Day 2 Part 2

PROJECT APPRAISAL
MODULE THREE
AREGA SEYOUM ASFAW (PHD)
ASSOCIATE PROFESSOR OF ACCOUNTING &
FINANCE
COLLEGE OF BUSINESS & ECONOMICS
JIMMA UNIVERSITY
P.O.BOX 378
AREGAS10@GMAIL.COM
JIMMA, ETHIOPIA
3. ASPECTS OF PROJECT ANALYSIS

The important facets of project analysis

are:
◘ Market Analysis
◘ Technical Analysis
◘ Ecological Analysis
◘ Financial Analysis
◘ Economic Analysis
 … Cont’d
Potential Market
Market Analysis
Market Share
Technical Viability
Technical Analysis
Sensible Choices
Environmental Damage
Ecological Analysis
Restoration Measures

Risk
Financial Analysis
Return

Benefits & Costs in Shadow Prices

Economic Analysis
Other Impacts
Figure 3.1 Key Issues in Project Analysis
 … Cont’d

Feasibility Study
◙ The Feasibility study is concerned with the
first FOUR Phases of Capital Budgeting viz.,
planning, analysis, selection (appraisal), and
financing; and involves market, technical,
ecological, financial and economic analysis.
◙ The Schematic diagram of the feasibility study
is shown in Figure 3.1 next slide.
 Generation of Ideas
Fig. 3.2
Feasibility Initial Screening
Study: A
Schematic Is the Idea Prima Facie Promising?
Diagram Yes
Plan Feasibility Analysis
Terminate

Conduct Market Conduct Technical

Analysis Analysis

Conduct Analysis Financial

Conduct Economic &

Ecological Analysis

Is the Project Worthwhile?

Yes No
Terminate
 3.1 Market and Demand Analysis
 The first step in project analysis is to estimate
the potential size of the market for the product
proposed to be manufactured (or service
planned to be offered) and get an idea about the
market share that is likely to be captured.
 The key steps involved in market and demand
analysis are organized into seven sections as
follows:
a. Situational analysis and specification of
objectives
b. Collection of secondary information
 … Cont’d
 Secondary information provides the base & the
starting point for the market and demand
analysis.

c. Conducting market survey

 Secondary information, though useful often, does
not provide a comprehensive basis for market
and demand analysis. It needs to be
supplemented with a primary information
gathered through a market survey, specific to the
project being appraised.
Fig. 3.3 Key Steps in Market & Demand Analysis & Their Interrelationship

Collection of
Demand
Secondary
Forecasting
Information

Situational
Analysis & Characteriza
Specification tion of the
of Objectives Market

Conduct
Market
Market
Planning
Survey
 … Cont’d
d. Characterization of the market:
 Based on the information gathered from
secondary sources and through the market
survey, the market for the product/service may be
described in terms of the following:-
♦ Effective demand in the past and present
♦ Methods of distribution & sales promotion
♦ Price
♦ Consumer
♦ Supply and competition (from substitutes &
near-substitutes)
♦ Government policy
 … Cont’d
Effective Demand in the Past and Present
☺To measure effective demand in the past and
present the starting point typically is apparent
consumption which is defined as:
Production + Imports – Exports – Change in Stock Level
☺The figure for apparent consumption has to be
adjusted for consumption of the product by the
producers and the effect of abnormal factors. The
consumption series, after that adjustments, may be
obtained for several years.
 YEAR Local Import Export Apparent Growth
Production Consumption Rate
2000 875,000 250,000 125,000
2001 1,250,000 375,000 137,250
2002 1,550,000 550,000 162,500
2003 1,800,000 800,000 189,750
2004 2,200,000 1,200,000 237,500
2005 3,050,000 1,800,000 377,250
2006 3,450,000 2,600,000 399,500
2007 3,850,000 3,200,000 477,890
2008 4,150,000 4,200,000 765,650
2009 4,500,000 5,600,000 895,500
Average 2,667,500 2,057,500 376,779

Required: Calculate the apparent consumption of the product and Compute the
corresponding growth rate
 Methods of Demand Forecasting

Qualitative Time series projection Causal

Method Methods Method

Jury of Executive Delphi Trend Exponential Moving

Method Method Projection Smoothing Average
Method Method Method

Chain Consumption End use Leading Econometric

Ratio Level Method Indicator Method
Method Method Method
 … Cont’d
e. Demand Forecasting
 After gathering information about various aspects
of the market and demand from primary and
secondary sources, attempt may be made to
estimate future demand.
 A wide range of forecasting methods are
available to the market analyst (see slide 9). These
may be classified into three broad categories as
discussed below.
 … Cont’d
☺ Projecting market data is the critical factor for
determining both the scope of the project and
the resources required.
☺ This will be the basis for the production
programme, plant capacity and derived
requirements for inputs, labour & investment
etc.
 … Cont’d
I. Qualitative Methods
These methods rely essentially on the judgment
of experts to translate qualitative information into
quantitative estimates. The important qualitative
methods are:
(1) Jury of Executive Method:
Involves soliciting the opinions of a group of
managers on expected future sales & combining
them into a sales estimate.
 … Cont’d
Advantages
(i) It is an expeditious method for developing a
demand forecast
(ii) It permits consideration of a variety of factors like
economic climate, competitive environment,
consumer preferences, technological developments
etc. to be included in subjective estimates provided
by the experts.
Limitations
(iii)The biases underlying subjective estimates cannot
be unearthed easily.
(iv)The reliability of this technique is questionable.
 … Cont’d
(2)Delphi Method: This method is used for eliciting
the opinions of a group of experts with the help of a
mail survey.
The steps involved in this method are:
(i) A questionnaire is sent to a group of experts by mail &
asked to express their views.
(ii) The responses received from the experts are
summarized without disclosing their identity, and sent
back to the experts meant to probe further reasons for
extreme views expressed in the first round.
(iii)The process may be continued for one or more rounds
till reasonable agreements emerges in the views of the
experts.
 … Cont’d
II. Time Series Projection Methods
(1) Trend Projection Method
 Trend projection method involves the following
steps:
(i) Determine the trend of consumption by
analyzing past consumption statistics
(ii) projecting future consumption by
extrapolating the trend.
 … Cont’d

NB. When the trend projection method is used the

most commonly employed relationship is the linear
relationship.

Y = a + bX
Where; Y = Trend value
a = Intercept of the relationship
b = Slop of the relationship
X = Independent variable (time)
 … Cont’d
b

a = Ῡ – b̅X
Where, X = Mean of X
Ῡ = Mean of Y
Advantages of the LSM
(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
Disadvantages of LSM
(i)It is more complex compared to other methods
 Illustration – Trend Projection Method
To illustrate the use of Trend Projection Method, the
following demand data for a product will be used as
shown in Exhibit 3.1 below:
Exhibit 3.1 Demand Data
Year Demand Year Demand
2003 10* 2010 20
2004 13 2011 22
2005 14 2012 23
2006 17 2013 22
2007 18 2014 24
2008 18 2015 24
2009 19 2016 25
*In thousand units
Required: Find the least Squares Regression line for the data given in
Exhibit 3.1
Exhibit 3.2 Calculations in the Least Square Method

X (time) Y XY X2
0 10 0 0
1 13 13 1
2 14 28 4
3 17 51 9
4 18 72 16
5 18 90 25
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
∑X=91 ∑Y=269, ∑XY=1988 ∑X2 =819
 … Cont’d
(2) Exponential Smoothing Method:
 In this method forecasts are modified in the light
of observed errors.

