Chapter One

Introduction
1.1 meaning and definition of project
1.1. What is a project?
Organizations perform work. Work generally could be classified into either operations or
projects, although in some cases both of them may overlap. Both operations and
projects share many characteristics in common like:
 People perform both the activities.
 Both are constrained by limited resources.
 Both are planned, executed, and controlled.
However, operations and projects differ primarily in their repeatability. Operations are
ongoing and repetitive whereas projects are temporary and unique.
A project is a unique endeavor to produce a set of deliverables within clearly specified
time, cost and quality constraints.
Projects are different from standard business operational activities as they:
 Are unique in nature: They don’t involve repetitive processes. Every project
undertaken is different from the last, whereas operational activities often involve
undertaking repetitive (identical) process.
 Have a defined timescale: projects have a clearly specified start and end date
within which the deliverables must be produced to meet specified customer
requirement.
 Have an approved budget: projects are allocated a level of financial expenditure
within which the deliverables must be produced to meet specified customer
requirement.
 Have limited resources: at the start of a project an agreed amount of labor,
equipment and materials is allocated to the project.
 Involve an element of risk: projects entail a level of uncertainty and therefore
carry business risk.
 Achieve beneficial change: the purpose of a project, typically, is to improve an
organization through the implementation of business change.

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For many organizations, projects are a means to respond to requests that cannot be
addressed within the organization’s normal operational limits.

Projects are undertaken at all levels of the organization. They may involve a single
person or many thousands. Their duration ranges from a few weeks to a few years.
Projects may involve a single unit of one organization or may cross-organizational
boundaries. As projects are often implemented as a means of achieving an
organization’s strategic plan they are critical for the organizations growth. Examples of
projects could include:
 Developing a new product or service.
 Effecting a change in structure, staffing, or style of an organization.
 Developing a new or modified information system.
 Implementing a new business procedure or process.

Project management is the application of knowledge, skills, tools, and techniques to

project activities to meet project requirements. Project management is accomplished
through the use of the following 5 processes:
 Initiation
 Planning
 Execution
 Controlling and
 Closure
1.2. Features of a project
Projects are classified based on several criteria, including: ownership, source of
finance, and forces behind the projects.

1. Based on ownership:

a. Private sector- mostly projects undertaken by business enterprises.

b. Public sector- projects undertaken by national and local government bodies.

c. NGOs- development projects are most often undertaken by non-government

and non-for profit organizations.

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2. Based on the Sources of Finance:

a. Government treasury- projects may be entirely financed by government

budget as per its priority. For instance, construction of regional airport.

b. Government treasury and external sources- most projects are financed by

the joint partnership of the government and donor groups. For example, a
road project may be financed 50% by the government and 50% by a foreign
donor.

c. External sources of Finance- projects may be financed totally by parties other

than the government but established for the well being of the citizens and the
ownership may be for the government or the public.

3. Based on the forces Behind:

a. Demand driven/need driven- based on identified unsatisfied demand project

can be created or on unsatisfied basic needs like food, water and shelter.

b. Donor driven- the force behind the financing organization. Donors will have
their own say and influence the types of projects to be established.

c. Political Driven- Projects may be established in response to some political

situation such as for example because of national elections, projects by
religious organizations.

4. Based on their nature:

a. Civil engineering, construction, petrochemical, mining, quarrying, projects far

away from the contractor’s home office, and involve special risk as well as
problems of organizational communication.

b. Manufacturing projects- conducted in a factory or other home based

environment and enable exercising on the spot management.

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 c. Research projects- established for pure research consuming large sum of
money and lasting over years resulting in dramatic profitable discovery or
proving waste of money.

d. Management projects- projects that require the employment of an external

project manager or managing contractor for issues such as relocating head
quarters, developing and introducing a new computer system, preparing for a
trade exhibition, producing a feasibility or other study report, restructuring the
organization etc.

Project exhibits the following basic characteristics.

1. A project involves the investment of scarce resources in the expectation of future

benefits;
2. The project will have a measurable Objectives. Projects have specific of benefits
that can be identified, quantified and valued, either socially or
monetarily/commercially/.
3. Related to the specificity of objectives, the projects have specific beneficiaries or
clientele group, which needs to be specifically spelt out during project planning
studies.
4. A project is the smallest operational element unit. A project can be planned,
financed and implemented as a unit. Often projects are the subject of special
financial arrangements and have their own management.
5. The boundaries of projects make them distinguishable from each other.
 Projects are conceptually bounded. The problem and specific objective (need)
that justify the project involves conceptual delimitations.
 Projects are geographically bounded. Projects exist in space and we say that
projects are geographically (locationally) bounded.
6.
 Projects are organizationally bounded. Projects require the establishment of a
special organization or the crossing of traditional organizational boundaries,
meaning there should be certain organizational unit responsible for project

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 implementation.
 Projects are time bounded. One factor that makes projects bounded is the time
(life cycle) of a project. Projects have specific lifetime, with a specific start and
end time in which a clearly defined set of objectives are expected to be achieved.
7. Uncertainty and risks is inherent in any project. Achieving project objectives cannot
be predicted in advance with accuracy. The factors that make project risk are:
 Significant and multiple types of scarce resources committed today expecting
outcome in the future;
 Benefits are expected to be generated in the future, which is less predictable;
 Capital investments are irreversible; therefore, perfect exit assumption of the
perfect competition model is refuted.
8. It has a scope that can be categorized into definable tasks. Projects usually have
well defined sequence of investment and production activities
9. It may require the use of multiple resources. This has an implication on
management of project implementation. The more diverse the types of resources
are mobilized the more complex will the management be. The outcome of project
and hence development endeavor is sensitive to the management of each type of
resources. Ill managed resource can contribute more to cost than to benefit.

1.3. Project, program and Plan

Planning can be defined as a “continuous process that involves decisions or choices
about alternative ways of using available resources with the aim of achieving a
particular goal or set of goals at some time in the future.”
The rationale for planning is that it serves as a tool that enhances the effectiveness in
mobilizing resources and enables allocation of resources into priority areas of
development. In this regard, development planning can be regarded as an attempt to
raise the rationality of decision-making. The hierarchical relationship among
development plans, programs, tasks, and work packages is depicted below:

Development Plans

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 Programs

Projects

Tasks

Work Packages

Figure: Hierarchical Relationships

It is necessary to distinguish between projects and programs because there is

sometimes a tendency to use them interchangeably. A project refers to an investment
activity where resources are used to create capital assets, which produce benefits over
time and has a beginning and an end with specific objectives, while a program is an
ongoing development effort (plan) involving a number of projects. Programs may or
may not necessarily be time bounded. Yet programs cannot live forever, they have
limited life cycle, which however, may or may not be explicitly stated. So in effect in
terms of time delimitation, there is only relative difference between programs and
projects. For instance, a health program may include a water project as well as
construction of a health center; both aimed at improving the health of a given
community that previously lacked easy access to these essential facilities.

Note that projects can stand alone without being part of certain program. So, one can
visualize that the linkage of policies, development plans, and projects. Projects, which

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are not linked with others to form a program, are sometimes referred to as “stand alone”
projects.

Development plans:

 Most forward looking (futuristic)

 Broad and require systematic thinking, preparation and appraisal

 Attempts to bring welfare in the society

Programs:

 Derived from development plans

 Exceptionally large with long term objectives

 Explores specific area with broader scope

Projects:

 Derived from a program

 Unique investigative tool

 A development activity with specific objectives

 Funded by a program

 An implementation element (entity)

Tasks:

 Work elements under a project

 Specific approaches for doing things

 Set of activities comprising a project

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Work packages:

 Sub elements of a given task (or undertaking)

 Something accomplished stage by stage

 Collection of work packages defines a given task

As it can be observed from the above framework, in general, the essence of

development planning is futuristic, i.e., it is most forward looking and involves
systematic thought and preparation. Virtually, every nation, be it developed or
developing, should have a systematically elaborated national plan to hasten economic
growth and further a range of social objectives. Therefore:

1. Projects provide an important means by which investment and other

development expenditures foreseen in plans can be clarified and realized. Sound
development plans require good projects, just as good projects require sound
planning. The two are interdependent.

2. A sound plan requires a great deal of knowledge about existing and potential
projects. Sound planning rests on the availability of a wide range of information
about existing and potential investments and their likely effects on growth and
other national objectives. Thus, plans require projects. Realistic planning involves
knowing the amount that can be spent on development activities each year and
the resources that will be required for particular kind of project.

3. Effective project preparation and analysis must be set in the framework of a

broader development plan. Projects are part of an overall development strategy
and a broader planning process.

4. The more elaborated the plans and policies of the governments are, the easier
becomes the work of the project planner. For example, the project planner will
have to refer to such plans and policies to see whether the project being
considered fits well in the plan and contributes most to the fundamental
objectives of the government. These objectives can include self-sustaining

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 growth, promotion of employment, income distribution, etc.

5. As projects rightly called the “Cutting Edge” of development, they are powerful
means to achieve the development objectives; they are the crucial building
blocks of a development structure.

6. Projects aim mainly at increasing the production of goods and services, which
are fundamental components of people’s welfare, and the main objective of any
development effort is, of course, to advance social well-being.

Differences:

PROJECTS PROGRAMS

specific objectives General objectives

Specific project areas No specific project areas

Specific beneficiaries group No Specific beneficiaries group

Clearly determined and allocated No clear and detailed financial resource

funds allocation

Specific lifetime No specific lifetime

Similarities:
Projects and programs have similar characteristics in a way that both are:
 Having objectives;
 Requiring financial, human, material, etc inputs (or resources);
 Generating outputs, (goods/services), of value;

 Serving as instruments for the execution of development plans in order to boost

the national economy.

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 Chapter Two

The Project Cycle

2.1. What is project Cycle?

The way in which projects are planned and carried out follows a sequence that has
become known as the project cycle. The cycle starts with the identification of an idea
and develops that idea into a working plan that can be implemented and evaluated.
Ideas are identified in the context of an agreed strategy. It provides a structure to
ensure that stakeholders are consulted and relevant information is available, so that
informed decisions can be made at key stages in the life of a project.

The project cycle considers various stages in which each stage not only is grown out of
the proceeding one/those that are under way/but also leads into the subsequent ones.
The planning process does not contain such a stringent sequence of events since all
the aspects of the project have to be considered simultaneously and, if necessary,
adjusted to one another. Therefore, a project cycle is a self-renewing cycle in that new
projects may grow out of the old ones in a continuous process and self-sustaining cycle
of activity.

These processes can usefully be considered as a comprehensive sequence in the sense

that for the project that is implemented, each stage naturally follows the proceeding one
and leads on to the next. Actually, the division into stages is artificial; but it helps us to
understand that project planning, though a continuous process over time, has distinct
phases and stages. And therefore, throughout the project cycle, the primary
preoccupation of the analyst is to consider alternatives, evaluate them, and to make
decisions as to which of them should be advanced to the next stage in the planning
process.

Regarding the classification of the aspects for the purpose of project analysis, there are
many equally valid ways in which the project cycle may be divided and the identifiable
stages may be described. There are alternative models that deal with the project cycle.

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However, in this text, and exclusively in this chapter, more emphasis will be given to the
two basic Models that are widely accepted as a model of project by institutions,
analysts, and mostly dealt in academic literatures. These are: “The Baum Cycle (also
called the World Bank Project Cycle)” and “The UNIDO Project Cycle”. In addition to
these two, a third model developed by Development projects Studies Authority in
Ethiopia (called “The DEPSAs Model”), which is more or less identical with the UNIDO
cycle, will be briefly discussed.

2.2. World Bank’s Project Cycle

A project with the characteristic already outlined above typically run through at least
several separable stages of activities that can be thought of as constituting a definite
sequence, which some writers and institutions have called “a project cycle”. In this
regard, the first basic model of a project cycle developed by Warren. C. Baum in 1970
was by then adopted by the World Bank as a project cycle. Initially, this model had
recognized only four main stages in the project cycle, namely:

1. Identification

2. Preparation

3. Appraisal and Selection

4. Implementation

Later in 1978, the author has added additional two stages called “Negotiation” and
“Evaluation”. In this version of the Baum model, negotiation comes after projects pass
the appraisal process and become a candidate for realization. It is after appropriate
negotiations that projects become implementation entity. And then, projects that are
implemented will be the concern for evaluation, which usually closes the cycle as it
gives rise to the identification of new projects. This model, therefore, includes a total of
six identifiable stages in the project cycle. The World Bank accepted the amendment
and hence, this new version has been in use since then. Thus, each of Baum’s main
stages is discussed briefly below:

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 1. Identification :

The first stage in the project cycle and in the planning process is to find potential
projects. The sources of projects may be one or more of the following:

Some may be “resource based” and stem from the opportunity to make profitable use
of available resources.

Some projects may be “market based” arising from an identified demand in home or
overseas markets.

Others may be “need-based” where the purpose is to try to make available to all people
in an area of minimal amounts of certain basic material requirements and services.

Well-informed “technical specialists” and “local leaders” are also common sources of
projects. Technical specialists could identify many areas where they feel new
investments might be profitable, while local leaders may have suggestions about where
investments might be carried out.

Ideas for new projects also come from “proposals to extend and/or expand existing
programs and projects” as well as from identifying technological alternatives.

