DEVELOPMENT PLANNING

AND PROJECT ANALYSIS II

Econ 3132

CHAPTER ONE:
The Basic concepts of Project
Planning
 Chapter 1 Basic Concepts
1.1 The Project Concept
Introduction
• Project planning involves estimating and comparing
beneficial effects of an investment with its costs.
• Projects are the cutting edge of development.
• Implementing development programmes is the most
difficult problem in developing countries due to poor
project preparation.
• But, Project preparation is not the only aspect of dev’t.

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• Identifying national dev’t objectives, selecting priority
areas for investment, designing effective price policies and
mobilising resources are all critical.
• Unless projects are carefully prepared in a substantial
detail, inefficient expenditure is likely to result a tragic loss
in nations’ short of capital.
• In many countries, the capacity to prepare and analyse
projects lags.
• The time and effort required to prepare suitable projects
is continuously underestimated.

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• Much attention is paid to policy formulation and planning
of greatly broader scope.
• Specific projects on which to spend the available money
and on which a great deal of dev’t depends are
overlooked.
• Ill-conceived, hastily planned projects, virtually
improvised on the spot, are too often the result.

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Definition of a Project
• A project is the whole complex of economic activities
in the undertaking that uses scarce resources to gain
benefits.
• Think of a project as an investment activity in which
financial resources are spent to create capital assets
that produce benefits over an extended period.
• But in some projects, costs are incurred for production
expenses or maintenance purposes from which
benefits can normally be expected, usually within
about a year.

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• Projects form a clear and distinct portion of a larger,
less precisely identified programme.
• The whole programme might possibly be analysed as
a single project.
• But normally it is better to keep projects small, close
to minimum size that is economically, technically and
administratively feasible.

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• Likewise, it is generally better in planning projects to
analyse successive increments.
• In this way, the return to each relatively small
increment can be judged separately.
• If a project approaches programme size, there is a
danger that high returns from one part of it will mask
low returns from another.

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A project is:
• an activity for which money will be spent in expectation
of returns and logically lends itself to planning, financing
and implementing as a unit.
• the smallest operational element prepared and
implemented as separate entity in a national plan.
• a specific activity, with specific starting and ending points,
intended to accomplish specific objectives.

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• A project is a unique activity noticeably different from
preceding similar investments, and it is likely to be
different from succeeding ones.
• It is not a routine segment of an ongoing programme.
• It will have a well-defined sequence of investment and
production activities, and a specific group of benefits,
that we can identify, quantify and determine a money
value for.

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Basic characteristics of a project
These characteristics are elements that make a project.
1.A single definable purpose, end-item or result. This is
usually specified in terms of cost, schedule and
performance requirements.
2.Every project is unique. It requires the doing of
something different, something that was not done
previously. Even in what are often called “routine”
projects such as home construction, the variables such as
terrain, access, zoning laws, labour market, public
services and local utilities make each project different. A
project is a one-time, once-off activity, never to be
repeated exactly the same way again.
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3. Projects are temporary activities. A project is an ad hoc
organization of staff, material, equipment and facilities that
is put together to accomplish a goal. This goal is within a
specific time-frame. Once the goal is achieved, the
organization created for it is disbanded or it is reconstituted
to begin work on a new goal (project).
4. Projects cut across organizational lines. Projects always cut
across the regular organizational lines and structures within
a firm. They do this because the project needs to draw from
the skills and talents of multiple professions and
departments within the firm and sometimes even from
other organizations. The complexity of advanced
technology often leads to additional project difficulties, as
they create task interdependencies that may introduce new
and unique problems.
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5. Projects involve unfamiliarity. Because a project differs
from what was previously done, it also involves
unfamiliarity. And often a project also encompasses
new technology and, for the organization/firm
undertaking the project, these bring into play significant
elements of uncertainty and risk.
6. The organization usually has something at stake when
undertaking a project. The unique project “activity”
may call for special scrutiny or effort because failure
would jeopardize the organization/firm or its goals.

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7. A project is the process of working to achieve a goal. During
the process, projects pass through several distinct phases,
which form and are called the project life cycle. The tasks,
people, organizations, and other resources will change as the
project moves from one phase to the next. The organizational
structure and the resource expenditures build with each
succeeding phase; peak; and then decline as the project
approaches completion.

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 Classification of projects
1.New, Extension and Rehabilitation/Maintenance
projects
New Projects: require substantial early capital
investment and embody many physical inputs
Extension and Rehabilitation Projects: embody less
capital but more human resource skills and institutional
development.
Appraisal of a new project demands more time and
resources.

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2. Blue print projects
Where a project can be planned in considerable and
predictable detail before implementation begins, has few
opportunities for revision once implementation is underway,
tends to be capital and equipment intensive, and is top-down
in relation to project beneficiaries.
Most appropriate for engineering type projects.

3. Participatory projects
People or process or labour intensive
Evolves and alters as it is implemented
Unpredictable,
Owned by the beneficiaries
Difficult to appraise
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4. Single versus Multiple-intervention projects
 Projects may comprise single/multiple interventions.
 Single intervention projects are simple to appraise.

5. Productive, Social and infrastructure projects

 Productive sectors: like agriculture, industry and tourism,
where project inputs and outputs are quantified and
valued for comparison.
 Social sectors: like education and health where
quantifying and valuing outputs may not be easy.
 Infrastructure sectors: like transport, power, water
supply, sanitation, telecommunications and housing
where both the above conditions exist.