☻ Ft+1 = Ft + α (Dt – Ft), or,

☻ Ft + 1 = α Dt + (1 - α ) Ft

Where; α = weightage factor for the current demand (the

smoothing parameter which lies between 0 & 1)
Dt = demand during the present period
Ft + 1 = Forecast for next period t
Ft = Forecast of demand made for the present period
 … Cont’d
(3) Moving Average Method:
 In this method, the forecast for the next period
is equal to the average of sales for several
preceding periods.

(III) Causal Methods:

 This method assumes that demand is related to
some underlying factor(s) in the environment,
and that cause-and-effect relationships are at
work.
 Illustration – Exponential Smoothing Method
Exhibit 3.3 Exponential Smoothing Method
Data Forecast Error in Forecast for t+1
t (St) (Ft) (et = St – Ft) Ft+1 = Ft + α(et)

1 28.0 29.0 -1.0 F2 = 29.0 + 0.2 (-1.0) = 28.8

2 29.0 28.8 0.2
3 28.5 28.8 -0.3
4 31.0 28.7 2.3
5. 34.2 29.2 5.0
6. 32.7 30.2 2.5
7. 33.5 30.7 2.8
8. 31.8 31.3 0.5
9. 31.9 31.4 0.5
10 34.3 31.5 2.8
 Illustration – Moving Average Method
To illustrate the use of the moving average techniques,
consider the following time series.
Exhibit 3.4 Moving Average Method
Year Sales
1 28
2 29
3 28.5
4 31
5 34.2
6 32.7
7 33.5
8 31.8
9 31.9
10 34.3

If n is set equal to 4 (n has to be specified by the forecaster), the forecast for

period five will be equal to ______________ .
 … Cont’d
f. Uncertainties in Demand Forecasting
 Demand forecasts are subject to error &
uncertainty which arise from three principal
sources:
☻ Data about past and present market
☻ Methods of forecasting
☻ Environmental change
 … Cont’d
g. Market Planning
 Prepare a marketing plan for the new product.
A marketing plan usually has the following
components:
☺ Current market situation
☺ Opportunity and issue analysis,
☺ Objectives
☺ Marketing strategy
☺ Action program
 … Cont’d
Exhibit 3.5 Estimated Actual Demand
Year Domestic Import Export Apparent Growth
Production Consumption Rate
2018
2019
2020
2021
2022
2023
2024
2025
Average
 … Cont’d
Supply Side Consideration
(i) Analysis of Existing Supply
 Both local and imported supply of the product or
service should be carefully examined based on the
available data obtained from different sources.
 Domestic productions in terms of quantity, value,
capacity utilization of domestic firms and trend
development have to be analyzed.
 Similarly, Imported supply of product must be
assessed in terms of quantities & prices so as to
make the supply statistics complete.
 … Cont’d
(ii) Supply Projections
 Supply projections can be done by considering
the capacity utilization rates of the envisaged
project, the capacity of existing suppliers, and
other projects already in the pipeline.
 … Cont’d
 In general, the following steps are important in
projecting supply of the product/services:
◘Identify major suppliers of the product or services
◘Obtain info on past production level & attainable
capacity of each supplier
◘Identify the major reason for major deviation
between actual level of production& attainable capacity
◘Consider the attainable full capacity as potential
supply from each supplier
◘In the absence of data on individual supplier and in
case the number of suppliers is large use CSA data of
local production.
Local Available Production Capacity
Supplier Attainable Capacity
Supplier 1 0.00
Supplier 2 0.00
Supplier 3 0.00
Total 0.00

Attainable Capacity of Similar projects in the

pipeline (90%)
Project Attainable Capacity
Project x 0.00
Project Y 0.00
Project Z 0.00
Total 0.00
 Demand and Supply Gap
 After the demand and supply situation for a given
product or services are quantified, comparison must
be made to see whether there exist unsatisfied
demand or not. The project can be proposed if and
only if there is unsatisfied demand; or if there is
shortage of supply. The quantified demand & supply
information can be compared in the table below.
Year Demand Supply Unmet Excess
(1) (2) Demand Supply
(1 – 2)

Existing Planned Total

2018
Year Domestic Production Forecasted Export Forecasted Supply
2018
2019
2020
2021
2022
2023
2024
2025
2026
2027

Required: Based on the data given in the above table

forecast the Supply trend
 3.3 Technical Analysis
 The Broad purpose of technical analysis is
(a) to ensure that the project is technically
feasible in the sense that all the inputs required
to set up the project are available & ( (b)
to facilitate the most optimal formulation of the
project in terms of technology, size, location, and
so on.
3.3.1 Technology Selection

The choice of technology is influenced by a

variety of considerations:
☻Plant Capacity
☻Principal Inputs
☻Investment Outlays and Production cost
☻Use by other units
☻Product mix
☻Latest Developments
☻Ease of Absorption
 … Cont’d
Appropriateness of Technology
 Appropriate technology refers to those methods of
production which are suitable to local economic,
social, and cultural conditions.
 The appropriateness of the technology should be
evaluated in terms of the following questions:
◘ Whether the technology utilizes local raw
materials?
◘ Whether the technology utilizes local
manpower?
◘ Whether the technology protects ecological
balance?
◘ Whether the goods and services produced
cater to the basic needs?
 … Cont’d
 While selecting the best technologies for the
proposed project, the following factors must
also be given due attention:
☻ Technological impact on the environment: The
technology that we are going to select should not
only the one that minimizes pollution, but should
also preserve the natural resources and saves
renewable resources.
☻ Careful evaluation and assessment of hazardous
technologies and the use of toxic materials at
different stages of production should be made.
 … Cont’d
The primary goals of technology assessment are
to determine and evaluate the effect (impact) of
different technologies on the society and national
economy.
3.3.2 Material Inputs and Utilities

 Different materials and other inputs required

for operating the project should be identified
and their availability, supply and method of
estimating operating costs should be analyzed.
 Material inputs and utilities may be classified
into four broad categories: (i) raw materials, (ii)
processed industrial materials & components,
(iii) auxiliary materials & factory supplies, and
(iv) utilities.
 … Cont’d
Raw Materials
 Raw materials (processed and /or semi-
processed) may be classified into four types:
(i) Agricultural products,
(ii) Mineral products,
(iii) Live stock & forest products, and
(iv) Marine products
 … Cont’d
Agricultural Products
◙ Identification of the type of raw materials and
supplies to be used in the project.
◙ In studying agricultural products the quality
must first be examined. Then, an assessment of
quantities available , currently & potentially, is
required.
◙ Their users & cost of material inputs & supplies
have to be analyzed.
 … Cont’d
Mineral Products
☺In assessing mineral raw materials, information is
required on the size of exploitable deposits and
the properties of raw materials.
☺The study should provide details of the location,
size, and depth of deposits and the potential
availability of the materials.
 … Cont’d