In general, most projects start as an elementary idea. Eventually, some simple ideas are
elaborated into a form to which the title “project” can be formally applied.

2. Preparation:

Once projects have been identified, there begins a process of progressively more
detailed preparation and analysis of project plans. At this stage, the project is being
seriously considered as a definite investment action. Project preparation,(also called
project formulation), involves pre-feasibility and feasibility studies and covers the
establishment of commercial, technical, institutional, financial, and socio-economic
feasibility. Decisions have to be made on the scope of the project, location and site, soil
and hydrological requirements, project size (farm or factory size), etc.

Resource based investigations are undertaken and alternative forms of projects are

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explored. Complete technical specifications of distinct proposals accompanied by full
details of financial and economic costs and benefits are the outcome of the project
preparation stage. The project now exists as a set of tangible proposals. Practically,
project design and formulation is an area in which local and international consultants
are very active, especially for big projects that cover large areas and have big budgets.

3. Appraisal and Selection:

After a project has been prepared, it is generally appropriate for a critical review or to
conduct an independent appraisal. This provides an opportunity to re-examine every
aspect of the project plan and determine whether the proposal is appropriate and sound
or not before large sums are committed. Generally, internal government staffs only are
used for this work and not consultants and projects are appraised both in the field and
at the desk level. Appraisals should cover at least seven aspects of a project, each of
which must have been given special consideration during the project preparation phase:

 Technical: here the appraisers concentrate in verifying whether what is proposed

will work in the way suggested or not.

 Financial: the appraisers try to see if the requirements of 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 and the arrangements for the disposal of the products are
verified.

 Incentive: the appraisers see to 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 appraisers here try to see whether what is proposed is good from
the viewpoint of the national economic development interest, all project effects
(positive as well as negative) are taken into account, and check if all are correctly

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 valued.

 Managerial: this aspect of the appraisal examines if the capacity exists for
operating the project and see if those responsible ones can operate it
satisfactorily. Moreover, it tries to see if the responsible are given sufficient
power and scope to do what is required.

 Organizational: the appraisers examine the project it is organized internally and

externally into units, contract, policy, institution, etc so as to allow the proposals
to be carried out properly and to allow for change as the project develops.

The appraisal process builds on the project plan but may involve new information if the
appraisal team feels that some of the data used at preparation or some assumptions
are faulty. The implications of the project on the society and the environment are also
more thoroughly investigated and documented. Similarly, the technical design, financial
measures, commercial aspects, incentives, and economic parameters are thoroughly
scrutinized. These issues are the subjects of specialized appraisal report. On the basis
of an appraisal report, decisions are made about whether to go ahead with the project
or not. The appraisal may also change the project plan or develop a new plan, that is,
comment made at the appraisal stage frequently give rise to alternations in the project
plan (project appraisal).

After appraisal, the viable project proposals are chosen for implementation on the basis
of the priorities of the stakeholders and the available resources. For instance, Treasury
may impose a ceiling on the ministries with a big portfolio of investments, calling for
prioritization of the core and lower priority projects. 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 its own appraisal before completing negotiations with the borrower.

4. Negotiation and Financing :

Once the project to be implemented is agreed on, for donor funded projects,
discussions are held on funding and associated aspects of funding such as conditions

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for grants, repayment period, interest rates on loans, flow of funds, contributions from
stakeholders, and whether there is co-financing or not. This culminates into an
“Agreement Document” for the project, which binds all the parties involved during
implementation of the project.

5. Implementation:

The objective of any effort in project planning and analysis clearly 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.

Frequently, original proposals are modified, though usually only with difficulty, because
of the need to get agreement between the parties involved. It is during implementation
that many of the real problems of projects are first identified. Because of this, the
feedback effects on the discovery and design of new projects and also the deficiencies
in the capabilities of the project actor can be revealed. Therefore, to allow the
management to become aware of the difficulties that might arise, recording, monitoring,
and progress reporting are important activities during the implementation stage.

Some of the aspects of implementation that are of particular relevance to project

planning and analysis are the following:

 The first is that, the better and more realistic a project plan is, the more likely it is
that the plan can be carried out and the expected benefits realized.

 The second is that, project implementation must be flexible. Circumstances will

change and project managers must be able to respond intelligently to these
changes. The common ones are: technical changes (soils, water logging, and
nitrogen application); price changes; economic policy and environmental
changes; political changes, etc. and these all will alter the ways in which projects

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 should be implemented.

6. Evaluation:

The final phase in the project cycle is evaluation. Once a project has been carried out, it
is often useful, (though not always done), to look back over what took place, to compare
actual progress with the plans, and to judge whether the decisions and actions taken
were responsible and useful. The extent to which the objectives of a project are being
realized provides the primary criterion for an evaluation. The analyst looks
systematically at the elements of success and failure in the project experience to learn
how better to plan for the future.

Evaluation is not limited only to completed projects. It is a most important managerial

tool in on-going projects and rather, formalized evaluation may take place at several
times in the life of a project. Evaluation may be undertaken when the project is in trouble
as the first step in a re-planning effort. Careful evaluation should precede any effort to
plan for new projects and it is also needed to follow-up the progress of projects. And,
finally evaluation should be undertaken when a project is terminated or is well into
routine operation.

Different groups or units may do the evaluation of projects. Among others,

 Project’s management unit often continuously evaluates its experience as

implementation proceeds.

 The sponsoring agency, perhaps, the operating ministry, the planning agency, or
an external assistance agency may undertake evaluation.

In large and innovative projects, the project’s administrative structure may provide a
separate evaluation unit responsible for monitoring the projects implementation and for
bringing problems to the attention of the projects’ management. Evaluation can help not
only in the management of the project after the initial phase, but also help in the
planning of future projects. Experience with one project can give rise to new ideas for
extension of the project, repetition, the need for “vertically” associating projects that
supply inputs to or process products from this project, and other ideas which become

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the seeds to generate new project proposals.

2.3. The UNIDO Project Cycle

The UNIDO has established a project cycle comprising the following three distinct
phases:

1.The pre-investment phase

2. The investment phase, and

3. The operating phase.

Each of these three phases is divided into stages, some of which constitute important
consultancy, engineering, and industrial (manufacturing) activities. In this regard,
increasing importance should be attached to the pre-investment phase as a central
point of attention, because the success or failure of an industrial project ultimately
depends on the marketing, technical, financial and economic findings and their
interpretations, especially in the feasibility study. 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.

1. The pre-investment phase:

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According to the UNIDO manual, the pre-investment phase comprises several stages:

 Identification of investment opportunities (opportunity studies)

 Analysis of project alternatives and preliminary project selection as well as

project preparation (pre-feasibility and feasibility studies), and

 Project appraisal and investment decision (specialized appraisal reports)

Support or functional studies are also part of the project preparation stage and are
usually conducted separately, for later incorporation in a pre-feasibility study or
feasibility study as appropriate. Though it is easier to grasp the scope of an opportunity
study, it is not an easy task to differentiate between a pre-feasibility and feasibility study
in view of the frequently inaccurate use of these terms.

The division of the pre-investment phase into stages avoids proceeding directly from
the project idea to the final feasibility study without examining the project idea
systematically or being able to present alternative solutions. This cuts out many
feasibility studies that would have little chance of reaching the investment phase.
Finally, it ensures that the project appraisal to be made by national or international
financing institutions becomes an easier task when based on well-prepared studies. All
too often, project appraisal actually amounts to project preparation, given the low
quality of the feasibility study submitted.

(A) Opportunity Studies

The 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, which should analyze:

1. Natural resources

2. The existing agricultural base (it may be the basis for agro-industries)

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 3. Future demand for consumer goods

4. Imports substitution and export possibilities

5. Environmental impacts (mandatory or non-revenue producing projects)

6. Expansions of existing capacity

7. Manufacturing sectors (successful in other countries)

8. Diversification

Opportunity studies are rather sketch in nature and rely more on aggregate estimates
than on detailed analysis. Opportunity studies could be general or specific.

¤ General opportunity studies (“sector approach") could be area studies designed to

identify opportunities on a given area (Administrative province, backward region);
industry studies to identify opportunities in delimited industrial branch; and resource-
based studies to reveal opportunities based on the utilization of natural, agricultural, or
industrial resources.

¤ Specific project opportunity studies (“enterprise approach”) are seen in the form of
products with potential for domestic manufacture. A specific project opportunity study
may be defined as the transformation of a project idea into a broad investment
proposition.

A project opportunity study should not involve any substantial cost in its preparation, as
it is intended primarily to flashlight the principal investment aspects of a possible
industrial proposition. The purpose of opportunity study is to arrive at a quick and
inexpensive determination of salient facts of an investment possibility.

(B) Pre-Feasibility Studies

The project idea must be elaborated in a more detailed study. However, formulation of a
feasibility study that enables a definite decision to be made on the project is a costly
and time-consuming task. Therefore, before assigning larger funds for such a study, a
further assessment of the project idea might be made in a pre-feasibility study. This is

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to see if:

* All possible project alternatives are examined,

* The project concept justifies detail study,

* All aspects are critical and need in-depth investigation, and

* The project idea is viable and attractive or not.

A pre-feasibility study should be viewed as an intermediate stage between a project

opportunity study and a detailed feasibility study, the difference being in the degree of
detail of the information obtained and the intensity with which project alternatives are
discussed. The structure of a pre-feasibility study should be the same as that of a
detailed feasibility study.

(C) Support/Functional/Studies

Support or functional studies cover aspects of an investment project, and are required
as prerequisites for, or in support of, pre-feasibility and feasibility studies, particularly
for large-scale investment proposals. This may include:

 Market studies of products

 Raw material and factory supply studies

 Laboratory and pilot plant tests

 Location studies

 Environmental impact assessment.

 Economies of scale studies

 Equipment selection studies

The contents of a 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

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enough to give directions to the subsequent stage of project preparation. In most cases,
a support study when undertaken either before or together with a feasibility study, form
an integral part of the latter and lessen its burden and cost.

Feasibility Studies

A feasibility study should provide all data necessary for an investment decision. The
commercial, technical, financial, economic, and environment prerequisites for an
investment project should, therefore, be defined, refined and critically examined based
on alternative solutions already reviewed in the pre-feasibility study. The results of these
efforts is then a project whose background conditions and aims have been clearly
defined in terms of its control objective and possible marketing strategies, the possible
market shares that can be achieved, the corresponding production capacities, the palnt
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. 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 unequivocally(clearly) in order not to omit any
essential part and its related cost.

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 application-bearing
in mind that the larger the project the more complex will be the information required.
Although feasibility studies are similar in content to pre-feasibility studies, the industrial
investment project must be worked out with the greatest accuracy in an iterative
optimization process, with feedback and inter-linkages, including the identification of
commercial, technical, and entrepreneurial risks.

The sensitive parameters such as the size of the market, the production program, or the
mechanical equipment selected should be examined more closely. A feasibility study

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should be carried out only if the necessary financing facilities, as determined by the
studies, can be identified with a fair degree of accuracy. There would be little sense in a
feasibility study without the reliable assurance that, in the event of positive study
findings, funds could be made available. For that reason, possible project financing
must be considered as early as the feasibility study stage because financing conditions
have a direct effect on total costs and, thus, on the financial feasibility of the project.

(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 gains. Large investment and development
finance institutions have a formalized project appraisal procedure and usually prepare
appraisal reports. 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, and financial and possibly
also economic aspects.

2. The Investment/implementation Phase

The investment or implementation phase of a project provides 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:

 Establishing the legal, financial, and organizational framework

 Tendering, evaluation of bids, and negotiations

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  Technology 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 supplies and suppliers and

setting up the administration of the firm.

 Recruitment and training of personnel

 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 especially important to

receive comprehensive tenders for goods and services for the project from a
sufficiently large number of national and international suppliers of proven efficiency and
with good delivery capacity.

Negotiations and contracting are concerned with the legal obligations arising from the
acquisition of technology the construction of buildings, the purchase and installation of
machinery and equipment and financing. This stage covers the signing of contracts
between the investor or entrepreneur, on the one hand, and the financing institutions,
consultants, architects and suppliers of raw materials and required inputs, on the other.

The construction stage involves the 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.

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Of particular relevance is the timely initiation of marketing arrangements to prepare the
market for the new products (pre- production marketing) and secure critical supplies
(supply marketing).

Plant commissioning and start up is usually a brief but technically critical span in
project implementation. It links the proceeding construction phase and the following
operational (production) phase.

In general, it is to be noted that in the pre-investment phase, the quality and

dependability of the project are more important than the time factor, while in the
investment phase, the time factor is more critical in order to keep the project within
the forecast made in the feasibility study.

3. The Operating Phase

The problem of the operating phase needs to be considered from both a short and a
long-term view point.

 The short-term view relates to the initial after commencement of production

when a number of problems may arise concerning such matters as the
applications of production techniques, operation of equipment, or inadequate
labor productivity owing to lack of qualified staff and labor. Most of these
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 projections made at the pre-investment phase. If
such strategies and projection prove faulty, any remedial measures will not
only be difficult but may prove highly expensive.

The given outline of the investment and operating phases of an industrial project is
undoubtedly an oversimplification for many projects, and, in fact, certain other aspects
may be revealed that even greater short or long term impacts.

