1

3. PROJECT PREPARATION AND

ANALYSIS
Overview of feasibility study
 A key process that justifies whether to go a head with certain project
idea or disregard it.
 A feasible business venture is one where the business will:
• Generate adequate cash-flow and profits
• Withstand the risks it will encounter
• Remain viable in the long term and meet the goals of the founders

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Why do feasibility study
 Give focus to the project and outline alternatives by narrowing them
 Surfaces new opportunities through the investigative process

 Identify reasons not to proceed

 Enhance the probability of success

 Provide quality information for decision making

 Help to increase investment in the company

 Help in securing fund

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Claims not to do feasibility study
 We know what is feasible as an existing business is already doing it
 Why do another feasibility study when one was done few years a go

 Feasibility studies are a way for consultants to make money

 The market analysis is done by the company that sell us the equipment

 Why not just hire a general manager who can do the study

 Feasibility studies are waste of time

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Consequences of poor project preparation
 Low capacity utilization
 Heavy cost overruns

 Deteriorated financial profitability

 Lingering illness or the sudden death syndrome

 Overestimated returns

 Underestimated costs

 Omission of a necessary component

 Optimistic projections (yield and date)

 Failure to consider the variability of climate

 Optimistic calendar for implementations

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Cont’d
 In order for a project to be viable it has to go through a series of
rigorous testing.
 This is basically done at an appraising stage of project lifecycle.

 Market, technical, institutional feasibility, commercial profitability and

social cost benefit analysis are prerequisite for an investment.
 Project should, therefore, be defined and critically examined on the
basis of alternative solution already reviewed

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Market and Demand Analysis
 first step in project analysis is to estimate the potential size of the
market proposed for the product to be manufactured.
 Market and demand analysis is concerned with two broad issues;
• what is the likely aggregate demand for the product?
• What share of the market will the project enjoy

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 Cont’d
 in-depth study and assessment of various factors:
• patterns of consumption,
• growth,
• income elasticity
• price elasticity of demand,
• composition of the market,
• nature of competition,
• availability of substitutes

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Situational analysis and specification of objectives

 to get a 'feel' for the relationship between the product and its market,
the project analyst may informally talk to customers, competitors,
middlemen, and others in the industry
 look at the experiences of the company to learn about the
preferences and purchasing power of customers, actions and
strategies of competitors and practices of the middlemen.

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Cont’d
 If situational analysis generate enough data to measure the market
and enable us to have a clear picture of projected demand and
revenue, a formal study need not be carried out, particularly when
time and cost consideration so suggest.
 In most cases, of course a formal study of market and demand is
warranted

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Cont’d
 suppose that a small but technological competent firm has developed
an LCD projector based on a new principle that appears to offer
several advantage over the conventional (former) LCD.
 chief executive of the firm needs information about where and how
to market the new LCD projector.

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 Cont’d
 The objectives of market and demand analysis in this case may be to
answer the following questions:
• Who are the buyers of LCD?
• What is the total current demand for LCD?
• How is the demand temporarily distributed (pattern of sales over the year)
and geographically?
• What is the break-up of demand for LCD of different size?
• What prices will the customers be willing to pay for the improved LCD?

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Cont’d
• How can potential customers be convinced about the superiority of the new
LCD?
• What price and warranty will ensure its acceptance?
• What channel of distribution are most suited for the LCD?
• What trade margin will induce distributors to carry it?
• What are the prospects of immediate sales?

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COLLECTION OF SECONDARY INFORMATION
 information may be obtained from secondary and/or primary sources.
 Secondary information is information that has been gathered in some other
context and is already available.
 Primary information represents those information which are collected for the first
time to meet the specific purpose on hand.
 Secondary information provides the base and the starting point for market and
demand analysis.
 It indicates what is known and often provides leads and cues for gathering
primary information required for further analysis.

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source of secondary information
 census of Ethiopia – Quinquennial census report
 national sample survey reports

 statistical abstracts

 annual survey of industries/agriculture and export

 economic survey

 annual report by national bank of Ethiopia

 bulletin on import and export

 other publications

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Evaluation of secondary Information
• Available readily and economically; but it reliability, accuracy and relevance can be questioned.
Hence, it is important to know:
• Who gathered it and for what objective it was gathered
• When the information was gathered and when it was published
• Representativeness of the period covered
• If the terms in the study are carefully and unambiguously defined
• How the sample was chosen
• How representative the sample was
• The process of information gathering
• The degree of misrepresentation of the respondents
• The degree of sampling bias and non-response bias
• The degree of accuracy in editing, tabulating and analysis
• The appropriateness of statistical analysis used in the process
MARKET SURVEY
 For undertaking a market survey there is a need to have a sample,
which represents the entire market.
 Thus, sampling is the process of drawing a limited number of subjects
from a larger population or universe.
 Since, the researcher cannot survey the entire universe or population
that they are interested, they usually draw a sample of subjects from
the population for investigation.

