost by a single manufacturer
who can enjoy economies of scale. Similarly, a study of the output of the existing
industries may reveal opportunities for adding value through further processing of the
main outputs, by – products, as well as waste products.
Review Import and Export. Analysis and review of import statistics for a period of five
to seven years is helpful in understanding the trend of imports of various goods and
potential for import substitution. Similarly, an examination of export statistics is useful
in learning about the export possibilities of various products.
Study plan outlays and Governmental Guidelines. Since government plays a very
important role in the economy, its proposed outlays in different sectors provide useful
pointers toward investment opportunities.
Look at the Suggestions of Financial Institutions and Development Agencies. In a
bid to promote development of industries in their respective states, state financial
corporations, state industrial development corporations, and other developmental bodies
conduct studies, prepare feasibility reports, and offer suggestions to potential
entrepreneurs. The suggestions of these agencies are helpful in identifying promising
projects.
Investigate Local Materials and Resources: A search for project ideas may begin with
an investigation into local resources and skills. Various ways of adding value to locally
available materials may be examined.
Analyze Economic and social Trends. Changing economic conditions and consumer
preferences provide new business opportunities. Hence, a study of economic and social
16
trends is helpful in projecting demand for various goods and services. For example, the
greater awareness of the value of time is dewing on the Public. Thus, the demand for
time – saving products like prepared food items, powered vehicles, etc. has been
increasing.
Study New Technological Developments. New Products or new processes and
technologies for existing products developed by research laboratories may be examined
for profitable commercialization.
Draw Clues from Consumption Abroad. By taking higher risks, entrepreneurs may
identify projects for the manufacture of products or supply of services which are new to
the country but extensively used abroad. Automatic vending machines, entertainment
parks, pre–fabricated houses, and fast food restaurants are examples of projects belonging
to this category.
Explore the Possibility of Reviving Sick Units. When industrial sickness is spreading
over the country, there are innumerable units which have been characterized as sick. This
units are either closed or face the prospect of closure. A significant proportion of sick
units, however, can be nursed back to health by sound management infusion of further
capital, and provision of complementary inputs. Hence, there is fairly good scope for
investment in this area. Such investments typically have a shorter gestation period
because one does not have to begin from scratch.
Identify Unfulfilled Psychological Needs. Through an assessment of unfulfilled
psychological needs, firms can easily catch an idea for further reprocesses of goods and
make up of services. For well – established, multi – brand product groups like bathing
soap, detergents, cosmetics, and tooth paste, the question to be asked is not whether there
is an opportunity to manufacture something to satisfy an actual physical need but whether
there are certain psychological needs of the consumers which are presently unfulfilled.
To find out whether such an opportunity exists, the technique of spectrum analysis is
useful. This analysis is done in the following manner: (i) Important factors influencing
broad choice are identified. (ii) Exiting brands in the market are positioned on a
continuum in respect of the factors identified in step (i). (iii) gaps which exist in relation
to consumer psychological needs are identified.
Attend Trade Fairs. National and international trade fairs provide an excellent
opportunity to get to know about new products and developments.
Stimulate Creativity for Generating New Product Ideas. New product ideas may be
generated by thinking along the following lines: Modification, Rearrangement, Reversal,
Magnification, Reduction, Substitution, Adaptation and Combination.
At macro level:
At macro level, project ideas can be obtained from various sources as mentioned below:
Project ideas from government policies and plan:
From time to time governments produce guidelines such as the national
development plans and session papers which spell out the directions the
government should take to achieve certain targets in various sectors of the
economy and guidelines to various organizations and individuals. The information
contained in these documents is useful in generating ideas for new projects. For
Example: If the government intends to start a number of new schools in a given
area then a number of projects which of related to the retirements of such schools
would be considered.
Project ideas from technical specifications:
For many industrial projects, ideas will usually tend to come from technical
specifications, which by virtue of their experience and for research findings will
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give useful information which may lead to the manufacturing of new products or
improving the existing products.
Project ideas from local leaders:
For community and social projects, local leaders usually have important ideas,
which they together with their local people, have identified as being important in
improving the welfare of the people. In the case of social projects depending in
which one is to identify, there may be a number of other projects which are linked
to the identified projects.
Example: A project of constructing a dam for the generation of hydro electric
power will be giving suggestions for the start of irrigation projects, a fishing
project and other related projects.
Project ideas from Entrepreneurs:
For commercial and industrial projects, Entrepreneurship is an important source
of ideas. Entrepreneurships include the characteristics of preparation of
managerial competence and motivation to achieve results. Although
entrepreneurship skills have been passed on from one generation to another along
Family and social-economic circles, it has been recognized that programs for
entrepreneurship development will help individuals to come up with useful ideas
which can be translated into viable projects.
2.5. Preliminary SCREENING
Screening is an initial review of project ideas and concepts to see if they should be
advanced or abandoned at an early stage. Once a project profile has been prepared, it
would be important to develop a clear idea of what the proposed project is supposed to
achieve. For this purpose, the following aspects may be looked into:
 Compatibility with the promoter
 Consistency with governmental priorities
 Availability of inputs
 Adequacy of market
 Reasonableness of cost
 Acceptability of risk level
Compatibility with the Promoter
The project idea must be compatible with the interest, personality, and resources of the
entrepreneur. According to Murphy, a real opportunity has three characteristics: (i) It fits
the personality of the entrepreneur – it squares with his abilities, training, and proclivities.
(ii) It is accessible to him. (iii) It offers him the prospect of rapid growth and high return
on the invested capital.
Consistency with Governmental Priorities
Project idea should go in line with the national goals and governmental regulatory
framework. The questions to be raised in this context are:
 Is the project consistent with national goals and priorities?
 Are there any environmental effects contrary to governmental regulations?
 Can the foreign exchange requirements of the project be easily accommodated?
 Will there be any difficulty in obtaining the license for the project?
Availability of Inputs
There has to be reasonable assurance for the resources and inputs required for the project.
To assess this, the following questions need to be answered:
 Are the capital requirements of the project within manageable limits?
 Can the technical know – how required for the project be obtained?
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 Are the raw materials required for the project available domestically at a
reasonable cost? If the raw materials have to be imported, will there be problems?
 Is the power supply for the project reasonably obtainable from external sources
and captive power sources?
Adequacy of the Market
The current size of the market must offer the prospect of adequate sales volume.
Moreover, there should be a potential for growth and a reasonable return on investment.
To determine the adequacy of the market the following factors need to be examined:
 Total present domestic market
 Competitors and their market shares
 Export markets
 Quality – price profile of the product vis – a- vis competitive products
 Sales and distribution system
 Projected increase in consumption
 Barriers to the entry of new units
 Economic, social, and demographic trends favorable to increased consumption
 Patent production
Reasonableness of Cost
The cost Structure of the proposed project must enable it to realize an acceptable profit
with a price. The following should be examined in this regard:
 Cost of Material input
 Labor Costs
 Factory Overheads
 General administrative expenses
 Selling and distribution costs
 Service costs
 Economies of scale
Acceptability of Risk Level
The desirability of a project is critically dependent on the risk characterizing it. In the
assessment of risk – a difficult task, indeed – the following factors should be considered:
 Vulnerability to business cycles
 Technological changes
 Competition from substitutes
 Competition from imports
 Governmental control over price and distribution
Therefore, during the preliminary selection, the analyst should eliminate project
proposals that
 Technically unsound and risky
 Have no market for the output
 Have inadequate supply of inputs
 Are very costly in relation to benefits and
 Assume over ambitious sales and profitability
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Chapter Three: project preparation (Feasibility study)
3.1 Nature of Project
Projects represent the commitment of human and physical resources to produce specific
outputs in a given time and budget framework. Projects vary in scale, purpose and
duration. They may be initiated within community, requiring modest inputs and
producing tangible outputs within a relatively short timeframe. At the other extreme,
projects may require substantial financial resources and only generate benefits in the long
term. For example, the former could be an adult literacy project in a village; the latter
may be the provision of universal primary education for all children of school age in a
country. Whilst the former needs one trainer and a few teaching materials, the latter
requires numerous schools, teachers, equipment and administration. Projects may stand-
alone or be integrated into a programme, with several projects contributing to one overall
goal. Despite the difference in scale and nature of projects, there are aspects of sound
project management that are universal.
However in most practical situation it is not uncommon to find a situation where only a
few projects are sufficiently analyzed, carefully prepared and optimally selected. This
happens because of two major reasons;
 Lack of skilled manpower to carry out a detail analysis and
 Unwillingness of the entity undertaking the project to spend money on this

process.
Hence many projects are implemented without any extensive feasibility studies. In the
obscene of detailed feasibility studies, project implementing agencies usually use non-
numeric project selection models. They are;
1. The sacred cow model
In this model, a project is usually suggested by a senior and powerful individual in an
organization and the idea is then passed to the officers below. In many cases, other
officers are required to assist the boss to achieve what he/she wants. Although such
projects may not pass through vigorous analysis, the boss may persist until he/she is
convinced that it can no longer work. Many projects in the public sector of developing
countries have been initiated using this approach. Usually, these projects are initiated by
powerful politicians such as ministers with the aim to give their home areas the so called
‘accelerated development’.
2. Operating necessity model
In this project selection model, projects are initiated because they are required to keep a
system in the operation. These are threatening situations such as floods which will simply
call for projects to be started without much evaluation. Funding of projects initiated in
this manner is usually done without making though and meticulous analysis that goes
with projects preparation and identification.
3. Competitive necessity model
Projects are usually initiated and given a lot of support if they will help an organization
maintain a competitive edge over other organizations. Such projects are considered to be
of survival importance to an organization and may not necessarily be required to go
through careful numerical analysis.
4. Product line extension model
This model is used when a project is intended to develop and distribute a new product or
products. Usually, such project if intended to fill a gap or to strengthen a weak link or to
take the organization to a new direction, will be judged favorably without careful
calculations of the profitability of the project.
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5. Competitive benefit level
This model is used where a firm has several projects that must be considered and some
ranking is given. In actual practice, in this model, the projects are sorted out into three
categories; good, fair and poor. This is done according to some development merit list.
Such a list may contain doctrine such as if the project is labor intensive, and then it might
be given more priority.
However scholars have indicated that the application of the aforementioned models to
project selection may be limited to projects which do not involve huge investment of
resources. Yet it is believed that this process is wasteful if many projects are appraised
but is eventually abandoned. With a lot of care exercised, especially at the feasibility
stage the abandonment should seldom happen. Hence for projects which involve huge
resources, especially those involving governments and other institutions such as the
World Bank and the International Monetary Fund, feasibility studies must be usually
carried out before a project is selected for implementation.
3.1. Market and Demand Analysis

In most circumstances, the first step in project analysis is to estimate the potential size of
the market for the product proposed to be manufactured (or service planned to be offered)
and get an idea about the market share that is likely to be captured. The task demands an
in – depth study and analysis of various factors such as: existing pattern of consumption
and growth, consumption of the market, nature of competition, income levels of the
society, availability of substitutes, system of distribution channels, etc.
The objectives of market and demand analysis in preparing a project are to:
 Identify potential consumers or buyers.
 Gathering secondary and/or primary data/ information
 Market survey
 Market classification/characterization of the market demand forecasting
 Uncertainties in demand fore casting
 Market planning
3.1.1. Situational Analysis and Specification of Objectives
The primary purpose of situational analysis is to generate enough data about the market
without formal study, which normally demands time and cost. Most often, of course, a
formal study of the market and demand is warranted. To conduct such a study, it is
necessary to spell out its objective clearly and comprehensively. Often this means that,
the intuitive and informal goals that guide situational analysis need to be expanded and
articulated with greater clarity.
To get an idea about the proposed product or services and its market share, the project
formulators, therefore, need informally, to talk to consumers or customers, competitors,
distributors preferences, purchasing power, organizations, or other similar or different
producers or services providers. It may be also advantageous to look at experiences of
the organizations in dealing with customers and their strategies.
Key steps in Market and Demand Analysis and their Inter – relationships
21
Collection of secondary Demand

information Demand
Forecasting
Forecasting
Situational Analysis Characterization of

and Specification of the Market
Objectives
Characterization of
the Market
Conduct of Market Market

Survey Planning
Conduct of Market Market

Survey Planning
3.1.2. Collection of Secondary Information

To conduct market demand, study information may be collected from secondary and / or
primary sources. Secondary sources are information gathered in some other places or
context and are already available. Information for market and demand analysis may be
obtained from central statistics office, sample survey reports, planning reports, academic
studies, etc. These sources may provide starting point for market and demand analysis.
However, their reliability, relevance, and accuracy for intended purpose should be
carefully examined. Moreover, it provides leads and clues for gathering primary
information required for further analysis.
3.1.3. Conduct Market Survey
A comprehensive basis for market and demand analysis may be difficult to obtain from
secondary information. As such, primary information through a market survey tailored to
the specific needs of the project under preparation is necessary. There are two types of
survey for this purpose. These are a census survey and a sample survey.
In a census survey, the whole population is included (covered). Generally they are
employed for investment goods and intermediate goods if they are principally used by
small number of users or consumers. These types of surveys often tend to be costly and
infeasible.
In a sample survey, a sample of population may be drawn. This method is found to be
cheaper and easier.
The information sought in a market survey may relate to one or more of the following:
 Total demand and rate of growth of demand,
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 Demand in different segments of the market,
 Income and price elasticity of demand,
 Motives of seeking the product or service,
 Unsatisfied needs or demand,
 Purchasing power of customers,
 Satisfaction with the existing product or service,
 Distribution patterns and preferences,
 Attitude towards the product or service,
 Socio – economic conditions of the consumers,
These information need to be collected and analyzed in the context of the proposed
project.
3.1.4. Characterization of Market Survey
Based on the information collected through a sample survey or secondary sources it may
be necessary to classify the market for the product or service in the following manner:
 The past and present effective demand,
 Break down of demand
 Consumers or customers,
 Distribution and sales promotion,
 Supply and competition
 Price
 Government policy
o Effective Demand in the Past and Present
To get the past and present effective demand, it is necessary to estimate apparent
consumption (i.e production plus imports less exports and change in stock). In
competitive market effective demand and apparent consumption are generally equal. In
most developing countries, where competitive markets do not exist for a variety of
products due to exchange restrictions and controls on production and distribution, the
figure of apparent consumption may have to be adjusted for market imperfections.
Moreover, to obtain clear insight into the nature of aggregate market demand it may be
necessary to break down demand for different segments of the market. Segmental
information is helpful to formulate market strategies that are appropriate to different
market segments.
o Breakdown of Demand
To get an in depth insight to the nature of demand, the aggregate (total) market demand
may be broken down into demand for different segments of the market. Market segments
may be defined by (i) Nature of product, (ii) Consumer group, and (iii) Geographical
division. Segmental information is helpful because the nature of demand tends to vary
from one segment to another. The demand from consumers in high income brackets may
not be sensitive to price variations and different marketing strategies may be appropriate
for different market segments.
o Consumers or Customers
Customers may be classified based on demographic (age, sex), economic (income),
sociological (profession, residence, social background), attitude (preferences, intentions,
habits, attitudes, and responses). This is not an exhaustive classification and the
formulators may be able to find meaningful groupings or categories based on targeting
processes.
23
o Price
Along with statistics relating to physical quantities. It may be helpful to distinguish the
following types of prices:
(i) Manufacturer’s price quoted as FOB (free on board price or CIF (cost, insurance, and
freight) price, (ii) Landed price for imported goods, (iii)Average whole sale price, and
(IV) Average retail price.
o Methods of Distribution and Sales Promotion
The existing methods of distribution and sales promotion has been analyzed. This is
essential to identify patterns of consumption and problems encountered in making the
proposed product/service.
o Supply and Competition
It is necessary to know the existing sources of supply and whether they are foreign or
domestic. For domestic sources of supply, information along the following lines may be
gathered: Location, present production capacity, planned expansion, capacity utilization
level, bottlenecks in production, and cost structure.
Competition from substitutes and near – substitutes should be specified because almost
any product may be replaced by some other product as a result of relative changes in
price, quality, availability, promotional effort, and so on.
o Government Policy
Government policy may influence the market and the demand for a product/service.
Governmental plans, policies, and legislations, which have an influence on the market
and demand of the product under examination should be disclosed. These are reflected
in: production targets in national plans, import and export trade controls, import duties,
export incentives, excise duties, sales tax, industrial licensing preferential purchases,
credit controls, financial regulations, and subsidies /Penalties of various kinds.
3.1.5. Demand Forecasting
After the completion of information gathering about various aspects of the market and
demand from primary and secondary sources, it may be possible to estimate future
demand. There are several forecasting methods which are made available to the market
analyst. These methods may be classified in three broad categories as shown below:
Methods of Demand Forecasting
I. Qualitative Methods. These methods depend on essentially on the judgment of
experts to translate qualitative information in to quantitative estimates. The important
qualitative methods are:
 Jury of executive method
 Delphi method
II. Time Series Projection Methods. These methods generate forecasts on the basis of
an analysis of the historical time series. The important series projection methods are:
 Trend projection method
 Exponential Smoothing method
 Moving average method
III. Casual Methods. These method is more analytical than the preceding methods,
casual methods seek to develop forecasts on the basis of cause – effect relationships
specified in an explicit, quantitative manner. The important casual methods are:
 Chain ratio method
 Consumption level method
 End use method
24
 Leading indictor method
 Econometric method
o Jury of Executive Option Method
Popular in practice, involves soliciting the opinions of a group of managers on expected
future sales and combining into sales estimate. It is a speedy method for developing a
demand forecast. This method of demand forecasting will have certain advantages and
disadvantages.
The advantages of this method are: (i) It is an expeditious method for developing a
demand forecast. (ii) It permits a variety of factors like economic climate, competitive
environment, consumer preferences, technological developments, and soon to be
included in the subjective estimates provided by the experts. (iii) It has immense
appeal to managers who tend to prefer their judgment to mechanistic forecasting
procures.
The disadvantages of this method are: (i) The biases underlying subjective estimates
can not be easily avoided. (ii) The reliability of this technique is questionable.
o Delphi Method
This method involves eliciting the opinions of group of experts, who don’t interact face –
to – face, usually with help of a mail survey, into a forecast through an interactive
process. In this method, a questionnaire is sent to a group of experts and responses
received are summarized without disclosing the identify of the experts. These will sent
back to experts to probe extreme views expressed in the first found. The method seems
appealing but the value of expert opinion is questionable.
Delphi method appeals to many organizations for the following reasons: (i) It is
intelligible to users. (ii) It seems to be more accurate and less expensive than the
traditional face – to – face group meetings.
o Trend Projection
This method involve extrapolating the past trend onto the future. The most commonly
employed relationship is the linear relationship. A straight line describes the linear trend,
explained by the following equations:
Ty = a + bx
Where:
 ‘Ty’ denotes the underlying trend of variable Y.
 ‘X’ denotes the points of time (each number consecutively)
 ‘a’ is the intercept term
 ‘b' denotes the change in Ty per unit of time.
o Exponential smoothing Method
In exponential smoothing, forecasts are modified in the light of observed errors. If the
forecast value for year t, Ft, is less than the actual value for year t, St, the forecast for the
year t + 1, Ft + 1, is set higher than Ft. If Ft > St, Ft + 1 is set lower than Ft. In general
Ft + 1 = Ft + α et
Where: Ft + 1 = Forecast for year t + 1
α = Smoothing Parameter (which lies between 0 and 1)
et = Error in the forecast for year t = St – Ft
o Moving Average Method
This method smoothes out fluctuations when the data set shows irregular variations. It is
produced by averaging the values of a consecutive set of data: three, four, five …
25
periods. The moving average is ‘centered’ against the mid – point of the averaging
period.
o Chain Ratio Method
Under this method, the potential sales of a product may be estimated by applying a series
of factors to a measure of aggregate demand. The chain ratio method uses a simple
analytical approach to demand estimation. However, its reliability is critically dependent
on the ratios and rates of usage used in the process of determining the sales potential.
While some of these ratios and rates of usage may be based on objective proportions,
others will have to be subjectively defined.
o Consumption Level Method
The consumption – level method considers the level of consumption, using standard and
defined coefficients, and can be usefully adopted for consumer products. Thus, the
demand for cars can be estimated by determining the ratio of cars per 1000 inhabitants, or
the coefficients of car ownership among identified income levels, industrial units and
Government. Once the total requirements are known, the actual car population is
subtracted from the total to arrive at the new demand. Replacements requirements can be
added to this forecast.
Consumer income is a major determinant of consumption levels, influencing the
household budget allocations which consumers are willing to make for a given product.
With certain exceptions, product consumption levels have a high degree of positive
correlations with the income levels of consumers.
Income Elasticity of Demand
The extent to which demand changes in response to variations in income is measured by
the income elasticity of demand. It is measured as follows:
E1 = Q2 – Q1 × I1 + I2
I2 – I1 Q2 + Q1
Where E1 = Income elasticity of demand
Q1 = quantity demanded in the base year
Q2 = quantity demanded in the following year
I1 = income level in the base year
I2 = income level in the following year
Example: The following information is available on quantity demanded and income
level; Q1 = 80, Q2 = 88, I1 = 1,000, and I2 = 1,040. What is the income elasticity of
demand? The income elasticity of demand is:
88  80 1,000  1,040
E1   2.43
1,040  1,000 88  80
Demand forecast can be determined based on the information of income elasticity of
demand along with projected income. To illustrate, suppose the present per capital
annual demand for paper is 1kg and the present per capital annual income is Br. 16,400.
the income elasticity of demand for paper is 2. The projected per capital annual income
four years hence is expected to be 15 percent higher (in real terms) than what it is now.
The projected per capital demand for paper four years hence will be:
Present per capital Per capital Income