There are various ways in which the project cycle may be viewed and portrayed

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depending on the purpose, emphasis, and detail required to illustrate. According to the
Guidelines to project planning in Ethiopia (1990) of Development Project Studies
Authority (DEPSA), the project cycle comprises three major phases,

A. Pre-investment

B. Investment, and

C. Operating phase.

Each of these three phases may be divided into stages. The Guidelines has divided the
Project cycle into six stages as follows:

1. Identification

2. Preparation

3. Appraisal/decision

4. Implementation

5. Operation

6. Ex-post evaluation.

The pre-investment phase consists of the first three stages, the investment phase
includes the fourth stage, and the operation phase covers the last two stages. The
project cycle means the various stages of information gathering and decision-making,
which take place between a project’s inception and completion.

In reality, these are somewhat artificial, but do serve to emphasize the need to think of
project planning as a process of decision-making taking place overtime. Broadly
speaking, what is important about this process is that it should begin with the
identification of number of alternatives, using existing information and gathering new
data in such a way as to limit alternatives under consideration to those few, which are
more promising.

Throughout the project cycle, the primary preoccupation of the analyst is to consider

Page 25
alternatives, evaluate them, and to make decisions as to which of them should be
advanced to the next stage. In short, the project planning process is essentially a task of
eliminating less viable ideas and alternatives; and in the continuum, planner naturally
hopes that the best alternative will emerge. In this process:

The results and/or outputs of a given stage serve as the input or part of the input of the
next stage, if it is decided to proceed to the next stage;

The output or part of the output of one stage may be used as new input (feedback) to
reconsider or revise, where necessary, the result of proceeding stages; and

Most importantly, the results of the implementation, operation, and ex-post evaluation
stages of a project constitute valuable experienced for the preparation of subsequent
projects provided these inputs are systematically documented and analyzed.

CHAPTER 3

PROJECT IDENTIFICATION

3.1 project idea – meaning

I. General

Project Identification is the process of searching for and subsequently finding potential
projects that could feasibly generate benefits in excess of costs accruing to the society
and contributing towards the attainment of specified development objectives. Project
identification is made in rather general terms with broader scope at the first glance and
then, the idea will be progressively developed. In the continuum, even alternative
versions of the same may be conceived.

II. Who Identify Projects?

The following groups may identify projects:

 Small producers organizations/producers’ unions

 Large scale individual private sector producers

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  Product marketing organizations

 Private sector companies (local/multinational)

 State owned enterprises & organizations

 Government ministries, authorities, agencies, and commissions

 Development banks, local as well as foreign, and international development

agencies

 Other aid agencies and self aid associations

 Local governments; state, regional, and sub-regional authorities

 Local political & pressure groups such as oppositional parties

 NGO’s: Local or international

 Credit institutions & cooperatives

 Credit unions, saving and loan associations, saving banks, commercial banks, etc.

PRE-IDENTIFICATION

“Pre-identification” is an important prelude to protect identification. The pre-

identification stage involves surveying, reviewing, inventorying, and analysis of
strategies and policies, data about natural resources, and socio-economic variables.
This stage is a synonym to opportunity study under the UNIDO cycle, which is very
important phase in project planning. Unfortunately, this aspect of planning is either
totally ignored or for which inadequate resources are provided in most developing
countries. There are a number of reasons for disregarding this aspect in project
planning:

 First and, perhaps, most important of all is the sheer ignorance: to learn its
importance and to identify ways of carrying out surveys; inventorying of
resources; collection, organization, and integrating data; and analyzing the
information cost-effectively and generate useful information.

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  Secondly, such work tends to be regarded as an extensive task resulting in
excessive overhead costs. Moreover, often, funds for such activities are
expended in tight schedules during end of budget period.

 Thirdly, much of the work has tended to be time consuming and hence, people
lack the initiatives to start it, unable to foresee and measure its benefits, and not
patient to wait for results.

Nowadays, modern technology is revolutionizing the survey methods and the means for
carrying out synthesis and analysis, speeding up some processes, reducing the costs of
surveys, and providing new ways of looking at things. Identifying existing gaps, generate
useful information, accomplishing analysis of data, and throwing up ideas for possible
projects is a pre-requisite to sound project formulation. In addition, project identification
must be carried out within national, regional, and Sectorial development framework and
policies including pricing, taxation, and subsidy. Otherwise, much time and effort might
be wasted in the process of identifying and preparing projects that might be
inconsistent with existing policies, strategies, and priorities and hence, might turn out to
be unfeasible by the end of the day.

Thus, those who are responsible for identifying projects need to be aware of accepted
strategies and policies as well as to be in position to feedback information to those who
are responsible for formulating policies.

PROJECT IDENTIFICATION

The search for promising project ideas is the first step towards establishing a
successful venture. The key to success lays in getting into the right business at the right
time. The objective is to identify investment opportunities, which are prima facie
feasible and promising and merit further examination and appraisal. project
identification is the process identification should be an integral part of the micr-planning
exercise, with Sectorial information and strategies being the main sources of project
ideas.

In practice, however, projects do not always derive from national and sectoral plans.

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Instead, they may originate from several sources. Irrespective of their origin, project
ideas, in general, should aim at overcoming constraints on the national development
efforts, be it material, human, or institutional constraint, or at meeting unsatisfied needs,
and demand for goods and services. Constraints, needs, and demands should be
interpreted broadly to include, for instance, foreign exchange constraints that might
indicate the need to undertake projects for export promotion or import substitution.

The variety of projects makes it impossible to prepare an exhaustive list of sources

from where project ideas emanate; but much depending on the experience and
imagination of those entrusted with the task of initiating development project. In
general, one can distinguish two levels where project ideas are born: the macro-level
and micro-level.

3.2. SOURCES OF PROJECT IDEAS

3.2.1. Macro Source of Project Ideas

Among the various institutions, and sources, the following are the most important ones
in developing countries at the macro level:

 Federal/central or Regional Government

 Bilateral and Multilateral Agreement

 International Development Agencies.

In general, in developing countries, the government remains to be the major source of

project for the reason that it:

A. Has the necessary resource for the task

B. Has unlimited access to data and information

C. Has the required facilities to conduct survey, studies and reviews

D. Is fully familiar with the development objective priorities and strategies, i.e. the
development goals, priorities, and strategies often are not clear to private groups.

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 [Ambiguity exists regarding the development goals or it may not be in their best
interest]

Specifically, project ideas emerge from the following macro sources:

 National policies, strategies, and priorities as may be enunciated(or articulated)

by government from time to time

 National, Sectorial, sub-Sectorial, or regional plans and strategies supplemented

by special studies, sometimes called opportunity studies, conducted with the
explicit aim of translating national, Sectorial, sub-Sectorial, and regional
programs into specific projects.

 General surveys, resource potential surveys, regional studies, master plan, and
statistical publications, which indicate directly or indirectly investment
opportunities

 Constraints on the development process due o shortage of essential

infrastructure facilities, problems in the balance of payments, etc.

 Government decisions to correct social and regional inequalities or to satisfy

basic needs of the people through development projects.

 A possible external threat that necessitates projects aiming at achieving, for

example, self-sufficiency in basic material, energy, transportation, etc

 Unusual events such as droughts, floods, earthquakes, hostilities, etc

 Government decisions to create project-implementing capacity in such areas as

construction, etc.

 At the macro-level, project ideas can also originate from multilateral or bilateral
agreements, development agencies, and as a result of regional or international
agreements in which the country participate

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  In addition, inspirations of individuals and institutions, workshops, and
development experiences of other nations may point to some interesting project
ideas in the local context.

3.2.2. Micro Source of Project Ideas

At the micro-level, many institutions/entities could generate project ideas, among

which the following are the main ones:

 Private and Public Enterprise

 Local groups or Organizations

 Consumer groups and Associations

 Financial Institutions/ Credit Associations

 Cooperatives, Farmers’ Unions, etc

 New technology Suppliers.

There are quite diverse micro-sources of project ideas that emanate from:

 The identification of unsatisfied demand or needs

 The existence of unused or underutilized natural or human resources and the

perception of opportunities fro their efficient use

 The need to remove shortages in essential materials, services, or facilities that

constrain development efforts

 The initiative of private or public enterprises in response to incentives provided

by the government

 The necessity to complement or expand investments previously undertaken

 The desire of local groups or organizations to enhance their economic status and
improve their welfare

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  Analyze the performance of existing industries

 Examine the inputs and outputs of various industries

 Review imports and exports

 Look at the suggestions of financial institutions and development agencies

 Investigate local materials and resources

 Analyze Economic and Social Trends

 Study new Technological Developments

 Draw clues from consumptions abroad

 Explore the possibility of reviving sick units

 Attend trade-fairs (trade promotion)

 Project proposals may also come from multinational firms, in response to

government investment incentives or else when such firms consider production
within the country is a better way to secure a substantial share of the domestic
market for their products.

Screening Potentially Promising Ideas

Once a list of project ideas has been put forward, the first step is to select one or more
of them as potentially promising. This, calls for a quick preliminary screening by
experienced professionals who could also modify some of the proposals. At this stage,
the screening criteria are vague and rough, that become specific and refined as project
planning advances.

During the preliminary screening to eliminate ideas, which prima facie are not promising,
it is required to look into the aspects such as:

 Compatibility with the promoter

 Consistency with government priorities

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  Availability of inputs

 Adequacy of market

 Reasonableness of costs

 Acceptability of risk level

During preliminary selection, the analyst should eliminate project proposals that:

 Are technically unsound and risky;

 Have no market for the output;

 Have inadequate supply of inputs;

 Are very costly in relation to benefits;

 Assume over-ambitious sales and profitability.

Obviously, since the criteria tend to be somewhat nebulous (vague, imprecise, and ill-
defined), much depends on the experiences and sense of objectivity of the
professionals applying them. It is, however, necessary to conduct this screening, even
with indistinct criteria, in order to reduce the number of project alternatives to a
manageable level to which more work and time will be devoted. Indeed, project planning
can be viewed as a process of elimination, i.e. elimination of interior alternatives. As a
result of the preliminary screening exercise, a project profile, an opportunity study report,
or an identification study report, as appropriate, is prepared showing which project
alternatives should be rejected and which ones may be advanced to the next stage.

PROCESS OF IDENTIFICATION

Generally, an idea of projects may come to our mind from observing existing
opportunities and problems in a given context. When we are more concerned about
project identification, the formal task of conducting identification studies, (opportunity
studies), is one of the best available option to project planners, which is critically
important to generate and/or come up with useful information.

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Objective of identification studies:

To collect sufficient data and generate beneficial information concerning the

background, technical, economic, social, and environmental aspect of a potential
project.

The following table presents the approaches, aspects, and considerations in project
identification studies:

APPROACHES ASPECTS CONSIDERATIONS

Area studies  Identification of  backward/marginalized

opportunities in given area areas
as localities, regions,
states, etc

 To bring balanced
development

Industry studies  Identification of  Development plans &

opportunities in the programs
industrial sector
 Investment policy
 Specific marketable
 Economic policy
product

 Diversification

 Import substitution

 Export possibilities

Resource based  Opportunities in exploiting  Industry policy

studies natural resources
 Other policies &
 natural resource priorities
analysis

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  Import substitution

Sector analysis/  satisfaction of social  Sectorial strategies

Studies needs: Agricultural,
 Sectorial priorities
manufacturing, health,
education, etc  Existing unsatisfied
needs

 Sectorial development
level

Project Idea Generation Process

1. Survey & Review of Endowments and Facilities (infrastructure):

Surveying, reviewing and analysis of existing policies, resource endowments, and

socio-economic variables.

 Natural resource: review of the natural resource endowments of the

country.

 Human resource : review of educational standard and facilities

 Socio-economic variables : review of various socio economic factors such

as :

 Housing facilities & standard

 Utilities services

 health and nutrition services

 income distribution

2. Field survey and interview:

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  Asking people what goods or services they want in order to identify their
unsatisfied needs.

 Asking people what their problems are.

 Asking the public unit closest to the people at the grass-root level about what
the needs of the people in the community are.

3. Observing and analysis of prevailing situation:

 Observing and examining current demand & supply situation for

goods/services

 Examining past& future trends for goods and services

 Observing possibilities for improvements/ quality & quantity

 Observing opportunities & threats in the invention & introduction of new

technology, etc.

4. Deliberations, discussions, and trainings:

o Discussions and deliberations in seminars, workshops, conferences both

local and international

o Meeting at different levels within the organization

o Educational & training programs

5. Brainstorming:

A group of people suggesting different ideas regarding future activities, very

quickly, before analyzing and/or considering the source of the idea more
carefully.

6. Exposure to publication & media:

 Reading various publications and media: journals, magazines, newsletter,

newspapers, etc

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  Audio-visual media (discussions, reports etc)

 Visual media (cinema, video)

7. Informal discussions and meetings:

 Get together meeting

 Friendship meetings (fraternal associations)

Feeling of feasibility:

The observation studies, discussions, etc made in accordance with the above manner
could ultimately lead to the generation of project ideas. The individuals or entities
generating the idea develop a kind of feeling that the project ideas could be feasible.
Those project ideas that seem to be feasible would then become the basis for
identification of potential projects that:

 Could be thoroughly investigated & assessed

 Need be supported by tangible and factual evidences

Approaches to Project Idea Generation

Broadly speaking, project ideas could be generated through the following two
approaches:

Top-Down Approach (Macro level)

It is an approach whereby individuals at the micro level, or grass root level, are not
involved in the process of project idea generation.