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Market survey (cont’d)
• Information sought in a market survey may relate to:
• Total demand and rate of growth of demand
• Demand in different segments of the market
• Income and price elasticities of the market
• Motives for buying
• Purchasing plans and intentions
• Satisfaction with existing products
• Unsatisfied needs
• Attitudes towards various products
• Distributive trade practices and preferences
• Socio-economic characteristics
Steps in a Sample Survey
 Define the target population
 Select the sampling scheme and sample size

 Develop the questionnaire

 Recruit and Train the Field Investigators

 Obtain information as per the questionnaire from the sample

respondent
 Scrutinize the information gathered

 Analyze and Interpret the Information- parametric and non

parametric
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 Cont’d
 Results of data based on sample survey will have to be extrapolated to the target
population.
 Here it should be noted that the results of the market survey can be affected by:
• non representativeness of sample
• imprecision and inadequacies in the questions,
• failure of the respondent to comprehend the questions
• deliberate distortion in the answer given by the respondent
• slipshod scrutiny of data
• incorrect and inappropriate analysis and interpretation of data.

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Market characterization
 Based on the information gathered from secondary sources and
through the market survey, the market for the product may be
described in terms of:
 Effective
demand in the past and present
 Breakdown of demand
 Price
 Methods of distribution and sales promotion
 Consumers
 Supply and competition
 Government policy

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Effective Demand in Past and Present
 To gauge the effective demand the starting point is apparent consumption which
is defined as:
ED= Production + Imports – Exports – Changes in Stock Level
 In a competitive market, effective demand and apparent consumption are equal.

 However, in most of the 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

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Breakdown of Demand
 To get a deeper insight into the nature of demand, the aggregate
(total) market demand may be broken down into demand for
different segments of the market:
• Nature of product: commercial vehicles covers trucks and buses of various
capacities
• Consumer groups: industrial users and domestic consumers
• Geographical divisions

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Price
 Price statistics must be gathered along with statistics pertaining to
physical quantities.
 It may be helpful to distinguish the following types of prices.
• manufacturer's price quoted as FOB (Free on board) price or CIF (Cost,
insurance and freight) price
• landed price for imported goods
• average wholesale price, and
• average retail price

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Method of Distribution and Sales Promotion
 The method of distribution may vary with the nature of product.
 Capital goods, industrial raw materials or intermediates, and
consumer products tend to have differing distribution channels.
 Further, for a given product, distribution methods may vary.

 Likewise, methods used for sales promotion (advertising, discount gift

schemes) may vary from product to product.

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26
Consumer classification
Demographic & sociological Attitudinal

 Age  Preference
 Sex  Intention
 Income  Habits
 Profession  Attitudes
 Residence  Responses
 Social background
Supply and Competition
 It is necessary to know the existing source 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

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Competition
 Competition from substitute and near substitute should be special
because almost any product may be replaced by some other product
as a result of:
• relative charges in price,
• quality,
• availability,
• promotional effort and so on.

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Government Policy
 The role of government in influencing the demand and market for a
product may be significant.
 Governmental plans, policies, legislation and orders which have a
bearing on the market and demand of the product under examination
should be spelt out.
 These are reflected in: production target in national plans, import and
export trade controls, import duties, export incentives, excise duties,
sales tax, industrial licensing, preferential purchase, credit controls,
financial regulation and subsidies/penalties of various kinds

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DEMAND FORECASTING
 After gathering information about various aspects of the market and
demand from primary and secondary sources, an attempt may be
made to estimate future demand.
 A wide range of forecasting method is available to the market analyst.

 This may be broadly divided into two categories:

• qualitative and
• quantitative methods.

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Qualitative Methods
 These methods rely essentially on the judgment of experts to
translate qualitative information into quantitative estimate
• Jury of executive opinion method- method calls for the pooling of views of a
group of executive and combining them into sales estimate by averaging
• Delphi method: this method involves converting the views of a group of
experts, who do not interact face to face into a forecast through an iterative
process
• Opinions of sales persons
• Customers expectations

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Quantitative Methods
 time series projection and causal methods.
 Time series projection methods: generates forecasts on the basis of
an analysis of the historical time series.
 The important time series projection methods are as follows:
• Trend projection method
• Exponential smoothing method
• Moving average method
Ft +1 = At + (1 −  )Ft
where
0   1

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Linear Regression

• Identify dependent (y) and independent (x)

variables
b=
 XY − ((X ) Y ) • Solve for the slope of the line
 X 2 − ((X ) X )

b=
 XY − n XY


2
X − nX
2

• Solve for the y intercept

a = Y − bX
• Develop your equation for the trend line
Y=a + bX
 Example
• Forecast demand for year 11: Period Orders
• Using trend analysis 1 122
2 91
• Three year moving average 3 100
• Exponential smoothing with 4 77
5 115
alpha of 0.2 if forecasted 6 58
dd for year 10 was 102. 7 75
8 128
9 111
10 88
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Causal methods
 Chain ratio method: a simple analytical approach, this method calls for applying a series of
factors for developing a demand forecast.
 Adult male in Ethiopia= 20 ml
 Proportion of adult male popl using shaving blades= 0.6
 Adult male using shaving blade= 20 mlx0.6= 12 ml
 Number of times person shaves/year= 100
 Total shaves/year 1200 ml
 Prop. Of shaving done with stainless blade= 0.4
 Average shaves per stainless blade = 6
 Stainless blades used per year= (1200 mlx0.4)/6= 80 ml
 Market share the firm could capture= 0.2;
 Hence, potential sale of the firm will be 0.2x80 ml= 16 million

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 Cont’d
 Consumption level method: useful for a product that is directly
consumed, this method estimate consumption level on the basis of
elasticity coefficient, the important ones being the income elasticity
of demand and the price elasticity of demand.