Demand = 1 + change in  elasticity
income level of demand
= (1 + (0.15 x 2)) = 1.3 kg
The aggregate demand projection for paper will simply be:
26
Projected per capital demand x Projected Population
Income elasticities differ not only between products but also, for a given product,
between different income groups and different regions. Therefore, whenever it is
possible to determine variations in per capital income by income groups and regions, the
analysis should not be limited to the average per capital income in the whole national
economy, but disaggregate analysis should be attempted.
Price Elasticity of Demand
The price elasticity of demand measures the responsiveness of demand to variations in
price. It is the ratio of relative variations in the volume of demand to the relative
variation in price, may be expressed as follows:
Ep = Q2 – Q 1 × P1 + P2
P2 – P1 Q2 + Q1
Where Ep = Price elasticity of demand
Q1 = quantity demanded in the base year
Q2 = quantity demanded in the following year
P1 = price per unit in the base year
P2 = Price per unit in the following year
Example: The following information is available about a certain product:
P1 = Br 800, Q1 = 20,000, P2 = Br. 1,000, Q2 = 19,000. What is the price elasticity of
demand? The price elasticity of demand is:
EP = 19,000 – 20,000  800 + 1,000 = - 0.23
1,000 – 800 19,000 + 20,000
This coefficient can be very useful for studying sensitivities in the economics of a
project, by enabling consideration of the price levels that may prevail in future.
Variations in price clearly affect sales, and consequently production levels and the unit
costs of production. The coefficient assumes, however, that other market conditions and
behavior remain constant. Moreover, the coefficient is applicable only to quite small
variations in price, since it does not remain constant over a wide range of price variations.
End – Use Method
The end – use method is particularly suitable for assessing intermediate products.
It involves the following:
o All possible uses of a product are identified, including, for example, input to other
industries, direct consumption demand, imports and exports;
o The input – output coefficient of the product and the industries using the product
are obtained or estimated. It is then possible to derive the demand for a product,
that is, for consumption plus its exports and net imports, from the projected output
levels of the consuming industries.
End – use method utilizes consumption coefficients, and is therefore, also called the
consumption coefficient method, involves the following steps:
i) Identify the possible uses of the product.
ii) Define the consumption coefficient of the product for various uses.
iii) Project the output levels for the consuming industries.
iv) Derive the demand for the product.
This method may be illustrated as follows:
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Illustrative Example:
Assume in a certain town annual petrol consumption per vehicle is as given below:
Annual Petrol consumption

Per vehicle
Vehicle (thousand liters)
- Private cars 2.20
- Taxis 6.50
- Commercial /vehicles using petrol 9.60
- Motor cycles 0.10
To determine the forecast consumption level, when identified, the coefficient appropriate
for a consumption level goal is multiplied by the size of the activity.
Forecasts of demand for petrol based on the above consumption coefficient are given as
follows:
Projected Demand for Petrol
Vehicle Consumption Cars in year X Projected Demand for
Coefficient petrol in year x
(thousand litres)
Private cars ……… 2.20 300 660
Taxis…………….. 6.50 150 975
Commercial vehicles..9.60 200 1920
Motor cycles……..... 0.10 250 25
Consumption coefficients vary over time from one market to another, in size of
producing units and as a function of technological change. For petrol consumption, the
consumption coefficients differ between the types of vehicle but each coefficient can vary
from one period to another. Hence, extreme care must be exercised in the determination
of past, and especially in projection of future, coefficients.
Leading Indicator Method
Leading indicators are variables which change a head of other variables, the lagging
variables. Thus, observed changes in leading indicators may be used to predict the
changes in lagging variables. For instance, the change in the level of urbanization ( a
leading indicator) may be used to predict the change in the demand for air conditioners (
a lagging variables).
There are two basic steps which are involved are: (i) At first, identify the appropriate
leading indicator (s). (ii) Second, establish the relationship between the leading indicator
(s) and the variable to the forecast.
An important advantage of this method is that, it does not require a forecast of an
explanatory variable, but it is not always possible to determine the leading indicator, and
the lead time may not be stable. The extent that the relationship itself may also change
over time.
Econometric Method
An econometric model is all about a mathematical representation of economic
relationship (s) derived from economic theory. The primary objective of econometric
analysis is to forecast the future behavior of the economic variables incorporated in the
model.
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Practically, two types of econometric models are employed; the single equation model
and the simultaneous equation model. The single equation model assumes that one
variable, the dependent variable (also referred to as the explained variable). The
following is an example of the single equation model is given below:
Dt = a0 + a1P1 +a2Nt
Where Dt = demand for a certain product in year t
Pt = Price for the product in year t
Nt = income in year t
Simultaneous equation model depicts economic relationships in terms of two or more
equations.
GNPt = Gt + It + Ct
It = a0 + a1 GNPt
Ct = b0 + b1GNP1
Where GNpt = gross national product for year t
Gt = governmental purchases for year t
It = gross investment for year t
Ct = consumption for year t
An econometric model involves the following four broad steps:
Specification: This refers to the expression of an economic relationship in a mathematical
form.
Estimation: This involves the determination of the parameter values and other statistics
by a suitable method such as the least squares method.
Verification: This step is concerned with accepting or rejecting the specification as a
reasonable approximation to the truth on the basis of the results of estimation.
Prediction: This involves projection of the values of explained variable (s)
The econometric method, as a mechanism for demand forecasting offers certain
advantages: (i) The process of econometric analysis sharpen the understanding of
complex cause – effect relationships. (ii) The econometric model provides a basis for
testing assumptions and for indging how sensitive the results are to changes in
assumptions.
Econometric method are not free from certain drawbacks, among these: (i) It is expensive
and data demanding. (ii) To forecast the behavior of the dependent variable, one needs
the projected values of the independent variable (s).
3.1.6. Market Planning
An appropriate marketing plan should be formulated to reach the proposed
product/service to a desired level of customers. The prime purpose of the marketing plan
is meeting the customer needs better than their competitors. The marketing plan should
focus on customer needs, nature of product or service offering, channel function and
coverage. In planning the market the detailed information that has been collected and
analyzed should be targeted on the following:
 Customer, consider core needs and ancillary needs.
 Distribution, indicate role of distributors, whole salers and retailers
 Promotion which includes advertising, branding, own sale efforts.
 Princing, indicate final price to customers, trade margins, duties on the intended
price.
 Services, state warranties, after – sale service, training, installation, etc
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 Market segmentation, breakdown markets into meaningful groupings or segments
giving emphasis on distinguished characteristics, size of segment, accessibility,
and degree of competition.
3.2. Technical Analysis
Technical aspect of the project provides the basis for all other forms of project design and
analysis because a technically unfeasible project must be either revised or abandoned,
regardless of its performance in other areas.
Analysis of technical and engineering aspect is done continually when a project is being
examined and formulated. Other types of analysis are closely interwoven with technical
analysis. Technical feasibility must be conducted on the basis of the project’s ability to
meet its objectives using a technology and standards, which are appropriate to the
circumstances of the country in which the project will be located.
Project formulators or promoters must bear in mind the key word ‘appropriate’ in
formulating a project. The project should have to be designed analyzed interms of its
appropriateness and relevance with regard to the project’s objective. In line with this
perspective, the project objective is the key to technical analysis.
The broad purpose of technical analysis is (a) to ensure that the project is technically
feasible in the sense that the inputs required to set up the project are available, and (b) to
facilitate the most optimal formulation of the project interms of technology, size,
location, and so on. The following are basic issues pertaining to technical analysis using
common sense and economic logic.
 Manufacturing process /technology
 Technical arrangements
 Materials and Inputs
 Plan capacity
 Location and site
 Structures and civil works
 Environmental aspects
3.2.1. Manufacturing Process Technology
In manufacturing a product or service often two or more alternative technologies are
available. For instance, cement can be made either by the dry process or the wet process.
Similarly, a soap can be manufactured by the semi – boiled process or the fully – boiled
process.
o Technology Choice
Selection of appropriate technology and know–how is a critical element in any feasibility
study. Such selection should be based on a detailed consideration and evaluation of
technological alternatives and the selection of the most suitable alternative in relation to
the project to investment strategy chosen and to socio – economic and ecological
considerations. Appropriate technology choice is directly related to the conditions of
application in particular situations. What may be appropriate in industrialized economies
with high labor costs may not necessarily be the optimum for low – age developing
countries, with severe constraints on infrastructure and availability of inputs. On the
other hand, a plant in a developing country that produces primarily for export to
industrialized countries may need to utilize the latest automated and capital – intensive
production processes in order to compete in such markets. Competitive production
capability in intended markets is one of the most crucial factors for technology choice,
and the related plant capacity can be a major determinant of such capability. Generally,
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technology choice must be directly related to market, resource and environmental
conditions and the corporate strategies recommended for a particular project.
It is also necessary to take into account new technological developments and applications
and their impact to plant capacity. The choice of technology is influenced by a variety of
considerations:
 Plant capacity
 Principal inputs
 Investment outlay and production cost
 Use by other units
 Production mix
 Latest developments
 Ease of absorption
Plant Capacity. Often, there is a close relationship between plant capacity and production
technology. Perhaps, only a certain production technology may be viable so as to meet a
given capacity requirement.
Principal Inputs: The chosen technology, in some cases, may be influenced by the raw
materials available – for instance, 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.
Use by Other Units: The technology adopted must be proven by successful use by other
units.
Product Mix: The chosen technology must be judged in terms of the total product – mix
generated by it, including saleable by – products.
Latest Developments: The technology adopted 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.
o Appropriateness of Technology
Appropriateness of technology refers to the methods of production which are suitable to
local economic, social, and cultural conditions. Nowadays, advocates of appropriate
technology urge that the technology should be evaluated in terms of the following points:
 Whether the technology utilizes local raw materials?
 Whether the technology utilizes local manpower?
 Whether the goods and services produced cater to the basic needs?
 Whether the technology protects ecological balance?
 Whether the technology is harmonious with social and cultural conditions?
3.2.2. Technical Arrangements
To obtain the technical know–how needed for the proposed manufacturing process,
suitable arrangements must be made. When collaboration is sought, among other things,
the following aspects of the arrangement must be worked out in detail:
 The nature of support to be provided by the collaborators during the designing of
the project, selections and procurement of equipment, installation and erection of
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the plant, operation and maintenance of the plant, and training of the project
personnel.
 Process and performance guarantees interms of plant capacity, product quality
and consumption of raw materials and utilities.
 The price of technology in terms of one – time licensing fee and periodic royalty
fee.
 The continuing benefit of research and development work being done by the
collaborator.
 The period of the collaboration agreement.
 The assistance to be provided and the restrictions to be imposed by collaborator
with respect to exports.
 The level of equity participation and the manner of sharing management control,
especially if the technical collaboration is backed by financial collaboration.
 Assignment of the agreement by either side in case of change of ownership.
 Termination of the agreement or other remedies when either party fails to meet its
obligation.
 Approach to be adopted in unexpected situations.
3.2.3. Material Inputs and Utilities
An important aspect of technical analysis is concerned with defining the materials and
utilities required, specifying their properties in is some detail, and setting up their supply
programme.
There is a close relationship between the definition of input requirements and other
aspects of project formulation, such as the definition of plant capacity, location and
selection of technology and equipment, as these inevitably interact with one another.
Material inputs and utilities may be classified into four broad categories: (i) Raw
materials, (ii) Processed industrial materials and components, (iii) Auxiliary materials
and factory supplies, and (iv) Utilities.
o Raw Materials
Raw materials (processed and/or semi – processed) may be classified into four types; (i)
Agricultural products, (ii) Mineral products, (iii) Livestock and forest products, and (iv)
Marine products.
Agricultural products:
If the basic raw material is agricultural products, its quality, present and potential
quantities should be identified. In food processing industry, only the marketable surpluses
of agricultural products should be viewed as basic raw materials, after meeting the
consumption and sowing requirements. If the project requires large quantities the
production of agricultural products should be increased by extending area of cultivation
(sugar cane) or adding one more crop to estimate availability, the data on the past crop to
be collected and also to study their distribution by market segment. Storage and
transportation costs to be considered. Future cultivation studies should be based under
varied conditions and the quality and suitability to be tested.
Livestock and forest product:
Specific surveys are conducted for viability of an industrial project to have a more
dependable and precise data base. To assess the potentials of availability, yield and cost
of collection, other consideration are, ecological factors, national policies, and bilateral
and multilateral agreements, fishing quotas by quantity related licenses and the danger of
over fishing.
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Mineral products:
Information about metallic, non-metallic and clays and their exploitable deposits, proven
reserves, viability, open cost or underground mining, location, size, depth, quality of
deposits, impurities etc, should be gathered. Deposit from different location may differ in
chemical properties. Analysis and test results of ores and mineral should be included in
project reports.
Processed industrial materials and components:

To defined requirement of base metals, semi processed material part and components and
specifications are to be detailed. Their availability and price may be unstable in
international market. Substitutes and FOREX constraints should be enquired into. Careful
analysis should be conducted regarding source of chemicals and petrochemicals, both on
the domestic and foreign markets, their costs and backward linkages.
Factory Supplies:
These include auxiliary materials like chemicals, additives, packing materials, paints,
varnishes, maintenance materials, oils, grease, cleaning materials, wear and tear parts and
tools etc, and estimate of utilities consumption is essential for identifying the existing
sources of supply and shortages. The utilities include: Electricity: An analysis of energy
situation, sources, cost, power demand, load aspect, stand by arrangements, consumption
level and rejection of thermal power plants for environmental reasons are certain points
to consider in the study. Fuels: while using large combustion materials, environmental
protection and technologies are to be integrated in the planning. Using of coal is resulting
in worldwide carbon dioxide pollution and increased global temperatures. Thus care has
to be taken in the choice of use of fuels. Water: the requirement of the water estimated
should be by considering recycling arrangements, for various purposes. Packing
materials: packing materials are most important for the commodity; for export markets,
special protective packing may be required and in competitive markets attractive packing
may be helpful. Recycled waste: pollution! In developing countries, dumping of wastes
is no longer possible. Proper technology usage and sophisticated recycling methods
should be suggested. Spare Parts: to avoid break downs of machinery and equipments,
essential spare parts and tools should be identified and keep it in stock. They may
comprise large number of small items.
Specification of requirements:
All requirements of material and supplies should be identified and specified in the study
considering all socio-economic, commercial, financial and technical factors. Project
characteristics and envisaged technology determines the requirement of materials and
supplies. Flow sheets for materials and other inputs indicating quantitative flows should
be prepared. The quality of various inputs and their quantities are estimated based on the
user demand and market expectations about the products of the project. The nominal and
feasible plant capacity will have to be defined on the basis of varying supply conditions,
number of shifts and products, skill of the labor force and marketing strategies. To
identify the characteristics of materials and inputs, the analysis should cover physical
properties, mechanical properties, chemical properties and electrical and magnetic
properties.
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Availability and supply:
The source of materials availability, their users and price of inputs are to be analyzed.
The interdependencies between project, material and input requirements and supply of
these items should be considered. The machinery, equipment, production process,
capacity etc. may have to be revised if inputs with the specified characteristics and
quantities are not available. Data regarding locations of availability, area of supply,
whether concentrated or dispersed, transportability, transport costs and alternate usage of
such materials need to be collected. If the material has to be imported, the implication of
such imports should be assessed. There may be lack of knowledge of alternative external
source of inputs. The implications of domestic production of materials that were being
imported should be analyzed. If alternative materials are used, the discussion should also
include an assessment of the environmental impact of each material.
Supply program
Making use of the marketing research information, suppliers to be identified and input
quantities should be determined. The objectives of supply marketing are; 1. Cost
minimization that will have significant impact on profitability. The 80-20 rule should be
followed. 2. Reliability of supplies, quality wise, quantity wise and timing. Late
deliveries and lack of quality may have serious consequences for the production process.
3. To cultivate good business relations with suppliers for smooth and mutual trusting
transactions. Purchasing prices and condition largely depend on the bargaining power of
the project and its management. The systematic observation and analysis of supply
market is of central operations depending on the market conditions.
Costs of raw materials and supplies:

The costs of materials and other supplies have to be analyzed in detail to determine
project economies. In case of domestic materials, current prices have to be viewed in the
context of past trends and future projections of the elasticity of supply. The costs of
alternative means of transport should also be considered. For imported martial CIF prices
to be adopted together with loading and unloading, port charges, tariffs, insurance and
taxes, cost of internal transport and other cleaning costs.
Estimates of annual operating costs for materials and supplies are to be made explaining
the price mechanism and key factors affecting price including price controls by the
government. Cost estimates are to be divided in to foreign and local currency components
are specified exchange rates. Some costs may vary with capacity utilization and
production levels and others may be fixed. It is advisable to divide cost items to variable
and fixed. Cost estimates may be expressed either as the cost per unit produced or in
terms of a contain production level to conduct sensitivity analysis. The amounts resulting
from environmental protection and pollution control measures should be included in
indirect costs element in addition to over head costs at the level of service, administration
and sales centers.
3.2.4. Plant Capacity

The term production capacity can be defined as the volume or number of units that can be
produced during a given period. Plant capacity may be seen from two perspectives:
Feasibility normal capacity (FNC) and nominal maximum capacity (NMC). FNC refers
to capacity achievable under normal working conditions, taking into account not only the
installed equipment and technical conditions of the plant, such as normal stoppages,
down time, holidays, maintenance, tool changes, desired shift patterns and indivisibilities
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of major machines to be combined, but also the management system applied. Hence, the
feasible normal capacity is the number of units produced during one year under the above
conditions.
Nominal Maximum Capacity (NMC) is the technically feasible capacity, which
frequently corresponds to the installed capacity as guaranteed by the supplier of the plant.
A higher capacity – nominal maximum capacity – may be achieved, but this would entail
overtime, excessive consumption of factory supplies, utilities, spare parts and wear – and
tear parts, as well as disproportionate production cost increases.
3.2.5. Location and Site
The choice of location and site necessitates an assessment of demand, size, and input
requirement. Although most often the terms ‘location’ and ‘site‘ are used synonymously,
they should be distinguished. Location refers to a relatively broad area like a city, an
industrial zone, or a costal area; site refers to a specific piece of land where the project
would be set up.
The locational requirements and conditions that are significant for the selection of both
location and site should be judged against the defined corporate strategies and the
financial and economic impacts.
Choice of Location
In a feasibility study, a good starting – point for the final selection of a suitable location is
the location of raw materials and factory supplies, or if the project is market oriented –
the location of the principal consumption centers in relation to the plant.
Generally, the choice of location is influenced by a variety of considerations: proximity
to raw materials and markets, availability of infrastructure, labor situation, governmental
policies, and other factors.
Proximity to Raw Materials and Markets
Proximity to the sources of raw materials and nearness to the market for the final
products are an important considerations for location. In light of a basic location model,
optional location is one where the total cost (raw material transportation cost plus
production cost plus distribution cost for the final product) is minimized. Practically, it
means that:
i) a resource – based project like a cement plant or a steel mill should be located close to
the source of the basic material (for example, limestone in the case of a cement plant and
iron ore in the case of a steel plant; (ii) a project based on imported material may be
located near a port; and (iii) a project manufacturing a perishable product should be close
to the centre of consumption.
A great many industrial products, however, are not affected by any one particular factor.
Petroleum products and petrochemicals, for example, can be located at source, near
consumption centers or even at some intermediate point. A wide range of consumer
goods and other industries can be located at various distances from materials and markets
without unduly distorting project economics.
Availability of Infrastructure
In a feasibility study, availability of power, transportation, water, and communications
should be carefully assessed before a location decision is made.
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Inadequate supply of power or its high unit cost in a particular area can constitute a major
constraint for a project or for a particular technological process such as electrical
smelting. The project has to provide its own power source, where the location of
resource – based project can not be changed. Power requirements can be defined in
relation to plant capacity, and the supply and cost at various locations should be studied.
In assessing power supply, the following should be looked into: the amount of power
available, the stability of the power supply, the structure of the power tariff, and the
investment required by the project for a tie – up in the network of the power supplying
agency.
Transportation facilities (by rail, road, air, or water) may be available for the inflow of
various inputs and for the marketing of outputs. The availability, reliability, and cost of
transportation for various alternative locations should be assessed.
Water requirement for the project can be assessed based on the given plant capacity and
technology. Once the required quantity is estimated, the amount to be drawn from the
public utility system and the amount to be provided by the project from surface or sub –
surface sources may be determined. Moreover, the following factors may be examined
i.e. its relative costs, relative dependability, and relative qualities.
In addition to power, transport, and water, the project should have good communication
facilities, including telex telephone, and internet should also be ascertained for alternative
locations.
Labor Situation
In project where there is labor–intensive, the labor situation in a particular location
becomes important. The key considerations in evaluating the labor situation are:
 Availability of labor, skilled, semi – skilled and unskilled
 Existing labor rates
 Labor productivity
 State of industrial relations
 Labor legislation
 Other major factors
Governmental Policies
Policies and regulations of a government have a considerable influence on location. In
most of the cases of public sector projects, location is directly decided by the
government.
In the case of private sector projects, location is influenced by certain governmental
restrictions and inducements. Most often the government may forbid the setting up of
industrial projects in certain areas which suffer from urban congestion. Particularly, the
government may offer inducements for establishing industries in back ward areas. These
inducements consist of subsidies, concessional finance, sales tax loans, power subsidy,
income tax benefits, lower promoter contribution, and so on.
Other Factors
Before making final location selection decision, several other factors have to be assessed
as well. These are:
 Climatic conditions
 General living conditions
 Proximity to ancillary units
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 Ease in coping with pollution / controlling pollution
Climatic Conditions: The climatic conditions like temperature, humidity, wind,
sunshine, rainfall, snowfall, dust, flooding, and earthquakes have an important influence
on location decision.
General Living Conditions: the general living conditions, such as the cost of living ,
housing situation, safety, and facilities for education, health care, transportation and
recreation need to be assessed carefully.
Proximity to Ancillary Units: Most of the firms depend on ancillary units for components
and parts. Coordination becomes easy, transportation costs are lower, and inventory
requirements become considerably lower, if the ancillary units are located in a near by
area.
Ease in Coping with Environmental Pollution: A project may eventually cause
environmental pollution in various ways: it may throw gaseous emissions; it may produce
liquid and solid discharges; it may cause noise, heat, and vibrations. The locaitonal study
should analyze the cost of alleviating environmental pollution to tolerable levels at
alternative locations.
Site Selection
After the completion of final locational selection, a specific project site and, if available,
site alternatives should be defined in the feasibility study. This will require an evaluation
of the characteristics of each site. The structure of site analysis is basically the same as
for location analysis and the key requirements, identified for the project, may give
guidance also for site selection. For sites available within the selected area, the following
requirements and conditions are to be assessed:
 Ecological conditions on site (soil, site hazards, climate etc.)
 Environmental impacts (restrictions, standards, guidelines)
 Socio – economic conditions (restrictions, incentive, requirements)
 Local infrastructure at site location (existing industrial infrastructure, economic
and social infrastructure, availability of critical project inputs such as labour and
factory supplies)
 Strategic aspects (corporate strategies regarding possible future extension, supply
and marketing policies)
 Cost of land
 Site preparations and development, requirements and costs
The cost of land tends to differ from one site to another in the same broad location. Sites
close to a city cost more whereas sites away from the city cost less.
The cost of site preparation and development depends on the physical features of the site,
the need to demolish and relocate existing structures, and the work involved in obtaining
utility connections to the site. Some sites may require substantial work on site
preparation and development, or it may be exposed to site hazards such as strong winds,
fumes, and flue gases from nearby industries or to risks of floods. The required land area
should be specified on the basis of buildings, technical installations and facilities
included in the project. Moreover, topography, altitude and climate may be of
importance for a project, as well as access to water, electric power, roads and railways or
water transport.
Construction Requirements
The choice of location and site may sometimes strongly affected by the construction and
installation works during the future project implementation. Among the relevant aspects
37
of it, such as the existence of local contractors, availability of building materials, means
of transport for heavy machinery and equipment to be bought to the site, a developed
social infrastructure and a climate where construction workers accept to live for certain
years probably three to five years are important. Existing facilities of different kinds may
for instance reduce the construction cost and consequently the investment costs as well as
financing required. Hence, the feasibility study should therefore identify and describe
requirements and demands during the construction and installation phase.
Structures and Civil Works

Structures and civil works may be divided into three groups: (i) Site preparation and
development, (ii) Buildings and structures, and (iii) Outdoor works.
Site Preparation and Development
Site preparation and development includes 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
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 related works.
Buildings and Structures
Buildings and Structures may have divisions, such as (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) residential buildings.
Outdoor Works
Outdoor works include (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.)
3.2.7. Environmental Aspects
The feasibility study should include, a thorough and realistic analysis of the
environmental aspects of the projects. Underestimation of the environment has resulted
in negative consequences such as poor human health, social disruption, reduced
productivity and ultimately, the undermining of development. When considering
environmental aspects a number of issues may be taken into considerations, these may
include the following:
 A clear understanding of the meaning of sustainability
 Assessment of the potential environmental impact of the project.
 Formulation of mitigation measure and a plan of action.
Environmental Sustainability
The world commission on Environment and Development (WGED) defined sustainable
development as “development that meets the needs of the present without compromising
the ability of future generations to meet their own needs”. This definition emphasizes the
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idea of maintaining the economic value of environmental capital stock. Hence, the
project formulators must seek to:
 Maintain if possible increase the value of man made capital.
 Avoid damage to critical natural capital at all costs.
 Limit exploitation of renewable natural capital to sustainable level.
 Internalize the cost of depleting non – renewable resources through some
form of compensation measures.
Environmental Impact Assessment

Environmental impact assessment is part of the project planning process. Practically it is
an integral part of feasibility analysis. Environmental benefits or costs of a project are
usually externalities or side effects that affect the society wholly or partially. In a broader
socio – economic evaluation of the feasibility of a project, environmental effects on the
quality of life are considered along with other factors to determine if the overall effect of
the project is positive, or to determine what modifications may be necessary to achieve a
positive evaluation.
In principle, environmental impacts should be assessed on the basis of legal regulations
and emission standards and guidelines established in the country where the project is
located. Whereas, in countries, where no or only vague regulations and standards are
defined, it may be advisable to anticipate a future serious environmental control
measures, especially in the case of long – term projects.
Generally, externalities or side effects may bound to create environmental conflicts that
might ultimately lead to compensation claims, substantial costs for purification and
equipment, and possibly to the extent of the closure of the plant.
The general objective of environmental impact assessment in project analysis is to ensure
whether the development projects are environmentally sound. This implies that the
effects of the project over its estimated life do not unacceptably degrade the environment,
and that no residual effects are anticipated that would contribute to long – term
environmental deterioration. It is well known that the immediate and long – term health
and welfare of people are linked to their natural, cultural and socio – economic
environment. Because of this reason, and to promote the objective of incorporating the
ideas and aspirations of the affected population in the decision process, right from the
earliest stages and through out the project development cycle, public participation is
desirable.
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 project for
each of the alternative project designs.
 To incorporate in the designs 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 impacts qualitatively and quantitatively, as required, for
the purpose of determining the overall environmental merit of each alternative.
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Stages of Environmental Assessment
The environmental impacts of each of the project cycle will usually differ one to the
other. As first, a preliminary environmental impact assessment is made by using a check
– list or standardized set of criteria to ensure consideration of all relevant environmental
factors, and to determine which impacts would need to be analyzed in detail during the
second stage.
In the second stage, the environmental impact assessment consists in the identification
and evaluation of environmental impacts resulting from the project. Some times a site
visit with all members of the assessment team is essential if the environmental situation is
complex and significant for the investment decision.
The third stage of environmental impact assessment involves the preparation of the
environmental impact statement. The final environmental impact statement should
specify any mitigation measures that can possibly make the recommended alternative
environmentally acceptable.
40
3.3. Financial Estimates / Analysis
3.3.1. Cost of Project

The cost of the project represents the total of all items of outlay associated with a project
that can be financed by long - term funds. Generally, the total outlays will include the
following:
 Land and site development
 Buildings and civil works
 Plant and machinery
 Technical know – how and engineering fees
 Expenses on foreign technicians and training
 Miscellaneous fixed Assets
 Preliminary and capital issue expenses
 Pre – operative expenses
 Provision for contingencies
 Margin money for working capital
 Initial cash losses
Land and Site Development
Major costs for land and site development include the following items:
 Basic cost of land including conveyance and other related charges.
 Premium payable on lease hold and conveyance charges.
 Cost of leveling and development.
 Cost of leveling approach reads and internal roads.
 Cost of gates.
 Cost of tube wells.
Practically, cost of land tends to vary from one location to another. In rural location the
cost of land is relatively lower. Whereas, in urban and semi – urban locations the cost
becomes higher. Site development expenditure also vary considerably depending on the
location and topography of the land.
Buildings and Civil Works
The cost of the buildings and civil works depends on the types of structures required.
Mainly, buildings and civil works cover the following:
 Buildings for the main plant and equipment.
 Buildings for auxiliary services such as steam supply, work shops, laboratory,
water supply, power house, etc.
 Non – factory buildings like lounge, guest houses, time office, etc.
 Silos, tanks, wells, chests, basins, cisterns hopers, bins and other structures which
are necessary for installation of the plant and equipment
 Garages
 Sewers, drainage, etc.
 Other related engineering works.
Plant and Machinery
In a project undertakings, the cost of plant and machinery constitute the major component
of the project cost, consists of the following:
41
 Cost of imported machinery: It is the total 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: it consists of (i) for (free on board), (ii) sales tax,
and other taxes, if any, and (iii) transportation charges to the site.
 Cost of stores and spares.
 Foundation and installation charges.
The cost of the plant and machinery is based on the recent available quotation adjusted
for possible escalation.
3.3.2 Cost of Production
Generally, it is essential to make realistic forecasts of production or manufacturing costs
for a project in order to determine it’s the future viability.
Given the estimated production, the cost of production may be worked out. The principal
components of cost of production are:
 Material cost
 Utilities cost
 Labor cost
 Factory overhead cost
Materials
Materials, predominantly variable costs, such as raw materials, factory supplies and spare
parts. Materials are the most important component of cost and generally the material cost
comprises the cost of materials, chemicals, components, and consumable stores required
for production. It is a function of quantities in which these materials are required and the
prices that can be paid for them
The following points should be considered, while estimating the material cost:
i) The requirements of various material inputs per unit of output may be
established on the basis of one or more of the following : (a) theoretical
consumption norms, (b) experience of the industry, (c) performance
guarantees, and (d) specification of machinery suppliers.
ii) The total requirement of various materials inputs can be obtained by
multiplying the requirements per unit of output with the anticipated output
during the year.
iii) The prices of materials inputs are defined in CIF (cost, insurance, and freight)
terms.
iv) The present costs of various material inputs is considered. In other words, the
factor of inflation is ignored. It may be recalled that the factor of inflation is
ignored in estimating the sales revenues too.
v) If seasonal fluctuation in prices are regular, the same must be considered in
estimating the cost of material inputs.
Utilities
Utilities consist of power, water, and fuel. The requirements of power, water, and fuel
may be determined on the basis of the norms specified by the collaborators, consultants,
etc. or the consumption standards in the industry, whichever is higher.
Labour
Cost of labour is the cost of all the manpower employed in the factory. Normally, the
labour cost is the function of the number of employees and the rate of remuneration. The
requirement of workers depends on the number of operators/helpers required for
42
operating various machines and manning various services. Based on the existing general
norms in the given industry, the number of supervisory personnel and administrative staff
may be calculated.
While estimating remuneration rates, the prevailing rates in the industry- area should
considered. The remuneration should include, besides basic salary, dearness allowance,
house rent allowance, conveyance allowance, medical reimbursement, leave travel
concession, provident fund contribution, gratuity contribution, and bonus payment.
Moreover, account should be maintained for vacations, overtime work, night work, work
on holidays, etc.
Factory Overheads
In general, factory over heads are fixed costs. Collectively, factory overheads referred to
as the expenses on repairs and maintenance, rent, taxes, insurance on factory assets, and
so on. Repairs and maintenance expenses depends on the state of the machinery – this
expense bound to be lower in the initial year and higher in the later years. Rent, taxes,
insurance, etc. may be calculated at the prevailing rates.
3.3.3. Working Capital Requirement