 Projects are identified at the higher planning (or macro) level and implemented at
the decision of officials at the top.

 It is based on the national plan and strategies.

 The government need not go down because the problem might be

understandable.

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  However, it may not relate to the existing reality in particular vicinity.

 Such projects may encounter resistance & implementation difficulties due to lack
of interest by the society.

 Such projects are implementation entities at given local area, which may not be
consistent with the needs in the context and hence, may not necessarily reflect
the realities in the locality.

Bottom-Up Approach (Micro level)

A bottom-up idea generation process requires base line surveys, which is based on the
realities existing in different localities.

Project Ideas

Survey of needs Survey of key Survey of resources

development
bl

 May get community support, successfully implemented, and the potential

benefits might easily be visualized (seen) by the society. This may help to
create goodwill and positive images towards the institution.

STEPS IN PROJECT IDENTIFICATION:

Step 1: Generation of project ideas.

Step 2: Screening project ideas: giving priorities based on resources, compatibility to

objectives, potential to enhance competitiveness, and value adding in the society.

Step 3: Identification of candidate projects passing the screening criteria

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Step 4: Propose for pre-feasibility/ feasibility studies

PROBLEMS IN PROJECT IDENTIFICATION

 Ambiguity about the development objectives of the country:

 People may not clearly identify development goals

 development goal may not be well communicated

 may not be in the best interest of units or groups

 may not get full hearted acceptance from the public

 Priority issues in the existing development objectives:

 Conflict regarding the priorities set

 opposing views may result in lack of interest & commitment

 Differences in views regarding critical aspects of priority

 differences in prioritizing goals & objectives

 Limited information and data and obstacles in data/information flow and

accessibility:

 Data and information flow problem

 accessibility of data flowing

 limited data& information

 data may not be dependable(reliable) to use

 Conflict of interest between local beneficiary group: (i.e. some groups may
bear the cost and others may get the benefit)

 What are the costs & benefits of identified projects?

 Who bears the costs & benefits in the society?

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  Is benefits accruing to other groups while the costs paid by a given
local group (unit)

 Mechanisms to compensate those bearing the costs

 Unless compensated, the consequences might be unfavorable, costly,

and severe as well.

UNIT 4 PROJECT PREPARATION

4.1. Markets and Demand Analysis

Market analysis is a process of assessing the level of demand for the product or service
to be produced from the project. This in other words means determining the
marketability of the product or the service of the project under consideration. Different
techniques of demand forecasting are used in analysing the availability of market for
the products and assessing the level of demand.

Objective of the study:

The study of market and demand analysis, being the first in project preparation, has the
following main objectives:

 To systematically assess the market and the market environment to

generate pertinent data.

 To collect, analyze, and report data about a specific market situation

 To obtain insight about the target market structure

 To identify customers’ needs and behavior in the market.

 To design the marketing mix fit in the context

 To identify available distribution channels

 To identify competitors and their characteristics in the target market

 To determine the socio-economic aspects relevant to the preparation and

Page 40
 evaluation of the project’s market strategy

 To identify the existing strengths and weaknesses in the internal

environment of the firm

 To project the level of demand expected

 To delineate marketing opportunities and threats

 To decide on subsequent aspects of a project

 To develop sales program of the firm.

4.2. Raw Materials and Supplies Study

General

An important aspect of technical analysis is concerned with defining the materials and
supplies required, specifying their properties in some detail, and setting up their supply
program.

 There is close relationship between the study of raw materials and supplies
required and other project formulation stages, such as definition of plant
capacity, location, and selection of technology and equipment, as these inevitably
interact with each other.

 The main basis for selection of materials and inputs is, however, the demand
analysis, the production program and finally the plant capacity.

Therefore, issues relating to material and input requirements should be covered in the
feasibility study.

Objectives of Input Study:

 To determine

 types of raw materials and supplies required

 Availability of basic raw material suppliers

Page 41
  quantity of raw materials needed for the plant

 quality of raw materials and suppliers available and needed

 To estimate the cost of raw materials and supplies needed

 To develop supply programs and devise supply marketing schemes.

UNIDO Approach in the study:

The approach followed by UNIDO in the study of raw materials and supplies is as
follows:

Step 1: Classification of raw materials:

1. Raw materials (unprocessed and semi processed.

 Agricultural products

 livestock and forests products

 marine products, and

 mineral products

2. Processed Industrial materials and components

3. Factory supplies: Auxiliary materials, utilities, and spare parts.

Step 2: Specification of requirements:

 Product characteristics and material inputs

 Requirements of raw materials and factory supplies.

Step 3: Check Availability and supply of the raw materials

Step 4: Supply marketing and supply program:

 Supply Marketing, with the objective of :

Page 42
  Cost minimization

 Risk minimization (reliable supplies sources)

 Cultivating relations with the suppliers

 supply program

Step 5: Estimate costs of raw materials and supplies

 Unit costs, annual costs, and overhead costs.

The approach followed by the UNIDO is adopted and each of the aspects indicated in
the above five steps is explained next.

4.3 Location, Site and Environment Impact Assessment (EIA)

I. Location and Site Selection Aspects:
In Location and site selection, the following considerations should be
made:
 The choice of location should be made from a fairly wide geographical area,
within which several alternative sites can be considered.
 An appropriate location could extend over a considerable area, such as along a
river bank or 15 kilometer radius around an urban area in a particular geographic
district.
 Within a recommended location one or more specific project sites should be
identified and assessed in detail.
 For each project alternative, the environmental impact of erecting and operating
the industrial plant should be assessed.
The main criteria or key requirements for selecting proper location and sites should
always be identified at early stage of the study. Qualitative analysis of these key
requirements would then allow the assessment of a number of potential locations and
sites, and the rejection of those not fulfilling the key requirements. The remaining
alternatives are then subject to a more in-depth qualitative analysis of technical,
financial, social environmental and economic aspects of location and site selection.

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The most important or critical requirements include, among others:
The Natural Environment (climatic conditions and Ecological requirements.
Environmental Impacts
Socio economic policies (Role of public policies and Fiscal and legal aspects)
Infrastructural Conditions (Infrastructure dependence, factory supplies, Human
resources, Infrastructural services, and Effluent and waste disposal facilities)
Final choice of location (resource or market orientation)
In site selection, the requirements and relevant factors are:
Site requirements (cost of land, construction requirements, local condition,
Infrastructure, effluent and waste disposal, Human resources)
Final site selection and cost estimates.
II. Location Analysis
Location analysis has to identify locations suitable for the industrial
project under consideration. A project can potentially be located in a
number of alternative regions, and the choice of location should be made
from a fairly wide geographic area within which several alternative sites
may have to be considered.
The study should also indicate on what grounds alternative locations have
been identified and give reasons for leaving out other locations that were
suitable but not selected.
The choice of suitable locations require an assessment of, among others,
 Market and marketing aspects
 The availability of critical project inputs, such as:
Raw materials
Factory supplies
 Technical projects requirements
 The type of industry
 Technology and process
 Characteristics of products or outputs
 Size of the plant
 Organizational requirements and management structure.

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As key aspects vary from industry to industry, the project analyst will have to use their
professional skills to identify those key criteria, which are relevant for each specific
project. The identification of key requirements helps to reduce the number of potential
locations and sites at an early stage.
III The Natural Environment

Climatic Conditions:

Climate can be an important factor for choice of location. Apart from the direct impact
on project costs of such factors as dehumidification, air conditioning, refrigeration, or
special drainage, the environmental effects may be significant. Thus, information
should be collected on temperature, rainfall, flooding, dust, fume and other factors for
different locations.

Ecological requirements:

Some projects may not have negative environmental impacts by themselves, but would
rather be sensitive to such effects. Agro industrial projects clearly depend on the use of
raw materials that have not been degraded by contaminated water and soil.
Management and labor may be reluctant to work in a factory located in a polluted area
with health risk.

.Environmental Impact Assessment (EIA)

EIA is an assessment which aims at ensuring that development projects are

environmentally sound (friendly).The feasibility study should include a thorough and
realistic analysis of the environmental impact of the industrial project. The impact is
often of crucial importance for the socio-economic, financial, and technical study of the
project.

Objectives of Environmental Impact Assessment:

General:

To ensure the project under consideration is environmentally sound.

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 To incorporate in the project design any existing regulatory requirements,
emission standards, and guidelines

To identify measures for mitigation of adverse environmental impacts that land

for.

To enhance the likely beneficial impacts of the project.

To determine environmental merits of alternative projects.

In principle, environmental impacts should be assessed on the basis of legal regulations

and emission standards and guidelines established in the country. In countries where
no regulations and standards are defined, it may be advisable to anticipate a future
tightening of environmental impact control measures. if trends are properly considered
during the project planning stage, unexpected costs for later plant adaptations,
conversions, rehabilitations, or even the shutdown of operations may be avoided or
minimized.

4.4. Production Program and Plant Capacity

Production Program: basis and Aspects

Sales program as a basis

Sales program shows the level of sales forecast to be realized during the specified life
of the envisaged plant (showing local sales, export sales, total revenues over project
life0.

1. Sales program is projected under market analysis

Market requirements and market structure identified

Marketing strategies will be defined & the implications broadly in terms of:

 Product pricing

 Production program

 Promotional efforts

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  Sales & distribution mechanisms

Marketing mix

Demand forecasting

2. Provides inputs for financial analysis

After projecting sales for different stages of production, a feasibility study should
define and come up with the detailed production program. A production program
defines the level of output to be produced during specified period and, from this
viewpoint, we can say that it should be directly related to the specific sales forecasts.

Aspects in Production Program

The demand and market analysis specify the sales program, which should be
transformed into the plant production program, taking into account losses of
production within the production plant site, in storage, transportation, and by
warranty service. It indicates the level of output to be produced during specified
period.

Objectives:

 To determine the type and range of products to be produced over the life of
the envisaged plant.

 To show the level of capacity utilization expected and the quantity of

production.

Considerations:

Determine capacity utilization

Determine the type of products or range of products

It is related to the sales program (sales forecast)

 The determinants of a production program during the initial production

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 years vary considerably from project to project.

 Thus, different approaches would have to be adopted for different

industries. Below are cases illustrating this:

Single Product Case: Cement factory, coal factory, tea factory, Sugar factory

Multiple Products Case: Electronics factory, machine tools, leather products, food
complex, Oil Refinery.

Case 1: Single-product-continuous process manufacturing as in cement production

Case 2: Multiple-products-continuous process production as in an oil refinery;

Case 3: Batch/Job orders production such as in an engineering workshop; and

Case 4: Assembly/mass manufacturing as for the production of motor cars.

4.5. Technology Selection

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

1. Licensing: A license gives the right to use patented technology and provides for
the transfer of related know-how on mutually agreed terms. Technology licensing
has developed into a popular and effective mechanism for trade in technology. In
cases where technology licensing is considered necessary, it is desirable to have
the technology package disaggregated and to identify critical contractual
elements.

2. Purchase of Technology: Outright purchase is appropriate when “one-time”

technological right or know-how are to be secured, and when there is little
likelihood of subsequent technological improvements or need for continued
technological support to the prospective licensee.

3. Participation of the license-holder in the joint venture: This refers to allowing

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 equity participation by a technology supplier. This type of acquisition is
sometimes found important for continuing technical assistance and supply of
inputs and services is necessary over a period of time, or access to external
markets that may otherwise be difficult to operate.

4. Disaggregation: The technology packages should be disaggregated into various

component parts, such as the technology proper, related engineering services,
phasing of domestic integration, supply of intermediate products and even the
supply of equipment by licensors. A distinction should be made between
essential and technological features and others that should be evaluated
separately.

5. Technology Absorption and Adaptation: The feasibility study should indicate the
measures and actions to be taken for technological absorption and adaptation of
the acquired technology to local conditions. An essential element in staff
planning and an efficient recruitment policy has to be combined with a
comprehensive training programme for various categories of plant personnel.
Technological adaptation requires not only the adjustment of special know-how
to local factor conditions, but also the capability to modify products and
processes to suit local preferences and requirements and to initiate a process of
innovative development in a particular field.

Contract Terms and Conditions:

The contractual terms and conditions for technology acquisition and transfer need ne
highlighted in the feasibility study. The contract for technology licensing should be
carefully scrutinized with respect to:

 definition (process, products, documentation)

 Duration ( adaptation, upgrading, and renewal)

 Warranty ( guarantee to technological features and know-how)

 Access to improvement (access to improvement made by licensor)

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  Industrial property right (patents and usage rights)

 Payments ( a lump sum, or royalties, or both)

 Territorial sales right( exclusive and non-exclusive)

 Training (in the plant of licensor or supply of expert)

 Supply of imported input ( intermediate products or components)

4.6. Organizational and Human Resource Study

This basically incorporates the socio-cultural patterns and institutions or the population
that the project is believed to serve. Does the project takes into account the cultural
setup and customs of the beneficiaries? Or will it disturb the accepted pattern? If so
how should this be included as part of the project design?

To have a chance of being carried out, a project must be related properly to the
institutional structure of the country or region where the project is to be carried.
Examples include the land tenure system, use of local institutions such as Idir or Debbo.