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6. Single and Multi-purpose projects
• Some projects are single purpose while others are set
out to be multi-purpose.
7. Slow and quick benefit yielding projects
 It is often important to recognize whether a project will
yield benefits slowly or quickly.
 An agricultural project concentrates on producing annual
crops will usually be much faster in yielding a benefit
than one focusing on planting tree crops like oranges
that will take 4 to 5 years to start to bear fruit.
8. Gender sensitive and age/culture specific projects

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1.2 The Project Cycle
•The “project cycle” is a natural sequence in the way
projects are planned and carried out.
•The cycle may be divided in many equally valid ways.
Here, it is divided into five stages:
Identification
Preparation and analysis
Appraisal
Implementation
Evaluation

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 Identification
• The first stage in the cycle is to find potential projects.

• Suggestions may come from many sources .

• The most common ones are well-informed technical

specialists and local leaders.
• Technical specialists may identify many areas where
new investment might be profitable.
• Local leaders have a number of suggestions about
where investment might be carried out.

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• Ideas for new projects may also come from proposals to
extend existing programmes.
• Suggestions for new projects arise because some
products are in short supply or will be exhausted in a
few years unless production is expanded.
• The analysis may be carried out based on general
knowledge or on a more systematic examination of
market trends and import statistics.
• Specific suggestions for projects will have to come from
the operating agencies responsible for project
implementation.
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 Preparation and analysis
• Once projects have been identified, there begins a
process of progressively more detailed preparation
and analysis of project plans.
• This includes all the work required to bring the project
to the point where appraisal can start.
• First step in preparation and analysis is to carry out a
feasibility study to get sufficient information for
deciding whether to begin a more advanced planning.

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• Details of the feasibility study will depend on the
complexity of the project and information already
available about the proposal.
• The feasibility study should define the objectives of
the project clearly.
• It will provide the opportunity to shape the project to
fit its physical and social environment and to ensure
that the project will be high yielding.

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• As projects are planned in greater and greater detail
the:
investment of time and money becomes more and
more substantial
expectations of vested interest continue to grow

• The financial and economic analysis should enter

early in the planning process, so that feasibility
studies introduce these aspects in the project plan.

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• The staff needed to work on the feasibility studies will
depend on the complexity of studies.
• To start, a single member may make a preliminary
estimate in a relatively short time.
• Later, the services of a small team, or perhaps outside
consultants, may be engaged.
• Once the feasibility studies have indicated that the
proposed project is worthwhile , detailed planning and
analysis may begin.
• By this time, the less promising alternatives will have
been eliminated.
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• This is the stage at which detailed study will commence.

• Detailed planning takes time, often a year or more for

complex projects and may be quite expensive.

• Careful preparation increases a project’s efficiency and

helps ensure its smooth implementation in the future.

• Preparation of the plan should itself be planned to avoid

delays and conserve resources.

• The project may be prepared by a special team

assembled for the purpose or by a consulting firm.

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 Appraisal
• After a project has been prepared, it is necessary to
conduct a critical review or an appraisal.
• Appraisal provides an opportunity to re-examine every
aspect of the project plan to assess whether the
proposal is appropriate and sound before investing
more money.

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• The appraisal process builds upon the project plan,
but it may involve new information if the specialists
on the appraisal team feel that some of the data are
questionable or some of the assumptions faulty.

• If the appraisal team concludes that the project plan is

sound, the investment may proceed.

• But if the appraisal team finds serious flaws, it may be

necessary for the analyst to alter the project plan or
to develop a new plan.

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 Implementation

•  The objective of any effort in project planning and

analysis is to have a project that can be implemented to
the benefit of the society.

• Thus, implementation is perhaps the most important

part of the project cycle.

• Some aspects of implementation are of particular

relevance to project planning and analysis.

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• The better and more realistic the project plan is, the
more likely it is that the plan can be carried out and
the expected benefits realised.

• This emphasizes the need for careful attention to each

aspect of project planning and analysis.

• Project implementation must be flexible.

• Circumstances will change, and project managers

must be able to respond intelligently to these changes.

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• The greater the uncertainty of the various aspects of the
project, the greater the likelihood that changes have to
be made.

• Even as the project implementation is in progress,

project managers will need to reshape and re-plan parts
of the project, or perhaps the entire project.

• Implementation is the process of refinement and

learning from experience-in effect it is a kind of “mini-
cycle” within the large project cycle.

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• Project analysts generally divide the implementation
phase into three different time periods.

i. Investment period, when the project investments

are undertaken.

ii. As the production builds up, the project is spoken

of as being in the development period.

iii. Once full development is reached, it continues for

the life of the project.

• Project life is keyed to normal life of major asset.

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 Evaluation
• The final phase in the project cycle is 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 may be undertaken when the project is in trouble, as

the first step in the re-planning effort.

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• Careful evaluation should precede any effort to plan
follow up projects.

• Finally, it should be undertaken when a project is

terminated.

• It may be conducted by many different people.

• Project management will continuously evaluate its

experience as implementation proceeds.

• The sponsoring agency, or an external assistance

agency may undertake evaluation.
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• The extent to which the objectives of a project are being
realised provides the primary criterion for evaluation.

• But the objectives cannot be accepted uncritically. The

inquiry should consider whether the objectives
themselves were appropriate and suitable.

• Evaluators want to know if these objectives were made

clear to planners and project managers.

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• The project should be reviewed to see if it was
appropriate in light of the objectives set forth.

• Each objective should be examined to determine

whether it was considered carefully and appropriate
provision for it was made in the project plan.

• The evaluation should consider the response of the

project management and the sponsoring agencies to
changing circumstances.

 
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• Carefully considered recommendations should come
from the evaluation about how to improve the
appropriateness of each aspect of the project design.

