Chapter 6- Project Analysis/Appraisal

 Technical analysis
 Market and demand analysis
 Financial analysis
 Socio-economic analysis
 Institutional analysis
 What is Project Appraisal?
• Project appraisal is “the process of assessing, in a
structured way, the case for proceeding with a project
or proposal, or the project's viability. It often involves
comparing various options, using economic appraisal
or some other decision analysis technique” [Business
Dictionary].

• It is a systematic and comprehensive review of the

economic, environmental, financial, social, technical
and other such aspects of a project to determine if it
will meet its objectives.
 …Definition
• Project Appraisal is a consistent process of reviewing a
given project and evaluating its content to approve or
reject this project, through analyzing the problem or
need to be addressed by the project, generating
solution options (alternatives) for solving the problem,
selecting the most feasible option, conducting a
feasibility analysis of that option, creating the solution
statement, and identifying all people and organizations
concerned with or affected by the project and its
expected outcomes.
• It is an attempt to justify the project through analysis,
which is a way to determine project feasibility and
cost-effectiveness.
 Process
• The process of project appraisal consists of five steps and they are
– initial assessment,
– defining problem and long-list,
– consulting and short-list,
– developing options, and
– comparing and selecting project.

• The process of appraisal generally starts from the initial phase of

the project.
• If an appraisal process starts from an early stage, then the
company will be in a better position to decide how capital should
be spent in the project and also it will help them to make the
decision of not spending too much or stopping a project that is
not economically viable.
 Key steps
• Various PM methodologies use various
approaches and techniques for developing a
project appraisal.
• According to ‘mymanagement guide’, there are si
steps for developing a project appraisal.
Step #1. Concept Analysis
• The first step requires to conduct a range of
analyses in order to determine the concept of the
future project and provide the Decision Package
for the senior management (project sponsors) for
approval.
 Key steps
Step #2. Concept Brief
• At this step, a summary of the project concept to define the goals,
objectives, broad scope, time duration and projected costs is
developed. All this data will be used to develop the Concept Brief.
• Further there is a need to develop a project statement document
that specifies the project mission, goals, objectives and vision. Then
you create a broad scope statement that specifies the boundaries,
deliverables ad requirements of your endeavor.
• Finally you make a preliminary schedule template that determines
an estimated duration of the project, and then develop a cost
projection document based on cost estimates and calculations.
 Key steps
Step #3. Project Organization
• The Concept Brief is used to determine an organizational
structure of the project. This structure should be developed
and explained in the Project Organizational Chart.
• The document covers such issues as governance structure
(roles and responsibilities), team requirements and
composition, implementation approach, performance
measures, other info.
• The idea behind the Project Organizational Chart is to
create a visual representation of the roles, responsibilities
and their relationships and what people/organizations are
assigned to what roles and duties within the project.
 Key steps
Step #4. Project Approval
• The final stage requires to review all the previous steps and gather
them into a single document called the Project Appraisal.
• This document summarizes all the estimations and evaluations
made, to justify the project concept and verify that the proposed
solution addresses the identified problem.
• The financial, the cost-effectiveness and the feasibility analyses will
serve as the methods of project appraisal to approve the project.
The document is to be submitted to the snooper stakeholders (the
customer, the sponsor) for review and approval. If the appraisal is
approved, then the project steps to the next phase, the planning.
The World Bank model Project life cycle

Identification

Preparation
Evaluation

Implementation Appraisal/
financing
Financial Analysis

 Cost of the project

 Production cost
 Means of finance
 Profitability projection
 Financial projection

 Discounting
 Non-discounting
 Time value of money
 Why is a Birr in hand today has more value
than a Birr to be received in one year? The
reasons may be one or a combination of the
following:
 As a business man I live in an uncertain world. A
promise to pay me one Birr in one year is only a
promise until I actually get it.
 Human nature naturally attaches more weight to
present pleasure than to the more distant joys.
 A Birr received now is more valuable than a Birr
to be received one year from now because of the
investment possibilities that are available for
today's Birr.
 Interest Formulas