Similarly, managerial issues are critical for successful completion of projects. Thus, the
project analyst must examine the ability of available staff to identify whether they have
the capacity to carry out the managerial needs of the project.

Organization and Manning

A division of the company into organizational units in line with the marketing, supply,
production and administrative functions is necessary not only from the operational
point of view, but also during the planning phase, to allow the assessment and
projection of overhead costs. It is also essential for the feasibility of a project that a
proper organizational structure should be determined in accordance with the corporate
strategies and policies. The organizational set-up depends to a large extent on the size
and type of the industrial enterprise and the strategies, polices and values of the
organization.

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Plant organization and management
Organization is the means by which the operational functions and activities of the
enterprise are structured and assigned to organizational units, represented by
managerial staff, supervisors and workforce, with the objective of coordinating and
controlling the performance of the enterprises and the achievement of its business
targets.

The organizational structure of an enterprise indicates the assignment of

responsibilities and delegation of authorities to the various functional units of the
company, and is normally shown in a diagram, often referred to as an organ gram. The
organizational functions are the building blocks of the company.

4.7Financial Analysis
The analysis of financial costs and benefits is a key step in the project preparation
process, which seeks to ascertain whether the proposed project will be financially viable
i.e. in the sense of being able to meet the burden of servicing debt and whether the
proposed project will satisfy the returns/expectations of those who provide capital
and/or the promoters.

Objectives of Financial cost-benefit analysis:

To establish the project’s financial viability for the private investor

Commercial profitability is the yardstick for selection among competing projects.

Components of financial analysis:

Investment cost estimation

Revenue estimation

Production costs & expenses

profitability analysis

Cash flow estimation and analysis

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 Financial ratio analysis

Uncertainty/risk analysis

Debt repayment schedule

Technical aspects of financial analysis:

At the technical level of financial analysis, the basic activities involved are:

 Projection of cash inflows and outflows- for each period that enables
computation of net cash flows of the project,

 Setting of the cost of capital-which is a very difficult task in countries like ours
where there is no capital markets,

 Discounting of net cash flows of the project.

Why evaluate cash flows rather than profits?

Cash is what ultimately counts-profits are only a guide to cash availability: they
cannot actually be spent.

Profit measurement is subjective-the time period in which income and expenses

are recorded, and so on, are a matter of judgment,

Cash is used to pay dividends-dividends are the ultimate method of transferring

wealth to equity shareholders.

4.7.1 Initial Investment Cost

Initial investment is the amount required to start a business or a project. It is also called
initial investment outlay or simply initial outlay. It equals capital expenditures plus
working capital requirement plus after-tax proceeds from assets disposed of or
available for use.

4.7.2. Production Cost

Production costs may include things such as labour, raw materials, or consumable

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supplies. In economics, the cost of production is defined as the expenditures incurred
to obtain the factors of production such as labour, land, and capital that are needed in
the production

4.7.3. Marketing Cost

Marketing costs are the all expenses that the company makes to market and sell its
products and develop and promote its brand. These marketing costs or expenses
include expenses incurred to change the title of goods, promotion of goods, inventory
costs and distribution of goods
4.7.4. Projection of Cash Flow
What is cash flow projection? Cash flow projection is a breakdown of the money that is
expected to come in and out of your business. This includes calculating your income
and all of your expenses, which will give your business a clear idea on how much cash
you'll be left with over a specific period of time.
Examples of cash outflow include money spent on fixed assets, salaries, payment
made to suppliers, loans taken and interest paid on them, wages, transport costs, and
insurance dividends that require you to pay.
4.7.5 Financial Evaluation
Financial evaluation is the process of comparing the financial benefits of a project or a
project component as indicated by the financial internal rate of return (FIRR) with the
financial cost as indicated by the weighted average cost of capital (WACC).
The most commonly used methods are the following four.

 Payback period analysis.

 Accounting rate of return.
 Net present value.
 Internal rate of return.
 Benefit Cost Ratio (BCR).
 Break – Even Analysis (BEA).
4.7.5.1. Payback Period (PBP)

Payback period is the number of years required to the project for recovering the

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 initial investment. This is one of the widely used methods for evaluating the
investment proposals. Under this method the focus is on the recovery of original
investment at the earliest possible time. It determines the number of years to recoup
the original cash out flow, disregarding the salvage value and interest. This method
does not take into account the cash inflows that are received after the payback
period.

There are two methods used to calculate the payback period

1. The annual cash flows are uniform

initial or orginal investment
Payback Period (PB) =
Annual cashflows
Shorter is the payback period better is the product

Eg: A project requires an investment of $ 100, 000; it will generate annual cash flow
of $25,000 per year. Calculate the payback period.
initial Investment
PB =
Annual Cashflows
100,000
PB = = 4 years
25,000

2. The annual cash flows are not consistent vary from year to year/Unequal cash
flows
Payback period(PB)
= Years before full recovery
uncovered cost
+
Annual cash flows during the next year
B
PB = E +
C

Where, PB =payback period.

E = number of years immediately preceding/before the year of final recovery.
B = the balance amount still to be recovered/uncovered cost.
C =cash flow during the year of final recovery.
E.g: Assume the initial investment for the following two projects is 700 Birr. The

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following information related to a company cash flow is given. Which project is the
better using the payback period?
Year Cash flows
Project A Project B
1 100 400
2 200 300
3 300 200
4 400 100
5 500 0
Solution

Years Project A Project B

Cash Cumulative cash Cash flows Cumulative cash
flows flows flows
1 100 100 400 400
2 200 300 300 700
3 300 600 200 900
4 400 1000 100 1000
5 500 1500 0 1000

PB for project A
B
PB for Project A = E +
C
100
PB for Project A = 3 years +
400
PB for Project A = 3 years + 0.25 = 3.25 Years
0
PB for Project B = 2years +
200
PB for Project B = 2 years + 0 = 2 Years
The shorter the payback period, the better the project, therefore project B is the better
project.

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 4.7.5.2. Accounting Rate of Return (ARR)
In this method, instead of taking the annual cash flows, we take the annual profits into
account. The net annual profits are calculated after deducting depreciation and taxes.
Expected Average Annual Net profit
Accounting Rate of Return (ARR) = x 100
Average cost of investment
Original cost+Salvage value
Average Cost of investment =
2
Total Annual net profit
average annual net profits
number of years
Initial Investment-salvage value
Annual Depreciation =
Life time of the project
Example: Assume that the project has the initial investment of 70,000 Birr, the life of the
project is 4 years and the salvage value is 6000 Birr at the end of year 4. The SLM
method depreciation is used. Income before depreciation and tax are 40,000 Br for year
1, 42,000 Br for year 2, 36,000 Br for year3, and 50,000 Br for year 4. Determine the ARR
by assuming the income tax rate is 40%.

Solution
Original cost+Salvage value
Average Cost of investment =
2
70,000+6000
Average Cost of investment = = 38 ,000 Birr
2
70,000-6,000
Annual Depreciation = = 16 ,000 Birr
4

Compute net profit for the 4 years

Year 1 Year 2 Year 3

Year 4

Income before depreciation and tax 40,000 42,000

36,000 50,000

Less annual Depreciation 16,000 16,000 16,000

16,000

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Income after depreciation but before tax 24,000 26,000 20,000

34,000

Less income tax (40%) 9,600 10,400 8000

13,600

Net income 14,400 15,600 12,000

20,400

Total Annual net profit

average annual net profits
number of years

14,400+15,600+12,000+20,400
average annual net profits = 15 ,600 Birr
4
Expected Average Annual Net profit
Accounting Rate of Return (ARR ) = x 100
Average cost of investment
15,600
Accounting Rate of Return (ARR ) = x 100 = 41 %
38,000
The ARR is compared to the predetermined rate. The project will be accepted if the

actual ARR is higher than the desired ARR. Otherwise it will be rejected.

4.7.5.3 Net present value (NPV)

Net present value is the difference between present value of future cash inflows and the
present value of future cash outflows discounted at a given cost of capital.
Steps
i. Find the present values of each cash inflows and cash outflows using a discount
%(cost of capital).
ii. Total the discounted cash inflows and outflows separately.
iii. Obtain the difference between cash inflows and outflows.

The decision rule here is to accept a project if the NPV is positive and reject if it is
negative
I) NPV > Zero accept
II) NPV = Zero accept

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 III) NPV < Zero reject

Example:
Alternative Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
projects
A 80,000 20,000 25,000 25,000 30,000 20,000
B 100,000 25,000 20,000 30,000 35,000 40,000
The required rate of return for both projects is 12%. Then evaluate this projects using
NPV.
Solution
Year Cash inflows Discounted Present Value
factor
A B A B
1 20,000 25,000 0.893 17,860 22,325
2 25,000 20,000 0.797 19,925 15,940
3 25,000 30,000 0.712 17,800 21,360
4 30,000 35,000 0.636 19,080 22,260
5 20,000 40,000 0.567 11,340 22,680
Total 86,005 104,565
NPV of project A=86,005-80,000= 6,005 Birr
NPV of Project B = 104,565 – 100,000 =4,565 Birr
Decision Rule: the project with high NPV should be accepted. So project A is the better
project.
a. Profitability Index method / Benefit cost Ratio
Profitability index method is the relationship between the present values of net cash
inflows and the present value of cash outflows. It can be worked out either in unitary or
in percentage terms. The formula is

Present value of cash inflows

Profitability Index(PI) =
Present value of cash outflows

PI > 1 Accept

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 PI = 1 indifference
PI < 1 reject
Higher the profitability index more is the project preferred.
From the above example we can calculate the profitability index as below
Present value of cash out flows for Project A =80,000 Birr
Present value of cash inflows for project A=86,005

Present value of cash inflows

Profitability Index(PI) =
Present value of cash outflows
86,005
Profitability Index(PI) = = 1.075
80,000

4.7.5.4 Internal rate of return

Internal rate of return (IRR): If we have a set of expected cash inflows and cash
outflows, the internal rate of return is the discount rate that equates the present
values of the two sets of flows.

If at is an expected cash outflow in the period t and Rt is the expected inflow for
the period t, the internal rate of return is the value of K that satisfies the following
equation (note that the Ao will be positive in this formulation of the problem):
2 n 2 n
Ao+A1/(1+k)+A2/(1+k) +....+An/(1+k) =R1/(1+k)+R2/(1+k) +….+Rn/(1+k)

Where, t=1,2,3….,n, The value of k is found by trial and error.

4.7.5.5 Benefit cost ratio (BCR)

The benefit-cost ratio (BCR) is a ratio used in a cost-benefit analysis to summarize the
overall relationship between the relative costs and benefits of a proposed project. BCR
can be expressed in monetary or qualitative terms.

If a project has a BCR greater than 1.0, the project is expected to deliver a positive net
present value to a firm and its investors.

The benefit-cost ratio (BCR) is an indicator showing the relationship between the

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relative costs and benefits of a proposed project, expressed in monetary or qualitative
terms.

If a project has a BCR greater than 1.0, the project is expected to deliver a positive net
present value to a firm and its investors.

If a project's BCR is less than 1.0, the project's costs outweigh the benefits, and it
should not be considered.

How the Benefit-Cost Ratio (BCR) Works

Benefit-cost ratios (BCRs) are most often used in capital budgeting to analyze the
overall value for money of undertaking a new project. However, the cost-benefit
analyses for large projects can be hard to get right, because there are so many
assumptions and uncertainties that are hard to quantify. This is why there is usually a
wide range of potential BCR outcomes.

The BCR also does not provide any sense of how much economic value will be created,
and so the BCR is usually used to get a rough idea about the viability of a project and
how much the internal rate of return (IRR) exceeds the discount rate, which is the
company’s weighted-average cost of capital (WACC) – the opportunity cost of that
capital.

The BCR is calculated by dividing the proposed total cash benefit of a project by the
proposed total cash cost of the project. Prior to dividing the numbers, the net present
value of the respective cash flows over the proposed lifetime of the project – taking into
account the terminal values, including salvage/remediation costs – are calculated.

The formula for benefit-cost ratio is:

Benefit-Cost Ratio = ∑ Present Value of Future Benefits / ∑ Present Value of Future

Costs.

4.7.5.6 break- even analysis (BEA)

Break-even analysis refers to the determination of the balance performance level

where project income is equal to project expenditure.

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The total cost of an operation is expressed as the sum of the fixed and variable
costs with respect to output quantity. That is,

TC(X)=FC+VC(x)

Where, x is the number of units produced,

TC(x) is the total cost of producing x units,

FC is the total fixed cost, and VC(x) is the total variable cost associated with
producing x units.

In this case the total revenue resulting from the sale of x units is defined as:

TR(x)=px, where p is the price per unit. The profit due to the production and sale
of x units of the product is calculated as

P(x0=TR(x)-TC(x)

The break even point of an operation is defined as the value of a given parameter
that will result in neither profit nor loss.

The parameter of interest may be the number of units produced, the numbers of
hours of operation, the number of units of a resource type allocated, or any other
measure of interest. At the break even point, we have the following relation ships:

At the breakeven point we have the following relationships:

RT(x)=TC(x)or

P(x)=0

In some cases, there may be known mathematical relationships between cost

and the parameter of interests.

For example, there may be a linear cost relationship between the total cost of a
project and the number of units produced. The cost expressions facilitate
straightforward break even analysis.