Livestock & Forest Products

◘ Secondary sources of data on livestock and
forest products often do not provide a
dependable basis for estimation. Thus, a specific
survey may be required to obtain more reliable
data on the quantum of livestock produce & forest
products.
 … Cont’d
Marine Products
♣ Assessing the potential 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.
 … Cont’d
Processed Industrial Materials and Components
 Processed industrial materials and components (base
metals, semi-processed materials, manufactured parts,
components, and sub-assemblies) represent important
inputs for a number of industries.
 In studying them the following questions need to be
answered:
♣ 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 dependable are the supplies?
♣ What has been the past trends in Prices?
♣ What is the likely future behavior of prices?
 … Cont’d
Auxiliary Materials & Factory Supplies
♥ In addition to the basic raw materials and
processed industrial materials and components, a
manufacturing project requires various auxiliary
materials and factory supplies like chemicals,
additives, packaging materials, paints, varnishes,
oil, grease, cleaning materials, etc.
♥ The requirements of such auxiliary materials and
supplies should be taken into account in the
feasibility study.
 … Cont’d
Utilities
 A broad assessment of utilities (power, water, steam, fuel,
etc.) can be made only after formulating the project with
respect to location, technology, and plant capacity.
 Since the successful operation of a project depends on
adequate availability of utilities, the following questions
should be raised while conducting the inputs study:
♦ What quantities are required?
♦ What are the sources of supply?
♦ What would be the potential availability?
♦ What are the likely shortages/bottlenecks?
♦ What measures must be taken to augment supplies?
3.3.3 Production Program and Plant Capacity

(1) Production Program

 The production program, range and volume of
products to be produced depend on the market
requirements, proposed marketing strategy and
the availability of resources.
 A production program should define the levels
of output to be achieved during specified
periods related to the sales forecast.
 … Cont’d
Full production level may not be possible during
initial production operation owing to various
technological, production and commercial
difficulties in addition to marketing bottlenecks.
Normally a production and sales target of 40-50
percent of the capacity for the first year is
considered reasonable. Picking up gradually,
towards third or fourth year full production level
can be achieved.
 … Cont’d
 The production program should indicate the basic
products, by – products, and wastes during the
process.
 The production program (capacity utilization)
changes in time during project life. Initially the
production may not be higher than 40 to 50% of
the overall design capacity for the first one or two
years of operation because market is not ready to
acquire large amounts of new product or the
technological difficulties obstruct the full capacity
operation of the equipment.
 … Cont’d
(2) Determination of Plant Capacity
 Plant capacity (also known as production
capacity) refers to the volume or number of
units that can be manufactured during a given
period.
 Several factors have a bearing on the capacity
decision: Technological Requirement, Input
constraints, Investment cost, Market conditions,
Resources of the firm, and Government policy.
 … Cont’d
Technological requirements: For example, in process
industries, there is a minimum economic size
determined by the technological factors.
Input constraints: there may be constraints in the
availability of certain inputs (power, basic raw materials,
foreign exchange, etc.
Investment cost: the relationship between capacity and
investment cost is important. Typically, the investment
cost per unit of capacity decreases as the plant capacity
increases.
 … Cont’d

Market Condition: If the market for product is

likely to be very strong, a plant of higher capacity
is preferable.
Resource of the firm: the resources, both
managerial and financial, available to a firm
define a limit on its capacity decision.
Government Policy: the capacity level may be
influenced by the policy of the government.
 … Cont’d
 With regards to plant capacity, generally two
capacity terms used in relation to level of
operation.
1. A feasible normal capacity (FNC) – refers to
the capacity achievable under normal working
conditions considering the technical conditions
of the plant, normal stoppages, downtime for
maintenance & tool changes, holidays, shift
pattern and management system applied.
Thus, the feasible normal capacity is the
number of units produced during one year
under the above conditions.
 … Cont’d
2. A nominal maximum capacity(NMC)– is the
capacity which is technically attainable and this
often corresponds to the installed capacity as
guaranteed by the supplier of the plant.
♣ Nominal Maximum Capacity (NMC) is
defined by system engineering that is Equipment
installed capacity includes reserve and standby
capacity.
3.3.4 Location and Site

(1) Location
 Location analysis has to identify locations suitable
for the industrial project under consideration.
 Traditional approach to industrial location
focused, on the proximity of raw materials and
market place, mainly with the intention of
minimizing transport costs. However, the modern
view requires consideration of not only
commercial, technical and financial factors, but
also of the social and environmental impact a
project might have.
 … Cont’d
A project potentially located in a number of
alternative regions (several alternative locations
may have to be considered).
The choice of location is influenced by a variety
of considerations:
◘ Proximity to raw materials and markets
◘ Availability of infrastructure
◘ Availability of labor (especially for labor-intensive
projects)
◘ Technological and process characteristics
◘ Government policies (incentives, restrictions), and
◘ Other factors like climatic conditions, ease in coping
with pollution, general living conditions, etc.
 … Cont’d
 In terms of a basic location model, the optimum
location is one where the total cost viz.,
transportation cost, production cost and
distribution costs is minimized. This generally
implies that:
(i) Projects based largely on imported material may
need to be located at ports or near terminals.
(ii) A project producing perishable products or
agro-processing industries are market oriented and it
is advantageous to locate such production near the
major consumption centers.
 … Cont’d
(iii) A resource-based projects like a cement plant or
a steel mill should be located close to the source of
basic material.
(iv) Petroleum products and pharmaceutical can be
located at source or near consumption centers or
even at some intermediation point.
 … Cont’d
 As far as financial feasibility of alternative
locations is concerned, the following data-as
well as related financial risks, should be
assessed.
♠ Production costs (including environmental
protection costs)
♠ Marketing costs
♠ Investment costs
♠ Revenues
♠ Taxes, subsidies, grant and allowance
♠ Net cash flows
 … Cont’d
(2) Site Selection
 Once the broad location is decided upon, a
specific project site alternative should be defined
in the feasibility study. This will require evaluation
of the characteristics of each site.
 When selecting sites within the selected location,
the following requirements and conditions are to
be assessed:-
● Ecological conditions on site (soil, site hazards,
climate etc.)
● Environment impact (restrictions, standards, guidelines)
● Socio-economic conditions (restrictions, incentives,
requirements)
 … Cont’d
● Local infrastructure at site location (existing
industrial infrastructure, economic and social
infrastructure, availability of critical project inputs
such as labor and factory supplies)
● Strategic aspects (corporate strategies regarding
possible future expansion, supply and marketing
polices
● Cost of land
● Site preparation and development requirements
and costs (which include the work involved in
obtaining utility connections & the related costs ).
 … Cont’d
● Topography, altitude and climate may be
important for a project as well as access to water,
electric power, roads and railways transport.
● Recruitment of managerial staff and labor may
be a critical factor for the viability of the project.
Development of housing, schools, medical and
social center is necessary to attract the required staff
and labor force.
NB: Plant location and site selection can be
undertaken simultaneously.
 3.5 Machineries and Equipment