Interest is the excess amount which one

earns over one’s money lent to some one else
(individual, banks, organizations, etc,).
Interest may arise from one of the following
reasons.
Discount Rate or Rate of Discount which is
another name for interest may also be
defined as the discount of one unit of
principal for one unit of time.
There are different ways of interest
computation depending upon the repayment
conditions.

i) Simple Interest: The interest calculated for

any period is based on the remaining
principal amount
 Let
i the interest rate per interest period

n the sum of interest periods (time periods)

C capital (Present sum of money)

S capital (Future sum of money)

R an end period payment in a uniform series

Simple interest (I) is given by:

I = C  ni
S CI
 C  Cni
 C (1  ni)
ii) Compound Interest: Whenever interests
are to be calculated for any interest period
the basis for computation will be the
remaining principal plus any accumulated
interest charges at the beginning of that
period

If C is invested at interest I

at n 1
S  C  C  1 i
 C  Ci  C (1  i )
n2
S  C (1  i )  C (1  i )i

 C  Ci  Ci 2
 C 1  i 
2

n3
S  C1  i 
3
 Therefore, at n period

S  C 1  i 
n

; and

1
CS
1  i n

1  i n is called the single payment Compound Amount Factor(C.A.F)

1
1  i n is called single payment Present Worth Factor (P.W.F).
 Discounting

 Net Present Value

 Benefit-Cost Ratio
 Internal Rate of Return
 Net Present Value

NPV = NCF0 + (NCF1 x DF1) + NCF2 x DF2) + …. + (NCFn x an)

Where, NCFn = annual net cash flow

n = number of years
an = discount factor
 Interpretation of NPV

 A NPV of zero signifies that the benefits of the

project ( project cash in flows over time) are just
enough to recoup the capital invested and earn the
required return on the capital invested
 A positive NPV implied that the project earns excess
return. Since the return to the providers of debt
capital in fixed, the excess return accrues solely to
equity shareholders, there by augment their wealth
 A negative NPV implies that the project has no
ability to return the invested capital
 Advantages of NPV

 It introduces the time value of money.

 It expresses all future cash flows in
today’s values. This enables direct
comparisons.
 It allows for inflation and escalation.
 It took at the whole project from start to
finish
 It can simulate project what if analysis
using different values
 Disadvantages

 Its accuracy is limited by the accuracy of

the predicted future cash flows and
interest rates.
 It is biased towards short run projects.
 It does not include non financial data like
the marketability of the product.
 Internal Rate of Return

 Evaluation of a project with internal rate of

return provides the rate of return of the
project in its life time.
 The Internal rate of return is the value of
the discount factor when the NPV is zero.
 The IRR is calculated by either a trial and
error method or plotting NPV against IRR.
 It is assumed that the costs are committed
at the end of the year and these are the only
costs during the year
 IRR vs NPV

Region A

IRR
Region B
 Interpretation of IRR

 There are two economic interpretations of

internal rate of return:
 The internal rate of return represents the
rate of return on the unresolved
investment balance in the project Rejoin
A on the figure
 The internal rate of return is the rate of
return earned on the initial investment
made in the project Rejoin B on the figure
 Advantage of IRR
 It considers the cash flow stream in its
entirety.
 It takes in to account the time value of money.
 It appears to business men who are wanted to
think in terns of return.
 It appears particularly helpful in assessing the
margin of safety in a project.
 The ranking of projects on the internal rate of
return dimension does not change with
variations in the cost of capital
 Disadvantage of IRR
 It may not be uniquely defined. If the cash
flow stream of a project has more than one
change in sign, there in possibility of multiple
rates of return.
 The Internal rate of return figure can not
distinguish between lending and borrowing and
hence a high internal rate of return need not
necessarily be a desirable feature.
 The internal rate of return criterion can
mislead when choosing between mutually
exclusive projects that have substantially
different outlays.
 Benefit-Cost Ratio

BCR=PVB
I
where BCR= benefit- cost ratio
PVB= present value of benefits
I = Initial investment
NBCR=NPV =PVB-I
I I
Where NCBR= Net benefit- cost ratio.
NPV= Net present value
PVB= present value of benefits
I = Initial Investment
 Interpretation of BCR

When BCR NBCR Rule is

>1 >0 Accept

=1 =0 Indefinite
<1 <0 Reject
 Advantage

 It discriminates large and small projects.