Chapter 5
5.1 project planning
Projects are unique and complex and as a result they require a great deal of effort to

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plan. The diverse and separate activities that need to be performed, the different
resources required at differing times and the many groups of people involved can create
implementation and control problems.
The primary purpose of planning is to ensure that project objectives are met, risks
mitigated and that the probability of success of the project Is improved. Planning
determines the amount of resources, time, and effort required to implement the project.
Without a plan the team would not be able to implement the project successfully.
A project plan is not a static document, it is a working document because things change
during the duration of the project.
There could be unforeseen strikes by workers, global economic crises, interest rate
instability, foreign exchange volatility, excessive inclement weather e.g.tsunami, political
instability, and changes in the market conditions reducing the demand of the project’s
product. These are all real examples which would impact directly on the project’s
viability.
5.2. Project organization

The Functional Project Organization

On a project that uses people from the same organiza-tion, the existing line
organization can be used to manage the project.

This organizational structure is appropriate when the project is clearly the

responsibil-ity of one department. Many small projects use the functional
organization as the project organization.

A functional project is assigned to the functional department or division in a

company that has the most interest and technical ability to complete the project.

Almost all tasks in a project organized as part of a functional organization will

be completed within the one functional area. Existing managers in the
department double as project managers.

The advantages of using a functional organization to complete a project include:

➤Familiarity of the team; The team members are already familiar with
each other, and the skill levels of the staff are clearly understood.

➤Established administrative systems: The general administrative policies

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 and procedures are already understood by the team and cost centers.

➤Staff availability: The staff is readily available to the project because the
line managers control the staff assignments. Thus, there are few, if any,
interdepartmental conflicts over the use of resources.

➤Scheduling efficiency: The scheduling of staff can be highly efficient. As

a staff member is required, the person can immediately be assigned to a
task and then return to routine work without serious logistical interruptions.

➤Clear authority: The lines of authority and communication are

understood. Thus, the conflicts between project authority and line authority
are minimized.

There are times when an individ-ual has a unique technical skill and must be
given a supervisory or leadership role regardless of how difficult this person is to
work with. In this situation, you (and the rest of the team) just have to learn to
work with the difficult personality to get the job done. This is one of the stan-dard
challenges project managers must handle with aplomb.

The disadvantages of using a functional organization include:

➤Project isolation: The project may be completed in isolation from other

parts of the company and may fail to realize larger strategic goals as a
result. However, if new collaboration, networking, and Web-based tools are
employed, this isolation can be minimized.

➤Limited resources: The project is limited to the technical resources

within the department, which may not be adequate to complete the tasks
required. Of course, outside vendors and consultants can be hired, but
expertise within other departments of the company is not readily available.
This may lead to inefficiencies or redundancies in the project organization.

➤Bureaucratic procedures: There may be more levels of approval than

really necessary for the project because of the established bureaucracy in
the line organization. This may impede progress and slow decision-making.

➤Lack of project focus: The project may lack focus or priority in a

functional organization because it is not the only work being done. Thus,
routine depart-mental work may interfere with project work. In addition,
motivation for project work may suffer because the project is considered

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 “additional” or “optional” work as opposed to being a clear responsibility.

➤Department orientation: The project may suffer from “department-think.”

This occurs when the priorities of the department become the project
priorities, regardless of the actual goals for the project. Work outside the
department’s nor-mal concerns is given little attention, and the “finished”
project may not be complete or may suffer quality problems as a result.

A functional organization.

2.The Pure-Project Organization

In a pure-project structure, a team or “task force” is put together to accomplish

the project’s goals. In such an organization, all the team members report to the
project manager during the course of the project.

The team members do not have responsibility to other managers or jobs during
the course of their work on the project. When a team member’s responsibility for
the project is complete, the person returns to an-other job or is assigned to
another project. Only one project and one job are assigned at a time.

In the direct version of the pure-project structure, every project team member
reports directly to the project manager. This is appropriate for small projects with
15 or fewer people involved. In the indirect version of the pure-project structure
(suitable for larger projects), the project manager may have assistant managers

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or supervisors to manage subprojects or functional areas within the project.

As in an ordinary line or-ganization, the supervisors and assistants report directly

to the project manager, and the various functional teams within the project report
to the second-level managers. Extremely large projects may have multiple
management levels, just like a corporation.

Pure-project organizations are found in companies fulfilling large government

projects or in some engineering-driven companies that produce predictable
model updates for their products. Large construction projects often employ a
pure-project organization as well. If work on a complex, priority project spans a
year or more, a pure-project organization is often an advantage.

The advantages of the pure-project organization include:

➤Clear project authority: The project manager has true line authority over
the entire project. Thus, there is always a clear channel for resolving
project conflicts and determining priorities. The unity of command in a
pure-project organization results in each subordinate having one and only
one direct boss—a clear advantage in most situations.

➤Simplified project communications: Communication and decision-

making within the project are simplified because everyone reports to the
same project manager and focuses on the attainment of the same project
goals.

➤Access to special expertise: If similar projects will be completed by the

company on a cyclic basis, specific expertise in the components of the
project will be developed over time. It simply becomes a matter of
transferring the experts to the right project at the right time.

➤Project focus and priority: The pure-project organization supports a total

view of the project and a strong, separate identity on the part of the
participants.This helps keeps the project focused and integrated.

There are distinct disadvantages to the pure-project approach, however,

including:

➤Duplication of efforts: If a company has multiple projects with important

goals in progress at the same time, some efforts may be duplicated,
making the overall cost of the projects higher than necessary.

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 ➤Unclear loyalties and motivations: Project members form strong
attachments to the project and each other, which is good. When the
project is terminated, however, the team must be disbanded, and this leads
to uncertainty and conflict. Team members fear layoffs or anticipate
assignments in undesirable projects in the future. Thus, keeping
technically qualified people happy over the long haul becomes a major
challenge.

➤Intracompany rivalry: Rivalry and competition may become strong

between various projects in a company that uses pure-project organization
for its major projects. This results in a company that competes with itself
instead of with the competition—an ugly state of affairs.

➤Uncertain reintegration of resources: Integrating a pure-project group

back into the functional organization can be fraught with problems. People
who were involved in the project may be considered “outsiders” when they
return to their original jobs, or the jobs may have changed during the
course of the project.

A pure-project organiza-tion.

5.2.1. line and staff organization

Organizational structure involves, in addition to task organizational boundary

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considerations, the designation of jobs within an organization and the
relationships among those jobs. There are numerous ways to structure jobs
within an organization, but two of the most basic forms include simple line
structures and line-and-staff structures.

In a line organization, top management has complete control, and the chain of
command is clear and simple. Examples of line organizations are small
businesses in which the top manager, often the owner, is positioned at the top of
the organizational structure and has clear "lines" of distinction between him and
his subordinates.

The line-and-staff organization combines the line organization with staff

departments that support and advise line departments. Most medium and large-
sized firms exhibit line-and-staff organizational structures. The distinguishing
characteristic between simple line organizations and line-and-staff organizations
is the multiple layers of management within line-and-staff organizations. The
following sections refer primarily to line-and-staff structures, although the
advantages and disadvantages discussed apply to both types of organizational
structures.

Several advantages and disadvantages are present within a line-and-staff

organization. An advantage of a line-and-staff organization is the availability of
technical specialists. Staff experts in specific areas are incorporated into the
formal chain of command. A disadvantage of a line-and-staff organization is
conflict between line and staff personnel.

LINE-AND-STAFF POSITIONS

A wide variety of positions exist within a line-and-staff organization. Some

positions are primary to the company's mission, whereas others are
secondary—in the form of support and indirect contribution. Although positions
within a line-and-staff organization can be differentiated in several ways, the
simplest approach classifies them as being either line or staff.

A line position is directly involved in the day-to-day operations of the organization,

such as producing or selling a product or service. Line positions are occupied by
line personnel and line managers. Line personnel carry out the primary activities
of a business and are considered essential to the basic functioning of the
organization.

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Line managers make the majority of the decisions and direct line personnel to
achieve company goals. An example of a line manager is a marketing executive.

Figure 1 Line-and-Staff Organization

Figure 1

Line-and-Staff Organization

Although a marketing executive does not actually produce the product or service,
he or she directly contributes to the firm's overall objectives through market
forecasting and generating product or service demand. Therefore, line positions,
whether they are personnel or managers, engage in activities that are functionally
and directly related to the principal workflow of an organization.

Staff positions serve the organization by indirectly supporting line functions.

Staff positions consist of staff personnel and staff managers. Staff personnel
use their technical expertise to assist line personnel and aid top management in
various business activities. Staff managers provide support, advice, and
knowledge to other individuals in the chain of command.

Although staff managers are not part of the chain of command related to direct
production of products or services, they do have authority over personnel. An
example of a staff manager is a legal adviser. He or she does not actively engage
in profit-making activities, but does provide legal support to those who do.
Therefore, staff positions, whether personnel or managers, engage in activities
that are supportive to line personnel.

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LINE-AND-STAFF AUTHORITY

Authority within a line-and-staff organization can be differentiated. Three types of

authority are present: line, staff, and functional. Line authority is the right to carry
out assignments and exact performance from other individuals.

LINE AUTHORITY.

Line authority flows down the chain of command. For example, line authority
gives a production supervisor the right to direct an employee to operate a
particular machine, and it gives the vice president of finance the right to request
a certain report from a department head. Therefore, line authority gives an
individual a certain degree of power relating to the performance of an
organizational task.

Two important clarifications should be considered, however, when discussing

line authority: (1) line authority does not ensure effective performance, and (2)
line authority is not restricted to line personnel. The head of a staff department
has line authority over his or her employees by virtue of authority relationships
between the department head and his or her directly-reporting employees.

STAFF AUTHORITY.

Staff authority is the right to advise or counsel those with line authority. For
example, human resource department employees help other departments by
selecting and developing a qualified workforce. A quality control manager aids a
production manager by determining the acceptable quality level of products or
services at a manufacturing company, initiating quality programs, and carrying
out statistical analysis to ensure compliance with quality standards. Therefore,
staff authority gives staff personnel the right to offer advice in an effort to
improve line operations.

FUNCTIONAL AUTHORITY.

Functional authority is referred to as limited line authority. It gives a staff person

power over a particular function, such as safety or accounting. Usually, functional
authority is given to specific staff personnel with expertise in a certain area. For
example, members of an accounting department might have authority to request
documents they need to prepare financial reports, or a human resource manager
might have authority to ensure that all departments are complying with equal
employment opportunity laws. Functional authority is a special type of authority
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for staff personnel, which must be designated by top management.

LINE-AND-STAFF CONFLICT

Due to different positions and types of authority within a line-and-staff

organization, conflict between line and staff personnel is almost inevitable.
Although minimal conflict due to differences in viewpoints is natural, conflict on
the part of line and staff personnel can disrupt an entire organization. There are
many reasons for conflict. Poor human relations, overlapping authority and
responsibility, and misuse of staff personnel by top management are all primary
reasons for feelings of resentment between line and staff personnel. This
resentment can result in various departments viewing the organization from a
narrow stance instead of looking at the organization as a whole.

Fortunately, there are several ways to minimize conflict. One way is to integrate
line and staff personnel into a work team. The success of the work team
depends on how well each group can work together in efforts to increase
productivity and performance. Another solution is to ensure that the areas of
responsibility and authority of both line and staff personnel are clearly defined.
With clearly defined lines of authority and responsibility, each group may better
understand their role in the organization. A third way to minimize conflict is to
hold both line and staff personnel accountable for the results of their own
activities. In other words, line personnel should not be entirely responsible for
poor performance resulting from staff personnel advice.

Line-and-staff organizations combine the direct flow of authority present within a

line organization with staff departments that offer support and advice. A clear
chain of command is a consistent characteristic among line-and-staff
organizational structures. Problems of conflict may arise, but organizations that
clearly delineate responsibility can help minimize such conflict

5.2.2. Divisional organization

Businesses typically need organizational structures in order to perform at their

best. Divisional structure is one such system a company may use to improve
different aspects of its operations. While there are advantages to a divisional
organization, there are also some disadvantages—so it proves important to know
the pros and cons to understand how they may impact your business if

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implemented.

In this article, we define divisional structure, list the pros and cons of this type of
organizational structure and provide a solution for each con.

What is a divisional structure?

A divisional organizational structure is a system in which a company segments

its employees based on products or markets, as opposed to their job roles. Some
companies have marketing, sales and communications departments, while a
divisional organization has teams dedicated to a specific region or product.

This is most useful for larger companies that benefit from organizing their
workforce into relatively independent groups. Businesses using a divisional
structure may have one or more of the following characteristics:

1. Selling a wide range of customer-facing product lines

2. Offering both businesses-to-customer and business-to-business services

3. Advertising to a wide variety of demographics

4. Marketing their brand in different geographic locations

5. Serving major clients who need individualized attention

5.2. 3.The Matrix Organization

Implementing project management techniques sets in motion a significant

change in the culture of an organization. One of the more common results of
using project management in business is the introduction of “matrix
management”—a situation in which people report to multiple managers. Matrix
management involves coordinating a web of relationships that come about when
people join the project team and are subject to the resulting multiple authority-
responsibility-accountability relationships in the organization.
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The matrix organization is an attempt to take advantage of the benefits of a pure
project organization while maintaining the advantages of the functional
organization. It is rare to find pure-project or pure-functional organizations in
business any more. Matrix organizations are typical today, even when other
project management tools aren’t involved.