 The requirement of machineries and equipment

is dependent on the production techniques and
plant capacity. It is also influenced by the type of
the project.
 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. For example,
the configuration of machines required for the
manufacture of refrigerators could take various
forms.
 … Cont’d
 To determine the kind of machinery & equipment
required for a manufacturing industry, the
following procedure may be followed:
(i) Estimate the likely levels of production over time
(ii) Define the various machining and other
operations,
(iii)Calculate the machine hours required for each
type of operation
(iv)Select machineries and equipment required for
each function
 … Cont’d
 The equipment required for the 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, and others
 In addition to the machineries and equipment, a list
should be prepared of spare parts and tools
required.
 … Cont’d
Constraints in Selecting Machineries and Equipment
 In selecting machineries and equipment certain
constraints should be borne in mind:
(i) There may be limited availability of power to set up an electric-
intensive plant like, for example, a large electric furnace,
(ii) There may be difficulty in transporting a heavy equipment to a
remote location;
(iii)Workers may not be able to operate, at least in the initial
periods;
(iv)Sophisticated equipment such as numerically controlled
machines, and
(v) The import policy of the government (Government may
preclude the import of certain machineries & equipment).
 … Cont’d
Procurement of Plant and Machinery
The factors to be considered in selecting the
supplier(s) of plant and machinery are:
(i) The desired quality of the machinery
(ii) The level of technological sophistication,
(iii)The relative reputation of various suppliers,
(iv)The expected delivery schedules, the preferred payment
terms, and
(v) The required performance guarantee (includes
mechanical, input and output guarantees).
If in-house technical expertise is inadequate, external
consultant(s) may be employed to select plant and
machinery and supervise the installation of the same.
3.3.6 Structure and Civil Works

 Structures and Civil works may be divided into

three categories:
(i) Site preparation and development,
(ii) Buildings and Structures, and
(iii) Outdoor Works.
 … Cont’d
Site Preparation and Development:
 This covers the following:
☻ Grading and leveling of the site,
☻ Demolition and removal of existing structures,
☻ Relocation of existing pipelines, cables, roads,
power lines, etc.
☻ Draining and removal of standing water,
☻ Connections for the following utilities from the
site to the public network: power, water,
communications (telephone, telex, internet, etc.),
roads, railway sidings
 … Cont’d
Building and Structures
 Buildings and Structures may be divided into:
(i) Factory and process buildings;
(ii)Ancillary buildings required for stores, warehouses,
laboratories, utility supply centers, maintenance
services and others
(iii)Administrative buildings;
(iv)Staff welfare buildings, cafeteria, and medical
service buildings, and residential buildings
 … Cont’d
Outdoor Works
 Outdoor works cover:
♣ Supply and distribution of utilities (power,
♣ Communication, steam, and gas)
♣ Handling and treatment of emission, wastages, and
effluents;
♣ Transportation and traffic signals
♣ Outdoor lighting;
♣ Landscaping, and
♣ Enclosure and supervision (boundary wall, fencing,
barriers, gates, doors, security posts, etc.)
3.3.7 Environmental Issues

Environmental Impact Assessment

 A project may cause environmental pollution in
various ways: it may throw gaseous emissions; it
may produce liquid & solid discharges; it may
cause noise, heat & vibrations, etc.
 EIA is designed to develop an understanding of
the environmental consequences of newly
planned or existing projects and of any project
related activities.
 … Cont’d
 EIA is part of project planning process.
Environmental benefits or costs are usually
externalities or side effects that affect the society
in whole or in part.
 Projects that produce physical goods like
cement, still, paper and chemicals are likely to
cause more environmental damage. Hence, the
environmental aspects of these projects have to
be properly examined.
3.3.8 Organization Design and Human Resource
Analysis

For smooth implementation and operation of the

industrial project, availability of experienced and
qualified human power is very important.
Therefore, at the time of project appraisal,
availability of sufficient human power should be
duly scrutinized.
On the basis of the qualitative and quantitative
human resource requirement of the project, the
availability of the required human power, the
cost estimates for the wages, salaries, and other
personnel related expenses and training are
prepared for financial analysis of the project.
 Organizational Functions

The organizational functions are the building blocks

of the company. They may be grouped into
organizational units in line with the specific
requirements of the individual company:
● General management of the enterprise,
● Finance, financial control and accounting,
● Personal administration,
● Marketing, sales and distribution,
● Supplies, transport, storage,
● Production (Main plant, Service plants, Quality
assurance, Maintenance and repair).
 … Cont’d
 A design of the organization usually includes the
following steps:
1. Goals and objectives of the business are stated
2. Then functions are identified
3. Functions are grouped or related
4. Organizations structure or framework designed
5. All key jobs are analyzed, designed, & described
6. A recruitment and training program prepared.
 … Cont’d
 The two reasons for preparing an organization:-
1. To achieve optimal coordination and control
on all project inputs.
2. To structure the investment and production
costs and to determine the costs linked with
corresponding organizational units.
 … Cont’d
(1) Organizational Structure
 The organizational structure of the company
can take a number of shapes, the most common
being the pyramid shape, with tree
organizational levels: Top management, Middle
management and Supervisor management.
 Usually the organization structure is designed
primarily in line with the different functions.
Such as finance, marketing, production and
purchasing. However, there is no unique
organizational pattern.
 … Cont’d