 Disadvantage
 Under unconstrained conditions, the benefit- cost
ratio criterion will accept and reject the same
projects as the net present value criterion.
 When the capital budget is limited in the current
periods, the benefit- cost ratio criterion may rank
project correctly in the order of decreasingly
efficient use of capital. However, its use is not
recommended because it provides no means for
aggregating several smaller projects in to a package
that can be compared with a large project.
 When cash out flows occur beyond the current
period the benefit- cost ratio criterion is unsuitable
as a selection criterion
 Non-discounting Criteria

 It is possible to measure a project

withwhileness and prioritizing projects
through non-discounting criteria evaluation.
 Pay back period
 Urgency
 The accounting rate of
 Payback period

 Evaluation of the pay back period is important

to measure the risk of the project in its life
time.
 The lesser the pay back period the higher the
rank.
 Advantages
 It is simple and easy to use.
 It uses readily available accounting data to determine
cash flows.
 It reduces the project’s exposure to risk and
uncertainty
 The uncertainty of future cash flows is reduced.
 It is an appropriate technique to evaluate high
technology projects where the technology is changing
quickly and the project could run the risk of being
left holding out of the dead stock.
 It also considers the liquidity of the firm.
 It also useful when the danger of obsolescence is
greater, because it indicates that the investment is
safe when payback period is very short.
 Disadvantages
 It ignores the life of the project beyond the
payback period.
 It does not consider the profitability of the
projects.
 It dose not consider the time value of money.
repayments if their payback periods were the same
 It does not look at the total project.
 The figures are based on project cash flow only. All
other financial data are ignored.
 Although payback period would reduce the duration
of risk, it does not quantify the risk exposure.
 Example
• A $100,000 investment is made into a project. The net benefit of
this project is $15,000 per year. What is the payback period?
Solution:
• We first construct the net cash flow diagram.

• At year 6 the total income is 6 * 15000 = 90000

• At year 7 the total income is 7 * 15000 = 105000
• Hence sometime between year six and seven or to be precise in six
years and eight months, the initial investment is recovered.
• The payback period is then 80 months.
 Refer more examples
• Refer the e-book, Abol, A., “Economic &
Financial Analysis for Engineering & Project
Management”, 2000, pp. 3-65
 Urgency

 Evaluation of the project importance and

urgency can help in prioritizing and selecting
of projects.
 The greater the urgency the higher the rank.
 According to this criterion projects that are
deemed to be more urgent get priority over
projects that are regarded as less urgent
 The problem with this criterion; How can the
degree of urgency be determined?
 In many situations, however, it is difficult to
determine the relative degree of urgency
because of the lack of an objective basis. The
use of urgency criterion may imply that the
persuasiveness of those who propose project
would be come a very important factor in
investment decisions Resource allocation may
degenerate into a political battle.
 In view of these limitations of the urgency
criterion, we suggest that in general if should
not be used for investment decision making,
In exceptional cases, where genuine urgency
exists, it may be used provided investment
outlays are not large.
 The accounting rate of return

 The accounting rate of return; also referred

to as the average rate of return or the return
on investments, is a measure of profitability
which relates in come to investment, both
measured in accounting terms. Since income
and investment can be measured, there can be
a very large number of measures for
accounting rate of return .
 A = Average income after tax
Initial investment
B = Average income after tax
Average investment
C= Average income after tax but before interest
Initial investment
D=Average income before interests and taxes
Average investment
E=Average income after tax but interest and taxes
Average investment
F= Average income before interest and taxes
Average investments
 Interpretation

 Obviously, the higher the accounting rate of

return the better the project
 Advantages

 It is simple to calculate
 It is based on accounting information which is
readily available and familiar to business man
 It facilitates post-auditing of capital
expenditure
 Disadvantages

 It is based up on accounting profit, not cash

flow
 It does not take in to account the time value
of money
 The argument that the accounting rate of
return measures facilitates post- auditing of
capital expenditure is not very valied. The
financial accounting system of a firm is
designed to report events with respect to
accounting periods and for profit centers but
not for individual investments.
 Discussion Topics

