how to develop project feasibility studies
TRANSCRIPT
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How to
evelop
Project
Feasjbility
StUdieS
Revised dition
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How
to
repare
Project
easibility
Studies
Revised Edition
2 12
Manila Philippines
j e v o p m ~ t
a c a ~ e t \ 1
o l c
p h i l i w i ~ s
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ONTENTS
Page
Foreword y Antonio D Kalaw r . .......................................................v
Introduction .................................................................. .......... ......
...... 1
Project Summary ........ ...................... ....................... ................. ............. 4
Market Study ............................................ .......... ....................................7
Technical Study .................................................................................... 14
Financial Study ..... ......... ....... ....... .................................................. 23
Socio Economic Study ............................................... ......................... 52
Organization and Management Study .............................................54
Environmental
Impact Assessment Study ....................................... 7
Detailed
Outline of
a Project Feasibility Study ............................... 63
Pointers in Evaluating a Project Feasibility Study .......................... 65
A Final Note ............................................................... ........................71
Annexes
nnex
Market
Forecasting: Tools and Techniques .................................. 74
nnex B
BOI Guidelines in the Preparation of Project Feasibility Studies 85
nnex C
BOI Feasibility Study Format ...................................... ...... ............... 89
nnex
ADB Pre Feasibility Study Report Format ...................................... 95
References ....... ............. ...... ................................................................... 98
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FOREWOR
The first edition of this Manual was originally pr
epared
for
businessmen and would-be entrepreneurs who took part in seminars
conducted by the Development Academy of the Philippines under
its
industry
development
program
in the late 70s. The seminars
were intended
to assist small and medium-scale investors
in
the
Philippines. While the contents of this
book have been
derived from
univer
sal concepts and applications, care
has
been taken
to
include
only those which are essential in a feasibility study particularly, if
the study is meant to serve as a basis for a loan. A project feasibility
study
is, after all, supposed to establish the viability of a project,
not
dwell
on
details
which
are
required only
after
the
study
is
found
acceptable.
In
view of current developments
such as
technological
breakthroughs innovative industry practices as well as new
regulatory requirements, the Academy decided to come
up
with a
revised
edition
of the book.
t
features
new
cases,
the requirements
and
procedures for undergoing an Environmental ImpactStudy
IES)
for selected industries, as well as the Asian
Development
Bank s
(ADB) pre-feasibility study
report
format.
Likewise, this revised
edition
is designed to serve as a guide for
first-timers in project feasibility
study
(PFS) preparation and as a
reference material for students of bu siness and entrepreneurship
courses.
Pr ident
Development Academy
of the Philippines
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How
to
Prepare
Project easibility Studies
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ntroduction
A PROJECT FEASIBILITY STUDY or PFS is a thorough
and
systematic analysis of all factors affecting
the
chances of success of
a proposed undertaking. The PFS is a synthesis of separate studies
usually dealing
with
the marketing
technical financial socio
economic and
management
aspects
of
a project.
The
data facts and
other
findings presented in a PFS generally
become
the
basis for deciding whether the project is to be pursued
revised or otherwise abandoned. At the same time feasibility studies
pervade the entire life
of
a project from the time of conception of
a project idea to the time the concept is implemented or becomes
operational.
The role of project feasibility studies in the development of nations
cannotbe over-emphasized. A PFS is an essential medium of progress
both
as a means to initiate profitable projects for socio-economic
enhancement and industry expansion
and
as a tool in evaluating
actual project results against projected outcomes.
As
such a PFS
has
repercussions on the social economic cultural and
business
sectors of society.
To be sure some
past
undertakings have succeeded
without
the aid
of
a
study
. This however cannot be
used
as a basis for the
occasional criticism
that
project feasibility studies are next to useless;
or an
argument
for
the
failure
of
carefully-s tudied specific projects.
In the first place a project feasibility study is not an antidote for
failure or a guarantee of success. Its primary purpose is to enhance
the probability of success of a particular undert aking. It follows from
the widespread understanding that a carefully planned activity has
better chances of success in its implementation
than
one without a
plan.
To those who
argue
that feasibility studies
have
lost their
usefulness in these times of great uncertainty let it be said that
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such
studies
are even more important
now
in evaluating numerous
options arising from multiple possibilities. The project feasibility
study has proven to be one of the best instruments in meeting past
challenges
and
should prove its worth in this time o f constant change.
In this Manual, projects are discussed
in
the context of national
development programs, initiated by both government and private
institutions to
boost
progress
in the country's
administrative regions
and in various sectors of society. As a consequence, the applicability
of
these programs is analyzed
and
tested both according to region
and
sector.