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Income elasticity of demand


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 Cont’d
 Projected aggregate demand=
(Projected pop)x (current per capita demand)x(per capital change in income level)x EI
Example
Increase in per capita income= 10%
Present per capita income for coffee= 3 Kgs
Projected population next year= 100 ml
Projected per capita demand for coffee
(3kg)(1+0.10x0.85)= 3.255 Kgs
Aggregate demand for coffee=
(100 ml) (3kg)((1+0.10)x0.85)= 325.5 million Kgs

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 Cont’d
 End use method: suitable for intermediate products, the end use
method develops demand forecasts on the basis of the consumption
coefficient of the product for the various uses.
 Involves:
• Identification of possible uses of the product
• Define consumption coefficients of the product for various uses
• Project the output level for the consuming industry
• Derive demand for the product

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 Cont’d
 Harar coffee is used by four different coffee producers. The
relevant data given below

Consumption Project Project dd for

coefficients output next harar Coffee
year
Starbucks 1 50,000 50000
Green bond 0.5 25,000 12500
Silver 0.8 30,000 24,000
diamond
Oda star 0.25 80,000 20000
106,500 Kgs
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 Cont’d
 Leading indicator method: observed changes in leading indicators are
used to predict the change in lagging variables.
• Change in the level of urbanization may change the need for air conditioners
• Can be estimated using regression equation

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Uncertainties in demand forecasting
• Error and uncertainty in forecasting arise from:
• Data about past and present market
• Methods of forecasting
• Environmental change
Marketing plan
• A plan containing the following components shall be prepared:
• Current market situation
• Opportunity and issue analysis
• Objectives
• Marketing Strategy- STP, product, pricing, distribution, promotion
• Action Program- operationalizing the strategies
 44

TECHNICAL ANALYSIS
Technical analysis
 Analysis of technical and engineering aspect is done continually when
a project is being examined and formulated.
 Other types of analysis are dependent and closely intertwined with
technical analysis.
 The technical feasibility of a project is examined by the engineers in
the bank.

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 Technical analysis is concerned primarily with:
 material inputs and utilities
 manufacturing process/technology
 product mix
 plan capacity
 location and site
 machineries and equipment
 structures and civil works
 project charts and layouts
 work schedule

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MATERIAL INPUTS AND UTILITIES
 An important aspect of technical analysis is concerned with defining
the materials and utilities required, specifying their properties in
some detail and setting up their supply program.
 Material inputs and utilities may be classified into four broad
categories:
• Raw Materials,
• Processed Industrial Materials and Components
• Auxiliary Materials and Factory Supplies and
• Utilities.

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MANUFACTURING PROCESS/ TECHNOLOGY
 It is to be ensured that the manufacturing process to be adopted is
modern and at the same time appropriate to the level of economic
development of the country.
 the choice of technology is influenced by:
• Plant capacity
• Principal Inputs
• Investment outlay and production cost
• Use by other units
• Latest development
• Ease of absorption

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Acquiring Technology
 The company can acquire technology by
 Technology licensing- gives the licensee (the one who receive the
technology) the right to use patented technology and get related know
how on a mutually agreed bases.
 Outright purchases-

 Joint ventures arrangement- supplier of technology may participate

technically as well as financially in the project

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Appropriateness of Technology
 Appropriate technology refers to those methods of production which
are suitable to local economic, social and cultural conditions
 technology should be evaluated in terms of:
• 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 the ecological balance?
• Whether the technology is harmonious with social and cultural conditions?

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 Cont’d
 Product Mix- items, variation in size and quality
 Plant Capacity- Feasible Normal Capacity and Nominal Maximum
Capacity
 Locations and Site – proximity, infrastructure, government policy,

 Machineries And Equipment- plants, equipment (mechanical and

electrical), instruments, controls, and internal transportation systems
 Structure and Civil Works- site development and preparation, building
and structure, outdoor works

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 52

INSTITUTIONAL AND SOCIAL

ASPECTS
 Management
 Management is one of the most vital inputs for the success of a
business enterprise.
 It is the backbone of a project from appraisal stage to successful
implementation and future growth.
 It is the quality of management that makes all the difference between
success and failure of a project.
 Though management is the most important factor, yet it is the most
difficult to assess and evaluate because it is abstract, intangible and
non quantifiable.

53
Cont’d
 Assessment of management is more an art than a science.
 In management appraisal we are concerned with integrity, caliber,
resourcefulness, and quality of management.
 The aim is to identify management gap and inadequacies and
supplement them wherever necessary having regard to the
background, experience and managerial capability to the
entrepreneurs

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Project Organization and Responsibilities

 In Project Management, the structural organization

has to show:
• how a project organization is embedded within the parent
organization
• how the organization is structured internally within the
project team.