 Discuss and list out major sources of finance

for a project.
 The Project Pipeline Process

Project Idea & Partner Project Proposal &

Search Partnership

Need Concept Project Proposal Funding Implem-

entation

Screening/Prioritisation

More mature
project

More
information

Source: IPA Funds Programme Management 12-19 sept. 2011

 Project Financing

The financing of new projects continued to be

a problem, since corporate guarantees would
usually be required for loans to finance
projects.
Companies were therefore risking to the
extent of their total assets if a project
failed.
Development of project financing, therefore,
emerged from the need for companies to
shield themselves from such risks.
This has led to non-recourse or limited
recourse financing.
In this financing, creditors provide financing
to a project solely based on the merits of the
project itself, with limited or no recourse to
the companies sponsoring the project.
The project implementation demands the
establishment of a separate project company
by the project sponsors.
Such an arrangement has several advantages
for the sponsors.
It allows the sponsors to borrow funds to
finance a project without increasing their
liabilities beyond their investment in the
project.
Lenders assume a part of the project risks,
since they are lending without full recourse
and primarily on the basis of project assets.
On the other hand the sponsors have to
consider how to allocate risks to other
participants in their consortium.
They also need to carefully analyze the
financial feasibility of projects, in the light of
the risks involved and their proposed
distribution before submitting bids of
proposals for the schemes.
The financing is more often defined by its
revenue stream than by its products or
markets.
Interrelated contracts with third parties,
such as suppliers, purchasers/consumers and
government agencies, are crucial to the credit
support for the project.
Loan repayments are secured by project cash
flows, as in contractual agreements or as
indicated by demand forecasts, rather than by
projects assets.
To minimize their exposure to project risks
and uncertainty, project sponsors will rely
primarily on contract enforceability (or
guarantees).
Financial Flows of A Project Company
 Types of Capital

There are, in principle, three types of capital

available to all projects: equity, debt and
mezzanine capital.
Each plays a specific role in project financing
and has its own risk characteristics.
The return on each type of capital is
determined largely by its risk characteristics.
i) Equity Capital: It represents the funds
provided by the owners and is the lowest-
ranking capital of all in terms of its claims on
the assets of a project.
Normally, any distributions that can be made to
equity investors is done after all other project
obligations are satisfied.
If a project fails, therefore, all other claims must
be met before any claims can be made by equity
investors.
Equity investors therefore bear a higher degree of
risk than any other providers of capital.
Moreover, if after all other obligations are met, the
value of the remaining assets is less than the initial
equity capital of the project; the investors will bear
the loss.
Equity capital is also referred to as risk capital.
ii) Debt Capital: Senior debt has first claim
over all the assets of a project and must be
repaid first, according to a predetermined
schedule.
In contrast to equity capital, a project’s senior
debt has the highest ranking of all capital.
The claims of others can be considered only after
the claims of senior debt are satisfied. It bears
the lowest risk of all capital and correspondingly,
the returns are usually limited to just the interest
payments on the loans, irrespective of how
successful the project may be.
Equity investors would prefer a debt-equity ratio
as high as possible.
iii) Mezzanine Capital: The key characteristic of
mezzanine capital is that it has both debt and
equity features and, correspondingly, it has a risk
profile that is somewhere between debt and
equity capital.
 Examples of mezzanine financing are subordinated loans
and preference shares.
 Both have the characteristics of debt, in that regular
payments of interest and/or capital are involved.
 However, payments are subordinated to senior debt and
need only be made when project funds are available.
 When they are not available, mezzanine financing is
treated like equity and no payments are made hence,
mezzanine financing provides projects with an
additional equity cushion.
However, when funds are available, mezzanine
payments take precedence over equity capital, such
as dividend payments.
For bearing greater risk than senior loans,
mezzanine capital will be rewarded with potentially
higher returns.
This is achieved in one of two ways: higher interest
rates than the project’s senior loans and/or partial
participation in the profits or capital gains of
project equity.
Partial participation in capital gains can be
achieved by providing holders of subordinated
debt or preferred shares with share options,
convertible rights or warrants, so that they can
subscribe for shares of the project, usually at a
nominal price.
 Sources of Financing