• Hence, plans for project implementation can be

revised if the project is ongoing so that future projects
can be better planned if the evaluated project has
been completed.

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Aspects of Project Analysis
1. Demand and market analysis
2. Technical aspects
3. Institutional-organizational and managerial aspects
4. Social aspects
5. Financial aspects
6. Economic aspects
7. Ecological/environmental aspects

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1.3 Aspects of Project Preparation and Analysis
Demand and Market Analysis
• First step in this analysis is to estimate the
potential size of the market for the product
proposed to be manufactured and get an idea
about the market share likely to be captured.
• Thus, it is concerned with two broad issues:
i. What is the likely aggregate demand for the
product or service?
ii. What share of the market will the proposed
product enjoy?
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 Demand and Market … continued
• These are very important   but difficult questions
in project analysis.
• Intelligent and meaningful answers to them call
for an in-depth study and assessment of various
factors like patterns of consumption growth,
income and price elasticity of demand,
composition of market, nature of competition,
availability of substitutes, reach of distribution
channels, etc.

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Demand and Market … continued
• In many cases, project feasibility studies make a
short shrift of demand and market analysis.
• Given its importance, demand & market analysis
should be carried out in an orderly and
systematic manner.

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Situational analysis and specification of
objectives
• The project analyst may informally talk to
customers, competitors, middlemen, and
others in the industry to assess the
relationship b/n the product and its market.
• If possible, he may look at the experience of
the company to know about the preference
and purchasing power of customers, actions
and strategies of competitors and practices of
middlemen.

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Situational analysis and … continued
• If such a situational analysis generates enough
data to measure the market and get a reliable
handle over projected demand and revenues,
a formal study need not be required.
• But in most cases, a formal study of the
demand and market is warranted.
• To carry out a study, it is necessary to spell out
its objectives clearly and comprehensively.
• To spell out the objectives, it is helpful to
structure them in the form of questions.

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Situational analysis and … continued
• Always bear in mind how the information
generated will be relevant in
forecasting the overall market demand
assessing the share of the market that the
proposed project will capture.
• This ensures that questions irrelevant to the
demand and market analysis will not be asked
unnecessarily.

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Data Collection
• To answer questions listed in delineating the
objectives of market study, information may
be obtained from secondary/primary sources.
• Primary information: is collected for the first
time to meet the specific purpose at hand.
• Secondary information: has been collected in
some other contexts and is already available.
• Secondary information provides the base and
stating point for demand and market analysis.

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 Methods of Estimating Future Demand
 
• After gathering information about various
aspects of the market and demand, an attempt
may be made to estimate future demand.
• Forecasting methods-classified into 3 categories:
I. Qualitative Methods: these rely on the judgment
of experts to translate qualitative information
into quantitative estimates. The ones are Jury of
executive method and Delphi method.
II. Time Series Projection Methods: these generate
forecasts based on historical time series analysis.
 

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Methods of Estimating … continued
• Trend projection, exponential smoothing and
moving average are important time series
projection methods.
III. Causal Methods: these are more analytical
than the preceding methods which seek to
develop forecasts on the basis of cause-effect
relationships specified in an explicit,
quantitative manner.
• The important causal methods are: chain ratio,
consumption level, end use, leading indicator
and econometric methods.
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 Jury of Executive Method
•  This method involves soliciting the opinions of a
group of managers on expected future sales and
combining them into a sales estimate.
Advantages
i. a quick method to develop a demand forecast.
ii. permits the inclusion of various factors such as
economic climate, technological developments,
competitive environment, consumer
preferences, etc.) in the subjective estimates of
the experts.
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Jury of Executive Method … continued
iii. has enormous appeal to managers who tend
to prefer their judgment to mechanistic
forecasting procedures.

Disadvantages
i. The biases underlying the subjective estimates
cannot be easily discovered.
ii. Reliability of this technique is questionable.

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 Delphi Method
• This method is used for eliciting opinions of a
group of experts with the help of a mail survey.
Steps involved in the Delphi method are:
1. A group of experts is sent a questionnaire by
mail and asked to express their views.
2. The responses received from the experts are
summarised without disclosing identity of the
experts & sent back to them with questionnaire
that probes further the reasons for the extreme
views expressed in the first round.
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Delphi Method … continued
3. The process may be continued for one or
more rounds till a reasonable agreement
emerges in the views of the experts.
• It appeals to many organizations because
i. It is intelligible to users.
ii. It seems to be more accurate and less
expensive than the traditional face-to-face
group meetings.
• But there are certain questions:
i. What is the value of the exert opinion?
ii. What is the contribution of additional rounds
and feedback to accuracy?
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 Trend Projection Method
This
  method involves:
• Determining the trend of consumption by
analysing past consumption statistics.
• Projecting future consumption by extrapolating
the trend. Linear relationship is commonly used
Yt = a + bT
where, Yt = demand for year T
T = time variable
a = intercept of the relationship
b = slope of the relationship
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• To estimate the parameters a and b, the least
squares method is used.
•  According to this method, a linear relationship is
chosen to minimise the sum of squared
deviations from the line.
• The parameters are estimated using the following
equations:

b
TYnTY
T nT2 2

a Y bT

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e.g. Let’s use the following demand data to
illustrate the use of the trend projection method.
Year Demand (‘000) Year Demand (‘000)
1988 10 1995 20
1989 13 1996 22
1990 14 1997 23
1991 17 1998 22
1992 18 1999 24
1993 18 2000 24
1994 19 2001 25
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Solution: For purpose of linear trend analysis, it is
convenient to change the time axes as follows.
Actual Year for Actual Year for
Year Analysis Year Analysis
1988 0 1995 7
1989 1 1996 8
1990 2 1997 9
1991 3 1998 10
1992 4 1999 11
1993 5 2000 12
1994 6 2001 13
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 Yt = a + bT
The calculation of a and b is shown below.
Calculation in the least squares method
T Y TY T2
0 10 0 0
1 13 13 1
2 14 28 4
3 17 51 9
4 18 72 16
5 18 90 25
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Calculation in the least squares … continued
T Y TY T2
6 19 114 36
7 20 140 49
8 22 176 64
9 23 207 81
10 22 220 100
11 24 264 121
12 24 288 144
13 25 325 169
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Calculation in the least squares … continued
ΣT = 91
Ī = ΣT/n = 91/14 = 6.50
ΣY = 269
Ÿ = ΣY/n = 269/14 = 19.21
ΣTY = 1998
ΣT2 = 819

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Calculation in the least squares … continued
b = (ΣTY – nĪŸ)/(ΣT2 – nĪ2)
= [1998 – (14)(6.50)(19.21]/(819 – 14(6.5)2
= (1998 – 1748.11)/(819 – 591.5)
= 249.89/227.5 = 1.098 = 1.1
a = Ÿ - bĪ = 19.21 – 1.1(6.5) = 12.1
The least squares line is
Yt = 12.1 + 1.1T

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Advantages of the least squares method
i. It uses all the observations.
ii. The straight line is derived by an objective
statistical procedure.
iii. A measure of goodness of fit is available
Limitations of the least squares method
• Somewhat complicated than earlier methods
• Its results are valid only when certain
conditions are satisfied

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Other Relationships used
• Exponential Relationship: Yt = aebt
In logarithmic form: lnYt = lna + bt
• Polynomial Relationship:
Yt = a0 + a1t + a2t2 + … + antn
e. g. A polynomial of degree 2: Yt = a0 + a1t + a2t2
•  Cobb-Dauglas Relationship: Yt = atb
In logarithmic form: logYt = loga + blogt
where, Yt is demand for year t, t is the time
variable and a, b, and at,s are constants.
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Exponential Smoothing Method
•  In this method, forecasts are modified in the
light of observed errors.
• If the forecast value for year t, Ft, is less than the
actual value for year t, St, the forecast for year
t + 1, Ft + 1, is set higher than Ft.
• If Ft > St, Ft + 1 is set lower than Ft. In general,
Ft + 1 = Ft + αet
where, Ft + 1 = forecast for year t + 1
α = smoothing parameter (0 < α < 1)
et = error in the forecast for year t = St – 61
Ft
• How should the first forecast (F1) and the
smoothing parameter (α) be chosen?
• A simple and reasonably satisfactory rule is to
choose F1 as the mean of the warm-up sample.
(The warm-up sample consists of several
observations preceding the period for which the
forecasting exercise is began.)
•  For choosing α, consider several values in the
range of 0 to 1 and choose the value which
minimises the mean squared error (MSE) in the
warm-up period.
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Example
The following table shows the sales (in Birr) for a
certain product during a ten-year period.
Assume that the forecast for period 1 is 29. If
α = 0.2, derive the forecasts for the periods 2 to
11 using the exponential smoothing method.  
Solution:
Let St = Data, Ft = Forecast, et = Error = St - Ft
and Ft + 1 = forecast for year t + 1

63
T St Ft et Ft + 1 = Ft + αet
1 28.0 29.0 -1.0 F2 = 29.0 + 0.2(-1.0) = 29.0 – 0.20 = 28.8
2 29.0 28.8 0.2 F3 = 28.8 + 0.2(0.2) = 28.8 + 0.04 = 28.8
3 28.5 28.8 -0.3 F4 = 28.8 + 0.2(-0.3) = 28.8 – 0.06 = 28.7
4 31.0 28.7 2.3 F5 = 28.7 + 0.2(2.3) = 28.7 + 0.46 = 29.2
5 34.2 29.2 5.0 F6 = 29.2 + 0.2(5.0) = 29.2 + 1.00 = 30.2
6 32.7 30.2 2.5 F7 = 30.2 + 0.2(2.5) = 30.2 + 0.50 = 30.7
7 33.5 30.7 2.8 F8 = 30.7 + 0.2(2.8) = 30.7 + 0.56 = 31.3
8 31.8 31.3 0.5 F9 = 31.3 + 0.2(0.5) = 31.3 + 0.10 = 31.4
9 31.9 31.4 0.5 F10 = 31.4 + 0.2(0.5) = 31.4 + 0.10 = 31.5
10 34.3 31.5 2.8 F11 = 31.5+ 0.2(2.8) = 31.5 + 0.56 = 32.1
11 35.2 32.1 3.1 F12 = 32.1 + 0.2(3.1) = 32.1 + 0.62 = 32.7
64
Moving Average Method
•In this method of sales forecasting, forecast for
the next period is equal to the average of the
sales for several preceding periods. In symbols,
Ft + 1 = (St + St – 1+ … + St – n + 1)/n
where, Ft + 1 = forecast for the next period
St = sales for the current period
n = period over which average is taken
Remark: 1. The forecaster has to specify n.
2. No a priori way to determine n; it can
be arrived at by experimentation.
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 Example
To illustrate the use of the moving average
method, consider the following time series data.