Although
regional and sectoral
studies
of
development
programs
may be general
in
nature,
they
pave the
way
for a
more
thorough and specific identification of projects and arrive at different
ideas on how to apply national programs in terms of profitable,
realistic,
and
worka ble projects.
Every project goes through what
is
known
as a project
development cycle. As soon as a project
is
identified, its applicability
is
examined through further research, leading either to a generalized
pre-feasibility study, or directly to an analytic and systematic
presentation of findings in the form of a project feasibility study.
t
is
then evaluated in terms of its optimality, practicality, potential,
and
growth,
for presentation
to
and negotiation with financing sources
or institutions, where the study undergoes further evaluation and
reevaluation.
During the assessment of a project, recommenda tions on revisions
to the Project FeasibilityStudy or the non-feasibility of the proposed
undertaking
are made.
At this point, the project
is
going through the
Go
or No go
phase. If
it is found to be too risky
to
be feasible, the project is
eventually shelved. Any revisions and reevaluations of the project,
however, may enhance its feasibility
during
the implementation
stage. As soon as
the
project is implemented, its outcomes are
appraised
against the data
presented in the
feasibility study.
2
How
to
Prepare
Project Feasibility Studies
During the project appraisal, the implementing group pinpoints
the variances between actual project results and the data provided in
the project feasibility study. Taking into account changing conditions
and
deviations from the
expected
outcome,
the
project is
then
improved
in
terms of performance, scheduling, and costs. PERT CPM
(Program Evaluation and Review Technique/Critical
Path
Method)
techniques are usually incorporated in project implementation so as
to
reduce
variances
between
the projected
outcome and
the actual
results.
The consequences of the project's reappraisal will also provide
each region and sector with information
on
specific types of projects.
The data implies an influence on further decisions to be
made
on future project studies . Thus, the project development cycle is
completed.
The
following Guide to the preparation of Project Feasibility
Studies applies to both industrial and agricultural ventures. While
this
Guide
focuses
on industrial
projects, the PFS
preparer
is free to
make the necessary adjus tments to fit the recommended form and
content to agro-based projects as well. The overall guideline is for
the PFS to include comprehensively the major concerns of any PFS:
marketing,
production
, finance, organization,
and
socio-economic
viability of an
industrial
or agricultural project.
Intr
od
uction
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roject Summary
THE
FIRST
SECTION
of
a Project Feasibility
Study
is THE
PROJECT SUMMARY.
It presents th
e
highlights, descriptive
definition, long-range objectives, feasibility criteria, history,
and
basic
conclusions
of
the project under study. It gives the analyst
and
the
financier a capsule
view
of
the whole
project.
This portion starts with the
name of
the firm, the location and
size of its head office,
plant
site, and factory.
I t
then presents a
comprehensive description of
the
business, its operations,
and
its
product
lines. Major
assumptions used and
findings on
the
market,
technical, financial, socio-economic,
and management
feasibility
of the project are discussed. The status and timetable of the project
must also
be
stated.
In outline
form,
the
project
summary
contains
the
following:
A
NAME OF THE ENTERPRISE
Briefly explain the reason for
the
choice
of name
.
B
LOCATION
Pinpoint the location of the head office
and
the
plant
site and
give the
main
reasons for choosing the project sites. The factors
which
affect the choice of location
are
the
sources
of raw
materials, labor,
and
utilities; proximity to t he market;
nature
of available transportation;
and th
e cost of
land and
buildings.
The project must choose a location where maximum efficiency
can
be
attained at the lowest possible cost.
C. DESCRIPTIVE DEFINITION OF THE PROJECT
1 Related national program
Is the project in line with any government-initiated or
priority program?
2. ffinity to regional or sectoral studies
Is the project a result of encouraging findings in certain
regions
or
sectors
of
the country?
4 How to Prepar e Project Feasibility Studies
3
Project potential and proponent
Give a
conceptual description
of
the
project's
potential
worth and importance and the person or group of people
who will manage it.
D. LONG-RANGE OBJECTIVES
What does
the project expect to achieve
in
ten years,
in
terms of
size, capacity, volume, worth, role
in
its industry,
and impact
on the economy?
E FEASIBILITY CRITERIA
What were the most important guidelines used to judge
the feasibility of the project? Was it profitability?
Did
it
seriously consider the project's impact on the socio-economic
environment?
F. HIGHLIGHTS OF
THE
PROJECT
1 History
How did the project come about?