It is a normal trend that debt, equity and

mezzanine capital are obtained from
different sources.
However, there are cases where a single
source provides more than one type of capital,
in which case separate departments may
handle the different types of capital
separately.
 The primary sources of capital are:

 personal savings;
 loans and sales of bonds;
 profit plowback (Profits are used for
capital expansion).
i) Equity Capital Providers: The main source
of equity capital for a project comes from the
project sponsors or other investors that have
an active interest in the project.
This would include governments, contractors,
equipment suppliers, purchasers of output and
entrepreneurs.
Additional equity, if needed, would be sought from
passive sources, such as institutional investors and
possibly the general public through local or
international capital markets.
They are not normally involved in the promotion
and development or the management and operation
of the projects in which they invest. Their capital
is used to top up the equity requirements of a
project that cannot be met by sponsors.
ii) Commercial Banks: The most traditional
source of debt financing are commercial
banks.
To a lesser extent, they are also providers of
mezzanine capital.
Their operations essentially revolve around the
creditworthiness of their borrowers and the
security of their loans.
Much stress is put on prudential lending and
actions aimed at ensuring loan repayment. Some of
the considerations made by commercial banks
during the appraisal of a project are:
the level of commitment of the sponsors and other
major participants, in terms of investment and
personnel;
the completion and technical targets of the
project’s budget, as any slippage will have an
adverse effect on the economic viability of the
project;
the experience and capabilities of project
management in implementing this type of project,
the degree of confidence in the project’s cost and
revenue targets will be determined by the
reliability of the assumptions on which the inputs
supplies and demand projections are based;
the strength of government support, its
understanding of the private sector’s profit
motives and its attitudes towards risk sharing
helps the project to succeed; and
iii) Export Credit Agencies: Export credit
agencies (ECA) are considered to be an
important source of long-term credit.
As lenders, ECAs have the same concerns and
requirements as commercial banks and would also
be signatories to the credit agreement.
However, ECAs are usually state-owned, and their
primary objective is the promotion of their
country’s exports and the grants are usually tied
to the purchase of equipment from the ECA’s
country.
ECAs are usually substantially more generous than
those of commercial banks and highly suited to the
financing of long-term infrastructure projects.
iv) Bilateral and Multilateral Aid Agencies:
Many developing countries can also access
debt, equity and mezzanine financing from
bilateral and multilateral agencies, such as
that provided by the United States Agency
for International Development (USAID), the
Canadian International Development Agency
(CIDA), the Overseas Development
Administration of the United Kingdom (ODA),
the World Bank, the Asian Development Bank
(ADB) and the European Bank for
Reconstruction and Development (EBRD).
Bilateral sources of financing, including export
credits, are the most attractive funds available to
a project in terms of lower interest and longer loan
periods.
v) Institutional investors: Institutional
investors as a source of debt, equity and
mezzanine financing are non-bank financial
institutions such as insurance companies,
pension funds and investment funds.
 Institutional investors distinguish themselves
from commercial banks in that they mobilize
long-term contractual savings as opposed to
short-term deposits.
 By virtue of the long-term nature of the funds,
many institutional investors are able to provide
long-term debt, mezzanine and pure equity
financing.
 Institutional investors are therefore an
important source of long-term funds for large
projects.
vi) National and Regional Development Banks:
Financial appraisal looks at the financial
viability of projects from the standpoint of
project sponsors, investors and commercial
lenders, while economic appraisal looks at the
economic viability of projects from the
standpoint of national costs and benefits and
the best use of a country’s resources. It is
conceivable, therefore, that a project that is
economically viable may not be financially
viable and vice versa.
 Examples of such divergence are infrastructure
projects that are critical to the economic
development of a region but which governments
decide to implement on a non-tariff basis or for
which they decide to charge user fees that do not
fully cover operational costs.
Alternative project evaluation and
selection
Multi-Criteria Decision Making (MCDM)

 Decision making is the process of arriving at a

determination based on consideration of
alternatives.

