Unit –IV

Project Appraisal

# Concept of Project Appraisal:

Project appraisal is a generic term used to refer the process of assessing in a
structured manner, the case of proceeding with a project proposal. Project appraisal
is a technique of evaluating and analyzing investments entirely. It is an effort of
calculating the project’s viability. It is carried out in a systematic and scientific
manner because it determines the success or failure of the project. It helps in
optimum allocation of resources, proper selection of the project and systematic
planning and evaluating the costs and benefits.
According to NORAD, “Project appraisal is an overall assessment of the
relevance, feasibility and sustainability of a project prior to making a decision on
whether to undertake it.”
Thus project appraisal is carried out while evaluating an investment proposal.
While appraising the project before implementation, issues such as technical, social,
commercial, financial and economic are studied after being confident and sure that
the proposed project will be successful to achieve the objectives, the plan of the
project implemented.

# Appraisal Factors: The feasibility study serves as the groundwork for

appraisal. The aspects covered in feasibility study are reexamined during the
appraisal. The appraisal factors can be:
i. Technical Appraisal: technical and engineering analysis is necessary when a
project is formulated. Technical analysis seeks to determine whether the
prerequisites for the successful commissioning of the project have been
considered and reasonably good choices have been made with respect to
technical solutions, technical specifications, technical risks and uncertainties,
local resources availability, location, size, geology and process and so on.
ii. Economic Assessment: Economic analysis is also known as social cost benefit
analysis concerned with judging a project from the larger social point of view.
It ascertains the contribution of the project on self-sufficiency, employment and
social order. Similarly, it measures the impact of the project on saving,
investment, distribution of income in the society.
iii. Marketing Assessment: marketing analysis is primarily concerned with
marketing related issues. It will analyze the aggregate demand for the proposed
products or services in the future and the market share of the project.
iv. Financial Assessment: Financial analysis seek to confirm the proposed project
will be financially viable in the sense of being able to meet the burden of
serving debt and whether the project will satisfy the return expectations of those
who provide capital. The aspects to be looked during the financial analysis
include an investment outlay, cost of capital, break even points, etc.
v. Management Assessment: management analysis focuses on project
organization, management, institutional relationships, and management
capabilities in planning, organizing, staffing, leading, implementing and
controlling along with its limitations.
vi. Environmental Assessment: Environmental assessment is concerned with the
impact of the project on environmental issues such as environmental damage by
the project and restoration measure including others.

# Importance of Project Appraisal:

i. It helps in proper allocation of resources and ensures that investment is used in
right project.
ii. It helps to compare among the mutually exclusive projects. Capital budgeting
techniques helps to decide the most attractive project for an organization among
different projects.
iii. It helps an organization to know whether the project is being implemented as
per plan. In case of certain flaws, a manager can know about it in time and
rectify it.
iv. A project appraisal report adds to the knowledge of an organization in the long-
run. It helps to refer and take right decision in future if the activities are similar
to the one in past.
v. It helps to test the feasibility of the project. Financial, marketing, environmental
etc. feasibility study is carried out to see if the project is feasible.

# Tools of Project Analysis and Evaluation:

There are many tools to use in the evaluation and analysis of the project. They
are as follows.
Cost Benefit Analysis:
Cost Benefit Analysis is an analysis o the relationship between the costs of
undertaking a task or project, initial and recurrent, and the benefits likely to arise
from the changed situation, initially and recurrently. This is an important tool of
project analysis and evaluation. While investing in any project, analysis should be
done to find out how much benefit is possible. If not adequate possible benefit is
found from cost benefit analysis, then the project is rejected otherwise it is accepted.
Generally, the cost benefit is measured with monetary value but the present
day business includes social responsibilities in their sector. So, while analyzing cost
benefit of a project, not only monetary profit, but also social benefit should be
considered. The project is the product of the society. So it should be work remaining
within the society.
Capital Budgeting Techniques:
Capital budgeting is the planning process used to determine whether an
organization’s long term investment such as new machinery, new plants, new
products, and research & development, infrastructure development and public sector
projects are worth pursuing. It is the process of evaluating and selecting long-term
investment consistent with the organization’s goal of maximizing stakeholders
benefit.
Capital Budgeting is an extremely important aspect of an organization’s
financial management. It is classified into two broad categories discounting criteria
and non-discounting criteria.
1. Payback Period (PBP): The payback period is commonly used to evaluate
proposed investment projects. The payback period is the expected number of
years that is required to recover the original or the initial investment from the
net cash flows resulting from an investment project. It measures the period of
time required for the cost of the project to be recovered from the earning of the
project.
Decision Criteria:
 If payback period is less than or equal to pre-determined target value or
life of project, accept the investment project.
 If the payback period is greater than a pre-determined target value or
life of the project, reject the investment project.
 If the investment projects are mutually exclusive, select the project with
the lowest payback period.
Advantages:
 It is easy to apply and simple to understand.
 It considers earning from the project for the payback period.
 It provides bases to compare the profitability of alternative project.
Disadvantages:
 It ignores the time value of money.
 The payback method is that which does not consider cash flow after the
payback period so it does not consider the project as a whole.
 It is difficult to determine the maximum acceptable payback period.
 It ignores the uneven profit from various projects.