(2) Human Resource

The successful implementation and operation of
industrial projects need different categories of
human resources. Example, management,
supervisory staff and workers- with sufficient skill
and experience.
 … Cont’d
 The successful operation of well-designed
industrial project will ultimately depend on the
skill, experience and productivity of workers, staff
and management.
 Bad management or inadequate skills and
experience of personnel in key positions can
easily jeopardize a promising and carefully
planned project. A project with great risk and
uncertainties may on the other hand prove to be
successful due to good management and
qualified labor.
 … Cont’d
 The definition of personnel requirements by
categories and function is necessary for the
preparation of a detailed manning table,
including the calculation of total costs of
management, staff and labor and for comparison
of the needed personnel with the resource
available in the project region. This comparison
will facilitate the assessment of training needs.
 … Cont’d
 The following factors should be given due
consideration when the availability & employment
of human resources are analyzed:-
i. The general availability of relevant human
resource categories in the country and the
project region.
ii. The supply and demand situation in the project
region
iii. Recruitment policy and methods
iv. Training policy and program
 … Cont’d
NB. Difficulties in the recruitment of key personnel
(such as Managers, supervisors and skilled
labor) can be dealt with, in different ways:-
1. Recruitment is combined with intensive training
of key personnel in order to meet quality
requirements.
2. Foreign expertise is recruited.
 … Cont’d
3. Socio – economic and Cultural Environment
 Human resource requirements not only depend
on techno – economic and financial or
commercial factor, but also are determined to
certain extent by social and socio – economic
conditions in the country and location of the
project.
 … Cont’d
(i) Legislation and Labor Terms
 Labor terms can be regulated by legislation or trade
union contracts or be based on common practice.
 The prevailing rules regarding
● national holydays,
● shift pattern,
● working hours, and
● annual sick and training leave will have an impact
on the effective number of working hours and days per
year, and therefore affect the human resource
requirement.
 … Cont’d
(ii) Labor Norms
 The human resources requirement should be
estimated on the basis of experiences of and
comparisons with similar projects in the project
country and region. This will help to estimate the
realistic effective machine hours and productivity.
(iii) Occupational Safety
 Minimum standards of occupational safety should be
established and enforced. The study should assess
the relevant existing regulations on occupational
safety.
 … Cont’d
iv. Health Care and Social Security
 The project analyst should also identify & consider
necessary plant components regarding
arrangement for health care and social security for
the human resources to be employed.
 The cost of such component will have to be
estimated and included in the cost tables.
 … Cont’d
Training Plan
 Lack of experienced and skilled personnel can
constitute a significant bottleneck for project
implementation and operation in developing
countries. Thus extensive training program should be
designed and carried out as part of implementation
process of investment projects.
 Training can be provided by specially recruited
experts or by expatriate personnel. Personnel at
various levels should have undergone any training
necessary before production starts, during the pre –
production and construction stage.
 4. Financial and Economic Analysis
The purpose of the financial analysis is to assess
the financial viability of the proposed project, i.e.,
if the proposed project is financially attractive or
not from the entity’s viewpoint.
The unit of analysis is the project not the entire
economy.
 … Cont’d
 In general, the project financial analysis has four
main parts:
(1)Estimation of total project costs – the main aim
here is to ensure that the project’s financial
requirements are accurately estimated; estimates of
total costs broken down into local and foreign
currency costs for land construction, equipment
installation, working capital and pre-operating
expenses are to be provided.
 … Cont’d
(2) Proposed financial plan – the purpose is to
ensure that all investment expenses of the project are
covered through an adequate financing plan that
indicates expected sources and terms (e.g. debt &
equity financing).
(3) Operating Costs – direct and indirect costs should
be properly forecasted
 … Cont’d
(4)Expected Profitability and Returns – to ensure
that adequate funds are available during the operation
phase to pay for needed inputs & to repay debts and
to ensure adequate profit to pay (under reasonable
assumptions about the future) shareholders.
 A careful examination of the above aspects is
essential to assess the financial soundness of a
project.
 … Cont’d
Specifically, the financial analysis includes the
following steps:
☺determine annual project revenues; ☺
determine project costs;
☺calculate annual project net benefits; ☺
determine the appropriate discount rate;
☺calculate the financial net present value; ☺
calculate the financial rate of return; and
☺conduct risk and sensitivity analysis.
 … Cont’d
 The feasibility study should assemble all cost
components so as to obtain an estimate of the
(a) Total investment cost,
(b) Total production costs and
(c) The financial & economic viability of
the project.
 Once the size of the investment is known, an
assessment of project financing should be
made.
 … Cont’d
 Assembling the components of investment and
production costs, particular attention should be
paid to the timing of expenditure and costs, as
it influences the cash flow of the project and its
internal rate of return.
 Investment and production costs should be
planned on an annual basis in line with the
requirements of cash flow analysis.
 … Cont’d
 There is no exact formula for computing the
investment and production costs, thus various
ways to estimate these figures can be considered.
However, calculations of: (a) Fixed cost, (b) Pre
– production capital costs, (c) Working
capital, and (d) Production costs, should have
scope for correction for contingencies and
price escalation.
 Total Investment Cost

 The cost of a project represents the sum of all items

of outlay associated with a project that are
supported by long-term funds.
 It is the sum of outlay on the:
(i) Land and site development, (cost of land, leasehold, land
development, etc.)
(ii) Buildings and civil works,
(iii) Plant and machinery,
(iv) Technical know-how and engineering fees,
(v) Expenses on foreign technicians and training of local
experts abroad: (travel, boarding, loading expenses plus
salaries & all)
(vi) Miscellaneous fixed assets: (fixed assets & machinery which
are not part of the direct mfg. process).
 … Cont’d
(vii) Preliminary and capital issue expenses:
(expenses incurred in identifying the project,
conducting the market survey, preparing the
feasibility report, for drafting articles of association,
etc. expenses borne in connection with raising
capital from the public are capital issue costs.
(viii) Pre-operative expenses, (all expenses incurred
till the commencement of commercial production
like rent, taxes, travel expenses, interest, insurance,
start-up & miscellaneous expenses, etc.)
 … Cont’d
(ix) Provision for contingencies,(this is made to
provide for certain unforeseen expenses & price
increases over & above the normal inflation rate which
is already incorporated in the cost estimates.
(x) Margin money for working capital: the principal
support for working capital is provided by commercial
banks & trade creditors. However, certain part of the
working capital has to come from long-term sources of
finance referred to as ’Margin money for working
capital’, this is an important element of the project
cost.
 … Cont’d
 The margin money for working capital is sometimes
utilized for meeting over-runs in capital cost. This
leads to a working capital problem when the project
is commissioned. To mitigate this problem financial
institutions require that a portion of the loan
amount equal to the margin money for working
capital, be blocked initially so that it can be released
when the project is completed.
(xi) Initial cash losses. Most projects incur cash losses
in the initial years. Failure to make a provision for such
cash losses in the project cost generally affects the
liquidity position and impairs the operation .
 Table 3.6 The Capital/Investment Cost of the project may be as shown under

Description Local Cost Foreign Total Costs

(Birr) Costs (Birr) (Birr)

Land
Building & Site Development
Equipment & Machinery
Indigenous
Imported
Know-how
Training
Miscellaneous Fixed Assets
Preliminary & Pre-operating
Base Costs
Provision for Contingency (10%)
Working Capital
Total Investment Costs
 Project Life

At the time of project appraisal, the life of the

project to be considered is the economic life of
the major fixed assets. For example, for
Manufacturing industry the project life is
usually 10 years since the major assets are
production machineries. On the other hand, for
hotel projects, the project life is 20 years as the
major asset is building.
In this regard, economic life of a certain fixed
asset is the time period at which the fixed asset is
able to give service efficiency.
 Project Operating Costs

 Operating cost of a project consists of (i) direct

material cost of production, (ii) direct labor
costs, (iii) factory overhead costs of production,
and (iv) various admin and selling expenses. Of
course, the type of cost varies from project to
project.
 Operating cost can be (i) fixed and (ii) variable
components.
 … Cont’d
 Fixed operating cost – includes maintenance,
admin & managerial charges, etc. which will be
relatively fixed with respect to the volume of
production but may vary with scale of operation
 Variable operating cost – covers such items as
materials, power, labor inputs that will vary directly
with the volume of production.
 Hence, in project appraisal the variable and fixed
costs shall be clearly segregated and reasonably
estimated.
 …Cont’d
(i) Depreciation
 Depreciation is a process of allocating in a systematic
and rational manner the cost of a capital assets over
the period of its useful life.
 Depreciation costs should be calculated on the basis
of the original value of fixed investments, according
to the methods applicable (straight-line, declining
balance or accelerated depreciation methods etc.)
and rate adopted by management and approved by
the tax authorities.
 The same applies for non – tangible costs, such as
capitalized pre – production expenditure.
 … Cont’d
 Annual depreciation charges are frequently
included under overhead costs. Since, however,
these costs are treated separately for the
discounted cash flow method, depreciation
costs should be shown separately from
overhead costs. In this way, it is still possible to
include them for the calculation of factory and
unit costs, as well as for financial evaluation.
Exhibit 3.7 Computation of Depreciation & Amortization for the proposed Project

Type of Fixed Asset Total Cost Rate Applied Year 1-5 Year 6-10
Plant & Machinery 0.00 10% 0.00 0.00
Building & Civil Work 0.00 5% 0.00 0.00
Equipment & Furniture 0.00 10% 0.00 0.00
Leased land 0.00 As per the life of 0.00 0.00
the lease
Auto, trucks, motor vehicles, etc. 0.00 20% 0.00 0.00
Pre-operating Costs (Amortization) 0.00 20% 0.00 0.00
Total Depreciation & Amortization 0.00 0.00 0.00
 … Cont’d
(ii) Costs of Financing
 Financial costs such as interest on term loans
should be shown as a separate item, because they
have to be excluded when computing the
discounted cash flows of the project, but are to be
included for financial planning.
 When forecasting overhead costs, attention should
be given to the problem of inflation
 Means of Finance