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Project Organization and Responsibilities-Cont’d

 In Project Management

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Project organization & responsibilities
 A Project Management Office (PMO) is a separate office,
staffed with full time employees, to help coordinate all
project activities within the organization.
 Project sponsor: manager or executive who can oversee a project,
delegate authority to the Project Manager and can provide support as a
trainer or coach to the Project Manager
 The steering committee :
 is a group of senior managers responsible for business
issues affecting the project.
 They usually have budget approval authority, make decisions
about changes in goals and scope and are the highest
authority to resolve issues or disputes
 Both the project sponsor and the steering committee are
responsible for project governance
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Project organization & responsibilities
 An advisory committee is a group of people that represents key
project stakeholders and provides advice to the project.
 The project manager is naturally the key person within the
project organization and has the overall responsibility for meeting
project requirements within the agreed to time, cost, scope and
quality constraints which form the framework of the project plan.
 A team leader is a person responsible for managing one part of a
project, or a “subproject.”
 Team member
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As a Project Manager - What do you Manage?
 Schedule
 The project timeline, identifying the dates (absolute or relative
to a start date) that project tasks will be started and
completed, resources will be required and upon which
milestones will be reached.
 Scope
 Projectscope involves identifying and describing the work that
is needed to produce the deliverables of the project in
sufficient detail to ensure that:
 All the appropriate work is completed
 And ONLY the appropriate work is completed

 Resources
 Team Members who perform project work
 Executive Sponsor and Guiding Team expectations
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 Roles of the Project Manager

Communicate

Communicate

The role of the project manager is to direct, supervise and

control the project from beginning to end.

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Types of Project Organizations
• There are two fundamentally different ways of
organizing projects within the parent organization
• The project as part of the Functional (divisional)
Organization
• The project as a free-standing part of the parent
organization

• A third type, called a Matrix Organization is a hybrid

of the two main types
• Each has advantages and disadvantages
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Types of Project Organizations-Cont’d
• Pure Functional (Divisional) organization
• Projects fall within the organizational units
• Pure Project organization
• Company consists solely of project teams
• Used by companies that “do” projects
• Matrix organization
• Project members belong both to project and functional unit
• Various levels of matrix organizations

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Project Management Structures
The Project as Part of the Functional Organization
• Different segments of the project are delegated
to respective functional units.
• Coordination is maintained through normal management
channels.
• Used when the interest of one functional area dominates
the project or one functional area has a dominant interest
in the project’s success.

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Functional Organizations

64
Organizational Models-Cont’d
pure line organization or functional organization

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66
Functional Organization of Projects
 Advantages
1. No Structural Change
2. Flexibility
3. In-Depth Expertise
4. Easy Post-Project Transition
 Disadvantages
1. Lack of Focus
2. Poor Integration
3. Slow DM
4. Lack of Ownership
 Pure Project Organization
(Projectized Organizational Structure)

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Organizational Models-Cont’d
pure project organization (“task-force”)

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Pure Project Organization

69
Advantages of pure project
• PM with full project authority
• Shorter communication lines than hybrid
organization
• Higher project commitment of team
• Faster decision making
• Unity of command makes life easier for staff
• Organization is structurally simple and flexible

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Problems with pure project

• Stockpiling of expertise and equipment to assure

critical state never reached
• Experts develop too much depth --- not enough
breath
• Inconsistency in carrying out policies and
procedures
• Projectitis: excessive attachment of team to
project
• Team worries of “life after the project ends”
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Project Management Structures (cont’d)
 Organizing Projects: Matrix Structure
 Hybrid organizational structure (matrix) is overlaid on the normal
functional structure.
◼ Two chains of command (functional and project)
◼ Project participants report simultaneously to both functional and project
managers.
 Matrix structure optimizes the use of resources.
◼ Allows for participation on multiple projects while performing normal
functional duties.
◼ Achieves a greater integration of expertise and project requirements.

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Matrix Organization Structure

73
Different Matrix Forms
• Weak Form (functional matrix)
• The authority of the functional manager predominates and the project
manager has indirect authority.
• Strong Form (Project Matrix)
• The project manager has broader control and functional departments act as
subcontractors to the project.
• Balanced Form
• The project manager sets the overall plan and the functional manager
determines how work to be done.

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75
Project Organization: Matrix Form
 Disadvantages
 Advantages 1. Dysfunctional Conflict
1. Efficient 2. Infighting
2. Strong Project Focus 3. Stressful
3. Easier Post-Project Transition 4. Slow
4. Flexible
Choosing the Appropriate Project Management
Structure

• Organization (Form) Considerations

• How important is the project to the firm’s success?
• What percentage of core work involves projects?
• What level of resources (human and physical)
are available?

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Choosing the Appropriate Project Management Structure
(cont’d)

 Project Considerations
 Size of project
 Strategic importance
 Novelty and need for innovation
 Need for integration (number of departments involved)
 Environmental complexity (number of external interfaces)
 Budget and time constraints
 Stability of resource requirements

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 78

FINANCIAL FEASIBILITY ANALYSIS

January 2016
 Why
 to determine, analyze and interpret all the financial consequences of
an investment that might be relevant to and significant for the
investment and financing decisions.