2. Discounted Payback Period: Discounted payback period is the modified

version of regular payback period. Discounted payback period is defined as the
number of years required to recover the investment outlay on the present value
basis. Here, the project’s annual cash flows are first discounted by the
organization’s cost of capital and then using the same procedure used in regular
payback period, the discounted payback period is calculated.
Decision Criteria:
 If the discounted payback period is less than or equal to pre-determined
target value or life of project, accept the investment project.
 If the discounted payback period is greater than a pre-determined target
value or life of the project, reject the investment project.
  If the investment projects are mutually exclusive, select the project with
the lowest discounted payback period.
Advantages:
 It is easy to apply and simple to understand.
 It considers earning from the project for the payback period.
 It provides bases to compare the profitability of alternative project.
 Failing to take into account the time value of money has been
overcome.
Disadvantages:
 The discounted payback method is that which does not consider cash
flow after the discounted payback period so it does not consider the
project as a whole.
 It is difficult to determine the maximum acceptable discounted payback
period.
 It ignores the uneven profit from various projects.

3. Net Present Value: Net Present Value (NPV) is one of the techniques for the
appraisal of the project. The NPV of a project is the sum of the present values
of all the cash flows-positive as well as negative that are expected to occur
over the life of the project. It is the difference between the total present value
of expected future cash flows and initial investment. It is the difference
between discount benefits and discounted cost of the project. If the Net
Present valve is positive, the project will be selected and otherwise it will be
rejected. It introduces the time value of money and inflation. It also gives
accurate profit and loss forecast but it excludes non financial data like market
potential.
Decision Rule:
The NPV decision rule is to accept all the possible NPV projects in an
unconstrained environment, or if projects are mutually exclusive, accept the
one with the highest NPV. If the NPV is zero, it is a matter of indifference.
Limitations of NPV Method:
 The NPV is expressed in absolute terms rather than in relative terms. It
does not factor in the scale of investment.
 The NPV rule does not consider the life of the project. Hence, when
mutually exclusive projects with different life are being considered, the
NPV rule is based in favor of the higher term project.

4. Benefit-Cost Ratio: It is an analysis of the relationship between the costs of

undertaking a task or project, initial and recurrent, and the benefits likely to
arise from the changed situation, initially and recurrently the present value of
money.
 Benefit Cost Ratio BCR = PVB/I
Net Benefit Cost Ratio NBCR = PVB-I/I = BCR-1
Benefits of Benefit-Cost Ratio:
 BCR measures the net present value per rupees of outlay.
 It can discriminate between large and small investment and preferable to
the net present value criterion.
 Under unconstrained conditions, the benefit-cost ratio criterion will accept
and reject the same projects as the net present value criterion.
 When the capital budget is limited in current period, the benefit-cost ratio
may rank projects correctly in the order of decreasingly efficient use of
capital.
Limitations of BCR:
 BCR does not provide aggregate several smaller projects into a package
that can be compared with large projects.
 When cash outflows occur beyond the current period, the benefit-cost
criterion is unsuitable as a selection criterion.

5. Internal Rate of Return: The Internal Rate of Return (IRR) of a project is

defined as the discount rate that makes its net present value (NPV) equal to
zero. IRR is the discount rate which equates the present value of future cash
flows with the initial investment. It is the estimated rate of return for a
proposed project. It is a measuring tool to calculate the return on investment.
The project with the highest IRR will be selected. It also considers the time
value of money. However it is complex to understand and use.
Decision Rule:
If the IRR is greater than the cost of capital, project should be selected
and if the IRR is less than the cost of capital, project should be rejected.