After identifying the project’s investment costs

the next step is to show how it is to be financed.
The common source of finance for a project are:
(1) Equity Capital
(2) Term loans
(3) Deferred Payment
(4) Debentures
(5) Unsecured loans from Promoters
(6) Government
 … Cont’d
Share Capital:
 There are two types of share capital – equity capital
and preference capital.
 Equity capital represents the contribution made by
the owners of the business, equity shareholders.
 Preference capital represents the contribution made
by preference shareholders & the dividends paid on
it is generally fixed.
 … Cont’d
Term loans
 Provided by the financial institutions and commercial
banks, term loans represent secured borrowings which
are a very important source for financing new projects
as well as for the expansion, modernization and
renovation schemes of existing firms.
 Term-loans can be of two types: (i) Birr denominated
term-loan – which is given for financing land,
buildings, civil works, indigenous plant & machinery,
etc. & foreign currency term-loans – provided for
meeting the foreign currency expenditures towards the
import of equipment and technical know-how.
 … Cont’d
Deferred Credit
 Many a time the suppliers of the plant and
machinery offer a deferred credit facility under
which payment for the purchase of the plant and
machinery can be made over a period of time.
Debenture:
 Debentures are instrument for raising debt capital.
 Two types of debenture- convertible & nonconvertible.
Nonconvertible debentures are straight debt
instruments carrying fixed interest rate. Convertible
debentures are debentures convertible, wholly or
partially, into equity shares.
 … Cont’d
Incentive Sources:
 The government and its agencies may provide
financial support as an incentive to certain types of
promoters or for setting up industrial units in
certain locations.
 This incentive may take the form of seed capital
assistance (provided at a nominal rate of interest),
or capital subsidy (to attract industries to certain
locations), or tax deferment or exemption (from
sales tax) for a certain period.
 … Cont’d
Unsecured Loans:
 Unsecured loans are typically provided by the
promoters to bridge the gap between the promoters
contribution (as required by financial institutions)
and the equity capital the promoters can subscribe
to.
Public Deposits
 Public deposits represent unsecured borrowings
from the public at large.
Lease & Hire Purchase Finance
 Represent a form of borrowing different from the
conventional term loans and debenture capital.
 Sales Forecast

 Typically, the starting point for profitability projections is

the forecast of sales revenues.
 In estimating sales revenues, the following points should be
borne in mind:
(1) It is not advisable to assume a high capacity utilization
level in the first year of operation. It is sensible to assume
that capacity utilization would be somewhat low in the first
year and rise in the third or fourth year of operation.
A reasonable assumption with respect to capacity utilization is as
follows:
40 – 50 percent of the installed capacity in the first year
50 – 80 percent of the installed capacity in the second year
80 – 90 percent from the third year onwards
 … Cont’d
(2) The selling price considered should be the price
realizable by the firm net of excise duty
(3) It is not necessary to make adjustments for stocks of
finished goods. For practical purposes, it may be
assumed that production would be equal to sales.
(4) The selling price used may be the present selling
price. It is assumed that changes in selling price will be
matched by proportionate changes in cost of
production.
Sales and production are closely related. Hence, they
may be estimated together. For this purpose, the
format given in Exhibit 3.4 may be used.
Exhibit 3.8 Estimates of Production and Sales
Product 1 Product 2

Year Year
20x1 20x2 20x3 20x4 20x5 20x1 20x2 20x3 20x4 20x5

1. Installed
Capacity(Qty/year)
2. No. of working days
3. No. of shifts
4. Est. production per day
(Qty)
5. Est. Annual production
(Qty)
6. Est. Output as % of
plant capacity
7. Sales (Qty) after
adjusting stocks
8. Value of Sales in ETB.
 Cost of Production

 Given the estimated production, the cost of

production may be worked out. The major
components of cost of production are:
♣Material cost
♣Utilities
♣Labour cost
♣Factory Overhead
 … Cont’d
Materials
 The most important element of cost, the martial
cost comprises of the cost of raw materials,
chemicals, components, and consumable stores
required for production. It is a function of the
quantities in which these materials are required the
prices payable for them.
 While estimating the material cost the following
points should be borne in mind:
 … Cont’d
1. The requirements of various material inputs per unit of
out put may be established on the basis of either the
theoretical consumption norm or based on the
experience of the industry.
2. The total requirements of various material inputs can be
obtained by multiplying the requirements per unit of
output with the expected output during the year.
3. The prices of material inputs are defined in CIF terms.
4. The present cost of various material inputs is considered.
In other words, the factor of inflation is ignored.
5. If seasonal fluctuations in prices are regular, the same
must be considered in estimating the cost of material
inputs.
 … Cont’d
Utilities
 Utilities consists of power, water and fuel.
 The requirements of power, water, and fuel may
be determined on the basis of the norms
specified by the collaborators, consultants, etc.
or the consumption standards in the industry,
whichever is higher.
 … Cont’d
Labor
 Labor cost is the cost of all the manpower
employed in the factory.
 Labor cost naturally is a function of the number of
employees and the rate of remuneration.
 The number of supervisory personnel and admin
staff may be calculated on the basis of the general
norms of prevailing in the industry.
 Labor cost estimates may be raised at the rate of
5% per annum to allow for annual increment.
 … Cont’d
 In estimating remuneration rates, the prevailing
rates in the industry/area should be taken into
account.
 The remuneration should include, besides basic
pay, transport/fuel allowance, house rent allowance,
conveyance allowance, medical reimbursement
provident fund contribution, bonus payments,
gratuity contribution, overtime payment.
 … Cont’d
Factory Overhead
 The expenses on repairs and maintenance, rent,
taxes, insurance on factory assets, and so on are
collectively referred to as factory overheads.
 Repairs, and maintenance expense depends on the
state of the machinery – this expense tends to be
lower in the initial years and higher in the later
years.
 … Cont’d
 Rent, taxes, insurance, etc. may be calculated at
the existing rates. A provision should be made
for meeting miscellaneous factory expenses. In
addition, a contingency margin may be
provided on the items of factory overheads.
 Profitability Projections