79
Why Financial analysis
 It provides an adequate financing plan for the proposed investment
 It determines the profitability of a project

 It assists in planning the operation and control of the project by

providing management information to both internal and external
users
 It advises on methods of improving the financial viability of a project
entity
 It illustrates the financial structure of the project and its existing and
potential financial viability.

80
METHODS OF FINANCIAL ANALYSIS
 Resource flow statements
 Profit and loss statements

 Cash flow statements and

 Balance Sheet

81
Resource flow
 The benefit and cost items included in the statement should include
only those items, which are incremental.
 The resource flow statement shows: (1) the list of resources used in
the project and (2) the resources generated by the investment on the
project.

82
Elements of resource flow
 Investment costs: investment costs cover capital expenditure
items such as land, buildings, equipment and furniture
a) Initial fixed investment costs. This includes investment made for the
acquisition of land, development of land for construction purpose,
civil works (laying the foundation), equipment and machinery costs,
installation of the machines or the plant, vehicle, furniture, building
b) Pre-production capital expenditure
• Research and development
• Pre-feasibility or feasibility study cost
• Training costs incurred before the commencement of the operation
• Recruitment of personnel costs
• Arrangement for marketing of the product
• Arrangements for supplies

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Investment cost cont’d
c) Working capital
• Working capital is simply a revolving fund. It is the difference between current
asset and current liability.
• This is known as a circulating fund because at the end of the project's life it
can be put as a benefit of the project.
• Defining the working capital requirement appropriately is important because
many projects fail while they are in operation due to shortage of cash or
working capital.
• The amount of the total working capital required depends upon the operating
costs for the project

84
 Working capital (Cont’d)
 There are three basic components of physical working and capital
inventories needed for production to be continuous. These are:
• Initial stock and materials
• Work-in-process and
• Stock of outputs

85
Working capital (cont’d)
 the amount of funds required for operating needs varies from time to time in
every business.
 But a certain amount of assets in the form of working capital are always required;
if the business has to carry out its functions efficiently and without a break.
 The two types of requirements are permanent (fixed) and variable.
• The permanent working capital is that part of capital which is permanently locked up in
the circulation of current assets and in keeping it moving.
• variable working capital changes with the volume of the output of the project

86
Elements of resource flow (cont’d)
 Operating Costs/Production Costs. Operating costs can be divided
into two: Fixed and Variable components.
 Variable cost includes items such as materials, power, labor inputs
required for manufacture which will vary directly with the volume of
production; while fixed costs will include maintenance, administration
and managerial charges which will be relatively fixed with respect to
the volume of production.

87
 Years
No Items 1 2 3 4 5 n
Capacity Utilization Rate (%) 50% 75% 80% 85% 90% 100%
1 Raw material
2 Labor
3 Utilities
4 Repair
5 Maintenance and Repair
6 Factory Overhead
Factory Costs (1-6) (a) XX XX XX XX XX
7 Administrative costs
8 Sales costs
9 Distribution cost
Operating Costs (7-9) (b) XX XX XX XX XX
10 Depreciation (c)
11 Interest expenses (d)
Total production Cost
(a + b + c + d) (Bold) XX XX XX XX XX
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operating cost includes
1. Cost of Production
 Material cost
 Wages including salaries for executives
 Utilities
 Repairs and maintenance
 Factory over heads. These items include expenses for the factory as:
◼ rent, for factory, if any
◼ insurance premium for factory assets and factory workers
◼ postage, telephone, fax, e-mail, etc, in the factory
◼ traveling expenses
◼ depreciation of plant and machinery and other factory equipment
◼ proportionate management expenses

89
operating cost includes
2. Administrative Expenses
 This represents all indirect expenses incurred in the organization including
estimates for
 salaries of all indirect staff
 postage, telephone, fax, e-mail
 traveling expenses
 insurance other than for the factory assets
 rent, rates, taxes, electricity and
 depreciations of all fixed assets other than factory fixed assets

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operating cost includes
3. Selling Expenses
 estimated expenses in sales divisions as per projected
organizations and includes the items:
 salaries and personnel cost for sales staff and managers as planned
 publicity, advertisement, exhibitions, etc.

 subsidies, commissions, discounts to dealers, etc.

 administrative expenses of sales office including rent.

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operating cost includes
4. Depreciation
 Depreciation expenses represent consumption of utility units
contained in an asset.
 It relates to the cost center where such assets are installed.