2
Project
timetable and status
How long will it take for the project to be operational? What
stage is the project presently in?
3.
Nature o
he
industry
Briefly describe
the
industry, its
product
lines, the
demand
supply
situation, history,
growth
patterns, problems and
potentials, and role in the economy.
4 Mode of inancing
Briefly discuss
the
sources of funds, the financing terms,
and
the reasons for choosing such sources
and
terms.
5 Investment
costs
How much funding
is
needed
to
make
the project fully
operational?
How
are these
funds
to
be
allocated?
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G.
MAJOR
ASSUMPTIONS
USED
AND
SUMMARY OF
FINDINGS
AND
CONCLUSION:
1 Market feasibility
Discuss
the
nature of
the
unsatisfied demand which the
project seeks
to
meet its growth and the manner
in
which it
is to
be
met. Here
the supply-demand
situation is
examined
the
target markets
analyzed
and the
marketing
program
formulated.
2 Technical feasibility
Discuss
the nature of the
product line
the technology
necessary for
production
its availability
the proper mix of
production
resources
and the optimum
production volume.
3.
Financial
feasibility
Present the overall financial picture in terms of
operating
cash requirements profitability
and
cash flow.
4. Socio economic feasibility
What are
the effects of the projecton society and the regional
and national
economy
as a whole? Is
it
generally beneficial
to the people? Is it in line with any national or regional
economic
development program?
5.
Management feasibility
What
is
the management
structure? Is
it appropriate
for the
managerial
needs
of the project? What is the
salary
scale? Is
it compatible
with industry standards?
6 How to Prepare Project Feasibility Studies
arket
tudy
THE MARKET
STUDY
is
the
lifeblood of
virtually every
project
feasibility
study.
While profitability
is generally the
focal
point of
a
project study the question
of demand is
the most basic
issue.
Obviously there
can be
no discussion of profitability or of
the other
aspects of
the
feasibility
evaluation
if there is no demand
for
the
product.
t
is therefore imperative that the
market
study be gtven
the first consideration.
The
market study seeks
to determine the following:
1.
The
size
the nature
and
growth
of total demand for the
product;
2 The description and price of the product to
be
sold;
3.
The
supply
situation
and the nature
of
competition;
4
The differen t factors affecting
the market of the product;
and
5. The
appropriate
marketing
program
for the product.
A. PRODUCT DESCRIPTION
In
describing the product
to
be marketed the
following
are
taken into
consideration:
1. Name
o
he product
2 eatures o the product - its physical chemical and
agronomic properties
3.
Uses of
the
product
-
as
a finished
commodity as
input to
other production
activities
4. Major users of the product -
individuals and/or
firms
5. Geographical areas
o
dispersion - where product is mostly
found
or
to distributed in
the
case of a new
commodity
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B DEMAND
An analysis of demand is part of the important task of
identifying the
needs
of consumers and
determining whether
they are willing
and have
the capacity to pay for
the products
a
business
intends to produce. n
forecasting demand,
one
takes
into consideration not only production and importation figures
of
the
past but
also
such other
factors as credit availability,
income distribution, population growth, price variations, age
composition, the degree of urbanization, tastes and preferences,
money supply, Gross National Product or GNP, and so on.
Thus, demand analysis involves analyzing macroeconomic
variables, i.e., data on the level of the individual firm or at
least on the level of
an
industry grouping (an industry being
defined as the conglomeration
of all firms
producing
a more
or less
homogenous output)
. An example of
macro
analysis
would
be
to study the Gross National Product (GNP) and its
components.
f
GNP
is
expected
to
rise rapidly,
businessmen
would ordinarily expect good times for their businesses.
In selling a product for mass consumption, the prospective
investormight give more attention to the growth rate of a GNP
component
like Personal Consumption Expenditures.
Or
a
producer of equipment would be more interested
in
the Gross
Capital Formation component. An exporter
would,
of course,
be interested in the export figures of goods and services.
On
the micro level, the
demand
for a firm's product is a
function of
many
variables
such
as the price of a product,
the
price of a substitute product, income, population, etc.
An analysis of income distribution, for example, could give
us an idea of what types of products consumers can afford.
Two other important concepts in demand analysis are 1 price
elasticity,
which measures the
response of
quantity
demanded
of a particular product to variations in its price, and 2 income
elasticity, which measures the response of quantity demanded
of a particular product to variations in income.
8
How to Prepa re Project Feasibility Studies
The size, the nature, and growth of total de
mand
for the
product must be determined in the following manner:
1.