 Given the estimates of sales revenues and cost

of production, the next step is to prepare the
profitability projections or estimates of working
results (referred by financial institutions). The
estimates of working results may be prepared
along the following lines:
A Cost of Production
B Total Admin Expense
C Total Sales Expenses
D Royalty & Know-how Payable
E Total Cost of Production (A+B+C+D)
F Expected Sales
G Gross Profit Before Interest (F – E)
H Total Financial Expenses
I Depreciation
J Operating Profit (G – H – I)
K Other Income
L Preliminary Expenses Written-off
M Profit/Loss Before Tax (J+K – L)
N Provision for Taxation
O Profit After Tax (M – N)
Less: Dividends on
♦ Preferred Capital
♦ Equity Capital
P Retained Profit
Q Net Cash Accrual (P+I+L)
 … Cont’d
Cost of Production
This includes the cost of materials, labor, utilities, and
factory overheads.
Total Admin Expenses: This consists of (i) admin
salaries, (ii) directors remunerations, (iii) professional
fees, (iv) light, postage, telegrams, and telephones &
office supplies (stationary, printing, etc.), (v) insurance
and taxes on office property, and (vi) miscellaneous
items.
 … Cont’d
Total Sales Expense: included in this head are:
●commission payable to dealers,
●packing & forwarding charges,
●salary of sales staff (may be increased by 5%
per annum,
●sales promotion & Advertising expenses, and other
miscellaneous expenses. Typically, selling expenses vary
between 5% and 10% of sales.
Royalty & Know-how Payable: Royalty rate is
usually 2 – 5% of sales. Royalty is payable often for a
limited number of years, say 5 to 10 years.
 … Cont’d
Total Cost of Production: This is the sum of Cost of
production, total administrative expenses, total sales
expenses, and Royalty & know-how payable.
Expected Sales: the figures for expected sales can be
obtained from the estimates of sales and production
schedule.
Gross Profit Before Interest: this represents the
difference between expected sales and total cost of
production
 … Cont’d
Total Financial Expenses: include interest on term
loans, interest on bank borrowings, commitment
charges on term loans, and commission for bank
guarantees, etc.
In estimating the interest on term loans, two points
should be borne in mind: (i) Interest on term loans is
based on the present rate of interest charged by the
lending financial institutions. (ii) Interest amount
would decrease according to the repayment schedule
of the term loan.
 … Cont’d
Depreciation: this is an important item, particularly
for capital intensive projects.
Other Income: This represents income arising from
transactions not part of the normal operations of the
firm. Example includes sale of machinery.
 … Cont’d
Write-off of Preliminary Expenses: Preliminary
expenses up to 5% of the cost of project or capital
employed, whichever is higher, can be amortized in
five equal annual installments.
Profit/Loss Before Tax: this equals Operating profit +
Other Income – Write-off of preliminary expenses.
Provision for Taxation: In the current Ethiopian
Company law, Corporations pay 30% flat tax rate on
their profit
 … Cont’d
Profit After Tax: this is equal to Profit/Loss before
tax less provision for taxation
Retained Profit: the difference between profit after
tax and dividends (if any) is referred to as ‘Retained
Profit’. It is also called ‘Ploughed back earnings’.
Net Cash Accruals: the net cash accrual from
operations is equal to: Retained Profit + Depreciation
+ Write-off of Preliminary expenses + Other non-cash
charges.
 Exhibit 3.9 Profitability Projection/Estimates of Working Results
Product 1
Year Ending (In thousands birr)
20x1 20x2 20x3 20x4 20x5 20x6 20x7 20x8 20x9 20x
10
A Cost of Production:
Admin expenses:
●Admin salaries,
●Remuneration to Directors,
●Professional fees,
●Light, postage, telegrams &
telephones, office supplies
Insurance & Taxes on office prop.
Miscellaneous
B Total Admin Expenses

C Total Sales Expenses

D Royalty & Know-how expense

E Total Cost of Production
(A+B+C+D)
F Expected Sales
G Gross Profit Before Interest (F – E)
 ………………… Exhibit 3.9 Cont’d

Year Ending (In thousands birr)

20x1 20x2 20x3 20x4 20x5 20x6 20x7 20x8 20x9 20x10

H Total Financial Expenses:

●Interest on term loans
●Interest on working capital loans
I Depreciation

J Operating Profit (G – H – I)

K Other Income (if any)

L Preliminary Exp. Written off

M Profit/loss before tax (J+K – L)

N Provision for Taxation
O Profit after Tax (M – N)
Less: Dividend on Preference share
P Retained Profit
Add: Depreciation
Preliminary Expenses Writn off
Q Net Cash Accruals
 Projected Cash Flow Statement

Cash Flow Statement

 The cash flow statement shows the movement of
cash into and out of the firm and its net impact on
the cash balance within the firm.
 A format for preparing the cash flow statement,
which is really a cash flow budget , is presented in
Exhibit 3.6 below:
Exhibit 3.10 Cash Flow Statement
Sources of Funds Disposition of Funds

1. Share Issue 1. Capital Expenditure for the project

2. Profit before tax with interest added back 2. Increase in Working Capital

3. Depreciation Provision for the year
4. Increase in secured medium & long-term
borrowings for the project
5. Increase in unsecured loans &deposits
6. Increase in bank borrowings for working capital
3. Decrease in secured medium & long-term
borrowings
4. Decrease in unsecured loans & deposits, Decrease
in bank borrowings for working capital
5. Decrease in liabilities for deferred payment
(including interest) to machinery suppliers
6. Increase in investments in other companies

7. Increase in liabilities for deferred payment 7. Interest on loans (term & bank borrowings)
(including interest) to machinery suppliers
8. Sale of fixed Assets 8. Taxation

9. Sale of investments 9. Dividends (both Preference& Equity)

10. Other income (indicate details) 10. Other Expenditure (indicate details)

11. Total (A) 11. Total (B)

Opening Balance of Cash in hand & at bank………………………………………………………………………………... Birr__________

Plus/Minus: Net Surplus/ Deficit (A – B) ………………………………………………………………………………………
_________
Closing Balance of Cash in hand & at bank ………………………………………………………………………………….
_________
 Illustration
To illustrate how the projected cash flow statement is
prepared let us consider a simple example. The
balance sheet of Ghibe Company at the end of 20x1 is
as follows:
Liabilities Assets
Share Capital Br. 100 Fixed Assets Br. 180
Reserve & Surplus 20 Investments -
Secured & unsecured loans 130 Current Assets 180
Current Liabilities 90 Cash 20
Provisions 20 Receivables 80
Inventories 80

Br. 360 Br. 360

 … Cont’d
The projected Profit & loss Statement & the Distribution of Earnings for
20x2 is given below:
Sales Br. 400
Cost of Goods Sold 300
Depreciation 20
Profit before Interests & Taxes 80
Interest 20
Profit before Tax 60
Tax 30
Profit after Tax 30
Dividends 10
Retained Earnings 20
 … Cont’d
During 20x2, the company plans to raise a secured
term loan of 20, repay a previous term loan to the
extent of Br. 5, and increase unsecured loans by Br.10
Current liabilities & provisions are expected to
remain unchanged. Moreover, the company plans to
acquire fixed assets worth Br. 30 and increase its
inventories by Br. 10. Receivables are expected to
increase by Br. 15. other assets would remain
unchanged, except cash. The firm plans to pay Br. 10
by way of Equity Dividend.
Exhibit 3.11 Projected Cash Flow Statements of Ghibe Company
Sources of Funds
Profit before tax with interest added back Br. 80
Depreciation 20
Increase in Secured Loans 15
Increase in unsecured loans 10
Total (A) 125
Disposition of Fund
Capital Expenditure Br. 30
Increase in Working Capital 25
Interest 20
Taxation 30
Dividends - Equity 10
Total (B) Br. 115
Opening Balance of Cash in hand and at Bank 20
Net Surplus/Deficit (A – B) 10
Closing Balance of Cash in hand and at Bank Br. 30
 Projected Balance Sheet
 The balance sheet, showing the balances in various
assets and liability accounts, reflects the financial
conditions of the firm at a given point of time.
 The Liabilities & Owners Equity side of the balance
sheet shows the sources of finance employed by the
business.
Share Capital – represent paid-up equity & preference capital
Reserve & Surplus – represent mainly the accumulated
retained earnings.
Secured Loans – represent the borrowing of the firm
against which security has been provided (debenture, term-
loans)
 … Cont’d
Unsecured loans – represent borrowings against which
no specific securities has been provided (fixed deposit
from public & unsecured loans from promoters, etc.)
Current Liabilities – are obligations which mature in the
near future, usually with in a year (payables from
purchase of materials & supplies, accruals of wages,
salaries & rentals, etc.)
Provisions: include mainly tax provisions, provisions for
provident fund, provision for pension & gratuity &
provision for proposed dividends).
 … Cont’d
 The Assets side of the balance sheet shows how
funds have been used in the business. The major
asset components may be described as follows:
Fixed Assets – represent tangible long-lived resources
ordinarily used for producing goods and services. They
are normally stated as Cost less Accumulated
Depreciation.
Investments – represent financial securities owned by
the firm.
 … Cont’d
Current Assets, loans & Advances – include Cash,
Debtors, inventories of different kinds and loans
& advances made by the firm.