6. Accounting/Average Rate of Return: ARR is the average annual percentage

of net income or average investment. This method of evaluating is based on
the profit generated by the project. In this method, net profit is used as a return
on investment. Several factors have to be considered in calculation of net
profit like nature of business, the risk involved in return from the bank
deposit, external environment etc. it also provide standards to compare
profitability of the alternative projects like payback period. However, it
ignores the time value of money and it is difficult to define the satisfactory
rate of level.
Decision Criteria:
Accept the Project: Equal or Higher the Accounting Rate of Return than pre-
specified cu off rate of return (above the cost of capital).
Reject the Project: Lower the Accounting Rate of Return than pre-specified
cu off rate of return (below the cost of capital).
 Advantages:
 It is simple to calculate.
 It is based on accounting information which is readily available.
 It considers the benefits over the entire life period of the project.
Disadvantages:
 It is based on the accounting profit not financial profit.
 It does not consider the time value of money.
 There are numerous measure of ARR. This creates controversy, confusion,
and problems in interpretation.
 The target or hurdle rate of return cannot be specified in relation to the goal
of investor wealth maximization.

# Similarities and Differences on Project Analysis:

Difference between NPV & IRR
NPV IRR
The total of all the present values of cash IRR is described as a rate at which the
flows (both positive and negative) of a sum of discounted cash inflows equates
project is known as Net Present Value or discounted cash outflows.
NPV.
NPV calculates a time series of cash IRR is a percentage value expected in
flows, both incoming and outgoing, in return from a capital project.
terms of currency.
NPV methods works accurately even in IRR is a percentage value expected in
inconsistent cash flow as it is the return from a capital project.
collection of all the inflows & outflows
and finding an average over the entire
period.
It represents surplus from the project. It represents point of no profit no loss
(Break even point).
Variation in the cash outflow timing will Variation in the cash outflow timing will
not affect NPV. show negative or multiple IRR.
NPV method can evaluate big long-term IRR gives better accuracy on short term
projects better. projects with consistent inflow or
outflow figures.

Similarities between NPV & IRR

 Both the techniques are helpful in selecting independent investment project or
mutually exclusive project.
 The decision criteria for NPV and IRR is similar i.e. both brings same accept
reject conclusion.
 Both techniques consider time value of money
Difference between NPV & Payback Period
NPV
NPV of a project is the sum of the
present values of all the cash flows-
positive as well as negative that are
expected to occur over the life of the
project.
NPV analysis removes the time element
in weighing alternative investments.
It introduces the time value of money
and inflation.
NPV considers the cash flow up to the
time period needed to recover initial
investment and gives accurate profit and
loss forecast.
Payback Period
Payback period is the expected number
of years that is required to recover the
original or the initial investment from the
net cash flows resulting from an
investment project.
Payback period is focused on the time
required for the return on an investment
to repay the total initial investment.
Payback period doesn’t properly assess
the time value of money, inflation,
financial risks, etc.
Payback period doesn’t take into
consideration any probabilities that may
occur after the payback period nor
measure total incomes.

Difference between Payback & Discounted Payback Period:

Payback Period Discounted Payback Period
Payback period is the length of time it The discounted payback period is the
takes the net cash revenue/ cash cost length of time it takes the discounted net
savings of a project to payback the initial cash revenue/cost savings of a project to
investment. payback the initial investment.
It does not take into account the time It takes into account the time value of
value of money. money.
Payback period is calculated as a ratio of The project’s annual cash flows are first
the cost of the investment and the annual discounted by the organization’s cost of
income amount projected from that capital and then calculated same as
investment. regular payback period.
Generally, payback period is shorter than Discounted payback period is longer than
the discounted payback period. the standard payback period but gives a
more accurate estimate on when the
company can expect a return on its
investment.

Similarities between Payback & Discounted Payback Period:

 Both Payback and Discounted Payback Period measures the ‘period of time’
required for the cost of the project to be recovered from the earning of the
project.
 Both the techniques are used as bases to compare the profitability of alternative
project.
 The decision criteria for selecting or rejecting an investment project or mutually
exclusive is same for both the techniques.
 Cash flows after the payback period are ignored, therefore the effects of the
whole project on the cash flows of the organization are not considered.