In a matrix organization, a clear project team is established that crosses

organizational boundaries. Thus, team members may come from various
departments. A project manager for each project is clearly defined, and projects
are managed as separate and focused activities. The project manager may
report to a higher-level executive or to one of the functional managers with the
most interest in the project.

However, the specific team members still report to their functional departments
and maintain responsibilities for routine departmental work in their functional
areas. In addition, people may be assigned to multiple project teams with
different responsibilities. The problem of coordination that plagues other project
structures is minimized because the most important personnel for a project work
together as a defined team within the matrix project structure.

The management responsibilities in these projects are temporary—a supervisor

on one project may be a worker on another project, depending on the skills
required. If project managers in a matrix situation do not have good relationships
with line man-agers in the organization, conflicts may arise over authority over
employees’ work and priorities. Not everyone adapts well to the matrix structure
for this and other related reasons.

The complexity that a matrix organization causes is clear: People have multiple
man-agers, multiple priorities, and multiple role identities. Because of these
complexities, before an organization enters into matrix organizational structures,
at least two of the following criteria for the project or the enterprise should be
met:

➤A need to share scarce or unique resources that are required in more

than one project or functional area

➤A requirement for management to provide high levels of information

processing and communication to complete the project

➤Pressure from the outside by customers or agencies to have one person

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 or group centralize control of the project even though the project may be
carried out by other groups in the organization

In cases in which projects meet these criteria, the matrix organization has
distinct advantages:

➤Clear project focus: The project has clear focus and priority because it
has its own separate organization and management. Most of the planning
and control advantages of a pure-project structure are realized in a matrix
organization.

➤Flexible staffing: Staffing is relatively flexible in matrix organizations

because resources from various line organizations are available without
job reassignment. Scarce technical resources are available to a wide range
of projects in a company that regularly employs matrix-organized projects.

➤Adaptability to management needs and skills: The authority of the

project manager can be expansive or limited, depending on the priority of
the project. If a project manager has strong authority, he or she has
command authority over most of the project. If a project manager has
weak authority, the line man-agers have a strong influence on project
activities. Thus, the matrix organization can be adapted to a wide range of
projects—some that need strong support from line managers and some
that require independent management.

➤Staff development opportunities: People can be given new challenges

and responsibilities that are not as likely to be offered in a purely functional
organization. People can gain exposure to new technical areas, develop
management skills, and have new experiences that maintain their interest
and motivation at work. Ultimately, these new experiences can lead to
more effective employees with high degrees of independence and
flexibility. And because people tend to be more responsible for the quality
of their own work in project-oriented groups, overall corporate productivity
can improve.

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 ➤Adaptability to business changes: Matrix organizations can adapt more
quickly to changing technological and market conditions than traditional,
purely functional organizations. This is largely because of the high people-
to-people contact in these organizations. In addition, matrix-organized
projects en-courage entrepreneurship and creative thinking that crosses
functional responsibilities.

The disadvantages and potential conflicts within a matrix organization must be

understood and dealt with to take advantage of the benefits of matrix
management. The more frequently reported problems in matrix managed
organizations include:

➤Built-in conflicts: Conflicts between line management priorities and

project management priorities are inevitable. The question of who is in
charge affects both the project and routine departmental work. The
division of authority and responsibility relationships in matrix organizations
is inherently complex. Matrix organizations are no place for intractable,
autocratic managers with narrow views of organizational responsibilities.

➤Resistance to termination: As in pure-project organizations, team

members may prefer their project roles to their line responsibilities,
creating interesting motivational challenges for managers. Because the
team members have unique identities and relationships in their project
roles, matrixed projects often resist termination.

➤Complex command and authority relationships: There is no unity of

command in a matrix organization—a clear violation of traditional
management principles. The team member is often caught between
conflicting demands of the line manager and the project manager. The
discomfort and uncertainty of having more than one boss at the same time
cannot be adequately described to someone who has never experienced
the situation. Of course, if the two bosses are adequately trained and are
open in their communications, many of these difficulties can be resolved
or eliminated.

➤Complex employee recognition systems: In a matrix organization, which

manager should complete the employee’s performance reviews or make
recommendations for raises? If the reward responsibilities and authorities
of the project manager and the line manager are not clearly identified, the

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 employee may feel unrecognized. It is imperative that both line
responsibilities and project responsibilities are accounted for in the
employee’s performance review process. Some form of reward system
needs to be established for team members within the project—whether
this is just public acknowledgment of a job well done or formal monetary
rewards depends on the project and your budget.

A matrix organization.

5.3. Project directing

The purpose of the Directing a Project process is to enable the Project

Board to be accountable for the project by making key decisions, to have
overall control and delegate day-to-day management of the project to the
Project Manager.

Objective

The objectives of the Directing a Project process are to provide authority

(to make a decision)

1. To initiate the project (allow the Initiating a Project process to

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 start).

2. To deliver the project’s products (start the delivery stages).

3. To close the project (when the Closing a Project process is done).

4. Provide direction and control during the project.

5. Be the interface to Corporate / Programme Management.

6. Ensure that post-project benefits will be reviewed.

5.4. Project control (monitoring and evaluation)

A project manager needs to ensure that the activities in the project are being carried out
in accordance with the approved plan, policy, schedule, budget, quality standard,
procedure, and utmost safety. Hence, it is absolutely necessary to monitor the project at
regular intervals and adopt suitable controlling measures in order to keep the project on
track. Read this article to learn about Project Monitoring, Evaluation, and Control?

What is Project Monitoring, Evaluation and Control?

A project manager needs to ensure that the activities in the project are being carried out
in accordance with the approved plan, policy, schedule, budget, quality standard,
procedure, and utmost safety. Hence, it is absolutely necessary to monitor the project at
regular intervals and adopt suitable controlling measures in order to keep the project on
track. Read this article to learn about Project Monitoring, Evaluation, and Control?

Monitoring and controlling is essentially required in any project simply because things
don’t always go according to plan no matter how much we prepare and to detect and
react appropriately to deviations and changes to the plan.

Even Projects that are well designed, comprehensively planned, fully resourced, and
meticulously executed will face challenges. These challenges can take place at any
point in the life of the project and the project team must regularly monitor the design,
planning, and implementation of the project to confirm they are valid and to determine

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whether corrective actions need to be taken when the project’s performance differs
significantly from its design and plan.

Before understanding the processes in each of the three categories of the project
monitoring, evaluation, and control phase in detail, it is extremely important to first
differentiate between them.

Monitoring is concerned with the gathering of information and connecting them with the
project plans and objectives.

Evaluation is interpretation & estimating the collected information.

Control is the corrective action that is undertaken if the desired result is not achieved.
They are three separate actions but go hand in hand as tools for assessing the status
and success of a project.project

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5.5. Human aspects of project management

One of the biggest challenges project managers face is balancing, organizing, winning,
overcoming, placating, supporting, guiding, leading, and as appropriate, modifying the
human aspects involved with the project. The key areas to be addressed include:
1. Project sponsorship and leadership
2. The organization structure and culture
3. The project team
4. Communication
Top Management/Stockholders/Stakeholders
Generally speaking, those at the top level of management in a company have a high
level of intelligence, education, experience, and interpersonal ability that qualifies them
for their positions. They are usually proven leaders and command the respect of their
subordinates. And thank goodness that respect exists, because the loyalty of a
company's workers is an integral trait of successful projects.
Senior corporate officials must thoroughly support the project before it gets off the
ground. Often, before significant funds are allocated to initiate a new undertaking, a
detailed presentation must be made to and a formal approval received from the
company's board of directors, who are elected by the shareholders. Top management
with the support of stockholders/stakeholders needs to continue in the oversight
capacity, holding the project manager accountable to schedule and cost requirements.

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Periodic status meetings are held, where the project manager presents details regarding
progress. At these meetings, and also on an occasional informal basis, executives
interrogate the project manager to ensure the full story is being presented.
The project manager is NOTHING without the project team. Part of the challenge is
assembling a team of qualified professionals, and then getting them to work together
like a finely tuned machine.

Members of the Project Team

The members of a project team will vary of course, depending on the project on which
the team is working. In a generic sense, the following leaders may serve on the team:

Project manager: The project manager is the coordinator, the leader, the administrator,
the motivator, the heart and brains for the team, and the soul of the project. If the
project is successful, the project manager is the hero. If the project fails, the project
manager is fired, or at best is assigned to another project.

Lead project engineer: The individual in charge of product design and development, with
responsibility for functional analysis, specifications, drawings, cost estimates,
quality/reliability, engineering changes, and documentation is the project engineer.

Lead manufacturing engineer: The task of this engineer is to ensure the efficient
production of the product or process that has been designed by the project engineer.
This includes having the responsibility for manufacturing engineering, design and
production of tooling/jibs/fixtures, production scheduling, and other production tasks.

Contract administrator: The administrator is responsible for all official paperwork,

keeping track of customer changes, billing, questions, complaints, legal aspects, costs,
and other matters related to the contract authorizing the project. Not uncommonly, the
contract administrator also serves as project historian and archivist.

5.6. pre-requisites for successful project implementation

The Prerequisites for Successful Project Implementation are

1. Adequate formulation.

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2. Sound project organisation.

3.Proper implementation planning.

4. Advance action.

5. Timely availability of funds.

6. udicious equipment tendering and procurement.

7. Better contract management.

8. Effective monitoring

Chapter Six

Social Cost Benefit Analysis (SCBA)

6.1 what is SCBA?

Social Cost Benefit analysis (hereafter referred to as SCBA) called economic analysis, is
a methodology developed for evaluating investment projects from the point of view of
the society (or economy) as a whole. Used primarily for evaluating public investments
(though it can be applied to both private and public investments), SCBA has received a
lot of emphasis in the decades of 1960s and 1970s in view of the growing importance
of public investments in many countries, particularly in developing countries, where
governments have played a significant role in the economic development. SCBA is also
relevant, to a certain extent, to private investments as these have now to be approved by
various governmental and quasi-governmental agencies which bring to bear larger
national considerations in their decisions.

6.2 Objective of SCBA

There are two main purposes in using CBA: To determine if the project business case is
sound, justifiable and feasible by figuring out if its benefits outweigh costs. To offer a
baseline for comparing projects by determining which project's benefits are greater than

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its costs.

Benefits of SCBA in Project Management

Social cost-benefit analysis in project management enables a complete comparison of

several project options. This is not merely a financial concern. Even so, an SCBA
recognizes non-financial consequences as well. For instance, consider the effects of
increased accessibility on the environment, the economy, and other factors.

Social cost-benefit analysis helps governments to pursue innovative initiatives that

benefit all, not just a selected few. Additionally, it aids in the entire development of an
economy by assisting in decision-making that increases job, investment, savings, and
consumption, increasing a country's economic activity.

Social cost advantages can be used for both investments. Thus, public investment is
vital for a developing nation's economic progress.

1. Market Instability

A private corporation would evaluate a deal based on productivity and relevant market
prices. However, the government must consider additional variables. Determining social
costs in the event of market inefficiency and when market pricing cannot specify them.
These hidden social costs are referred to as shadow prices.

2. Investments & Savings

A venture that results in increased savings is considered an investment in a market.

3. Income is distributed and redistributed

The initiative should not lead to revenue accumulation in the control of a few and the
distribution of income.

4. Career and Living Standards

The impact of a program on employment and level of livelihood will also be considered.
Therefore, the contract should result in a rise in employment and living standards.

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5. Externalities

Externalities can be detrimental and advantageous to an enterprise. As a result, both

impacts must be considered before approving a deal. For example, positive externalities
can take the shape of technological advances, while negative externalities might take
the form of rapid urbanization and ecological degradation.

6. Subsidy and Taxation

Taxation and subsidies are treated as expenses and revenue, respectively. However,
taxation and subsidy are regarded as transfer payments for social cost-benefit analysis.

6.3 Rationale for SCBA:

In SCBA the focus is on the social costs and benefits of the project. These often tend to
differ from the monetary 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

6.4 UNIDO approach:

Towards the end of the 1960s and in the early 1970s two principal approaches for SCBA
emerged: The UNIDO approach and the Little-Mirrlees approach.

The UNIDO approach was first articulated in the Guidelines for Project Evaluation,
United Nations, 1972 which provides a comprehensive framework for SCBA in
developing countries. The rigor and length of this work created demand for a succinct

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(brief and to the point) and operational guide for project evaluation in practice. To fulfill
this need, UNIDO came out with another publication, Guide to Practical Project Appraisal
in 1978.

The UNIDO method of project appraisal involves five stages:

1. Calculation of the financial profitability of the project measured at market prices.

2. Obtaining the net benefit of the project measured in terms of economic

(efficiency) prices.

3. Adjustment for the impact of the project on savings and investment.

4. Adjustment for the impact of the project on income distribution.

5. Adjustment for the impact of the project on merit goods and demerit goods
whose social values differ from their economic values.

Little-Mirrlees approach:

I.M.D. Little and J.A.Mirrlees have developed an approach (hereafter referred as the L-M
approach) to social cost benefit analysis expounded by them in the following works:
Manual of Industrial Project Analysis in developing Countries, Vol. II and Project
Appraisal and Planning for Developing Countries.