Miscellaneous Expenditures & Losses – represent

outlays not covered by the previously described
asset accounts and Accumulated losses, if any.
 … Cont’d
 For preparing the projected balance sheet at the
end of 20x2, the following information are
necessary:
☻ The balance sheet at the end of 20x1 (previous
year)
☻ The projected Profit & Loss Statement and the
distribution of earnings for 20x2
☻ The Sources of external financing proposed to
be tapped in 20x2
 … Cont’d
☻The proposed repayment of debt capital (long-
term, intermediate term, & short-term) during 20x2
☻ The outlays & the disposals of fixed assets during
20x2
☻ The changes in the level of current assets during
20x2
☻ The changes in other assets and certain outlays like
preoperative & preliminary expenses (which are
capitalized) during 20x2
☻ The Cash balance at the end of 20x2
 Illustration

The projected Balance Sheet of Ghibe

Company, based on the information
provided in the previous section, are
presented below
Exhibit 3.12 Projected Balance Sheet for Ghibe Company for 20x2
Account Category Opening Balance Changes During the Year Closing Balance
Assets
Fixed Assets Br. 180 +30 (additional outlay) Br. 190
- 20 (Depreciation)
Investments - - -
Current Assets 180 - 215
Cash 20 30
Receivables 80 +15 (Expected Increase) 95
Inventories 80 +10 (proposed Increase) 90
Total Br. 405
Liabilities & Equity
Share Capital Br. 100 - 100
Reserve & Surplus 20 +20 (Retained Earnings) 40
Secured Loans 80 +20 (additional term-loan) 95
- 5 (repayment)
Unsecured Loans 50 +10 (proposed Increase) 60
Current Liabilities 90 - 90
Provisions 20 - 20
Total Br. 405
 Illustration: Multi-Year Financial Projections

A new firm, ABC Company, is being set up to

manufacture alloy steel. The expected outlays
and proposed financing during the construction
and the first two operating years are shown
below in Exhibit 3.9. The projected revenues
and costs for the first two operating years are
shown in Exhibit 3.10. It may be assumed that
(i) the tax rate for the firm will be 60%, (ii) no
deductions (reliefs) are available, (iii)
preliminary and preoperative expenses will not
be written-off during the first two operating
years, and (iv) no dividend will be paid in the
first two operating years.
Exhibit 3.13 Proposed Outlays and Financing of ABC Company
(Birr in million)
Construction 1st Operating 2nd Operating
Period Year Year
Outlays
Preliminary & Preoperative Expenses 2 - -
Fixed Assets 20 20 10
Current Assets other than Cash - 20 10
Financing:
Share Capital 10 15 -
Term Loan 15 15 7.5
Short-term bank borrowing - 12 6
Exhibit 3. 14 Projected Production/Sales & Cost
(In millions of Birr)
1st Operating 2nd Operating
Year Year
Sales 30 60
Cost of Sales (excluding depreciation & interest) 30 40
Interest 4.8 6.4
Depreciation 2 2.8
Exhibit 3. 15 Projected Profit & Loss Statements of ABC Company
(In millions of Birr)
1st Operating 2nd Operating
Year Year
Sales 30 60
Cost of Sales (excluding depreciation & interest) 30 40
Interest 4.8 6.4
Depreciation 2 2.8
Losses (absorbed) - 6.8
Profit before tax (6.8) 4
Tax - 2.4
Profit after tax (6.8) 1.6
Exhibit 3.16 Projected Cash flow Statement of ABC Company
(Birr in million)
Construction 1st Operating 2nd Operating
Period Year Year
Source of Funds:
Share Issue 10 15 -
Profit before taxation - (2) 17.2
Depreciation Provision for the year - 2 2.8
Increase in secured medium & long- -
term borrowings for the project 15 15 7.5
Increase in bank borrowings for
working capital - 12 6.0
Total (A) 25 42 33.5
Disposition of Funds:
Capital expenditure for the project 20 20 10
Increase in current Assets - 20 10
Interest - 4.8 6.4
Other Expenditure (Preliminary &
Preoperative expenses) 2 - -
Taxes - - 2.4
Total (B) 22 44.8 28.8
Opening Balance of Cash in hand & in bank - 3 0.2
Net Surplus/Deficit (A – B) 3 (2.8) 4.7
Closing Balance of Cash in hand & at bank 3 0.2 4.9
Exhibit 3.17 Projected Balance Sheet of ABC Company
(Birr in million)
End of End of 1st 2nd Operating
Construction Operating Year Year
Period
Assets:
Fixed Assets 20 38 45.2
Current Assets 20 20 10
Cash 3 0.2 4.9
Others - 20 30
Miscellaneous Expenditures - 20 30
Preliminary & preoperative exp. 2 2 2
Profit & loss account balance - 6.8 -
Total 25.0 67.0 82.1
Liabilities & Equity:
Share Capital 10 25 25
- - 1.6
Reserve & Surplus
15 30 37.5
Secured loan (term loan)
Short-term bank borrowing - 12 18
25.0 67.0 82.1
Total
… Cont’d
… Cont’d
… Cont’d
 … Cont’d
5. Overhead Costs
 Overhead costs are frequently computed as a
percentage surcharge on total material and labor
inputs or other reference items, a procedure that,
in most cases, is not sufficiently accurate.
Overhead cost should be grouped as outlined
below.
 … Cont’d
i. Factory Overheads
 Factory overheads are costs that accrue in
conjunction with the transformation, fabrication
of extraction of raw materials.
 Typical cost items are: Wages and salaries
(including benefits and social security
contributions) of manpower and employees not
directly involved in production, Factory supplies,
such as utilities (water, power, gas, steam)
effluent disposal, office suppliers, & Maintenance.
 … Cont’d
ii. Administrative Overheads
 Administrative overheads should be calculated
separately in cases where they are of
considerable importance; otherwise they could
be included under factory overheads. Typical
cost items are: Wages and salaries (including
benefits and social security contributions),
Office supplies (utilities, communication),
Engineering (rents, Insurance of property), and
Taxes (properties).
 … Cont’d
These cost elements should be estimated for
administrative cost centers such as management,
bookkeeping and accounting, legal services and
patents, traffic management and public relations.
… Cont’d
… Cont’d
… Cont’d
… Cont’d
… Cont’d