Difference between IRR &ARR

IRR ARR
Internal Rate of Return (IRR) is the Accounting/Average Rate of Return is
discount rate which equates the present the average annual percentage of net
value of future cash flows with the initial income or average investment.
investment.
IRR can be computed for period of one ARR is computed for one year only.
or more years.
IRR is discounted cash flow method. ARR is non-discounted cash flow
method.
It considers time value of money. It does not consider time value of money.
The decision criteria for IRR is based on The decision criteria for ARR is set by
the cost of capital where management the management where the management
selects a project when its IRR exceeds team selects an independent project as
the cost of capital & rejects it when the long as it exceeds the limit the team has
IRR is less than the cost of capital. set.
Similarities between IRR and ARR
 For an investment that lasts exactly one year, the internal rate of return (IRR) is
the same as the return on investment or average rate of return (ARR).

Difference between NPV & BCR

NPV
NPV of a project is the sum of the
present values of all the cash flows-
positive as well as negative that are
expected to occur over the life of the
project.
The NPV is an absolute measurement of
the program’s benefits and cost.
To calculate NPV, the total discounted
cost is subtracted from the total
discounted benefits.
The NPV decision rule is to accept all
the positive NPV projects and to reject
BCR
BCR is an analysis of the relationship
between the cost of undertaking a task or
project, initial and recurrent and the
benefits likely to arise from the changed
situation, initially and recurrently.
The BCR is a relative measurement of
the investment’s benefit and cost.
To calculate the BCR, divide total
discounted benefits by total discounted
costs.
All projects with BCR greater than 1 are
accepted and the projects with BCR less
with negative NPV values, or if projects than 1 are rejected. BCR equals to 1 is
are mutually exclusive, the project with the state of indifferent to select or reject
highest NPV is selected. a project.

# Managing Project Risk:

Project risk is an uncertain event or condition that, if it occurs, has an effect
on at least one project objective. Managing project risk focuses on identifying and
assessing the risks to minimize the impact on the project. There are no risk free
projects because there are an infinite number of events that can have a negative
effect on the project. Risk management is not about eliminating risk but about
identifying, assessing and managing risk. It is the process of analyzing and
responding to risk factors throughout the life of a project and in the best interests of
its objectives. Proper risk management implies control of possible future and is
proactive rather than reactive.
According to the Project Management Institute’s PMBOK, “Risk
Management is one of the ten knowledge areas in which a project manager must be
competent.”
Thus managing project risk is the identification, assessment, and prioritization
of risks followed by coordinated and economical, application of resources to
minimize, monitor and control the probability and/or impact of unfortunate events or
to maximize the realization of opportunities. Risk management is a continuous
process and must not only be done at the very beginning of the project, but
continuously throughout the life of the project. Additionally, continuously risk
management will ensure that high priority risks are cost-effectively managed
throughout the project. It provides management at all levels with the information
required to make informed decision on issues critical to project success.

# Managing Project Quality:

Commentators have differing views on what constitutes a quality project. The
generally agreed parameters are that it delivers the desired outcomes on time and
within budget. Through our long experience, the Transformed team has identified 6
key factors that improve project quality:
i. A Good Plan: The Plan, Do, Check, Act cycle is fundamental to achieving
project quality. The overall project plan should include a plan for how the
project manager and team will maintain quality standards throughout the
project's cycle.
ii. Appropriate Communication: Despite good project planning and
scheduling, poor or absent communication with team members and
stakeholders can bring a project undone. Project managers need excellent
communication skills and a comprehensive scheme that encourages formal
and informal discussion of expectations, innovation, progress and results.
 iii. Manage Stakeholders: Stakeholders include everyone who has an interest
in, can influence or is affected by the project's implementation or outcomes.
To engage stakeholders, identify who they are, analyze their concerns and
what they need to know and then prepare a strategy to provide the
appropriate amount of information and opportunities for involvement.
iv. Good Measurement: Early in the process it is important to identify the key
outcomes and outputs of the project and how the manager will measure
whether they have been delivered. Implement processes that measure
progress, both qualitatively and quantitatively, throughout the project at
individual, team and whole project levels. This ensures that problems can be
identified early and successful tactics can be promulgated throughout the
project.
v. Constant Review: Along with good measurement go good review
mechanisms. Successful project managers diligently and regularly review
progress against the schedule, budget and quality elements of the project.
Regular review allows problems to be identified early so that corrective
action can be taken to keep the project on track. Review also helps team
members to learn and improve their skills.
vi. Act Early: Measurement and review are important, but they are only
effective if the project manager takes action on issues identified. Leaving
problems to be fixed up later is a recipe for disaster. Simple issues should be
addressed immediately. More complex issues should be added for action into
the project plan and resources allocated to address them.