In computing the working capital requirements, the minimum coverage of days for
current assets and liabilities should be determined first. Annual factory costs, operating
costs, and costs of products sold should then be computed, since the values of some
components of the current assets are expressed in these terms.
In estimating the working capital requirement and planning for its financing, the
following points should be considered;
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
(work – in – process), (iii) stocks of finished goods, (iv) debtors, (v) operating
expenses and (vi) consumable stores.
2. The principal sources of working capital fiancé are: (i) working capital advances
provided by commercial banks, (ii) trade credit, (iii) accruals and provisions, and
(iv) long term sources of financing.
3. There are limits to obtaining working capital advances from commercial banks.
They are into two forms: (i) the aggregate permissible bank fiancé is specified as
per the norms of lending, followed by lending bank, (ii) against each current asset
a certain amount of margin money has to be provided by the firm.
4. The margin requirement varies with the type of current asset. Since there is no
fixed formula for determining the margin amount, the ranges for various current
assets are as follows:
Current Assets Margin
Raw materials………………………………………….. 10 – 25 percent
Work – in- process ……………………………………. 20 – 40 percent
Finished goods ………………………………………… 30 – 50 percent
43
PROJECT SELECTION
Financial Evaluation
The financial evaluation of a commercial project mainly involves estimating
the return on investment and the profitability of the project. However, the
financial evaluation of non-commercial projects involve the identification of the most
efficient way of delivering the desired project outputs and ensuring that the project
outputs result in significant benefits to the community.
Financial appraisal includes the compilation of the list of alternative projects and the
associated streams of costs and benefits. The financial evaluation is conducted
using the cash flow rather than accounting profits method. The accuracy of the
evaluation will ultimately depend on:
The quality of the estimates on which the cash flows are based
The identification of all relevant cash flows and
The exclusion of all non-cash items.
Cash Flows from Total Funds Point of View

When cash flows are computed from the total funds point of view, the funds contributed
by all the suppliers of funds towards the project are considered for the calculation of the
initial investment. The operating cash flows are calculated by adding profit after taxes,
depreciation, non-cash charges, interest on long term borrowing (1-T) and interest on
short term borrowing (1-T). The terminal flow will be equal to the net salvage value of
fixed assets and net recovery of WC margin.
Example 5.2: Suppose BB project has the following cash outlays and sources of finance.
Br.4 in millions
Plant & Machinery Br 230
Working Capital 126
Sources of Finance
Equity 135
Long term loans 120
Trade Credit 44
Commercial Banks 57
The life of the project is 8 years. Plant & Machinery is to be depreciated
on a declining balance methods at the rate of 15% per annum. Annual sales are
expected to remain constant over the period at Br. 340 million. Cost of sales (including
depreciation but excluding interest) is expected to be Br. 180 million a year. The
company is under the 40% tax bracket. At the end of the 8 years, plant & machinery will
take a value equal to their book value and the investment in working capital will be
fully recovered. The rate of interest on long-term loans is 15% per annum. The loans
are repayable in six equal installments starting from the end of the third year. Short term
advances from commercial banks which will carry an interest of 16% per annum.
Will be maintained at Br. 57 million. They will be fully liquidated at the end of 8 years.
Trade credit would also be uniformly maintained at Br, 44 million and will be fully paid
at the end of 8 years. For the same example given above. The net cash flows from the
total funds point of view will be
44
Year 0 1 2 3 4 5 6 7 8
Investment -356
Initial flow
Sales 340 340 340 340 340 340 340 340
Op. costs 45.5 150.68 155.07 158.81 162 164.7 167 168.94
Depreciation 34.50 29.32 24.93 21.19 18.00 15.30 13.00 11.06

Int. LT 18 18 18 15 12 9 6 3
Int. WC 9.12 9.12 9.12 9.12 9.12 9.12 9.12 9.12
PBT 132.88 132.88 132.88 135.88 138.88 141.88 144.88 147.88
Tax 53.15 53.15 53.15 54.35 55.55 56.75 57.95 59.15
PAT 79.73 79.73 79.73 81.53 83.33 85.13 86.93 88.73
Op. Flow* 130.5 125.32 120.93 117.19 114 111.3 109 107.06
NSV of F. 62.7
Assets
Net Recovery of WC 25
margin
Terminal 87.7
Flow
NCF -356 130.5 125.32 120.93 117.19 114 111.3 109 194.76
Cash Flows (Total Funds Point of View)

 Operating Flow = PAT + Depreciation + Interests on long and short-term loans
(1– T)
Choice of Discount Rate
The next step in the financial evaluation phase is the determination of an
appropriate discount rate. The determination of an appropriate discount rate
is necessary for establishing the financial feasibility of a project. Most of the appraisal
Criteria used these days are time adjusted or discounted criteria, like net present
Value (NPV), benefit cost ratio (BCR) and internal rate of return (IRR). All
these require the use of a risk-adjusted discount rate to determine the actual
returns from the project . The most commonly used method for determining
the discount rate makes use of theoretical models like the capital asset Pricing model
(CAPM) and the weighted-average cost of capital (WACC) model. The CAPM is
used to ascertain the relevant cost of equity for a given level of risk. This is then
combined with the cost of debt funds in proportion to their respective Weights in the total
funds used to finance the project. This combined approach is known as the WACC.
E D
WACC   Re   Rd  (1  T )
V V
Where:
Re = Cost of Equity
Rd = Cost of Debt
E = Market value of the firm's equity
D = Market value of the firm's debt
V= E+D
E/V = percentage of financing that is equity
45
D/V = percentage of financing that is debt
Tc = the corporate tax rate
Project Appraisal Criteria
After determining the cash flows of a project, one must assess its viability. This can be
achieved through the use of discounted criteria or non-discounted criteria. Time adjusted
or discounted criteria include:
 Net Present value.(NPV)
 Internal Rate of Return. (IRR)
 Benefit-Cost Ratio or profitability index,(BCR or PI)
 The modified net Present value method. (MNPVM)
 The internal Rate of Return (IRR)
 Discounted payback period.
 Modified Internal Rate of Return (MIRR)
Traditional or Non-discounted criteria include
 Accounting Rate of Return.(ARR)
 Payback Period.
Certain assumptions are made when appraising projects using the criteria
given above. They are
 The risk of all project proposals under consideration does not differ from the risk
of the existing projects of the firm.
 The firm has certain criteria for evaluating the projects. Based on the criteria, the
investment decision will be either to accept or to reject the proposal.
Discounted Cash Flow/Time Adjusted Techniques

This method requires cash flows to be discounted at a certain rate known as the
cost of capital. This technique recognizes the fact that cash flows occurring
at different time periods and in different amounts can be compared only when
they are expressed in terms of a common denominator i.e. present value. Thus, in
this method, all the cash inflows are discounted at an appropriate discount rate and the
present value so determined is compared with the present value of cash outflows.
a) Net Present Value (NPV)

The net present value of a project is the sum of the present values of all cash flows
that are expected to occur over the life of the project. The general formula for NPV
is:
 CF0 CF1 CF2 CFn n
CFt
NPV 
(1  K ) 0

(1  K ) 1

(1  k ) 2
    
(1  k ) n
 
t 0 (1  k ) t
NPV = Net present value
CFt = Cash flow at the en d of year (t) (cash inflow has a positive sign and cash outflow h
as a negative sign)
n = Life of the project (number of years)
k = Discount rate
Note
The decision rule associated with NPV criteria is to accept all proposals with a NPV
greater than zero. This indicates accepting all projects that add value after
providing a return, consistent with the cost of capital and risk. Where two or more
projects are mutually exclusive, then the project with the highest NPV should be
chosen. The following example will make the concept clear:
46
Example: 5.7.1.
The cash flow stream of a construction project is estimated as follows:
YEAR CASH FLOW
0 -155,000
1 38,000
2 44,000
3 49,000
4 54,500
5 60,000
The cost of capital, K for the construction company is 14%
 155,000 38,000 44,000 49,000 54,500 60,000
NPV      
(1  0.14) 0 (1.14)1 (1.14) 2 (1.14) 3 (1.14) 4 (1.14) 5
The net present value of the above project at the cost of capital of 14% would be,
= -155,000 + 33,333.33 + 33,856.57 + 33,073.60 + 32,268.38 + 31,162.12
= 8694.00. Since the NPV of the project is greater than zero it can be accepted.
Merits of NPV criterion:
 It recognizes the importance of the time value of money.
 It takes into consideration the benefits occurring over the entire life of the project.
 It follows the principle of shareholder's wealth maximization.
Demerits of NPV criterion
The main drawbacks of this method are:
 In some cases it may be difficult to determine the appropriate discount rate. The
choice of an appropriate discount rate is important because the relative
desirability of the project will change with the change in discount rate.
 This method favors the project with the higher NPV. In some cases, the project
with a higher NPV may involve a higher initial outlay which may exceed the
budgeted investment outlay for the project.
 This method may not give satisfactory results when the two projects in
question have different economic lives.
(b) Modified Net present value (MNPV): one of the basic assumptions of NPV is that
all the intermediate cash flows are re-invested at a rate equal to the cost of capital.
However, if this assumption is invalid, the net present value has to be modified
taking into account the re-investment rate. The steps involved in the calculation of
the Modified Net Present Value are given below.
(i) The terminal value of intermediate cash flows calculated at the new re-investment
rate:
n
TV   CF (1  r )
t 0
t
' n t
Where,
TV = Terminal Value of the project’s cash inflows
CFt = Cash inflow at year end
r'= re-investment rate applicable to the cash inflows of the project
47
(ii) The Modified Net Present Value is calculated in the following manner: Where,
TV
NPVm   I0
(1  k ) n
Example: 5.4.1a
Consider the same example illustrated above. The net present value of a
construction project at the cost of capital of 14% is Br 8694. However,
the underlying assumption of the present value of annuity is that all the intermediate
cash flows are re-invested at the same rate of discount i.e. 14%. If the
re-investment rate is different from the discount rate, then the modified net present
value will be different from the net present value of Br 8694. Considering
re-investment rates of 18% and 12%, the modified net present value would be
Year Cash Flow FVIF @18% Future Value

0 -155,000
1 38,000 1.939 73,682
2 44,000 1.643 72,292
3 49,000 1.392 68,208
4 54,500 1.18 64,310
5 60,000 1 .00 60,000
338,492
TV
Modified Net Present value = I
(1  k ) N
338.392
 155,000 = 20,802.14
(1.14) 5
Re-investment Rate of 12% a Year

Year Cash Flow FVIF @12% Future
Value
0 -155,000
1 38,000 1.574 59,812
2 44,000 1.405 61,820
3 49,000 1.254 61,446
4 54,500 1.12 61,040
5 60,000 1.00 60,000
304118
Modified NPV = –I
304,118
=  155,000 = 2,949.36
(1.14) 5
It can be inferred from the above calculations that the modified net present value is
greater than the net present value if the re-investment rate is greater than the discount
rate. However, it is less than the net present value when the re-investment rate is less than
the discount rate. The drawback of the modified net present value method is determining
48
the rate of interest at which the intermediate cash flows will be re-invested. The
evaluation criteria used by the NPV method are:
 The project is accepted when the NPV is positive.
 The project is rejected when the NPV is negative.
 The project reaches the point of indifference when the NPV is zero.
For more than one mutually exclusive project, the one with the highest NPV must
be selected.
C) Benefit-Cost Ratio
The Benefit Cost Ratio (BCR) is a time-adjusted capital budgeting technique. Also
Known as the profitability index, it measures the present value of returns per Birr
invested. BCR is defined as the ratio of the present value of benefits to the initial
investment. It is represented as follows:
Where,
BCR = Benefit-cost ratio
PVB = Present value of benefits
I = Initial investment
The decision rule associated with BCR criteria is to accept all proposal with a BCR
greater than one. If the BCR is equal to one, the firm is indifferent to the project. If two or
more projects are mutually exclusive, then the project with the higher BCR should be
chosen. There is another measure - Net Benefit Cost Ratio (NBCR) linked to BCR. It is
the ratio between NPV and initial investment
Three decision rules associated with NBCR criterion are

 If NBCR is greater than zero, the project is accepted.
 If the NBCR is equal to zero, the firm is indifferent to the project.
 If the NBCR is less than zero, the project is rejected.
Example: 5.4.1c Consider the two mutually exclusive projects X and Y with the
following cash flow streams. The cost of capital for both the projects is 14%.
Year Project X Project Y
Cash PVIF Present Cash PVIF Present

Flow @14% value Flow @14% value
0 -155, 000 48,000

1 38,000 0.877 33,326 13,500 0.877 11,839.5
2. 44,000 0.769 33,836 14,700 0.769 11,304.
3. 49,000 0.675 33,075 17,300 0.675 11,677.5
4. 54,500 0.592 32,264 18,800 0.592 11,129.6
5. 60,000 0.519 31,140 20,500 0.519 10,639.5
163,641 56,590.4
The BCR of both the projects is calculated as follows:

Project X = Present Value / Initial Investment
= 163641/155000 = 1.05575
49
Project Y = Present Value / Initial Investment
= 56590.4/48000 = 1.17896
Though the BCR of both the projects is more than 1, Project Y should be accepted as it
has a higher BCR than Project X.
Merits of BCR Criterion
BCR, like NPV criterion, also considers the time value of money when evaluating
projects. It also takes into account all the benefits accruing over the life of the project. It
is superior to the NPV measure in the sense that it evaluates the project in relative terms
rather than absolute terms.
Demerits of BCR Criterion
This criterion may assign a similar ranking to two different projects.
The evaluation criteria used by the BCR method are:
 The project is accepted when the BCR is greater than one.
 The project is rejected when the BCR is less than one.
 The project reaches the point of indifference when the BCR is equal to one.
For more than one mutually exclusive project one with the highest BCR must be selected.
d) Internal Rate of Return Method
The fourth time-adjusted criterion for the appraisal of a project is the internal rate of
return. This refers to the rate of return that is earned by a project. It equals the present
value of cash inflows with the present value of cash outflows i.e. it is the discount rate at
which the NPV of the project is zero. If the IRR of a project is greater than the cost of
capital, the project should be accepted. In this case, the cost of capital is also called the
hurdle rate. The IRR is represented by the following formula:
Where CFt = Cash flows & outflow at different time periods

r = internal rate of return
n = Life of the project
To develop a better understanding of the calculation of the IRR, take a look at the
following examples:
Example 5.4.1:d) Firm XYZ Ltd. is planning to invest Br 65,000 in its new project. This
project is expected to last for 5 years. Its estimated cash flows are 12,500, Br 15,300,
Br16,700, Br 13,400 and Br 14,300 for the year one, two, three, four and five
respectively.
The IRR can be calculated using the following formula:
Br 65,000 =
Using the trial and error method, different rates are substituted in the formula to find out
which value can equalize the two sides of the formula. Let us first substitute “r” with 4%;
then the left hand side of the equation changes to:
Br 64,273 =
By using 4%, the value derived after solving the equation is less than Br 65,000. Hence,
we take 3%.
Br 65,490 =
50
By using 3%, the value derived after solving the equation is more than Br. 65,000. It is
therefore clear that the actual IRR lies somewhere between 3% and 4%. Using
interpolation, we find out a single value of IRR. The actual IRR calculated using
interpolation is 3.67% (3+65,000 – 64,273  65,490 – 64,273) When the payback period
is given, the IRR can be calculated
Where PB = Payback period

DFr = Discount factor for interest rate r
DFrL = Discount factor for lower interest rate
DFrH = Discount factor for higher interest rate.
Suppose a project's payback period is 3.52 years. Its initial investment is Br 75,000and its
average annual cash flows are Br 21,300. Then discount factors closer to3.52 is 3.605 at
12% and 3.517 at 13%. From this we can assume that the IRR is between 12% and 13%.
We can calculate the actual IRR with the help of the above formula.
= 12.96%
= 12.96%
The merits of this criterion are:

 It takes into account the time value of money.
 It considers all cash flows.
Drawbacks of this method are;
 It involves complicated calculations.
 It gives multiple rates of return when there is a series of changes in Cash flows i.e.
cash inflows and outflows.
 In case of mutually exclusive projects, the IRR method might accept a project
with higher IRR but with a relatively low NPV. This is because the IRR assumes
that all the cash inflows are again invested in the project at the internal rate of
return.
The evaluation criteria for the project using the IRR method are:
 The project is accepted when the IRR is greater than the cost of capital or required
rate of return.
 The project is rejected when the IRR is less than the cost of capital or required
rate of return.
 The project reaches the point of indifference when the IRR is equal to the cost of
capital or the required rate of return.
 When there are mutually exclusive projects, the one with the highest IRR must be
selected.

e) Multiple Rates of Return
Projects do not always have cash inflows every year. Sometimes, negative cash flows or
cash outflows occur, particularly when projects involve heavy investments or have long
gestation periods. This situation is the basic reason for the realization of multiple rates of
return.
Example: 5.7.1 e) Consider a project which has following cash flow streams and
calculate internal rate of return:
Year Cash flow
51
0 -1000
1 7000
2 -12000
Let IRR be r, equation to calculate the internal rate of return for the cash flow streams
given above will be
= – (1 + r)2 + 7(1 + r) – 12 = 0
=
= =r2 – 5r + 6 = 0
= (r – 2) (r – 3) = 0
= r = 2 or 3.
As there are changes in signs, there are two roots of the equation. So, there are two
internal rates of return for the project. Which one should be taken for the appraisal
becomes difficult for appraiser to appraise?
f) Modified Internal Rate of Return (MIRR)
Even though NPV is a better method conceptually than the IRR method, most managers
prefer IRR over NPV since IRR is a percentage measure. A percentage measure that
overcomes the short comings of regular IRR is known as modified internal rate of return
(MIRR).
The procedure for calculating MIRR is given below:
Step 1 Calculate the present value of the costs (PVC) associated with the project,
Using the cost of capital (r) as the discount rate:
n
cash out flowt
PVC  
T 0 (1  r ) t
Step 2: Calculate the terminal value (TV) of the cash inflows expected from the project:
TV  t 0 Cash inf low(1  r ) n t
n
Step 3: Obtain MIRR by solving the following equation:

PVC = = TV/(1 + MIRR)n
The following examples demonstrate the calculation of MIRR.
Example 5.4.1 f1)