 It involves making decision based on more

than one criterion, usually conflicting criteria.
Multi-criteria decision making models

 Linear Goal Programming (LGP),

 Multi-Attribute Utility Theory (MAUT),
 Technique for Order Performance By
Similarity to Ideal Solution (TOPSIS),
 Merit Point System (MPS) and
 Analytic Hierarchy Process (AHP).
 Analytic Hierarchy process
 Analytic hierarchy process (AHP) is a structured technique
for organizing and analyzing complex decisions.
 AHP provides a flexible and easily understood way
to analyze and decompose the decision problem.
 AHP allows subjective as well as objective factors
to be considered in the evaluation process.
 AHP is a method that can be used to establish and
connect both physical social measures, including
cost, time, public acceptance, environmental
effects, and so on.
 In its general form, it is a framework for
performing both deductive and inductive thinking.
Steps used to solve problem with AHP

Structuring hierarchy
Hierarchic Structure
Goal

Criteria-1 Criteria-2 Criteria-3 Criteria-4 Criteria-5

Alternative-1 Alternative-2 Alternative-3

 Setting priorities
Intensity of definition
importance
1 Equal importance
3 Moderate importance of one over
the other
5 Essential or strong importance
7 Very strong importance
9 Extreme importance
2, 4, 6, 8 Intermediate values between the
two adjacent judgments
Explanation
Two elements contribute equally to
the element
Experience and judgment slightly
favor one element over another
Experience and judgment strongly
fever one element over another
An element is strongly favored and
its dominance is demonstrated in
practice
The evidence favoring one element
over another is of the highest
possible order of affirmation
Compromise is needed between two
judgments
 Pair-wise Matrix Camparison
If you like the apple better than banana, you
thick a mark between number 1 and 9 on left
side, while if you favor banana more than
apple, then you mark on the right side.

For instance if you strongly favor banana to apple, mark it as follows.

 Synthesis
 we have to do some weighting and adding to
give us a single number to indicate the
priority of each element.

Check the consistency

 If the consistency level is below 0.1, select

the top ranked; otherwise go to the pair wise
comparisons.
 Illustration of the AHP
Step–1. Identify decision hierarchy
Goal
Appraisal of project

Financial
Technical Market& Demand Numerical
Objective

Project A Project A Project A

Project A

Project B Project B Project B Project B

Alternatives
Project C Project C Project C Project C
 Step – 2. Establish priorities.
1.The priorities of the four criteria in terms of over all goals.

technical market financial Numerical

criteria
financial 3 1/4 1 1/6
market 5 1 4 1/7
Numerical 8 7 6 1
technical 1 1/5 1/3 1/8

2. Priorities of the three projects in terms of the technical criteria

technical Project A Project B Project C

Project A 1 4 3
Project B 1/4 1 2
Project C 1/3 1/2 1
3. Priorities of the three projects in terms of the market and demand criteria

Market Project A Project B Project C

Project A 1 1/6 2
Project B 6 1 5
Project C 1/2 1/5 1

4. Priorities of the three projects in terms of the finance criteria.

Finance Project A Project B Project C

Project A 1 1/3 1/2
Project B 3 1 4
Project C 2 1/2 1
5. Priorities of the three projects in terms of the numerical criteria.

Numerical Project A Project B Project C

Project A 1 1/3 1/4
Project B 3 1 6
Project C 4 1/6 1
Step-3 Pair wise comparison matrix showing preferences for the
three projects in terms of the criteria (objectives).

1.Pair wise comparison matrix showing preferences for the three

projects in terms of the technical criteria.

Step-1.Sum (add up) all the values in each column.

Technical Project A Project B Project C

Project A 1 4 3
Project B 1/4 1 2
Project C 1/3 1/2 1
Sum 19/12 11/2 6
Step- 2 The value in each column are divided by the corresponding columns
sums.

Technical Project A Project B Project C

Project A 1/(19/12)=12/19 4/(11/2)=8/11 3/6=1/2
Project B 1/4/(19/12)=3/19 1/(11/2)=2/11 2/6=1/3
Project C 1/3//(19/12)=4/19 1/2/(11/2)=1/11 1/6=1/6

Step - 3.Convert fractions in to decimals and find the average of each raw.