Year 1 2 3 4 5 6 7 8 9 10 11 12

Sales 28 29 28.5 31 34.2 32.7 33.5 31.8 31.9 34.3 35.2 36

66
 Find the forecasts for periods 5 to 12.
•Solution: If n is set equal to 4 (n has to be
specified by the forecaster), the first forecast for
period 5 will be equal to
28.02 9 .02 8.5 31.0 1 16.5
 2 9.1
4 4
T
h efo rec astfo rp eriod6iseq ualto
29 .02 8 .5 31 .0 3 4.2 122 .7
  3 0.7
4 4
N.B .Ifn 4,thefirstfo rec
astc anb em ad
eon
lyfo
rpe
rio
d5.
Oth erfore castsfo llow a
sshow nb elow.

67
T St Ft Ft + 1 = (St + St - 1 + St - 2 + St - 3)/4
1 28.0
2 29.0
3 28.5
4 31.0
F5 = (28.0 + 29.0 + 28.5 + 31.0)/4 = 29.1
5 34.2 29.1 F6 = (29.0 + 28.5 + 31.0 + 34.2)/4 = 30.7
6 32.7 30.7 F7 = (28.5 + 31.0 + 34.2 + 32.7)/4 = 31.6
7 33.5 31.6 F8 = (31.0 + 34.2 + 32.7 + 33.5)/4 = 32.9
8 31.8 32.9 F9 = (34.2 + 32.7 + 33.5 + 31.8)/4 = 32.9
9 31.9 33.1 F10 = (32.7 + 33.5 + 31.8 + 31.9)/4 = 32.5
10 34.3 32.5 F11 = (33.5+ 31.8 + 31.9 + 34.3)/4 = 32.9
11 35.2 32.9 F12 = (31.8 + 31.9 + 34.3 + 35.2)/4 = 33.368
Chain Ratio Method
• The potential sales of a product may be
estimated by applying a series of factors to a
measure of aggregate demand.
•  The chain ratio method uses a simple
analytical approach to demand estimation.
• However, its reliability is critically dependent
on the ratios and rate of usage employed in the
process of determining the sales potential.
• Some of these ratio and rates of usage may be
based on objective proportions, while others
will have to be subjectively defined.
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 Consumption Level Method
• It is useful for a directly consumed product.
• It helps to estimate consumption based on
elasticity coefficients (income and price elasticity).
• Income elasticity: measures responsiveness of
demand to variations in income. It is defined as
EI = [(Q2 – Q1)/(I2 - I1)]*[(I1 + I2)/(Q1 + Q2)]
where, EI = income elasticity of demand
Q1 = quantity demanded in the base year
Q2 = quantity demanded in the following year
I1 = income level in the base year
I2 = income level in the following year 70
• The information on income elasticity of
demand along with projected income may be
used to obtain a demand forecast.
• The income elasticity of demand differs from
one product to another.
• Further, for a given product, it tends to vary
from one income group to another and from
one region to another.
• Hence, where possible, disaggregated analysis
should be attempted.

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• Price elasticity: measures the responsiveness of
demand to variations in price. It is defined as
EP = (Q2 – Q1)/(P2 - P1)*(P1 + P2)/(Q1 + Q2)
where,
EP = price elasticity of demand
Q1 = quantity demanded in the base year
Q2 = quantity demanded in the following year
P1 = price per unit in the base year
P2 = price per unit in the following year

72
• Future demand may be estimated based on
price elasticity and expected price change.
• Price elasticity may also be used to study the
impact of variable prices obtained in the future
on economic viability of the project.
• But in using the price elasticity measure, you
should bear in mind that:
i. It is applicable only to small variations.
ii. It is based on the assumption that the structure
and behavior remain constant.

73
 End Use Method
• This method is suitable for estimating
intermediate products.
• It is also known as the consumption coefficient
method.
• It involves the following steps:
1. Identify the possible uses of the product.
2. Define the consumption coefficient of the
product for various uses.
3. Project the output level for consuming industries.
4. Derive the demand for the product.
74
• Inputs required for its application are:
i. Projected output levels of consuming industries
ii. Consumption coefficients
•  But it may be difficult to estimate the projected
output levels of consuming industries.
• Essentially, the consumption coefficients may
vary from one period to another in the wake of
technological changes and improvements in the
methods of manufacturing.
• So, the end use method should be used wisely.

75
Leading Indicator Method
• Leading indicators are variables which change
ahead of other variables, the lagging variables.
• So, observed changes in leading indicators may
be used to predict changes in lagging variables.
• For example, the change in the level of
urbanization (a leading indicator) may be used
to predict the change in the demand for air
conditioner (a lagging variable).

76
• Two basic steps are involved in this method:
i. Identify the appropriate leading indicator(s).
ii. Establish the relationship between the leading
indicator(s) and the variable to the forecast.

•  Merit of this method: it does not require a

forecast of an explanatory variable.

• Demerits of this method:

• Difficult to find appropriate leading indicator(s).
• Lead-lag relationship may not be stable over
time.
77
Econometric Method
• An econometric method is a mathematical
representation of economic relationship(s)
derived from economic theory.
• The primary objective of econometric analysis
is to forecast the future behaviour of the
economic variables incorporated in the model.
• Two types of econometric models employed:
1. Single equation model
2. Simultaneous equation model.