DEMBEL Limited is evaluating a project that has the following cash flows:
YEAR 0 1 2 3 4 5 6
Cash flow
(Br. in million) -120 -80 20 60 80 100 120
The cost of capital for DEMBEL is 15 percent. The present value of costs is:
120 + 80/(1+0.15) = 189.6
The terminal value of cash inflows is:
52
20(1.15)4 + 60(1.15)3 + 80(1.15)2 + 100(1.15)1+ 120
= 34.98 + 91.26 + 105.76 + 115 + 120 = 467
The MIRR is obtained as follows:
189.6 = 467/(1+MIRR)6
(1+MIRR)6 = 2.463
1
1 + MIRR = (2.463) 6 = 1.162
MIRR = 0.162 = 16.2%
Example 5.4.1. f2)
Calculate the MIRR for projects C and D, which have an initial investment of Br
1,000,000 and Br 150,000 respectively. The cost of capital is 10%.
Project C Project D
End of Cash flows Future value Cash flows Future value
year of cash flows of cash flows
at the end of at the end of
5th year 5th year
1 Br. 250,000 366,025 Br. 65,000 95,167
2 Br .250,000 332,750 Br .65,000 86,515
3 Br .250,000 302,500 Br.65,000 78,650
4 Br .250,000 275,000 Br .65,000 71,500
5 Br .250,000 250,000 Br.65,000 65,000
Br 1,526,275 Br396,832
1,526,275
For project C , (1  MIRR ) 5   1.5262 andMIRR  (1.5262) 5  1  8.8%
1
1,000,000
396,932
For project D, (1  MIRR ) 5   2.6455 andMIRR  (2.6455) 5  1  21.48%
1
150,000
The MIRR method is superior to the IRR method. MIRR assumes that the project cash
flows are reinvested at the cost of capital where as the regular IRR assumes that the
project cash flows are reinvested at the project's own IRR. Since reinvestment at the cost
of capital (or some other explicit rate) is more realistic than reinvestment at IRR, MIRR
reflects the true profitability of a project. In addition, the problem of multiple rates does
not exist with MIRR. However, for choosing among mutually exclusive projects of
different size, the NPV method is better than the MIRR method because it measures the
contribution of each project to the value of the firm. The evaluation criteria under the
MIRR method are:
 The project is accepted when the MIRR is greater than the cost of capital or the
required rate of return.
 The project is rejected when the MIRR is less than the cost of capital or the
required rate of return.
 The project reaches the point of indifference when the MIRR is equal to the cost
of capital or the required rate of return.
 When there are mutually exclusive projects, the one with the highest MIRR must
be selected.
5.4.2. Traditional or Non-Discounted Criteria
When evaluating a project's viability, traditional or non-discounted criteria generally use
accounting profits rather than cash flows.
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(a) Averaged Rate of Return Method (ARR)
This method is also known as the accounting rate of return as it considers the accounting
profits of a firm over a period of time. ARR is represented as follows:
ARR = average annual income x 100/average investment throughout the life of the
project:
(int ial cos t of invst  salvage value
Whereas average investment 
2
Example:5.4.2.a)
Two machines, p and q, with an estimated salvage value of Br 2,500 have an initial cost
of Br 36,500 and an estimated life of 5 years. Depreciation is charged on the basis of the
straight line method. The estimated income of the machines over a period of 5 years is
given in the table below. The average rate of return of the machines is calculated as
follows:
Year Annual estimated Annual estimated
income of machine P income of machine Q
1 Br.3,540 Br. 4,920
2 Br. 4,635 Br. 6,025
3 Br. 5,820 Br. 8,132
4 Br. 6,210 Br. 7,565
5 Br. 5,575 Br. 2,560
Total Br. 25,780 Br. 29,202
Average income Br. 5,156 Br. 5,840
Average Investment Br. 17,000 Br. 17,000
ARR 30.33% 34.35%
The merit of this criterion is that it is easy to calculate and understand. However, the
demerit of this method is that it uses accounting profits instead of cash flows.
The evaluation criteria using this method are:
 The project is accepted when the actual ARR is greater than the required ARR.
 The project is rejected when the actual ARR is less than the required ARR.
 When there are mutually exclusive projects, the one with the highest ARR but
more than the cut off ARR must be selected
(b) Payback Period Method:
This is the most commonly and widely used method for the appraisal of capital
investment decisions regarding projects. This criterion evaluates a project on the basis of
the speed with which it recovers its initial investment. It can be computed in two ways:
When the cash inflows after tax (CFAT) are the same every year the following formula is
I0
used: PBP  Where I0 = initial investment
CFAT
CFAT = cash flow after tax.
Example: 3.7.2b.
Consider two mutually exclusive projects x and y. Project x is expected to earn a CFAT
of Br 8,750 every year for 6 years. Its initial investment is Br. 35,000. Project y is
expected to generate a CFAT of Br 11,200 every year for 6 years. Project Y's Initial
investment is Br. 35,000. Calculate the PB period for both the projects.
Project X Project Y
Initial Investment Br.35,000 Br. 35,000
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CFAT Br. 8,750 Br. 11,200
Payback period 4 yrs 3.12yrs
When cash inflows after tax are constantly changing from year to year, the method for
calculating PB is as follows:
Project X Project Y
Year CFAT Cumulated CFAT CFAT Cumulated CFAT
0 -155,000 - -48,000 -
1 38,000 38,000 13,500 13,500
2 44,000 82,000 14,700 28,200
3 49,000 131,000 17,300 45,500
4 54,500 185,500 18,800 64,300
5 60,000 245,500 20,500 84,800
Pay back 3.129yrs 3.038 yrs
period
Project X will recovered Br 131,000 of its initial investment in the first three years. In the
fourth year, it will recover the balance, i.e., (155,000 – 131,000 = 24,000). The payback
period in the fourth year is computed as follows 24,000/54,500 = 0.44.Therefore, the
investment in project X can be recovered in 3.44years. Similarly, the initial investment in
project Y can be recovered in 3.133 years.
The major advantages of this criterion are:
 Like ARR it is easy to calculate PB.
 It takes into account cash flows (and is hence superior to ARR).
 It helps identify projects which can earn quick returns (useful in industries where
rapid technological change is common).
This method has the following drawbacks:
 It does not consider the cash flows after the payback period.
 It does not consider the timing of cash flows.
 It does not show whether or not the project that has been accepted is going to
maximize the wealth of the stakeholders.
The evaluation criteria for this method are:
 The project is accepted when the actual payback period is less than the required or
predetermined payback period.
 The project is rejected when the actual payback period is greater than the required
or predetermined payback period.
 When there are mutually exclusive projects, the one with the lowest payback
period but less than cut off payback period must be selected.
(g) Discounted Payback Period Method

Unlike the payback method, this criterion takes into account the discounted cash flows of
a project. In this method, cash flows are discounted at the cost of capital, which shows
the time value of money as well as the riskiness of the cash flows. The decision rule for
this criterion is to accept the project with less payback period or when the accumulated
discounted cash flows are equal to the initial investment.
The discounted payback period is calculated as follows:
To understand the method better, let us consider the following example

55
Project X Project Y
Discounted Accumulate Discounted Accumulate
End of Cash flows d discounted Cash flows discounted
The year CFAT at the end cash flows CFAT at the end of cash flows
of the year the year
1 38,000 34,545 34,545 13,500 12,273 12,273
2 44,000 36,364 70,909 14,700 12,149 24,422
3 49,000 36,814 107,723 17,300 12,998 37,420
4 5,450 37,227 144,950 1,880 12,842 50,262
5 60,000 37,267 182,217 20,500 12,733 62,995
 The cost of capital is assumed as 10%

 The present value of cash flow at the end of the 1st year = Cash flows at the end
of the 1st year/(1 + 0.10)
The initial investment in Project X (Br.155000) is paid back in 4.27 years and the initial
investment in project Y (Br.48000) is paid back in 3.82 years this method has the
following merits:
 It takes into account the time value of money.
 It considers the riskiness of cash flows.
The demerit of this method is that it does not have any particular decision rules.
The evaluation criteria for this method are:
 The project is accepted when the actual discounted payback period is less than
the required or predetermined payback period.
 The project is rejected when the actual discounted payback period is greater than
the required or predetermined payback period.
 Where there are mutually exclusive projects, the one with the least discounted
payback period but less than the cut off payback period must be selected.
5.5: Appraisal Techniques in Practice for Various Types of Projects
 The most commonly used method for conducting a financial appraisal of small
projects requiring less financial investments is the payback method.
 For larger projects, the average rate of return is commonly used as the principal
criterion and the payback period is used as a supplementary criterion.
 Discounted cash flow (DCF) techniques are now being increasingly used to
evaluate large investments.
 Many other criteria are used for evaluating investments: profit per Birr invested
(calculates the actual profit earned in terms of each Birr invested); cost saving per
unit of product (calculates the amount of savings on the cost of production per
unit); and investment required to replace a worker (calculates the additional
amount required to replace an existing worker).
5.6. Caveats for Improved Financial Evaluation
 The appraisal criteria for evaluating projects should be standardized. The use of
many methods makes comparison between projects difficult.
 The approach followed for evaluating projects must be clearly defined. Vague
qualitative phrases should be substituted by quantitative measures wherever
possible. This is necessary to promote understanding and avoid confusion.
 Discounted cash flow techniques should receive greater emphasis. They are
theoretically superior and practically feasible.
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 To sum up, the evaluation must be carried out in explicit, well-defined, preferably
standardized terms and should be based on sound economic principles.
Investment decision-making must be based on a careful and sound evaluation of
the available data.
5.7. Social Cost Benefit Analysis (SCBA)
To reflect the real value of a project to society, we must consider the impact of the project
on society. Thus, when we evaluate a project from the view point of the society (or
economy) as a whole, it is called Social Cost Benefit Analysis (SCBA)/ Economic
Analysis.
5.7.1. Scope of SCBA
SCBA can be applied to both Public & private investments –
 Public Investment: SCBA is important especially for the developing countries
where government plays a significant role in the economic development.
 Private Investment: Here, SCBA is also important as the private investments are
to be approved by various governmental & quasi-governmental agencies.
5.7.2. Objectives of SCBA
Cost benefit analysis (CBA) is concerned with the examination of a project from the view
point of maximization of net social benefit while cost benefit analysis originated to
evaluate public investment; it is also used in project appraisal. Earlier, project appraisal
covered only private costs and benefits at present social costs and benefits are also
reckoned. Cost benefit appraisal a project proposes to describe and quantify the social
advantages and disadvantages of a policy in terms of a common monetary unit. The unit
should reflect society’s strength of performance for each outcome. The economist uses as
a measure of their preference, the consumer’s willingness to pay (WTP) for a good. There
fore, the main focus of Social Cost Benefit Analysis is to determine:
1. Economic benefits of the project in terms of shadow prices;
2. The impact of the project on the level of saving and investment in the society;
3. The impact of the project on the distribution of income in the society;
4. The contribution of the project towards the fulfillment of certain merit wants
(self- sufficiency, employment etc).
5.7.3. Significances of SCBA

CBA is unable to reflect social values. Hence SCBA has been emerged with some
interesting significances. These significances also make the SCBA different from
the CBA with respect to:
•Market Imperfections
• Externalities
• Taxes & Subsidies
• Concern for Savings
• Concern for Redistribution
• Merit Wants
1. Market Imperfections: Market prices, the basis for CBA, do not reflect the Social
values under imperfect market competition. Private costs and profits reflect social costs
and benefits only under perfect competition. Market prices which form the basis for
computing the monetary costs and benefits from the point of view of the project sponsor,
reflect social values only under conditions of perfect competition, which are rarely, if
ever, realized by developing countries, when imperfection exist, market price do not
57
reflect social values. The common market imperfections found in developing countries
are:
a. Rationing: Rationing of a commodity means control over its price and
distribution. The price paid by a consumer under rationing is often significantly
less than the price that would prevail in a competitive market.
b. Foreign exchange regulation: the official rate of foreign exchange in most of the
developing countries, which exercise close relation over foreign exchange, is
typically less than the rate would prevail in the absence of foreign regulation
2. Externalities: A project may have beneficial or harmful external effects that are
considered in SCBA, not in CBA. For example, it may create certain infrastructure
facilities like roads, which benefit the neighboring areas. Such benefits are concerned in
SCBA, though they are ignored in assessing the monetary benefits to the project sponsors
because they do not receive any monetary compensation from those who enjoy their
external benefit created by the project. Like wise, a project may have a harmful external
effect like environmental pollution.
3. Taxes and subsidies: From the social point of view, taxes & subsidies are nothing but
transfer payments. But in CBA, taxes & subsidies are treated as monetary costs and
benefits respectively and hence considered relevant.
4. Concern for Savings: In SCBA, the division between benefits & consumption is
relevant herein higher valuation is placed on savings. But in CBA such division is
irrelevant.
5. Concern for Redistribution: In SCBA, the distribution of benefits is very much
concerning issue where commercial private firm does not bother about it.
6. Merit Wants: Merit wants are important from the social point of view and therefore,
SCBA considers these wants, while merit wants are not relevant from the private point of
view.
5.7.4. Approaches to SCBA
There are two principal approaches for Social Cost Benefit Analysis.
A.UNIDO Approach, and
B. L-M Approach.
a) UNIDO Approach: This approach is mainly based on the publication of UNIDO
(United Nation Industrial Development Organization) named Guide to Practical
Project Appraisal in 1978. The UNIDO approach of Social Cost Benefit Analysis
involves five stages:
1. Calculation of financial profitability of the project measured at market prices.
2. Obtaining the net benefit of the project at shadow (efficiency) prices.
(Objective of SCBA-1)
3. Adjustment for the impact of the project on Savings & Investment. (Objective
of SCBA-2)
4. Adjustment for the impact of the project on Income Distribution. (Objective
of SCBA-3)
5. Adjustment for the impact of the project on Merit and Demerit Goods whose
Social values differ from their economic values. (Objective of SCBA-4)
Stage-1: Calculation of financial profitability of the project
 A good technical and financial analysis must be done before a meaningful
economic (social) evaluation can be made so as to determine financial
profitability.
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 Financial profitability is indicated by the Net Present Value (NPV) of the project,
which is measured by taking into account inputs (costs) and outputs (benefits) at
market price.
n
CFt
 Net Present value of a Project is calculated as: Vt    I 0 Here,
t 1 (1  k ) t
Vt = Value of outputs at market price at time t
Ct = Value of inputs at market price at time t
K = Discount Rate
T = Lifetime of the project
I0 = Initial cost at the start of the project.
 The project is viewed as financially feasible if NPV > 0.
Stage-2: Obtaining the net benefit of the project at economic (shadow) prices
 The Commercial Profitability analysis (calculated in stage - 1) would be sufficient
only if the Project is operated in perfect market. Because, only in prefect market,
market prices can reflect the social value. If the market is imperfect (most of the
cases in reality), net benefit of the Project is determined by assigning shadow
prices to inputs and outputs
 Shadow Prices reflect the real value of a resource (input or output) to society.
 Shadow Prices are also referred as economic prices, accounting prices, and
economic/accounting efficiency prices etc.
 Shadow Prices can be defined as the value of the contribution to the country’s
basic socio-economic objectives made by any marginal change in the availability
of commodities (output) or factor of production (input).
General Principles of Shadow Pricing
a) Numeraire:
 A unit of account in which the values of inputs and outputs are to be expressed.
 Numeraire is determined at-
• Domestic currency (BDT) rather than border price.
• Present value rather than future value. Because,” a bird in the hand is worth two in the
bush.”
• Constant price rather than current price.
b) Tradability:
 Tradability refers to whether a good or service is tradable or non- tradable; if
tradable whether it is fully traded or non-traded.
 A good/service is tradable in the absence of or within limited trade barriers.
 A tradable good/service that is non actually traded is called non traded
good/service.
A tradable good/service is actually traded when-
 The import (export) supply is perfectly elastic over the relevant range of volume.
 All additional demand (production) must be made (consumed) by import
(export) due to the full capacity in the domestic industry (fulfillment of demand
by domestic consumer).
 The import (CIF) price is less or the export (FOB) price is more than the domestic
cost of production.
A good/service is non-tradable; if
 Its import (CIF) price is greater than its domestic cost of production and/or
 Its export (FOB) price is less than its domestic cost of production.
Sources of shadow prices: The UNIDO approach suggests three sources of shadow
pricing, depending on the impact of the project on national economy. A project, as it uses
59
and produces resources, may for any given input to output (i) increase or decrease the
total consumption in the economy. (ii) Decrease or increase production in the economy.
(iii) Decrease imports or increase imports or (iv) increase exports or decrease exports.
c) Taxes: When shadow price are being calculated taxes usually pose difficulties.
The general guidelines in the UNIDO approach with respect to taxes are as
follows: (i) when a project results in diversion of non-traded inputs which are in
fixed supply from other producers or addition to non-traded consumer goods,
taxes should be included (ii) when a project augments domestic production by
other producers, taxes should be excluded (iii) for fully traded goods, taxes should
be ignored
d) Consumer willingness to Pay: If the impact of the project is on consumption in
the economy, the basis of shadow pricing is consumer willingness to pay. The
measurement of consumer willingness to pay may be explained with the help of
chart. In the graph shown in the exhibit, below DD1 represents the demand
schedules, SS, the supply schedule, E the equilibrium point, OQ the quantity
bought and OP the price per unit. Looking at the demand schedule, we find that
the consumer who buys the first unit is willing to pay OD for that unit and the
consumer who buys the last unit is willing to pay OP for the unit. The consumer
willingness to pay by consumers who buy the product is measured by the area
ODEQ. The Price paid by them, however, is only OPEQ. The difference between
ODEQ and OPEQ, namely DEP, is referred to as the consumer surplus.
Consumer willingness to pay
Price
S1
D
P E
S D1
0 Q Quantity
Stage 3: Adjustment for the impact of the project on savings and investment
Most of the developing countries face scarcity of capital. Hence, the governments of
these countries are concerned about the impact of project on savings and its value thereof.
Stage three of the UNIDO approach, concerned with this, seeks to answer the following
questions: Given the income distribution impact of the project, what would be its effects
on savings?
What is the value of such savings to the society?
Impact on savings:
The savings impact of a project is equal to:
Yi MPSi
Where, Yi = change in income group i as a result of the project.
MPSi = Marginal propensity to save of group i
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Example 5.10.4: As a result of a project the income gained/lost by four groups is Group
1 = Br. 100,000, Group 2 = Br.600, 000, Group 3 = Br.(200,000 )and Group 4 = Br.
(400,000). The marginal propensity to save these four groups is as follows:
MPS1 = 0.05, MPS2 = 0.10, MPS3 = 0.20 and MPS4 = 0.40
The impact on savings of the project is: 100,000X0.05 + 600,000 X 0.10 – 200,000
X0.20 – 400,000 X 0.40 = Br. 145,000
Stage 4. Measurement of the impact of Distribution:
Stage four of the UNIDO method is concerned with measuring the value of a project in
terms of its contribution to savings and income redistribution. To facilitate such
assessments, we must first measure the income gained or lost by individual groups within
the society.
Groups: For income distribution analysis, the society may be divided into various
groups. The UNIDO approach seeks to identify income gains and losses by the
followings.
 Project
 Other private business
 Government
 Workers
 Consumers
 External sector There can, however be other equally valid grouping.
Measure gains of loss:
The gain or loss to an individual group within the society as result of the project is equal
to the difference between the shadow price and the market price of each input or output in
the case of physical resources or the difference between the price paid and the value
received in the case of financial transactions.
Stage 5. Adjustment for Merit and Demerit Goods:
In some cases, the analysis has to be extended beyond stage four to reflect the difference
between the economic value and social value of resources. This difference exists in the
case of merit goods and demerit goods.
Merit goods:
A merit good is one for which the social value exceeds the economic value. For example,
country may place a higher social value than economic value on production of oil
because it reduces dependence of foreign supplies. The concept of merit goods can be
extended to include a socially desirable outcome like creation of employment. In the
absence of the project, the government perhaps would be willing to pay unemployment
compensation to provide mere make-work jobs.
Demerit good:
The social value of the good is less than it economic value. Foe example, a country may
regard alcoholic products as having a social value less than the economic value.
5.7.5. Little – Mirrlees Approach:
L.M.D. Little and James A. Mirrlees have developed an approach to SCBA which
is famously known as L-M approach. The core of this approach is that the social cost of
using a resource in developing countries differs widely from the price paid for it.
Hence, it requires Shadow Prices to denote the real value of a resource to
society. (Mentioned earlier)
Features of L-M Approach
 L-M Numeraire is present uncommitted social income.
61
 L-M methods opts for savings as the yardstick of their entire approach. Present
savings is more valuable to them than present consumption since the savings can
be converted into investment for future.
 L-M approach rejects the ‘consumption’ numeraire of UNIDO approach since the
authors (L & M) feel that the consumption of all level is valuable.
 This approach measures the cost and benefits in terms of international or border
prices.
5.8. Similarity between UNIDO and Little – Mirrlees Approach