Technical Project A Project B Project C Raw average

Project A 12/19=0.632 8/11=0.727 1/2=0.5 0.620
Project B 3/19=0.158 2/11=0.182 1/3=0.333 0.224
Project C 4/19=0.211 1/11=0.091 1/6=0.167 0.156
2. Pair wise comparison matrix showing preferences for the three projects in
terms of the market criteria. Step-1

Market Project A Project B Project C

Project A 1 1/6 2
Project B 6 1 5
Project C 1/2 1/5 1
sum 15/2 41/30 8

Step-2
Market Project A Project B Project C
Project A 1/(15/2)=2/15 1/6/(41/30)=5/41 2/8
Project B 6/(15/2)=12/15 1/(41/30)=30/41 5/8
Project C ½(15/2)=1/15 1/5/(41/30)=6/41 1/8
step 3
Market Project A Project B Project C Raw average
Project A 2/15=0.133 5/41=0.122 2/8=0.25 0.168
Project B 12/15=0.8 30/41=0.732 5/8=0.625 0.719
Project C 1/15=0.067 6/41=0.146 1/8=0.125 0.113
3.Pair wise comparison matrix showing preferences for the three projects in
terms of the financial criteria.

Finance Project A Project B Project C

Project A 1 1/3 1/2
Project B 3 1 4
Project C 2 1/2 1
sum 6 19/12 11/2

Finance Project A Project B Project C

Project A 1/(6)=1/6 1/3/(19/12)=4/19 1/2/(11/2)=1/11
Project B 3/(6)=3/6 1/(19/12)=12/19 4/(11/2)=8/11
Project C 2/(6)=2/6 1/2/(19/12)=3/19 1/(11/2)=2/11

Finance Project A Project B Project C Raw average

Project A 1/6=0.167 4/19=0.211 1/11=0.091 0.156
Project B 3/6=0.5 12/19=0632 8/11=0.727 0.62
Project C 2/6=0.333 3/19=0.158 2/11=0.182 0.224
4. Pair wise comparison matrix showing preferences for the three projects in
terms of the numerical criteria.

Numerical Project A Project B Project C

Project A 1 1/3 1/4
Project B 3 1 6
Project C 4 1/6 1
sum 8 9/6 29/4
Numerical Project A Project B Project C
Project A 1/8 1/3/(9/6)=2/9 1/4/(29/4)=1/29
Project B 3/8 1/(9/6)=6/9 6/(29/4)=24/29
Project C 4/8 1/6/(9/6)=1/9 1/(29/4)=4/29

Numerical Project A Project B Project C Raw average

Project A 1/8=0.125 2/9=0.222 1/29=0.035 0.127
Project B 3/8=0.375 6/9=0.667 24/29=0.828 0.623
Project C 4/8=0.5 1/9=0.111 4/29=0.138 0.25
5. Pair wise comparison matrix showing preferences for the three projects in
terms of the criteria (objectives).

technical market financial Numerical

criteria
financial 3 1/4 1 1/6
market 5 1 4 1/7
Numerical 8 7 6 1
technical 1 1/5 1/3 1/8
sum 17 169/20 34/3 482/336
technical market financial Numerical
criteria
financial 3/17 1/4/(169/20)=4/ 1/(34/3)=1/34 1/6/(482/336)=
169 42/482
market 5/17 1/(169/20)=20/ 4/(34/3)=12/34 1/7/(482/336)=
169 48/482
Numerical 8/17 7/(169/20)=5/1 6/(34/3)=3/34 1/(482/336)=56
69 /482
technical 1/17 1/5/(169/20)=1 1/3/(34/3)=18/3 1/8/(482/336)=
40/169 4 336/482
 technical market financial Numerical Raw
criteria average

Technical 3/17=0.059 4/169=0.024 1/34=0.029 42/482=0.087 0.05

Market 5/17=0.294 20/169=0.118 12/34=0.353 48/482=0.1 0.216

Financial 8/17=0.176 5/169=0.03 3/34=0.088 56/482=0.116 0.103

Numerical 1/17=0.471 140/169=0.828 18/34=0.529 336/482=0.697 0.631

 Step-4.Developing an over all priority ranking.