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Benefits
 Benefits can be direct (production output)
which may include items like:
• main product
• by product
• residual and other income
 Benefits can also be indirect or external: in a road
projects reducing transportation costs, reducing
operating costs for maintenance of vehicles and
saving time of the society are indirect benefits of the
project

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Project Resource Statements
Project Period
No Items 1 2 3 4 5 6
1 Land preparation
2 Buildings
3 Equipment
4 Vehicles
5 Total investment cost (1 + 2 + 3 + 4)
6 Factory costs
7 Administrative costs
8 Selling expenses
9 Depreciation
10 Total operating costs (6 + 7 + 8 + 9)
11 Incremental working capital
12 Benefits
13 Net Benefits (12-10-11)
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Project Financial Statements
 Financial analysis also involves formulation of various financial
statements, which enable project owners and other interested
stakeholders to know whether the projects worthy or not.
 commonly prepared financial statements are:
• balance sheet,
• loss and profit statement, and
• cash flow statements

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Criteria for evaluating financial viability of
projects
 There are different criteria to assess the financial feasibility of
projects:
 Payback period

 Discounting pay back period

 Net present value

 Internal rate of return

 Accounting rate of return

96
Example 1: NPV calculation

 AMA company is considering to invest in a particular project. The initial investment cost is Br.
100,000. It is expected that the project may generate a benefit for 5 years as shown below:


Year Operating cost Annual cash inflow

1 Br. 100,000 --
2 6,000 Br. 20,000
3 10,000 30,000
4 2,000 40,000
5 1,000 35,000

 The discounting rate is 10%

 Required: Calculate the NPV

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 Solution
Year Cost Revenue Present Value
(Cash in flows)
Factor
P.V. C PV.Rev
0 Br. 100,000 -- 1
100000 0
1 6,000 Br. 20,000 0.9091
5454.545 18181.82
2 10,000 30,000 0.8264
8264.463 24793.39
3 2,000 40,000 0.7513
1502.63 30052.59
4 1,000 40,000 0.6830
683.0135 27320.54
5 1,000 35,000 0.6209
620.9213 21732.25
Total
116525.6 122080.6

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Solution
 Net present value of the project = PV of Revenue – PV of Costs
= 122,080.6 – 116525.6
= Br. 5555

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 Cont’d
 Example: A company is considering investing on a particular
project. The alternative projects available are: Project A that
costs Br. 100,000, and Project B that Costs Br. 70,000. The net
cash in flows estimates are as follows:
Year Project A Project B
1 30,000 7,000
2 30,000 15,000
3 35,000 20,000
4 35,000 56,000
5 40,000 45,000
 Which project is good? Use payback period and NPV

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 IRR
• Internal Rate of Return (IRR): is defined as the discount rate that
makes the net present value zero. IRR method finds out the rate at
which – when applied on future cash inflows – the present value of
such inflows taken together should equal with the present value of
the cost of investment.

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 IRR (CONT’D)
• IRR = LDR + (HDR-LDR)  NPV of LDS/abs. D/ce the NPVs

• As you can see in the formula, you need to have two net present
values i.e., positive and negative NPVs that can be determined by the
trial and error method.
• The higher the discount rate is the lower NPV and the lower the
discount rate is the higher the NPV

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Example
 Example 1: NPV calculation
 AMA company is considering to invest in a particular project. The initial investment cost is Br.
100,000. It is expected that the project may generate a benefit for 5 years as shown below:

Year Operating cost Annual cash inflow

0 Br. 100,000 --
1 6,000 Br. 20,000
2 10,000 30,000
3 2,000 40,000
4 1,000 40,000
5 1,000 35,000
 Find the internal rate of return

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Calculate NPVs at 10%, 11%, % 12%
 At 10%, NPV = 5555.011
 At 11%, NPV= 2498.187
 At 12%, NPV= -430.755
 Hence, the IRR lies between 11% and 12%.
 Using the previous formula, IRR = 11% +(12-
11)%(2498.187/2928.943)= 11.85%