78
1. The single equation model assumes that one
variable, the dependent variable, is influenced by
one or more independent (explanatory) variables.
Thus, one way causality is postulated. Example:

Dt = a0 + a1Pt + a2Nt + Ut ………………………(1)

where, Dt = demand for a certain product in year t

Pt = price of the product in year t
Nt = income in year t
Ut = error term and a0, a1 & a2 are constants
79
2. The simultaneous equation model portrays
economic relationship in terms of two or more
equations. e.g. consider the model given by
GNPt = Gt + Ct + It + Et …………………………(2)
It = a0 + a1GNPt …………………………….(3)
Ct = b0 + b1GNPt……….……………………(4)
where, GNPt = gross national product for year t
Gt = government expenditure for year t
It = gross investment for year t
Ct = consumption for year t
Et = error term and a0, a1, b0 & b1 are constants
80
• In the above model, equation 2 is just a
definitional equation which says that the gross
national product (GNP) is equal to the sum of
government expenditure, gross investment
and consumption.
• Equation 3 postulates that investment is a
linear function of GNP.
• Equation 4 postulates that consumption is a
linear function of GNP.

81
• Econometric model involves four broad steps:
1.Specification: Expression of an econometric
relationship in a mathematical form.
2.Estimation: Determination of the parameter
values & other statistics by a suitable method.
3.Verification: Accepting or rejecting the
specification as a reasonable approximation to
the truth based on estimation results.
4.Prediction: Projection of the value of the
explained variable(s).

82
• Advantages
i. The process of econometric analysis sharpens the
understanding of complex cause-effect
relationships.
ii. Econometric model provides a basis for testing
assumptions and for judging how sensitive the
results are to changes in the assumptions.
• Limitations
i. It is expensive and data demanding.
ii. The difficulty in obtaining the projected values of
the independent variable(s) may be the main
limiting factor in employing the econometric
method for forecasting purposes. 83
Marketing Strategy
Marketing strategy covers: target segment,
positioning, product line, price, distribution,
sales force, sales promotion and advertising.
• Target segment The target segment from the
point of view of income is middle class. But
the segment needs to be described more
clearly in terms of its psychometrics. e.g. a
company may specifically target students or
teenagers or entry level executives.

84
 Marketing Strategy … continued
• Positioning This is how long a product is placed
in the mind of the customer. Having decided on
targeting students, a company could be
positioned as “romantic” or “rugged”. Similarly,
if entry level executives are targeted, the
positioning could be “self confidence” or
“daylong freshness”.
• Product line Would a company like to launch a
single variant or more than one variant? What
fragrance goes with a “romantic” soap and what
fits if the positioning is “rugged”?
85
 Marketing Strategy … continued
• Price Will a company be launched in mid-price
segment becuase the segment is growing? Will
the price decision change depending on whether
the positioning is “romantic” or “rugged”?
• Distribution A company may like to confine its
distribution centers in the South and East. It may
drop out ineffective outlets.
• Sales force This may be marginally increased. A
company is likely to press for an increase in the
efficiency of its individual salesmen to boost its
sales.
86
Marketing Strategy … continued

• Sales promotion Direct consumer promotion

is usually expensive because it covers
thousands of individual customers. A small
organization may like to promote dealers
because their number is limited. It may aim at
spending 60% of the promotion budget on
dealer schemes and the remaining on
consumer schemes.

87
Marketing Strategy … continued
• Advertising Unconventional and creative
advertising options may be allocated 60% of
the budget.
• The remaining goes to mainstream advertising
like newspapers, and TV.
• This is because mainstream advertising is
expensive and not affordable.

88
Material Inputs and Utilities
These are classified into four broad categories:
i. Raw materials
ii. Processed industrial materials & components
iii.Auxiliary materials and factory supplies
iv.Utilities
i. Raw materials (processed & semi- processed)
may be classified into four types:
a. agricultural products b. mineral products
c. Livestock products d. Marine products
89
Material Inputs and Utilities … continued
a. Agricultural Products: In studying these
products, the quality must be first examined.
Then an assessment of quantities available,
currently and potentially, is required.

Questions that may be raised in this context are:

• What is the present marketable surplus?
• What is the present area under cultivation?
• What is the likely increase in yield per unit
area?
90
Material Inputs and Utilities … continued
b. Mineral Products: In assessing mineral
materials, information is required on the
quantum of exploitable deposits and the
properties of raw materials.
• The study should provide details of location,
size and depth of deposits and the availability
of open cast or underground mining.
• Besides, information could be generated on
the composition of the Ore, level of
impurities, need for beneficiation, and
physical, chemical and other properties.
91
Material Inputs and Utilities … continued
c. Livestock and Forest Products: Secondary
data on livestock and forest products often do
not provide a reliable basis for estimation. So,
a specific survey is required to obtain more
reliable data on the quantum of livestock and
forest products.
d. Marine Products: Assessing the availability of
marine products and the cost of collection is
somewhat difficult. Preliminary marine
operations, essential for this purpose, have to
be provided for in the feasibility study.
92
Material Inputs and Utilities … continued
ii. Processed Industrial Materials & Components
These represent important inputs for a number of
industries. In studying them, the following
questions need to be answered: In the case of
industrial materials, what are their properties?
What is the total requirement of the project?
What quantity would be available from domestic
sources? What quantity can be procured from
foreign sources? How reliable are the supplies?
What has been the past trend in prices? What is
the likely future behaviour of prices?
93
Material Inputs and Utilities … continued
iii. Auxiliary Materials and Factory Supplies
In addition to the basic raw materials and
processed industrial raw materials and
components, a manufacturing project requires
various auxiliary materials and factory supplies
(chemicals, additives, packaging materials,
paints, varnishes, oils, grease, cleaning
materials, etc.) The requirements of such
auxiliary materials and supplies should be taken
into account in the feasibility study.
94
Material Inputs and Utilities … continued

iv. Utilities
•  A broad assessment of utilities (power, water,
steam, fuel, etc.) may be made at the time of
input study though a detailed assessment can
be made only after formulating the project with
respect to location, technology and plant
capacity.
• Successful operation of the project critically
depends on adequate availability of utilities.