Technical market Finance Numerical Criteria ranking

Project A 0.62 0.168 0.156 0.127 * 0.05
Project B 0.224 0.719 0.62 0.623 0.216
Project C 0.156 0.113 0.224 0.25 0.103
0.632
Over all project A priority =0.62*0.05 +0.168*0.216+0.156*0.103+0.127*0.632
= 0.164
Over all project B priority =0.224*0.05 + 0.716*0.216 + 0.62*0.103 + 0.623*0.632
=0.623
Over all project C priority =0.156*0.05 + 0.113*0.216 + 0.224*0.103 + 0.25*0.632
=0.213
 Project Score

Project A 0.164
Project B 0.623
Project C 0.213

Step -5.Conclusion
Based on the score project B should be appraised first and financed
confidentially.
 Further on AHP
• The first step in the AHP is to develop a graphical
representation of the problem in terms of the overall
goal, the criteria, and the decision alternatives.

Overall Goal: Select the Best Project

Criteria: Technical Financial Environm Market

ental
Decision Project A Project A Project A Project A
Alternatives:
Project B Project B Project B Project B
Project C Project C Project C Project C
 Preference Scale - 1
Verbal Judgment of Preference Numerical
Rating
Extremely preferred 9
Very strongly to extremely preferred 8
Very strongly preferred 7
Strongly to very strongly preferred 6
Strongly preferred 5
Moderately to strongly preferred 4
Moderately preferred 3
Equally to moderately preferred 2
Equally preferred 1
 Example: Synthesizing Procedure - 0
Step 0: Prepare pairwise comparison matrix

Env’tal P. A P. B P. C
P. A 1 2 8
P. B 1/2 1 6
P. C 1/8 1/6 1
 Example: Synthesizing Procedure - 2
Step 2: Divide each element of the matrix by its column
total.
– All columns in the normalized pairwise comparison
matrix now have a sum of 1.

Env’tal P. A P. B P. C
P. A 8/13 12/19 8/15
P. B 4/13 6/19 6/15
P. C 1/13 1/19 1/15
 Example: Synthesizing Procedure - 3
Step 3: Average the elements in each row.
– The values in the normalized pairwise comparison matrix have
been converted to decimal form.
– The result is usually represented as the (relative) priority vector.

Env’tal P.A P. B P. C Row Avg.

P. A 0.615 0.632 0.533 0.593 0.593

0.341
P. B 0.308 0.316 0.400 0.341  
0.066
P. C 0.077 0.053 0.067 0.066
Total 1.000
 Consistency - 1
• An important consideration in terms of the quality of
the ultimate decision relates to the consistency of
judgments that the decision maker demonstrated
during the series of pairwise comparisons.
– It should be realized perfect consistency is very difficult to
achieve and that some lack of consistency is expected to
exist in almost any set of pairwise comparisons.
– Example:
 Example: Inconsistency
Preferences: If, A  B (2); B  C (6)
Then, A  C (should be 12) (actually 8)

 Inconsistency

Environ P.A P. B P. C
mental
P.A 1 2 8
P. B 1/2 1 6
P. C 1/8 1/6 1
 Multi-Criteria Model
 Technical analysis
 Market and demand analysis
 Financial Analysis
 Socio-economic analysis
 Institutional analysis
 Discounting criteria
 Non-discounting criteria
 Technical analysis
 Raw materials
 Production process/technology
 Machinery and equipment
 Plant capacity
 Location and site
 Project charts and layout
 Schedule of project implementation
Market and demand analysis
 Demand analysis
 Supply analysis
 Marketing strategy

Financial Analysis
Cost of the project

Production cost

Means of finance

Profitability projection
Socio-economic analysis
Employment effect
Net foreign exchange effect
Impact of the project on net social benefits or
welfare
Environmental impact

Institutional analysis
Managerial analysis

Organization

Manpower
Discounting criteria
Net present value
Benefit-cost ratio
Internal rate of return

Non-discounting criteria
Urgency
Pay back period
Accounting rate or return