There is considerable similarity between the UNIDO approach and the L-M approach.
Both the approaches call for:

Calculating accounting (shadow) prices particularly from foreign exchange savings and
unskilled labor.

Considering the factor of equity.

Use of DCF analysis.

Despite considerable similarities there are certain differences between the two
approaches:

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The UNIDO approach measures costs and benefits in terms of domestic currency
whereas the L-M approach measures costs and benefits in terms of international prices,
also referred to as border prices.

The UNIDO approach measures costs and benefits in terms of consumption whereas
the L-M approach measures costs and benefits in terms of uncommitted social income.

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 together.

Foreign Exchange effect of a project:

The UNIDO method uses domestic currency as the numeraire. So the foreign exchange
input of the project must be identified and adjusted by an appropriate premium. This
means that valuation of inputs and outputs that was measured in border currencies has
to be adjusted upward to reflect the shadow price of foreign exchange.

How is the shadow price of foreign exchange established? The Guidelines method
determines the shadow price of foreign exchange on the basis of marginal social value
as revealed by the consumer willingness to pay for the goods that are allowed to be
imported at the margin. The shadow price of a unit of foreign exchange is equal to:

Where Fi is fraction of foreign exchange, at the margin, spent on importing commodity i.

Qi is the quantity of commodity I that can be bought with one unit foreign exchange
(this will be equal to 1 divided by the CIF value of the goods in question)

Pi is the domestic market clearing prices of commodity i.

Example: Commodities 1, 2, 3 and 4 are imported at the margin. The proportion of

foreign exchange spent on them, the quantities that can be bought per unit of foreign
exchange, and the domestic market clearing prices are as follows:

F1 = 0.3, F2 =0.4, F3=0.2, F4=0.1

Q1 = 0.6, Q2 =1.5, Q3=0.25, Q4=3

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P1 = 16, P2 =8, P3=40, P4=5

The value of a unit of foreign exchange is:

(0.3)(0.6)(16) + (0.4) (1.5) (8) + (0.2) (0.25) (40) + (0.1) (3) (5) = +Br. 11.180

The calculation of the shadow price of foreign exchange in terms of consumer

willingness to pay is based on the assumption that the foreign exchange requirement of
a project is met from the sacrifice of others. The use of foreign exchange by a project,
however, may also induce the production of foreign exchange through additional
exports or import substitution. In such a case, the shadow price of foreign exchange
would be based on the cost of producing foreign exchange, not consumer willingness to
pay for foreign exchange.

Chapter Seven

7.1 Source of Project Financing

There are two types of project financing: equity and debt financing. When
looking for money, you must consider your company’s debt-to-equity ratio. The
relation between amounts borrowed and amounts invested to the business by
the owners. The more money owners have invested in their business, the easier it
is to attract financing.

The proportion of debt to equity depends on how well the financial market is
organized and the availability of debt financing. In addition, the existence of
capital markets and the legal environment governing it will have a critical impact.
However, shortage of financial resources will be a critical constraint of
implementing feasible investment projects.

7.1.1 Equity Financing:

Most small or growth-stage businesses use limited equity financing. As with debt
financing, additional equity often comes from non-professional investors such as

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friends, relatives, employees, customers, or industry colleagues.

However, the most common source of professional equity funding comes from
venture capitalists. These are institutional risk takers and may be groups of
wealthy individuals, government-assisted sources, or major financial institutions.
Most specialize in one or a few closely related industries. Venture capitalists may
scrutinize thousands of potential investments annually, but only invest in a
handful. The possibility of a public stock offering is critical to venture capitalists.
Quality management, a competitive or innovative advantage, and industry growth
are also major concerns.

7.1.2 Debt Financing:

There are many sources for debt financing: banks, savings and loans,
commercial finance companies, and the microfinance institutions. State and
local governments have developed many programs in recent years to encourage
the growth of small businesses in recognition of their positive effects on the
economy.

Family members, friends, and former associates are all potential sources,
especially when capital requirements are smaller. Traditionally, banks have been
the major source of small business funding. Their principal role has been as a
short-term lender offering demand loans, seasonal lines of credit, and single-
purpose loans for machinery and equipment.

In addition to equity considerations, lenders commonly require the borrower’s

personal guarantees in case of default. This ensures that the borrower has a
sufficient personal interest at stake to give paramount attention to the business.
For most borrowers this is a burden, but also a necessity.

7.1.3. leasing

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Lease Defined

Lease finance is also a possibility, particularly in projects involving heavy capital goods.
However, to date, leasing has only played a very small part in the overall financial
equation and there are no real signs that the lessor market in the UK is opening up to
large scale infrastructure projects. There are a number of reasons for this.

First, the tax capacity available in the UK for investing in such projects is fairly limited.
The available tax capacity quickly gets used up by the small to medium ticket lease
market. At the big ticket end of the market, most of the financing has been done on
assets such as ships, aircraft and (more recently) satellites. It is easy to see why
institutional lessors prefer to finance these types of capital assets rather than investing
in, say, turbines for a power project.

Second, there are ownership liabilities that go hand-in-hand with leasing capital
equipment that cannot always be satisfactorily laid off through documentation. Lessors
traditionally are very risk averse creatures and, therefore, the prospect of becoming
embroiled in complex disputes in a project where they may be the owner of one of the
principal assets in question is not an appealing one to them. Third, the introduction of a
lessor into a project structure will add considerably to the complexity of the overall
structure and, therefore, to the documentation to an extent that the possible tax
advantages may very well not be wholly justified by the additional complexities and
expense involved.

In those areas where finance leases have been put in place for projects in the UK
(mainly power stations and cable financings) they have usually been structured on the
basis that the finance lessor does not take any project risk and the “tax risk” is shared
with the lenders.

So far as the project risk is concerned, the finance lessor would generally look to receive
a guarantee or letter of credit to cover it against any project risk that it may be exposed
to. This principle is usually acceptable to all parties as these are risks that the lenders
will be accustomed to assuming. The issue of tax risk, however, is not always so easy
to solve. Tax risk is the risk that there is an adjustment in the tax regime in a manner

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which reduces or eliminates the anticipated tax benefit of the lease. The variation of tax
rates, the availability of tax allowances, the rules on group relief etc., could all have an
adverse effect on the lease cash flows and economics of the project as a whole. The
problem, of course, for finance lessors is that if they are to assume any of the tax risks
they are, in effect, also taking a credit risk on the project company and, therefore, in
effect, in the project itself.

Lease is a contract under which a lessor, the owner of theassets, gives right to use the
asset to a lessee, the user of the assets, for an agreed period of time for a
considerationcalled the lease rentals.

In up-fronted leases more rentals are charged in the initialyears and less in the later
years of the contract. Theopposite happens in back ended leases.

Primary lease provides for the recovery of the cost of theassets and profit through lease
rentals during a period of about 4 or 5 years. It may be followed by a perpetual,
secondary lease on nominal lease rentals.

Difference Between Finance and Lease

The key difference between Finance and Lease is that in finance, the customer pays off
the product’s price by paying off monthly installments. If the customer fails, then the
lender takes away the product as the lender holds the lien on that product till payment
of entire debts, whereas, in the lease, one has to pay monthly fixed rental for using the
asset to the owner of such asset and asset is generally taken back by the owner after
the expiration of lease term.

There are options for procuring high-value articles, depending on the financial liquidity
available.

 Financing is a process whereby one will buy the relatively high priced articles and
is expected to pay back in the form of monthly payments. It is also known as
‘Hire Purchase Financing.’

 Leasing is considered a process of borrowing whereby the leasing firm will

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 purchase on behalf of the customer. Finance or lease are then allowed to use the
product/commodity against a monthly rent amount for a fixed term as agreed
upon in the contract entered by Finance and Lease parties.

7.2 cost of capital

What is the cost of capital?

The cost of capital for a project is a weighted sum of the cost of debt and the cost of
equity. The cost of capital is often used as the discount rate, the rate at which projected
cash flow is discounted to find the present value or net present value of a project.

Risk is an important element which is factored in to determine the cost of debt and
equity. Interest rate charged by lenders will depend on the level of risk they estimate for
the project. The higher the risk perceived, the higher the interest rate will be (interest
rate can be decomposed as the sum of a risk free rate - practically the rate at which
government can borrow money from the market - to which a risk premium is added).

Similarly, the cost of equity is defined as the risk-weighted projected return required by
investors and is established by comparing the investment to other investments with
similar risk profiles.

Government regulators need to consider the cost of capital when determining the
appropriateness of tariff levels. Ideally, the Internal Rate of Return of a project should be
equal to its cost of capital. If IRR is greater than the cost of capital, the
concessionaire/investor makes excess profit, and if the IRR is less than the cost of
capital, the concessionaire/investor loses money and may even go bankrupt.

Why the debt - equity ratio matters

Usually, banks will be more comfortable to lend to an entity which has a higher share of
equity as it makes the project safer while investor will try to reduce equity investments
to the minimum to increase their potential return through higher leverage.

How the cost of capital can be lowered

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The cost of capital of may be lowered through refinancing of PPP projects after their
construction phase. Sponsors may be required to provide a significant amount of equity
capital at the beginning of a project during the construction phase when the risk is high.
Once the construction is complete, the construction risks associated with it have been
overcome, and the cash flow begins to materialize, the expensive equity or debt capital
can be refinanced using cheaper debt capital thus lowering the total cost of capital.

How refinancing helps

The relationship between risk and return of a project changes over different phases. The
highest level of risk exists during the construction phase of a project when construction
delays and cost overruns can have serious consequences to a project's success. It is
during this phase that investors require the highest return on their capital to
compensate for the risk, thus the higher cost of capital. Once construction is over and
the cash flow from operations has begun, project risks drop off substantially and it is
possible for sponsors to refinance at a lower cost.

7.3. Public policy and regulation on financing

Financial regulation is a form of regulation or supervision, which subjects financial

institutions to certain requirements, restrictions and guidelines, aiming to maintain the
stability and integrity of the financial system. This may be handled by either a
government or non-government organization. Financial regulation has also influenced
the structure of banking sectors by increasing the variety of financial products available.
Financial regulation forms one of three legal categories which constitutes the content
of financial law, the other two being market practices and case law.

The objectives of financial regulators are usually:

1. market confidence – to maintain confidence in the financial system

2. financial stability – contributing to the protection and enhancement of stability of the

financial system

3. consumer protection – securing the appropriate degree of protection for consumers.

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One of the key purposes of establishing financial regulations is to maintain the integrity
of the financial system. When a bank fails, it is unable to meet its obligation to
depositors or other creditors, which can cause problems for the wider economy.

Financial regulations aims to: enforce applicable laws; prosecute cases of market
misconduct; license providers of financial services; protect clients; investigate
complaints; and maintain confidence in the financial system. In some such way, we all
depend on the financial system—from saving and accessing money, borrowing money
to maintain business, taking out mortgage or insurance, to getting claims paid when
something goes wrong.

How does it work?

There are two facets to financial regulation: prudential regulation and consumer
protection: Prudential regulation: ensuring that firms have the funding necessary to
trade safely and have the appropriate risk control in place and are properly governed.
Consumer protection: enduring that firms treat customers fairly from the sales process
to how complaints are managed.

Authorisation is an important part of prudential regulation. This means that only firms
are allowed to operate in the financial system one they have met the requirements.
Rules for consumer protection are also established, which informs firms how they
should treat their clients. Supervision, enforcement and regulation Firms must be
supervised to make sure they follow the rules of regulation. In order to make sure
financial service providers are following the rules, supervision is often strict and
intrusive. Risk-based supervision refers to how closely firms are supervised on the basis
of how much of a risk they pose to the financial system. Enforcement works to mitigate
poor behaviour in the financial services sector. When a firm has not been adhering to
the rules, steps are taken to make sure rules are regulated.Lastly, there’s resolution—
this refers to the process in which a financial institution is restructured in a way that
prevents it from doing any more harm to the economy.

7.4. Financing institutions

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A financial institution (FI) is a company engaged in the business of dealing with
financial and monetary transactions such as deposits, loans, investments, and currency
exchange. Financial institutions include a broad range of business operations within the
financial services sector, including banks, insurance companies, brokerage firms, and
investment dealers.

Virtually everyone living in a developed economy has an ongoing or at least periodic

need for a financial institution's services.

Financial institutions often match savers' or investors' funds with those seeking funds,
such as borrowers or businesses seeking to trade shares of ownership for funds.
Typically, this leads to future payments from the borrower or business to the saver or
investor. The tools for matching all of these parties up include products such as loans,
and markets, such as a stock exchange.

At the most basic level, financial institutions allow people to access the money they
need. For example, although banks do many things, their primary role is to take in
funds—called deposits—from those with money, pool the deposits, and lend the money
to others who need funds. Banks are intermediaries between depositors (who lend
money to the bank) and borrowers (who the bank lends money to).This works well
because while some depositors need their money at any given moment, most do not. So
banks can use deposits to make long-term loans. This applies to almost every entity
and individual in a capitalist system: individuals and households, financial and
nonfinancial firms, and national and local governments.

Financial institutions serve most people in some way as a critical part of any
economy—whether in banking, insurance, or securities markets. Individuals and
companies rely on financial institutions for transactions and investing. For example, the
health of a nation's banking system is a linchpin of economic stability. Loss of
confidence in a financial institution can easily lead to a bank run.

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