95
Material Inputs and Utilities … continued

Hence, the following questions should be

raised while conducting the input study.
• What quantities are required?
• What are the sources of supply?
• What should be the potential availability?
• What are the likely shortages/bottlenecks?
• What measures may be taken to augment
supplies?

96
 Location, Site and Environment
Location and Site
• The choice of location and site follows an
assessment of demand, size & input requirement.
• Location is a fairly broad area (a city, an industrial
zone, or a coastal area) while site is a specific
piece of land where the project would be set up.
• Various factors influence the choice of location:
proximity to raw materials and markets,
availability of infrastructure, labor situation,
government policies and other factors.
97
 Proximity to Raw Materials and Markets
• Proximity to source of raw materials & nearness to
market for the final products is crucial to location.
• In terms of basic location model, optimal location
is where the total cost is minimised. This, implies:
i. a resource-based project like a cement plant or a
steel-mill should be located close to the source of
the basic material;
ii. a project based on imported material may be
located near a port;
iii. a project that manufactures a perishable product
should be close to center of consumption.
98
Proximity to Raw Materials … continued
• However, for many industrial products,
proximity to the source of raw material or the
center of consumption may not be very
important.
• e.g. Petro-chemical Units or Refineries may be
located close to the source of raw material or
the center of consumption or at some
intermediate points.

99
Availability of Infrastructure
• Availability of power, transportation, water,
and communications should be carefully
assessed before a location decision is made.
• Adequate supply of power is a very important
condition for location since insufficient power
can be a major constraint, particularly in the
case of an electricity-intensive project like an
aluminum plant.

100
Availability of Infrastructure … continued
• In evaluating power supply, look into the
following aspects: the quantum of power
available, the stability of power supply, the
structure of the power tariff, and the
investment required by the project for a tie-up
in the network of power supplying agency.
• For transporting inputs of the project and
distributing the outputs, adequate transport
connections are required.

101
Availability of Infrastructure … continued
• The availability, reliability and cost of transport
for various locations should be assessed.
• Given the plant capacity and the type of
technology, the water requirement for the
project can be assessed.
• Once the required quantity is estimated, the
amount to be drawn from public utility system
and the amount to be provided by the project
from the surface or sub-surface sources may be
determined.
102
Availability of Infrastructure … continued

• To do so, the following factors may be

examined:
 relative costs,
 relative dependabilities,
 relative qualities
•  In addition to power, transportation, and
water, the project should have adequate
communication facilities like telephone and
internet.
103
Labour Situation
• In labour-intensive projects, the labour
situation in particular location becomes
important.
• The key factors to be considered in evaluating
labour situation are: availability of labour
(skilled, semi-skilled and unskilled); prevailing
labour rates; labour productivity; state of
industrial relations judged in terms of the
frequency and severity of strikes and lockouts
and degree of unionisation.
104
Government Policies
• Government policies have a bearing on
location decision.
• In the case of public sector projects, location is
directly decided by the government. It may be
based on a wider policy for regional dispersion
of industries.
• In the case of private sector projects, location
is influenced by certain governmental
restrictions and inducements.

105
Government Policies … continued
• The government may prohibit the setting up
of industrial projects in certain areas which
suffer from urban congestion.
• More positively, the government offers
inducements for establishing industries in
backward areas.
• These inducements consist of subsidies,
concessional finance, sales tax loans, power
subsidy, income tax benefits, lower promoter
contribution, etc.
106
Other Factors
•  Several other factors have to be assessed
before arriving at a location decision.
These are:
 Climatic conditions,
 General living conditions,
 Proximity to ancillary units
 Ease in coping with pollution
• Each of these factors are briefly describe
below.
107
Climatic Conditions
• The climatic conditions like temperature,
humidity, wind, sunshine, rainfall, snowfall,
dust, flooding, and earthquakes have an
important influence on location decision.
• They have a bearing on the cost as they
determine the extent of air-conditioning,
dehumidification, refrigeration, special
drainage, etc. required for the project.

108
General Living Conditions & Proximity to
Ancillary Units
General Living Conditions
•  The general living conditions like the cost of
living, housing situation, safety, and facilities for
education, health care, transportation and
recreation need to be assessed carefully.
Proximity to Ancillary Units
• Most firms depend on ancillary units. If ancillary
units are located nearby, coordination becomes
easy, transportation costs are lower, & inventory
requirements become considerably less.
109
 Ease in Coping with Environmental Pollution
• A project may cause environmental pollution
in various ways. It may :
 Emit gaseous pollutants
 Produce solid and liquid discharges
 Cause noise, heat and vibrations
• The location study should analyse the cost of
mitigating environmental pollution to
tolerable levels at alternative locations.

110
Site Selection
 • Once the broad location is chosen, attention
needs to be focused on the selection of a
specific site.
• Two to three alternative sites should be
considered and evaluated with respect to cost
of land and cost of site preparation & dev’t.
• The cost of land tends to differ from one site
to another in the same broad location.
• Sites close to a city cost more whereas sites
away from the city cost less.
111
Site Selection … continued
• Sites in an industrial area developed by a
government agency may be available at a
concessional rate.
• Cost of site preparation & dev’t depends on the
physical features of the site, a need to demolish
& relocate existing structures and the work
involved to obtain utility connections to the site.
• The work involved in obtaining utility
connections to the site and the cost associated
with it should be carefully scrutinised.