There is considerable similarity Between the UNIDO approach and the L.M approach
both the approaches call for:
1. Calculating accounting shadow prices particularly for foreign exchange savings and
unskilled labor.
2. Considering the factor of equity.
5.9. Difference between UNIDO and Little – Mirrlees Approach
Despite considerable similarities there are certain differences between the two
approaches.
1. The UNIDO approach measures costs and benefits in terms of domestic Birr
whereas; the L.M approach measures costs and benefits in terms of international
prices, also referred to as boarder prices.
2. The UNIDO approach measure costs and benefits in terms of consumption
whereas the L.M approach measures costs and benefits in terms of uncommitted
social income.
3. The stage-by-stage analysis recommended by the UNIDO approach focuses on
efficiency, savings, and redistribution considerations in different stages. The L.M
approach, however, tends to view these considerations tighter.
UNIT SIX
PROJECT FINANCE
6.1. Why Use Project Finance
Before we talk about finance, what do you know about project financing? Characteristics
of project financing? Types of project financing? Limitations of project financing? So, try
to provide your own answer by writing.
i. As an addition to its existing business rather than stand alone basis. Such project
finance is easy as it is by means of internal accruals and/or corporate loans.
ii. The lenders need high degree of confidence with reference to timely completion of the
project and without cost overrun; technically capable, sales projections achievable and
projected cash flows are adequate and realistic. The projections should be adequate to
service the debt obligations and be robust enough to cover any temporary problems that
may arise.
iii. The lenders need to ensure that the project risks are allocated to appropriate parties
other than the Project Company, or where this is not possible, mitigated in other ways.
iv. Lenders may also need to continue to monitor and control the activities of the Project
Company to ensure that the basis on which they assessed the risks is not undermined.
6.2. Project Financing
Project financing may be defined as the raising of funds required to finance a capital
investment proposal which is economically separable. The assets, contracts cash flows are
62
separated from the parent company and the assets acquired for the projects serve as collateral
for loans. The repayments are made from the revenue generated from the projects.
6.3. Characteristics of Project Financing
1. There is a presence of a special project entity.
2. The component of debt is very high and therefore gives raise to a highly leveraged
firm.
3. Project financing is separated form the parent company’s balance sheet.
4. Debt servicing and repayments are done only from the cash flows arising from the
projects.
5. Project financier’s risks are not entirely covered by the sponsor’s guarantee.
6. Third parties like suppliers, customers, government and sponsors commit to share the
risk of the project.
Conventional Financing vs. Project financing
CONVENTI ONAL FI NANCI NG PROJECT FI NANCI NG
Creditor makes an assessment of repayment Cash flows from project related assets alone are
of his loan by looking at all cash flows and considered for assessing the repaying capacity.
resources of the borrower.
End use of the borrowed funds is not The creditors ensure proper utilization of
strictly monitored by the lender. the fund.
Creditors are interested only in their money Project financiers are keen to watch the
getting repaid. performance of the enterprise and suggest
measures.
Project financiers can appoint their nominee is

the Board of directors of their clients.
6.5. Debt Financing Vs Equity Financing
Businesses need finance, either to expand an already existing business, or to start a new
one. There are three alternatives for financing a business, namely, self financing, equity
financing and debt financing. Self financing involves a huge risk and is generally taken
up by small business owners. That leaves us with the other two financing methods, that
is, debt and equity financing. Let's compare debt financing vs. equity financing on
various counts, but before that it is important to understand their meaning.
Debt financing means when a business owner, in order to raise finance, borrows money
from some other source, such as a bank. The business owner has to pay back this loan or
debt within a pre-determined time period along with the interest incurred on it. The
lender has no ownership rights in the borrower's company. Debt financing can be both,
short term as well as long term.
Equity financing means when a business owner, in order to raise finance, sells a part of
the business to another party, such as venture capitalists or investors. Under equity
financing, the financier has ownership rights equivalent to the investment made by him in
the business, or in accordance with the terms and conditions set between him and the
business owner. This is the main difference between debt financing and equity financing.
In equity financing, the financier has a say in the functioning of the business as well.
63
Ignoring preference capital (which is of minor significance) the basic differences between
shareholders’ funds (referred to as equity) and loan funds (referred to as debt) falls on:
 Process: Procedure of raising money through debt financing is easier, than raising
money through equity financing. In equity financing, there are a number of
security laws and regulations, which have to be complied by the business. Such
rules are not applicable for debt financing.
 Ownership Rights: In debt financing, the business owner has full control and
ownership of the business. In equity financing, the investor or the venture
capitalist has ownership rights, as well as decision making power, in running the
business.
 Rights over Profit: In debt financing, the lenders only have a right over the
principal loan and the interest incurred on it. They have no rights over the
profits or revenues generated by the business. Once the loan is repaid, the
relationship between the lender and the business owner also, ends in debt
financing.
 Ease of doing Business: In debt financing, decisions and rights regarding running
the business, solely lie with the owner. Whereas in equity financing, the
shareholders and investors have to be updated and consulted about the business
regularly. So, it is easier to do business with debt financing, than with equity
financing.
 Repayment: If the investors are backing the business, there will be no problem in
arranging finance for the business in future, as investors lend credibility to a
business and lenders will have no reservations in giving loans to such
businesses. Thus, equity financing improves the scope of arranging financing
for the business in future. However, if the business has taken too much loan,
that is, its debt to equity ratio is on a higher side, the investors will not like to
invest in such a business as it's a "high risk" venture.
 Cost to Company: In debt financing, the loan amount is already known and fixed,
so the business owner can make a provision for it beforehand. Also, the interest
incurred on loan in debt financing can be deducted from the corporate tax .
Thus, cost to company in debt financing is easy to forecast, plan and reimburse.
On the other hand, in equity financing, if the business generates huge profits,
the investor and the venture capitalist have to be paid back money, which is
much in excess of the amount they invested.
 Future Funding: if the investors are backing the business, there will be no
problem in arranging finance for the business in future, as investors lend
credibility to a business and lenders will have no reservations in giving loans to
such businesses. Thus, equity financing improves the scope of arranging
financing for the business in future. However, if the business has taken too
much loan, that is, its debt to equity ratio is on a higher side, the investors will
not like to invest in such a business as it's a "high risk" venture.
Thus, after comparing debt financing vs. equity financing, it can be concluded
that both have their pros and cons. Ideally, a business should have a mix of debt
and equity financing with the debt amount comparatively low, so that debt
management becomes easy. However, it is up to the owner of the business to
decide where his preferences lie. A business owner who wants full authority
over the business, should choose debt financing .While an owner who is willing
to share his risks and profits should opt for equity financing.
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Debt vs. Equity -- Advantages and Disadvantages
In order to expand, it is necessary for business owners to tap financial resources. Business
owners can utilize a variety of financing resources, initially broken into two categories,
debt and equity. "Debt" involves borrowing money to be repaid, plus interest. "Equity"
involves raising money by selling interests in the company. The following paragraph
discusses the advantages and disadvantages of debt financing as compared to equity
financing.
6.5.1. Advantages of Debt Compared To Equity
 Because the lender does not have a claim to equity in the business, debt does not
dilute the owner's ownership interest in the company.
 A lender is entitled only to repayment of the agreed-upon principal of the loan
plus interest, and has no direct claim on future profits of the business. If the
company is successful, the owners reap a larger portion of the rewards than they
would if they had sold stock in the company to investors in order to finance the
growth.
 Except in the case of variable rate loans, principal and interest obligations are
known amounts which can be forecasted and planned for.
 Interest on the debt can be deducted on the company's tax return, lowering the
actual cost of the loan to the company.
 Raising debt capital is less complicated because the company is not required to
comply with state and federal securities laws and regulations.
 The company is not required to send periodic mailings to large number of
investors, hold periodic meetings of shareholders, and seek the vote of
shareholders before taking certain actions.
6.5.2. Disadvantages of Debt Compared To Equity

 Unlike equity, debt must at some point be repaid.
 Interest is a fixed cost which raises the company's break-even point. High interest
costs during difficult financial periods can increase the risk of insolvency.
Companies that are too highly leveraged (that have large amounts of debt as
compared to equity) often find it difficult to grow because of the high cost of
servicing the debt.
 Cash flow is required for both principal and interest payments and must be
budgeted for. Most loans are not repayable in varying amounts over time based on
the business cycles of the company.
 Debt instruments often contain restrictions on the company's activities, preventing
management from pursuing alternative financing options and non-core business
opportunities.
 The larger a company's debt-equity ratio, the more risky the company is
considered by lenders and investors. Accordingly, a business is limited as to the
amount of debt it can carry.
 The company is usually required to pledge assets of the company to the lender as
collateral, and owners of the company are in some cases required to personally
guarantee repayment of the loan.
6.6. Factors Determining Capital Structure (debt equity ratio)
The key considerations in determining the debt equity ratio or capital structure are:
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i) Earning Per Share: Earning per share is simply equity earnings divided by the
number of outstanding equity shares, is regarded as an important financial
number that firms would like to improve. Hence, we need to understand how
sensitive is earnings per share (EPS) to changes in profit before interest and
tax(PBIT) under different financing alternatives.
ii) Risk; concerns the deviation of one or more results of one or more future events
from their expected value. Technically, the value of those results may be
positive or negative. However, general usage tends to focus only on potential
harm that may arise from a future event, which may accrue either from
incurring a cost ("downside risk") or by failing to attain some benefit ("upside
risk).The two principal sources of risk in a firm are:
Business risk
Financial risk
a) Business risk: A business risk is a circumstance or factor that may have a
negative impact on the operation or profitability of a given company.
Sometimes referred to as company risk, a business risk can be the result of
internal conditions, as well as some external factors that may be evident in the
wider business community. Business risk can be brought by, demand
variability, price variability, variability of input prices and proportions of
fixed assets.
b) Financial risk: It represents the risk emanating from financial leverage. When
a firm employs a high proportion of debt in its capital structure, it carries a
high burden of fixed financial commitments. Equity share holders, who have a
residual interest in the income and wealth of the firm are naturally exposed to
the risk arising from such fixed commitments. Equity share holders face this
risk, also referred to as financial risk, in addition to business risk. Generally,
the affairs of the firm are, or should be managed in the way that the total risk
born by equity share holders is not unduly high. This implies that if the firm
is exposed to a high degree of business risk, its financial risk should be kept
low and vice versa.
iii) Control: The rights issue options severely limits the financing ability of the firm-
the present owners may lack resources or inclination or both-the options
which may merit serious considerations are debt capital and public issue of
equity capital. In evaluating the options, among other things, the issue of
control is important.
iv) Flexibility: Flexibility for practical purpose means that the firm does not fully
exhaust its debt capacity. But differently, it implies that the firm maintains
reserve borrowing power to enable it to raise debt capital to fund unforeseen
needs.
v) Nature of assets: The nature of a firm’s assets has an important bearing on its
capital structure. If the assets are primarily tangible (plant, machinery and
buildings) and have a liquid resale/secondary market, debt finance is used
more. For example, electric utility companies use more debt because their
assets are mainly tangible, physical in nature. on the other hand if the assets
are primarily intangible(brands and technical know-how),debt finance is used
less. for example, software companies use very little debt, as their assets are
mainly intangible.
6.7. Situations that enforce a firm to use More Debt/ Equity
Use more equity when
The corporate tax rate applicable to the firm is negligible.
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Business risk exposure is high.
Dilution of control is not an important issue.
The assets of the firm are mostly intangible.
The firm has many valuable growth options.
Use more debt when
The corporate tax rate applicable to the firm is high.
Business risk exposure is low.
Dilution of control is an issue.
The assets of the firm are mostly tangible.
The firm has few growth options.
6.8. Menu of Financing:

Dear Students! Before you go through the following discussions try to define and explain
menu of financing and its components parts, their advantages and disadvantages in detail.
Project finance can be classified under two categories.
(i) Shareholders fund (Equity)
(ii) Loan funds (Debt)
The various forms of financing are given in the chart
Equity
capital
Equity Preference
capital
Internal
Accruals
Sources
of Term loans
Capital
Debt
Debentures
Working
Capital
Advance
Miscellaneous
Miscellane
67 Sources
ous
Sources
A) Equity/Ordinary Shares
Equity share represent ownership capital and its owners- ordinary share holders/ equity
holders-share the reward and risk associated with the ownership of corporate enterprises.
They are also called ordinary shares in contrast with preference shares. However, their
liability, unlike the liability of the owner in a proprietary firm and the partners in a
partnership concern, is limited to their capital contributions.
Some terms:
1. Authorized Capital; the amount of capital that a company can potentially
issue as per its memorandum, represents the authorized capital.
1. Issued Capital: the amount offered by the company t o the investor called the
issued capital.
2. Subscribed Capital: that part of issued capital, which has been subscribed to by
the investors, represents the subscribed capital.
3. Paid up Capital: the actual amount paid up by the investors is called paid up
capital.
4. Par value, issue price, Book Value and Market Value: The par value of an
equity share is the value stated in the memorandum and written on the share scrip.
The par value of equity shares is generally Br. 10, Br. 100.
The issue price is the price at which the equity share is issued. Generally the issue price
and par value are and the same for new companies. An existing company may some times
set its issue price higher than the par value.
The Book value of an equity share is equal to
Paid up Equity capital + Reserves and Surplus – intangible
----------------------------------------------------------------------
No. Of outstanding equity shares
Quite naturally, the book value of an equity share tends to increase as the ratio of reserves
and surplus to paid up capital increases.
Market Value: Market value of an equity share is the price at which it is traded in the
market. This price can be easily established for a company, which is listed on the stock
market and activity, traded.
Advantages of Equity:
1. Equity shares do not create any obligation to pay a fixed rate of dividend.
2. Equity shares can be issued without creating any charge over asset of the
company.
3. It is permanent source of capital and the company has not to repay it except
under liquidation
4. Equity share holders are the real owners of the company who have the voting
rights
5. In case of profits, equity shareholders are the real gainers by way of increased
dividends and appreciation in the value of shares.
Disadvantages of Equity shares:
1. If only equity share are issued, the company cannot take the advantage of trading
on equity.
2. As equity capital cannot be redeemed, there is a danger of overcapitalization.
3. Equity shareholders can put obstacles in management by manipulation and
organizing themselves.
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4. During prosperous periods higher dividends have to be paid leading to increase
the value of shares in the market and speculation.
5. Investors who desire to invest in safe securities with a fixed income have no
attraction for such shares.
A) Preference Shares
Preference share is a unique type of long term financing in that it combines some of the features
of equity as well as debentures. As a hybrid security or of financing:
• It carries a fixed/stated rate of dividend.
• It ranks higher than equity as a claimant to the income/assets.
• It normally does not have voting rights.
• It does not have a share in residual earnings/assets.
A preference share ordinarily does not carry voting rights. It is, however, entitled to every
resolution if:
• The dividend is in arrears for 2 years in respect of cumulative preference shares.
• The preference dividend has not been paid for a period of two/more consecutive
preceding years or for an aggregate period of three/more years in the preceding six years
ending with the expiry of the immediately preceding financial year.
Preference Share are of the Following Types
a) Cumulative preference shares: These shares have a right to claim dividend for those
years also subsequent years.
b) Redeemable Preference Shares: Normally, the capital of a company is repaid only at the
time of liquidation. Neither the company can return the share capital nor can the
shareholders demand its repayment. The company, however, can issue redeemable
preference shares. In this case the company has right to return redeemable preference
share capital after a certain period.
c) Irredeemable Preference Shares: Those shares, which cannot be redeemed unless the
company is liquidated, are known as irredeemable preferences shares.
d) Participating Preference Shares: the holders of that share participate in the surplus profits
of the company. They are firstly paid a fixed rate of dividend and then a reasonable rate
of dividend is paid on equity shares. If some profit remains after paying both these
dividends, then preference shareholders participate in the surplus profits.
e) Non – Participating Preference Shares: The shares on which only a fixed rate of
dividend is paid are known as non – participating preference shares. These shares do
not carry the additional right of sharing profits of the company.
f) Convertible Preference Shares: The holders of the shares may be given a right to convert
their holdings into equity shares after a specific period. Theses are called convertible
preference shares.
g) Non – convertible preference shares: The shares, which cannot be converted into equity
shares, are known as non – convertible preference shares.
Advantages of Preference Shares:
1. There is no legal obligation to pay preference dividend the company does not face
bankruptcy or legal action if it skips preference dividend.
2. There is no redemption liability in the case of perpetual preference shares. Even in the
case of redeemable preference shares, financial distress may not much because (i)
periodic sinking fund payments are not required. (ii) can be delayed without significant
penalties.
3. Preference capital is generally regarded as part of net worth. Hence, it enhances the
credit worthiness of the firm.
4. Preference shares do not, under normal circumstances, carry voting rights. Hence, there
is no dilution of control.
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5. No collateral is pledged in favor of preference shareholders. Hence, the mort gable
assets of the firm are conserved.
Shortcomings of the Preference Share Capital:
1. Compared to debt capital, it is said to be a more expensive sourer of financing
because the dividend paid to preference shareholders is not, unlike debt interest,
a tax – deductible expense.
2. Though there is no legal obligation to pay preference dividends, skipping them
can adversely affect the image of the firm in the capital market.
3. Compared to equity shareholders, preference shareholders have a priority claim
on the assets and earnings of the firm.
4. If a firm skips preference dividends for three years, it has to grant voting rights
to the preference shareholders, on matters affecting them.
B) Term loans:
The term loans given by financial institutions and banks have been the primary source of
long term debt for private firms and most public firms. Terms loans, also referred to as
term finance, represent a source of debt finance, which is generally repayable in less than
10 years. They are employed to finance acquisition of fixed assets and working capital
margin. Term loans differ from short-term bank loans, which are employed to finance
short-term working capital need and tend to be self-liquidating over period of time
usually less than one year.
Features of term loans:
The following features of term loans may be discussed.
Currency: financial institutions give Birr term loans as well as foreign currency term
loans. The most significant form of assistance provided by financial institutions’ Birr
term loans are given directly to industrial concerns for setting up new projects as well as
for expansion, modernization and renovation of projects. These funds are provided for
incurring expenditure for land, building, plant and machinery, technical know-how,
miscellaneous fixed assets, preliminary expenses, preoperative expenses, and margin
money for working capital.
Financial institutions provide foreign currency term loans for meeting the foreign
currency expenditure towards import of plant, machinery and equipment, and payment of
foreign technical know –how fees. The periodically liability for interest and principal
remains in the currency/currencies of the loan and is translated into Birr at the prevailing
rate of exchange for making payments to the financial institutions.
Security: Term loans typically represent secured borrowings. Usually assets, which are
financed with the term loan, provide the prime security. Other assets of the firm may
serve as collateral security.
Interest Payment and Principal Payment: the interest and principal repayment on term
loans are definite obligations that are payable irrespective of the financial situation of the
firm. To the general category of borrowers, financial institutions charge an interest rate
that is related to the credit risk of the proposal, subject usually to a certain floor rate.
The principal amount of term loan is generally repayable over a period of 4 to 7years
hereafter the initial grace period of 1 to 2 years. Typically, term loans provided by
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financial institutions are repayable in equal semi-annual installments or quarterly
installments.
Term loan Procedure:
The procedure associated with a term loan involves the following steps;
 Submission of loan application
 Initial processing of Loan Application
 Appraisal of the Proposed Project
 Issue of the Letter of sanction
 Acceptance of the Terms and Conditions by the Borrowing Unit
 Execution of Loan Agreement
 Creation of security
 Disbursement of loans
 Monitoring
D. Debenture/ Bonds/ Notes
Promissory note, debenture / bonds, represent Creditors hip securities and debenture
holders are long term creditors of the company. As a secured instrument, it is a promise
to pay interest and repay principal at stipulated times. In contrast to equity capital, which
is a variable income (dividend/ security, the debenture / notes are fixed income (interest)
security.
A fixed rate of interest is paid on debentures. The interest on debenture is a charge on the
profit and loss account of the company. These debentures are generally given a floating
charge over the assets of the company. When the debentures are secure, they are paid on
priority in comparison to all other creditors.
Types of Debentures:
 Simple, Naked or unsecured Debentures
 Secured or Mortgaged Debentures
 Bearer Debentures
 Registered Debentures
 Redeemable Debentures
 Irredeemable debentures
 Convertible Debentures
 Zero interest debentures
 Guaranteed debentures
 Collateral Debentures
Advantages of Debentures:
1. Debentures provide long-term funds to a company
2. The rate of interest payable on debentures is usually, lower than the rate of
dividend paid on shares
3. The interest of debentures is a tax-deductible expense and hence the effective cost
of debentures is lower as compared to ownership securities where dividend is not
a tax-deductible expense.
4. Debt financing does not result into dilution control because debenture holders do
not have any voting rights
5. A company can trade on equity by mixing debentures in its capital structure and
there by increase its earning per share.
6. Many companies prefer issue of debentures because of the fixed rate of interest
attached to them irrespective of the changes in price levels.
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7. Debentures provide flexibility in the capital structure of a company as the same
can be redeemed as and when the company has surplus funds and desires to do so.
Limitations of Debentures:
1. The fixed interests charges are repayment of principal amount on maturity legal
obligations of the company. These have to be paid even when there are no profits.
2. Charges on the assets of the company and other protective measures provided to
investors by the issue of debentures usually restrict a company from using this
source of finance. The company cannot raise further loans against the security of
assets already mortgaged to debenture holders.
3. The use of debt financing usually increases the risk perception of investors in the
firm. This enhanced financial risk increases the cost of equity capital.
4. Cost of raising finance through debentures is also high because of high stamp
duty
5. A company who’s expected future earnings is not stable or who deals in products
with highly elastic demand or who does not have sufficient fixed assets to offer as
security to debenture holders cannot use this source of raising funds to its benefit.
E. Working Capital Advance:
Working capital advance by commercial banks represents the most important
source for financing current assets.
Forms of Bank of Finance:
Working capital advance is provided by commercial banks in three primary
ways;(i) cash credit / Overdrafts,(ii) loans, and (iii) purchase/discount of bills. In
addition to these direct forms, commercial banks help their customers in obtaining
credit from other sources through the letter of credit arrangement.
Miscellaneous Sources:
Apart from the above-mentioned sources of finance, there are several other ways
in which finance may be obtained. These include:
Deferred Credit: Many times the suppliers of machinery provide deferred credit
facility under which payment for the purchase of machinery is made over a period
of time. The interest rate on deferred credit and the period of payment vary rather
widely. Normally, the supplier of machinery when he offers deferred credit
facility insists than the buyer should furnish a bank guarantee.
Lease finance: A lease finance represents a contractual arrangement whereby the
lessor grants the lessee the right to use an asset in return for periodic lease rental
payments. While leasing of land, buildings and animals has been known from
times immoral, the leasing of industrial equipments is a relatively recent
phenomenon.
Hire Purchase agreement: The hire purchases the asset and gives it on hire to
the hirer
The hirer pays regular hire purchase installments over a specified period of time.
These installments cover the interest as well as principal repayment. When the
hirer pays last installment, the title of the asset is transferred from the hire to the
hirer. The hire charges interest on flat basis.
Unsecured Loans: The promoters to fill the gap between the promoter
contributions required institutions typically provide unsecured loans and the
equity capital subscribed to by the promoters. These loans are subsidiary to the
institutional loans.
Deposits: deposits from the public, referred to as public deposits, represent unsecured
borrowing of one to three years duration. Many existing companies prefer to raise public
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deposits instead of term loans from financial institutions because restrictive covenants do
not accompany public deposits
UNIT SEVEN
PROJECT IMPLEMENTATION, MONITORING AND EVALUATION
7.1. Forms of Project Organization:
The traditional form of project organization is not suitable for project work for the following
reasons.
i) It has no means of integrating different departments at levels below the top
management, and
ii) It does not facilitate effective communication, coordination and control, when several
functional departments, with different professional backgrounds and orientations are
involved in the project work under time and cost pressures, which often call for
overlap, at least partial, of the development, design, procurement, construction, and
commissioning work.
The type of Project organization is determined by the authority that is given to the persons
responsible for the project, the project organization may take one of the following three forms;
7.1.1. Line and staff organization
7.2.2. Divisional Organization
7.2.3. Matrix Organization
7.1.1 Line and Staff organization:
In this form of organization, a person is appointed a with the primary responsibility of
coordination the work of the people in the functional departments; such a person referred to
commonly as the project coordinator, acts essentially in a staff position to facilitate the
coordination of line management in functional departments. The project coordinator does not
have authority and direct responsibility of the line management. He serves as a focal point for
receiving project related information and seeks to promote the cause of the project by rendering
advice, sharing information and providing assistance. He may gently coax line executives to
strive for the fulfillment of project goals. Deprived to exert leadership and feel unsure of his role.
His influence would depend on his professional competence, closeness to top management, and
persuasive abilities. Clearly this is a week form of organization, which may be employed mostly
for small projects. It is certainly not suitable for large projects.
7.1.2 Divisional Organization:
Under this form of project organization, a separate division is set up to implement the project,
headed by the Project Manager. This division has its complement of personnel over whom the
project manager has full line authority. In effect, this form of organization implies the creation of
a separate goal oriented decision of the company with its own functional departments. While the
project manager still has the problem of coordinating the inputs of the organizations involved in
the project, he has total formal control over the division heads.
Advantages:
 A very strong form of project organization.
 It facilitate the process of planning and control
 It brings better integration of effects and strengths the commitment of project related
personal to the objective of the project.
 It considerably improves the perfect of fulfilling the time and budget targets.
Limitations:
 It may entail on inefficient use of resources of the firm.
 It may result in an unnecessary duplication of specialist in the company.
 It may be difficult to achieve higher degree of specialization.
7.1.3 Matrix Organization:
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The matrix form of organization, the third form of project organization, seeks to achieve the twin
objectives of efficient use of resources and effective realization of project objectives, at the cost
of greater organizational complexity of course.
In a matrix organization, the personnel working on the project have a responsibility to their
functional superior as well to the project manager. This means that the authority is shared
between the project manager and the functional managers.
The authority and influence of the project manager are across the traditional vertical line of
command while the personnel maintain the departmental affiliation and are responsible to their
functional superiors; they are responsible to the project manager as well.
Limitations:
 There is dual subordinations
 Responsibility and authority are not commensurate
 The hierarchical principle is ignored.
7.2. Project Planning:
Project involving few activities, resources, constraints and inter relationship can be visualized by
the human mind and planned informally. However, when a project crosses a certain threshold
level of size and complexity, informal planning has to be substituted by formal planning, without
effective planning there may be chaos.
7.2.1. Functions of Project Planning:
Planning, a vital aspect of management serves several important functions.
i. It provides a basis for organizing work on the project and allocating
responsibilities to individuals.
ii. It is a means of communication and coordination between all those involved
in the project.
iii. It forces people to look ahead.
iv. It instills a sense of agency and time consciousness.
v. It establishes the basis for monitoring and control.
7.2.2. Areas of Project Planning:
Comprehensive project planning covers the following;
a) Planning the Project work: the activities relating to the project must be spell out in detail, they
should be properly scheduled and sequenced.
b) Planning the manpower and organization: the manpower required for the project must be
estimated and the responsibility for carrying out the project work must be allocated.
c) Planning the money: the expenditure of money in a time phased manner must be budgeted.
d) Planning the information system: the information required for monitoring the project must be
performed.
7.2.3. Project Work -break down structure:
The work breakdown structure, as it name suggests, represents a systematic and logical
breakdown of the project into its component parts. It is constructed by dividing the project into its
major parts, with each of these being further divided into sub parts. This is continued till a
breakdown is done in terms of manageable units of work for which responsibility can be defined,
thus the work breakdown structure helps in;
 Effective planning: by dividing the work into manageable elements, which can be
planned, budgeted and controlled.
 Assignment of responsibility for work element to project personnel and outside agencies.
 Development of control and information system.
7.3. Project Control:
Project control involves a regular comparison of performance against targets, a search for the
causes of deviation, and a commitment to check adverse variances. It serves two functions.
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(i) Regular monitoring of performance and (ii) it motivates project personnel to achieve project
objectives.
7.3.1. Reasons for ineffective control:
Effective control is critical for the realization of project objectives. Yet, control of projects in
practice tends to be in effective. There are three reasons for poor control of projects.
(i) Characteristics of the project: Most of the projects are large, complex
(ii) People Problem: naturally most of the operational mangers, used to the study rhythm of
normal operations and routine work. The lack of experience, training, competence and inclination
to control projects.
(iii) Poor control and information system: One of the factors, which inhibit effective control, is
the poor quality of control and information system. Some of the weakness observed in the control
and the information system are;
a) Delay in reporting performance
b) Inappropriate level of details
c) Unreliable information.
7.3.2. Project Performance Analysis:
Effective control over a project requires systematic ‘Performance Analysis’. For small and simple
projects, the project managers would do performance analysis for the project as a whole, or for its
major components. As the project business larger and more complex, performance analysis needs
to be done for individual segments of the projects.
7.3.3. Methods of Analysis:
Performance analysis seeks to remove this subjectivity be employing an analytical framework
based on the following terms.
a) BCWS: (Budgeted cost for work scheduled) It represents the total of three components (i)
budgets for all work packages, scheduled to be completed (ii) budgets for the portion in
process work, scheduled for the accomplished and (iii) budgets for the overheads for the
period.
b) BCWP: (Budgeted Cost for Work Performance) this is equal to the sum of the three
components (i) Budgets for work packages actually completed (ii) budgets applicable to
the completed in process work and (iii) overhead budgets
c) ACWP: (Actual Cost of Work Performed). This represents the actual cost incurred for a
accomplishing the work performed during a particular time period.
d) BCTW: (Budgeted Cost for Total Work). This is simply the total budget for the entire
project work.
e) ACC: (Additional Cost for Completion) this represents the estimate for the additional
cost required for completing project.
Given the above terms, the project may be monitored along the following lines;
Cost Variance: = BCWP – ACWP
Schedule variance in cost term: = BCWP-BCWS
Cost performance Index: = BCWP/ACWP
Scheduled performance Index: = BCWP/BCWS
Estimate cost performance Index: = BCTW/(ACWP+ACC)
7.4. Human Aspects of Project Management:
A satisfactory human relations system is essential for the successful execution of a project.
Without such a system, the other systems of project management, however sound they may be by
themselves, are not likely to work well, while technical problems can often be solved with
additional investment of resources, people’s problems may not be amenable to a satisfactory
solution on the short span of the project life.
To achieve satisfactory human relations in the project setting, the project manager must
successfully handle problems and challenges relating to;
 Authority
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 Orientation
 Motivation
 Group functioning
7.5. Pre-requisites for successful project implementation:
Time and cost overruns a project is very common in all places. Due to such time and cost
overruns, projects tend to become uneconomical. resources are not available to support other
projects and economic developments is adversely affected.
What can be done to minimize time and cost overruns and thereby improve the prospects of the
successful completion of projects? While a lot of things can be done to achieve this goal, the most
important ones appear to be as follows.
7.5.1: Adequate information: Often project formulation is defiant because of one or more of the
following shortcomings:
 Superficial field investigation
 Cursory assessment of input requirement
 Slip shot method used for estimating costs and benefits.
 Undue hurry to start
 Deliberate over estimation of benefits and under estimation of costs.
Costs may be taken to avoid the above deficiencies so that the appraisal and formulation of the
project is through, adequate and meaningful.
7.5.2 Sound Project Organization: A sound organization for implementation of the projects is
critical to its success; the characteristics of such an organization are;
(i) It is led by a competent leader
(ii) The authority of the project leads and his team is commensurate with their responsibility
(iii) Adequate attention is paid to the human being in the project
(iv) System and method are clearly defined
(v) Rewards and penalties to individuals are related to performance.
7.5.3 Proper implementation Planning:
Once the investment decision is taken and often ever while the formulation and appraisal are
being done, it is necessary to do detailed implementation, such planning should inter alia, seek to,
a) Develop comprehensive time plan.
b) Estimate meticulously the resource requirements
c) Define properly inter-linkages between various activities of the project.
7.5.4 Advance Action:

Advance action on the following activities may be initiated (i) acquit ion of land (ii) securing
essential clearance (iii) identifying technical collaborators (iv) arranging infrastructure facilities
(v) Preliminary design of engineering (vi) calling of tenders.
7.5.5 Timely availability of fund: Once a project is approved, adequate funds must be made
available to meet its requirements as per the plan of implementation it would be high desirable if
funds are provided even before the final approval to initiate advance action.
7.5.6 Judicious equipment tendering and procurement
Overdependence on foreign suppliers, even though seemingly advantageous from the point of
view of time and cost, may mean considerable outflow of foreign exchange and inadequate
incentive for the development of indigenous technology mean delays and higher uncertainty
about the must be sought which moderates the outflow of foreign exchange and provides
reasonable fillip to the development indigenous technology
7.5.7. Better contact Management
Since a substation portion of a project is typically excused though contracts, the proper
management of contracts is critical to the successful implementation of the project. In this
context, the following should be done.
76
 The competence and capability of all the contracts must be ensured
 Proper discipline must be inculcated among contracts and suppliers by insisting that
they should develop realistic and detailed resource and time plans which are
congruent with the project plan.
 Penalties which may be graduated must be imposed for failure to meet contractual
obligations
 Help should be extended to contractors and supplier when they have genuine
problems
 Project authorities must retain latitude to off lad contracts to other parties well in time
where delays are anticipated
7.5.8 Effective monitoring
In order to keep a tab on the progress of a system monitoring must be established. This helps in
 Anticipating deviations form the implementation plan
 Analyzing emerging problems
 Taking corrective action
In developing a system of monitoring, the following points must be keep in mind.
 If Should focus sharply on the critical aspects of the project implantation
 If must lay more emphasis on physical milestones and not on financial forgets
 If must be kept relatively simple. If made over complicated, if may lead to redundant
paper work and diversion of resources. Even worse, monitoring may be viewed as an end
in itself rather than as a means to implement the project successfully.
7.6: Difference Between PERT and CPM
While there are several features which are common to both CPM and PERT, there are
some major differences. These are:
(a) CPM uses single-time activity estimates, while PERT uses three-time activity
estimates – optimistic time estimate, pessimistic time estimate and most likely
time estimate.
(b) In CPM time-cost trade off procedures are used to expedite the project completion
at minimum cost, whereas in PERT they are not used.
(c) Since single-time activity estimates are used in CPM, the project activity duration
times are deterministic. The use of three-time activity estimates in PERT allows
the application of probability concept to access the degree of certainty associated
with project completion by a certain date.
(d) CPM, in general, is used in the case of small and medium repetitive construction
projects. On the other hand, PERT is used for managing one-time large complex
projects.
In practice, project managers combine the features of both CPM and PERT in managing
projects. The project management computer software packages, in fact, include the
features of both CPM and PERT.
7.7. Net Work Objectives:
The main objectives of network –based scheduling are as follows:
(a) The fostering of increased orderliness and consistency in the planning and
evaluating of all areas in the project.
(b) Providing of an automatic mechanism for the identification of potential trouble
spots in all areas which arise as a result of failure in one.
(c) The structuring of a method to give operational flexibility to the project by
allowing for experimentation in a simulated sense.
(d) The speedy handling and analysis of the integrated data, thus allowing for
expeditious correction of recognized trouble areas.
77
The value of orderliness and inclusiveness lies in an increased ability to integrate all parts
of the project into a meaningful whole. Orderliness and consistency of approach enable
networks to achieve the same measure of evaluation at the project subsystem level and
the project level. Orderliness and consistency are enabling mechanism for evaluation.
It is not possible, in large complex projects, to pay equal attention to all activities. A
suitable mechanism is necessary to identify those activities in the project that may be
potentially troublesome as seen at a given point of time. By minimizing attention on the
mass of activities that are of secondary importance at the moment, the project managers
can concentrate upon those activities which most seriously affect the project. A good
evaluation system however, should do more than show the current relative importance of
activities. It should be capable of aiding the managers by showing them some important
consequences of decisions that they can make as they seek to prevent or offset potential
trouble.
Once the manager encounters real trouble within a group of activities, he is faced with a
set of alternative decisions. Any one of these options may be capable of correcting an
undesirable situation. The evaluation system will allow him to correctly appraise the
consequences of these options. Most often, these options provide the manager with
information relating to time and cost. The decision is his to correctly balance the time
implications of a given action with related resource costs.
The true measure of an evaluation system is measured by the speed with which it can
recognize and correct for out-of-phase situations. Top evaluate the progress of project, it
is necessary to analyze a large amount of data and this can be accomplished only with
modern computing facilities.
7.8. Salient Features of Project Network Models:
The salient features of project network models can be briefly summarized as follows:
(a) Selection of specific, identifiable events that are planned to occur along the way
to successful conclusion of the project. These events must be both meaningful to
the development plan and of a definite, recognizable nature and each must be a
point in time.
(b) Linking the planned events so as to graphically portray the interdependencies
among them. The activities are the links between the events. Links between
events are indicated when there is a planned dependency.
(c) Estimation of the times necessary to move from event to event together with a
measure of uncertainties involved. The time estimates for activities are obtained
from technical personnel responsible for the accomplishment of the activities. The
evaluation system deals with future and the future is uncertain. PERT network,
not CPM, is designed to estimate this uncertainty. The procedure for
accomplishing this is probabilistic in nature.
(d) Analysis which systematically highlights relative criticality of events in the future
development. In PERT, the three time estimates are used to determine the elapsed
time or expected time to complete a single activity, and then into a probability
distribution typified by its mean and variance. The procedure then moves
systematically through the network activities and events and identifies the mean
and variance of the earliest time for each event, considering all previous events.
The final event in the network is fixed at a given point of time. The same analysis
78
is now applied in reverse order, to find out the mean and variance of the latest
times for each event.
7.9. Network Planning and Scheduling:

Before we develop the network showing the schedule of various project activities, it is
important to identify the activities and determine the interdependency between the
activities. The problems, in most cases, involve activity definitions and the question of
detail.
Interrelationship between activities includes both activities in parallel and activities in
series. Sometimes it may be desirable to condense several parallel activities, or activities
in series into one activity on a network. Also, it may be appropriate to expand an activity
into two or more activities on a network. The objectives of condensing and expanding
networks should be for improving the accuracy, eliminating excessive detail, and to
achieve other objectives in the development of the detailed network. In general, a safe
rule of condensation is that groups of activities independent of other activities may be
condensed without distorting the network logic.
The level of detail in a network depends on the degree of accuracy and economy of
presentation of the network. In considering any particular activity or group of activities
with regard to expanding, condensing, or eliminating it, the network planner has to
address the following questions:
(a) Who will use the network, and what are their interests and span of control?
(b) Is it feasible to expand the activity into more detail?
(c) Are there separate skills, facilities, or areas of responsibility involve in the
activity, which could be cause for more detail?
(d) Will the accuracy of the logic or the time estimates be affected by more or less
detail?
It may be generally stated that whenever a project involves a number of a group of
activities which are repeated at various times in a project such as housing complex, one
should consider
(a) developing a detailed network of the group,
(b) condensing the detailed network into a summarized version, and
(c) Using the condensed network in cycles that comprise the total project network.
The purposes of the detailed network are to develop an efficient plan for the group of
activities that will be repeated and to derive accurate time estimates for the condensed
version. In large research and development projects in defense, aerospace industry, etc.,
project networks often become too large for convenient use by several levels of
management involved. As a result, hierarchical or pyramid type networks are developed.
In other words, networks at a different level of detail for each level of management are
developed. These levels are defined by a Work Break down Structure (WBS). At each
level there may be several networks representing different projects within the over-all
project, and the networks at the next higher level are comprised of several condensed and
integrated networks.
After deciding the level of detail, the activities to be included in the network are listed,
indicating for each activity the predecessor activities. To establish precedence
relationship, the network planner should ask the following questions:
(a) What activities immediately precede this activity?
(b) What activity immediately follows this activity?
(c) What activity can be carried out concurrently?
79
Example: A project consists of the following activities: and the immediate predecessors
for each activity are also indicated in the table below:
Sequence of Activities:
Activity Immediate Predecessor Activity Time in Weeks
A ---- 2
B A 5
C A 3
D B 3
E A 4
F B, E 6
G C 8
H D, F 7
I G 2
J H, I 4
4 E F 6
2 5 3 7 4
1 2 4 6 8 9
A B D H J
C 33 8 7 2 I
5.11.1. (Project Network with Activity Estimates)

Note that activity f can commence after activities B and E are completed. The dotted
arrow line connecting events 4 and 5 is called a dummy activity. This dummy activity in
the network becomes necessary to reflect the dependency relationship between activity F
and activities A and E. A dummy activity is also called a zero-time activity.
For each activity, the time estimate is indicated in the table. The activity time estimate,
called activity duration, means the elapsed time of the activity expressed in units such as
working days, weeks, etc., rather than a measure of effort expressed in units such as man-
days. Estimates of activity duration do not include uncontrollable contingencies such as
fires, floods, strikes, bands, and so on. In estimating an activity’s duration time, the
activity should be considered independently of activities preceding or succeeding it.
When working days are used as time unit for activity duration, as in construction projects,
the computations of project duration assume that no activities take place on week ends
and holidays. However, this may be incorrect. For example, concrete may be cured on
non working days. In such cases, time estimates in working days tend to result in an
overestimate of the project duration. When activities of this type are expected to take
longer than 5 calendar days, the over-estimate can be corrected by suitable adjustment
(e.g., a curing estimate of 7 days can be estimated as 5 working days, assuming 5 day
working week). All time estimates in a network must be based on the same number of
working days per week. For any deviations. Adjustments must be made.
The activity time estimates shown above in the Fig - are single time estimates. In CPM,
the activity time estimates are single-time estimates. But in PERT, the activity time
80
estimates are three time –estimates. The time estimates in CPM are deterministic, and the
time estimates are probabilistic in PERT. The technical persons responsible for
accomplishing the activity provide a single time estimate in CPM, and three time
estimates under PERT. The three time estimates in PERT are:
Most optimistic completion time denoted by ‘a”. this time estimate assumes that
everything will go according to plan and with minimal amount of difficulties. This should
occur approximately 1 percent of the time.
Most Pessimistic completion time denoted by ‘b’. This time estimate assume that
everything will not go according to plan and that the maximum potential difficulties will
develop. This should also occur approximately 1 percent of the time.
Most likely completion time, denoted by ‘m’. this is the time that, in the mind of the
technical person, would most often occur should this activity be repeated again and
again.
From the above three time estimates, the expected time of an activity is calculated using
a  4m  b
the formula te 
6
Where te = expected time
a = most optimistic time
b = most pessimistic time
m = most likely time
In calculating the expected time of an activity using the three time estimates, two
assumptions are made. The first assumption is that the standard deviation () is one-sixth
of the time requirement range, i.e., ( b - a) / 6. This assumption is based on the probability
theory where the end points of the curve are three standard deviations from the mean.
This is shown in the figure given below. The second assumption is that the probability
distribution of time required for an activity follows beta distribution.
The expected time in PERT, calculated from the three time estimates, is useful for two
reasons. First, it is found from experience that this is more reliable because it takes into
account the longest and shortest possible time estimates. Second, it provides a probability
measure of 50 -50 chance for the completion of the activity.
The Three time estimates for the activities listed in the figure given below:
Activity Preceding Beginning Ending Optimistic Pessimistic Most Expected
Activities event event Time, a Time, b Likely
Time,t Time, m
A --- 1 2 1 3 2
B A 2 4 1 9 5 5
C A 2 3 2 4 3 3
D B 4 6 1 5 3 3
E A 2 5 2 8 3.5 4
F B, E 5 6 3 13 5 6
G C 3 7 4 12 8 8
H D, F 6 8 4 14 6 7
I G 7 8 1 3 2 2
J H, I 8 9 1 7 4 4
On a network, the three time estimates are shown above the arrow line, and the expected
line below the arrow line in the figure given below. There are, however, variations to this
way of representation. Whichever way it is shown on a network, it must be followed
consistently.
81
5
2, 3.5,8 4 0 6 3,5,13
1, 2, 3 1,5,9 1,3,5 4,6,16 1,6,14
1 2 4 6 8 9
2 2 3 7 7
3 2,3,4 1,2,3 2
4,8,12
3 8 7
(Project Network with Three Time Estimates)
UNIT EIGHT
PROJECT MONITORING AND EVALUATION
8.1. Project Monitoring
Generally, both monitoring and evaluating are management functions through which
stakeholders ascertain whether projects attain their objectives.
As a management function, ‘monitoring’ assesses whether project inputs are being
delivered, are being used as intended (to create outputs) and are having the initial effects
as planned. Particularly, monitoring is an internal project activity, a fundamental part of
good management, and hence, an integral part of day to day activity. The primary
function of monitoring is to provide and use data in a manner that management can
improve performance in the future.
8.1.1. Project Monitoring System
Project monitoring system is to track actual progress against planned progress at any
given time. It includes financial progress (monitoring of actual expenditure against
budgeted expenditure) as well as the progress of project activities.
When designing a monitoring system, the project formulators should consider the
following points:
 Identify key personnel for the monitoring information. These many include line
managers, accountants, contractors and suppliers.
 Indicate frequency of data/information collection time. Here data mean only
useful or relevant one.
 Identify responsibilities for data processing. Appoint also responsibilities to act
on the results of these data.
 Attempt to attain the right combination of speed and accuracy.
 Make sure that the monitoring system only intends to processes that data which is
necessary.
Information acquired through monitoring systems can be divided into three categories:
82
 Monitoring of physical progress
 Monitoring of financial progress
 Monitoring the quality of project outputs
8.1.1.1. Monitoring of Physical Progress
The prime purpose of physical progress monitoring is to ensure whether project activities
are on schedule. This can be achieved through milestone monitoring and time chart
monitoring.
Milestone Monitoring: Involves the use of project milestones which were identified as
part of the project implementation plan. The milestones which represent the actual data
can be entered in a tabular from or Gantt chart. Milestone monitoring provides a
retrospective record of project progress, but it is unable to provide us with information
about activities which are still in progress.
Time chart monitoring is a method which is used to anticipate whether or not
milestones will be reached on schedule.
When dealing with physical progress of an activity, there are three possibilities that will
happen:
 Activity outputs can be quantified as a single number. This is relatively simple
to monitor. For example, if the activity was to print a certain number of
magazines then the physical target and progress to date can be expressed in
terms of this single number (for example, 500 magazines printed out of a target
of 2000).
 Activity outputs can be measured and valued. This is the case with the
construction of buildings and roads. Progress towards meeting physical targets
should be expressed as:
Value of Work done
 100%
Total Value of Work Planned
 Activity outputs cannot be directly value. This is the case in activities such as
training or in supply – only contracts. These activities should use milestones to
mark the beginning and end of each separate activity phase. If this is not possible,
physical progress can be expressed as:
Time Spend to date
 100%
Total time to Complete
This may be difficult because the time taken may not have any relation to the actual
amount of physical progress towards activity completion. Once physical progress has
been monitored for all ongoing activities, it is possible to plot this information against
the implementation plan in the form of a bar chat.
8.1.1.2. Monitoring Financial Progress
This involves comparing actual expenditure against the financial plan (budget)
produced as part of the implementation plan. The project must therefore, have a cost
reporting system in place to enable a comparison of actual and predicted costs. Once
accurate data are accessible, it is possible to utilize this information in the process of
project cost control. Using the following relationship can do this:
Cost of Work to date Cost of Work Re maining

Value of Work to date Value of Work Re maining
The information gained through this calculation can then be entered
8.1.1.3. Monitoring the Quality of Project Outputs
83
This involves ensuring that outputs are delivered according to specification.
This is normally done through a system of direct inspection and specification.
Monitoring is sometimes carried out by outside agencies against a set of
internationally or nationally recognized standards.
8.2. Project Evaluation
Project evaluation appraises the progress and performance of a project compared to that
project’s planned progress and performance, or compared to the progress and
performance of other, similar projects. The evaluation also supports any management
decisions required for the project. Therefore, the evaluation must be conducted and
presented in a manner and format that assures management that all appropriate data have
been considered.
Like a project itself, the audit/evaluation has a life cycle composed of an orderly
progression of well defined events. These are the following:
1. Project Audit Initiation: This step involves starting the audit process, defining the
purpose and scope of the audit, and gathering sufficient information to determine
the proper audit methodology.
2. Project Baseline Definition: the purpose of this phase is to establish performance
standards against which the project’s performance and accomplishment can be
evaluated.
3. Establishing an Audit Database: Once the baseline standards are established,
execution of the audit begins. The next step is to create a database for use by the
audit team.
4. Preliminary Analysis of the project: After standards are set and data collected,
judgments are made.
5. Audit report preparation: this involves the preparation of the audit report,
organized by whatever format has been selected for use. A set of
recommendations, together with a plan for implementing them, is also a part of
the audit report.
6. Project Audit Termination: The same as to the project itself, after audit has
accomplished its designated task, the audit process should be terminated. When
the final report and recommendations are released, there will be a review of the
audit process.
A good evaluation system in a project right from the beginning may assist the project
implementers in identifying difficulties that hinder the progress of the projects as planned
and avoid repeating mistakes in their future endeavors.
Generally speaking, evaluation could be ongoing (mid – term), terminal or ex – post.
8.2.1. In – Progress Evaluation
It is necessary to exercise strict control on in – progress capital projects. There are two
aspects of controlling in – progress capital projects:
Establishment of Internal Control Procedures: Proper accounts are established for
every in – progress capital project. These are charged with all relevant expenditures,
which are further classified into capital and revenue items. These accounts reflect out –
of – pocket payments as well as allocated expenses. The project by project segregation of
costs ensures that proper attention can be directed to projects as they approach
stages/milestones.
Use of Regular Progress Reports: Periodic progress reports compare actual
expenditures against estimates. They provide several benefits: (i) They provide timely
information so that corrective action can be made to overcome potential problems. (ii)
84
They generate inputs for cash budgeting and fund raising. (iii) They serve as the basis
for calculating variances and explaining variances.
8.2.2. Post – Completion Evaluation
Post – audit or post – completion audit is an audit of a project after it has been
commissioned.
Regular post – completion audit of capital projects: (i) Provide a documented record of
experience that may be valuable in improving future decision making, (ii) Enable the firm
in identifying individuals with superior abilities in planning and forecasting (iii) Help in
discovering systematic biases in judgment, (iv) Induce healthy caution among sponsors,
and (v) Serve as a useful training ground for promising executives who need broader
business experience and exposure.
85
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Project analysis and Management

Chapter one: GENERAL INTRODUCTION

“A project is a one-shot, time-limited, goal-directed, major undertaking, requiring the

A project is a problem scheduled for solution.

1.2. Primary Features of a Project

2. Sect oral classification of projects:

 Indirectly Productive projects:

The Baum project life cycle (World Bank procedures)

1. Pre- investment phase

The DEPSA Model

1. Pre- investment Phase

A project is not a product or commodity to be purchased. It has a promise as well as a

An idea regarding a required intervention in a specific area to address identified problem

FIGURE – 1 BUISNESS ENVIRONMENT

 Have no market for the output

 Have inadequate supply of inputs

 Are very costly in relation to benefits and

 Assume over ambitious sales and profitability

 Unwillingness of the entity undertaking the project to spend money on this

3.1. Market and Demand Analysis

Collection of secondary Demand

Situational Analysis Characterization of

Conduct of Market Market

Conduct of Market Market

3.1.2. Collection of Secondary Information

Present per capital Per capital Income

Annual Petrol consumption

Processed industrial materials and components:

Costs of raw materials and supplies:

3.2.4. Plant Capacity

Structures and Civil Works

Environmental Impact Assessment

3.3.1. Cost of Project

3.3.3. Working Capital Requirement

Cash Flows from Total Funds Point of View

Depreciation 34.50 29.32 24.93 21.19 18.00 15.30 13.00 11.06

Cash Flows (Total Funds Point of View)

Discounted Cash Flow/Time Adjusted Techniques

a) Net Present Value (NPV)

Year Cash Flow FVIF @18% Future Value

Re-investment Rate of 12% a Year

Three decision rules associated with NBCR criterion are

Cash PVIF Present Cash PVIF Present

0 -155, 000 48,000

The BCR of both the projects is calculated as follows:

Where CFt = Cash flows & outflow at different time periods

Where PB = Payback period

The merits of this criterion are:

Step 3: Obtain MIRR by solving the following equation:

The following examples demonstrate the calculation of MIRR.

Example 5.4.1 f1)

(g) Discounted Payback Period Method

To understand the method better, let us consider the following example

 The cost of capital is assumed as 10%

5.7. Social Cost Benefit Analysis (SCBA)

5.7.3. Significances of SCBA

5.8. Similarity between UNIDO and Little – Mirrlees Approach

6.1. Why Use Project Finance

Project financiers can appoint their nominee is