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Social Cost benefit
analysis
Social cost benefit analysis
• Also termed economic analysis.
• Used for evaluating investment projects from the point of view of
society or economy as a whole.
• Primary used for evaluation of public projects but also used for
private since government bodies have a say in one or another way in
approval of private projects.
• Received special attention in 1960s and 1970s
Rationale for SCBA
• The focus is on social costs and benefits of the project. The principal
sources of discrepancy are:
• Market imperfections
• Externalities
• Taxes and subsidies
• Concern for savings
• Concern for redistribution
• Merit wants
Market imperfections
• Market prices don’t reflect social values of the product.
• Rationing- control over its price and distribution
• Prescription of minimum wage rates- wage paid what it would be
• Foreign exchange regulations- in regulated economy exchange is less than
what would prevail
Externalities
• Projects have benefits and costs to the neighboring area.
• A road constructed has benefit to others also.
• Projects do have also harmful external effects
Taxes and Subsidies
• From private point of view taxes are monetary cost and subsides are
definitely monetary gains.
• From social point of view, however, both are general regarded as
transfer payments and hence considered irrelevant in project
appraisal.
Concern for Savings
• Private firms do not put differential valuation on savings and
consumption.
• From social point of view, however, the division of benefits between
saving and consumption is very relevant.
• A birr benefits saved is deemed more valuable than a birr of benefits
consumed.
Concern for redistribution
• Private firms do not consider how benefits are distributed across the
various groups in the society.
• A birr of benefit going to an economically poor section is considered
more valuable than the a birr of benefit going to an affluent section of
the community.
Merit wants
• Goals and preferences not expressed in the market place, but
believed by policy makers to be in the larger interest may be
preferred to as merit wants.
• Adult education or balanced nutrition program for school age children though
not important from private point of view they are important from the social
point of view.
UNIDO Approach of SCBA
• Calculation of financial profitability of project measured at market
prices
• Obtaining the net benefit of the project measured in terms of
economic (efficiency) prices.
• Adjust for the impact of the project on saving and investments
• Adjustment for the impact of the project on income distribution
• Adjustment for the impact of the project on merit and demerit goods
Net benefits in terms of economic prices
• Shadow pricing-
• Choice of Numeraire- UNIDO recommends usage of “the net present
consumption in the hands of people at the base level of consumption in the
private sector in terms of constant price in domestic accounting birr”
• Tradability- The international price or border price represents the real value
of the good in terms of economic efficiency.
• Sources of shadow prices:
• Increase or decrease in total consumption
• Increase or decrease in production in the economy
• Decrease or increase in imports
• Decrease or increase in export
Tradability
• If the impact of the project is on consumption in the economy, the
basis of shadow pricing is consumers willingness to pay.
• If the impact of the project is on the production in the economy, the
basis of shadow pricing is cost of production
• If the impact is on international trade (Δ in import or Δin export), the
basis of shadow pricing is the foreign exchange value.
Taxes
• When 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
• When a project augments domestic production by other producers,
taxes should be excluded
• For fully traded goods, taxes should be ignored.
Tradable and non-tradable goods
• A good is fully traded when an increase in consumption results in
corresponding increase in import or decrease in export.
• A good is non-tradable if import price (CIF) is greater than it domestic
cost of production and if its export price (FOB price) is less than it
domestic cost of production.
Externalities
• Special class of goods not deliberately created by the project sponsor
but is an incidental outcome of legitimate economic activity or is
beyond the control of the persons who are affected by it for better or
for worse and not traded in market place.
LITTLE-MIRRLEES APPROACH
• Similarities between UNIDO and LITTLE-MIRRLEES
• Calculating accounting (shadow) prices
• Considering the factor of equity
• Using DCF analysis
• Differences
• UNIDO measures benefits and costs in domestic currencies and L-M measures
in international prices
• UNIDO measures in terms consumptions and L-M in terms of uncommitted
social income
• UNIDO is step-by-step focusing on efficiency, savings, and redistribution;
while L-M considers them all together.
 121

ENVIRONMENT ANALYSIS
Environmental analysis
 Projects have a significant impact on the environment: positive and
negative.
 The positive environment effects needs to be enhanced and the
negative effects need to be prevented or reduced thorough
appropriate mitigation measures to achieve this, project should be
subject to an environmental assessment.
 Concern for environmental degradation in Ethiopia has been growing
in recent years.

122
 Cont’d
 The constitution states that everyone has the right to live in a clean
and healthy environment and the government will make every effort
to provide such an environment (Article 44/1)
 The constitution also holds the government and the people of
Ethiopia responsible for the preservation of natural resources and
maintenance of ecological balances.

123
most urgent areas of environmental concerns
 The considerable land degradation including loss of nutrients owing
to removal of animal manure a crop residues for use as a fuel and
cattle feed
 The low quality and availability of water, as a result of which only
about one-fifth of the population has access to safe water.
 The rapidly growing urban environmental problems including lack of
sanitary facilities, inadequate refuse collection, and low standard of
housing.

124
ENVIRONMENTAL IMPACT ASSESSMENT

In environmental assessment
there are two main level of
assessment.
• impact of projects - Environmental Impact
Assessment (EIA) and
• impact of policies, plans and program-
Strategic Environmental Assessment (SEA).

125
Stages of Environmental Impact Assessment

Impact
Assessment and
Evaluation – Monitoring and
Screening Scoping
preparation of Auditing
environmental
impact statement

126
Screening
Screening is the initial review of a project to determine if
an EIA is required.

For certain types of project it can be a mandatory

requirement to undertake an EIA.

For others it will be a matter of decision by the relevant

regulatory authority.

For all major agricultural project it is likely that an EIA

would be required, and desirable

127
Scoping
 Once a decision has been made to commence an EIA the next exercise is
to assess the likely major impacts of the project on the environment.
 This is known as scoping an initial environment evaluation.

Major adverse No possible significant

impacts adverse impact
• outright rejection of • move on to its
the project implementation
stage

128
Impact Assessment &Evaluation
 This is the identification and prediction of all the environmental
impact of the proposed project, their likely affects both positive
and negative, the way to enhance or mitigate these impacts.
 The outcome of this stage will be a report of the assessment, this
is commonly called an Environmental Impact Statement (EIS).

129
 Cont’d
 EIA the EIS may include recommendation on whether the project
should proceed of the changes, which should be made to its design
to allow it to proceed to implementation.
 The EIS should also include recommendations on environmental
monitoring to take place after project implementation

130
Monitoring & Environmental Auditing
 The final stage of the Environmental Impact Assessment (EIA)
process, or a component of project management, is environmental
auditing
 Auditing can be undertaken either by the project itself or by an
external agency.
 The objective of auditing is to assess the impact of the project
against established standard.

131
 Cont’d
 Auditing can also be linked to the socio-economic impacts of a
project.
 An irrigation project may have the potential to increase water born
diseases, and measure to mitigate these may have been part of the
project design, monitoring of health statistics and auditing of these
figures can be used to assess if this impact has occurred or been
mitigated against.
 Monitoring and auditing require resources and a commitment by the
project operator and regulatory authorities.