# Reasons for Project Failure:

A project is considered a failure when it has not delivered what was required,
in line with expectations. Therefore in order to succeed, a project must deliver to
cost, to quantity, and on time; and it must deliver the benefits presented in the
business case. Though there are lots of factors which can be considered as major
reasons for the failure of any project. Some of them are:
i. Poor planning and/or inadequate process: Planning is the central to the
success of a project. It is important to define what constitutes project success or
failure at the earliest stage of the process. It is also essential to drill down the
big picture to smaller tasks.
ii. Poor leadership at any level: The “leader” is usually identified as the project
manager. However, the management-level executive also has a responsibility of
ensuring the project’s success. He/She should work together with the manager
to ensure that the company’s exact requirements are understood.
iii. Failure to set expectation and mange them: In working in a tem setting, it is
crucial to be able to manage people. If and when expectations are not met, there
should be clearly defined consequences. The task should then be prioritized and
possibly reassigned to a more competent individual.
iv. Inadequately –trained project managers: the project manager is taking on a
heavy responsibility. It is important to assign management roles only to
individuals who have the capabilities to meet requirements. In some cases,
poorly-trained managers are assigned to complex projects; this is a recipe for
failure.
v. Inaccurate cost estimation: There are instances when the cost of an
undertaking is grossly underestimated. When it runs out of resources, the
project cannot be completed. This can be mitigated when the lack of resources
is identified early by the project manager.
vi. Lack of communication at any level: Communication between the
management executive and the project manager, and between the latter and the
team members are always important. Everyone should feel free to come
forward to state their concern or give suggestions.
vii. Culture or ethical misalignment: The culture pf the company must prize
competence, pro-activeness, and professionalism. If it doesn’t the team
members may not have the motivation to do their best. In essence, everyone
involved must be concerned about the success of the undertaking.
viii. Disregard of project warning sign: When a project is on the verge of failing,
there will always be warning signs. Taking action immediately can save the
project. Otherwise, the whole endeavor can just go down the drain.

Reasons of Project Success:

Having a talented project manager is the first step to actual project success,
but there are other important factors that contribute largely to a project’s outcome. It
takes careful planning, attention to detail and effective communication to make a
project succeed. With vigilant management and a strong project closing, a company
can consistently reach project success. Some of the major factors of project success
are as follow:
i. Big picture is understood: It’s just as important to see the big picture as well
as details. Understanding the overall purpose and goal of the project allows
project manager to make decision and resolve issues that arise.
ii. Smart People: Without the right team in place, any strategy and plan has the
potential of completely falling apart. Because of this, the core project staff,
expert resources, supplier and all stakeholders should be part of the team
dynamic. All of those involved must have commitment to the group, share
similar vision for the projects and strive for overall success.
iii. Smart Planning: Comprehensive planning sets up a project for success from
the start. All stakeholders should be on board during the planning process and
always know in which direction the project is going to go. Planning can help the
tem to meet deadlines and stay organized. Good planning not only keeps the
project teams focused and on track, but also keep stakeholders aware of project
progress.
iv. Open Communication: Looking closely at details and listening to outside
source of information is vital to the success of a project. Keeping open
communication with the team is absolutely essential. When working under a
specific timetable, it is important that the team remains well-informed. If a
problem arises on one part of project, it can negatively impact other part as
well. Communication is the best way to prevent problems from occurring.
v. Careful risk management: Project managers know that things rarely go off
exactly as planned. During the planning process, it is vital to produce a risk log
with an action plan for the risks that the project could face. If something
happens, then the team can quickly resolve the issue with the management plan
that has already been set in place. This will give the team confidence when
facing project risks and help the clients feel comfortable with the project’s
progression.
vi. Strong Project Closure: If a project does not have strong closure, then it has
the potential to continue to consume resources. The project team must be firm
and agree with the customer that all critical success factors have been met.
Confirmation of the project delivery, testing, and release must be agreed upon
and signed off. Satisfaction surveys are good forms of documentation to log and
file for future reference and valuable information for use in the future.