112
Environmental Aspects
• As discussed earlier, a project may cause
environmental pollution in several ways.
• Projects that produce physical goods like
Cement, Steal, Paper and Chemicals by
converting natural resource endowments into
saleable products are likely to cause more
environmental damage.
• Consequently, the environmental impacts of a
project should be carefully assessed prior to its
actual implementation.
113
Environmental Aspects … continued
• Hence, the environmental aspects of these
projects have to be properly examined. The
key issues that need to be considered are:
• What are the types of effluents and emissions
generated?
• What should be done for proper disposal of
effluents and treatment of emissions?
• Will the project be able to secure all
environmental clearances and comply with all
statutory requirements?
114
 Engineering and Technology
Plant capacity
• Plant capacity is the volume (number of units) of
a product that can be produced during a given
period. It may be defined in two ways: feasible
normal capacity and maximum normal capacity.
• The feasible normal capacity is the capacity
attainable under normal working conditions.
• This may be established on the basis of installed
capacity, technical conditions of the plant,
normal stoppages, and downtime for
maintenance and tool changes, holidays and
shift patterns. 115
Plant capacity … continued

• The maximum normal capacity is the capacity

which is technically attainable and this often
corresponds to the installed capacity
guaranteed by the supplier of the plant.
• Several factors have a bearing on the capacity
decision. These are: technological requirement,
input constraints, investment cost, market
conditions, resources of the firm and
government policy.

116
Technological Requirement

• For many industrial products, particularly in

process type industries, there is a certain
minimum economic size determined by the
technological factor.
• For example, a cement plant should have the
capacity of at least 300 tones per day in order
to use the rotary kiln method; otherwise it has
to employ the vertical shaft method which is
suitable for lower capacity.

117
Input Constraints

•  In a developing country like Ethiopia, there

may be constraints on the availability of
certain resources.
 Power supply may be limited
 basic raw materials may be scarce
 foreign exchange available for imports may be
inadequate
• These kinds of constraints should be borne in
mind while choosing the plant capacity.

118
 Investment Cost
• When serious input constraints do not exist, the
relationship b/n capacity and investment cost is
an important consideration.
• Typically, the investment cost per unit of capacity
decreases as the plant capacity increases. This
relationship may be expressed as:
C1 = C2 (Q1/Q2)α
where, C1 = derived cost for Q1 units of capacity
C2 = Known cost for Q2 units of capacity
α = a factor reflecting capacity- cost
relationship (0 < α < 1). 119
Investment Cost … continued
• For example, suppose the known investment
cost for 5000 units of capacity for the
manufacturer of a certain product is Birr
200,000. What will be the investment cost for
10,000 units capacity if the capacity cost
factor is 0.6?
• Solution:
Given: Q2 = 5000, Q1 = 10, 000, C2 = 200, 000,
α = 0.6,C1 = ?

120
Investment Cost … continued

 0.6
Q  10,000
1  200,000
1
C C2 
Q2  5,000
  200,000(1.516)
0.6
200,0002
303
,200

121
Market Conditions
• If the market for the product is likely to be very
strong, a plant of higher capacity is preferable.
• If the market is likely to be uncertain, it might be
advantageous to start with a smaller capacity.
• If the market, starting from a small base, is
expected to grow rapidly, the initial capacity
may be higher than the initial level of demand-
further additions to capacity may be effected
with the growth of the market.

122
Resources of the Firm

• The resources, both managerial and financial,

available to a firm define a limit on its capacity
decision.
• Obviously, a firm can not choose a scale of
operations beyond its financial resources and
managerial capability.

123
Government Policy
•  The government policy may influence the
capacity level.
• Traditionally, the policy of the government is
to distribute the additional capacity to be
created in a certain industry among several
firms, regardless of economies of scale.
• However, this policy has been substantially
modified in recent years and the concept of
‘minimum economic capacity’ has been
adopted in several industries.
124
 Technology
•  Appropriate technology refers to those methods
of production which are suitable to the local
economic, social and cultural conditions.
• The advocates of appropriate technology urge
that the technology should be evaluated in
terms of the following questions: Does the
technology utilise local raw materials? Does the
technology utilise local manpower? Do the
goods and services produced cater to the basic
needs? Does the technology protect ecological
balance? Is the technology harmonious with
social and cultural conditions?
125
 Engineering
Plant layout
• It is concerned with physical layout of the factory.
• In process industries, the plant layout is dictated
by the production process adopted.
• But in manufacturing industries, there is much
greater flexibility in defining the plant layout.
• Important considerations to prepare plant layout:
consistency with production technology, smooth
flow of goods from one stage to another, proper
utilisation of the space, and scope of expansion
and safety of personnel.
126
 Machinery and Equipment
• The need for machineries and equipment depends
on production technology and plant capacity.
• It is also influenced by the type of project.
• For a process-oriented industry, like petro-
chemical unit, machineries and equipment
required should be such that the various stages are
matched well.
• The choice of machineries and equipment for a
manufacturing industry is somewhat wider as
various machines can perform the same function
with varying degrees of accuracy.
127
• To determine the kinds of machinery and
equipment required for a manufacturing
industry, follow the procedure outlined below:
i. Estimate the likely levels of production over time.
ii. Define the various matching & other operations.
iii. Calculate the machine hours required for each
type of operation.
iv. Select machines and equipment required for
each function.

128
• The equipment required for a project may be
classified into the following types:
i. Plant (process) equipment
ii. Mechanical equipment
iii. Electrical equipment
iv. Instruments
v. Controls
vi. Internal transportation system
vii. Others
 

129
• In addition to the machineries and equipment,
a list should be prepared of spare parts and
tools required.
• This may be divided into:
i. Spare parts and tools to be purchased with the
original equipment.
ii. Spare parts and tools required for operational
wear and tear.

130