132
TIMING OF ENVIRONMENTAL ASSESSMENTS
 In the past the environmental assessment of a project, if it happened at all took
place toward the end of the development of the project.
 This would often have been after the identification, design and financial
appraisal of the project.
 But the environmental viability of a project is essential for a successful and
sustainable project.
 This to undergo the preparation of project leaving the environmental to the end
makes no sense, especially, if this assessment indicates that the project is not
environmentally viable and sustainable.

133
Who conducts
 Participation of project beneficiaries is also crucial when
undertaking an Environmental Impact Assessment (EIA).
 Unless local communities have been involved in the original
identification and design of a project, the onset of an EIA may be
the first thing they know about the project.

134
ENVIRONMENTAL IMPACTS
 Project will have its own positive as well as negative impact on the environment
 the impact of agricultural project can be grouped into:
• Ecological impact: loss of fauna and flora (including deforestation)
• Impact on soil: erosion, salinization, alkalinization, fertility and structure
• Hydrology: water quality, surface flow, flooding, pollution
• Socio-economic impact: crop production, nutrition, employment, and health
• Infrastructure: transport, water supply, telecommunication
• Socio-cultural: cultural sites, and archeological sites
• Land use: land tenure, land rights,

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VALUATION OF COST AND BENEFIT WITH REGARD TO
ENVIRONMENT
 Economic analysis are to take into account all costs and
benefits of a project.
 With regard to environmental impacts, however, there are
two basic problems.
 First, environmental impacts are often difficult to measure in
physical terms.
 Second even when impacts can be measured in physical terms,
valuation in monetary terms is difficult.
 In spite of such difficulties, a greater effort needs to be made
to "internalize" environmental costs and benefits by
measuring them in money terms and integrating these values
in economic appraisal.
136
Issues in measuring environmental costs and
benefits

Determining Valuing
physical impacts in Discounting; Risk and
impacts and monetary and Uncertainty
relationship terms

137
Physical Impacts and Relationship
 The first step in environmentally sound economic analysis is to
determine the environmental and natural resource impacts of the
project or policies in question.
 These impacts are determined by comparing the "with project" and
the "without project" impacts.
 For determining physical impacts, an economist will have to rely on
the expertise of engineers, ecologists, agronomists, social scientists,
and other specialists.

138
Valuing the Impacts in Monetary Terms
 A number of conceptual approaches have been developed for
valuing physical impacts and relationships.
 An environmental impact can show itself in a measurable change
in production or environmental quality. Different methods are
appropriate depending on the types of effects.

139
Evaluation methods
 Market Based Methods
 The primary feature of these methods is that they are
based directly on market prices productivity. They are
applicable where a change in environmental quality
affects actual production or production capability.
• Change in Productivity Approach
• Loss-of-earnings Approach- lost earning due to premature
death
• Defensive or Preventive Expenditures- to avoid or reduce
unwanted environmental effects

140
 Methods Based on Surrogate Market Values
 The methods and techniques described in this section
use market information indirectly.
 the property value approach, - in the area as
compared to property in some other place.
 the wage differential approach- the additional cost or
cost saving on wage because of the project
 the travel cost method-

 uses of marketed goods as surrogates for non-

marketed goods- where environmental goods have
close substitutes that are marketed
141
 Cont’d
 Methods Based on Potential Expenditures or Willingness-to Pay
 Sometimes it is not possible to estimate the benefits of environmental
quality protection or improvements.
 In some of these cases it may be possible to estimate benefits by
calculating the costs of replacing the environmental services that have
been or might be destroyed by a project, or by estimating what people
might be willing to pay (WTP) to protect an environmental asset.

142
Potential Expenditures or Willingness-to Pay
(cont’d)
 Replacement Cost Approach- the costs of replacing a damaged
asset are estimated
 Shadow project approach- involves design and costing of
one/more shadow projects that would provide substitute
environmental services to compensate for the loss of the original
assets
 Contingent valuation- direct questionnaire about willingness to pay
for a benefit or willingness to accept compensation for tolerating
costs
143
The Discount Rate Issue
 past costs and benefits are treated as "sunk" and are ignored in
decisions about the present and future.
 Future costs and benefits are discounted to their equivalent
present value and then compared.
 the interest rate measures both the subjective rate of time
preference and the rate of productivity of capital

144
The Discount Rate Issue (Cont’d)
 The main recommendations, therefore, are that:
 the standard opportunity cost of capital be used (e.g., 10 percent) for
environmental cost-benefit analysis, as it is for NPV calculations and for
computing the IRR comparator:
 short-and long-term costs and benefits be estimated as carefully as
possible; and
 a rigorous analysis of non-monetary consequences (including those that
might be irreversible) be made to supplement standard cost-benefit
analysis.

145
Issues of Risk and Uncertainty
 Projects and policies alike involve risks and uncertainties.
 Risks are involved when probabilities can be assigned to the likelihood
of an event occurring, such as an industrial accident.
 Uncertainty describes a situation where little is known about future
impacts and where therefore no probabilities can be assigned to
certain outcomes, or where even the outcomes are so novel that they
cannot be anticipated.

146