Who and where
is the market? Segment the market according
to
type, manner of use, income classification, location, age,
etc . The manner of
segmenting
the market would depend
on the type of product being considered. For instance, the
market
for automobiles could
best be segmented by using
income as a yardstick. On the other hand, the market for
heavy
equipment
could
be
better
understood
by pinpointing
industry classification.
2. What is the total domestic demand from the
hi
storical point
of view?
3. Is there a foreign market?
f
so, determine the historical
demand
.
4.
Evaluate
demand growth
patterns in the
past and
project
future demand by applyingappropriate projection methods.
C.
SUPPLY
The supply situation may be determined as follows:
1.
Who and where
are the direct competitors? Classify them
according to
si
ze, product quality, location,
performance
,
and market segment
performance. t is important
to
determine the type of competition existing. Are there only a
few big firms producing the product being considered? Are
there
many
small firms
with
no single firm controlling the
market?
Or
is
it an industry
of
big and
small firms? The type
of competition in existence would influence the decisions
on
production capacity and
marketing
strategies.
2. Determine the historical domestic supply based on local
production and importations.
3 f there is a foreign market, determine the historical
supply
patterns in the targeted countries based on local production
and
importations.
4
Evaluate supply growth
patterns and
project future supply
by applying appropriate projection methods.
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D. DEMAND-SUPPLY ANALYSIS
I t is now
essential to combine the findings
on
the demand
and supply situation. The analysis may be
conducted
in the
following manner:
1
Compare the
demand
and
supply
trends.
2
Determine the
amount of demand
unsatisfied, especially
in
the projections.
If
demand appears
to
be fairly satisfied by
supply, it is useful to consider eitheror both of the following:
a. Whether factors affecting the market may disrupt the
equilibrium so as to cause
demand
to grow faster than
supply.
b. Whether the
quantity
of
the
product
is such that
it may
create additional demand or cause a shift of a portion of
the existing demand in its favor.
3. Determine the
share
of the market by establishing the
proposed production volume (determined in the technical
study) as against the
total
market
size.
E PRICE STUDY
In
economic theory, price is determined mainly by the demand-
supply situation.
n
increase in
demand
with constant supply
will hike prices. The opposite (i.e., high supply, low demand)
would likely result
in
the lowering of prices. There are,
however, other factors
which
exert some influence
on
the price.
Without any change in demand or supply, prices may go
up
if
raw
material costs rise;
or
prices
may
decline if
the government
decides to subsidize production. Prices may also be determined
by the simple cost-plus method
used by
accountants.
Keeping
all these
in
mind, the price
study
may best be
conducted
as follows:
1. Determine the selling prices of all similar and substitute
products.
2 Look into the history of these prices (including the range of
fluctuations) and establish the factors that mostly influence
their fluctuations over time.
3. Determine the responsiveness of
demand to
price changes.
1
How
to Prepare Project Feasibility Studies
Will there
be
a tremendous, slight or negligible increase
or
decrease
in
demand if prices are lowered or raised?
4. Establish the
product s
sellingprice, taking into consideration
all of the above, the market segment targeted, and the
operating costs and expenses (determined in the technical
and financial studies). Likewise, estimate the increases
foreseen in subsequent years.
F FACTORS AFFECTING THE MARKET
There are certain factors affecting the market that may or may
not be
difficult to quantify and/or predict. This section takes
into consideration the following:
1. Demand may be significantly affected
by
population
growth,
income changes, tastes, rural/urban developments,
prices of substitute and complementary products, and such
marketing tools as advertising, promotions, credit policies,
etc.
2 Supply may be
influenced
by
the
development
of substitute
products, the entry or exit of firms, sources
and cost
of production factors, government policies,
improved
technology, etc.
3. Prices may be affected
by
production costs, price controls,
inflation, etc.
G. ANALYSIS OF RESEARCH DATA
Data
analysis
and interpretation
is
one of
the
most
critical
phases of market research.
It
answers such questions as What
does this information mean? and
Is
the information relevant
to establish a marketing plan?
Following are the different types of Data Analysis.
1
Descriptive nalysis - describes the data gathered using
mean, median, mode, frequency distribution, range, and
standard deviation.
2 Inferential nalysis -
tests
the
validity of the hypothesis
and
identifies
standard
errors.
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3 Difference nalysis -
determines
if differences exist
between groups of respondents, e.g., ev aluate statistical
significanceof difference
in
the
means
of two
groups in
a
sample using t-test of differences and analysis of variance.
4 ssociative nalysis -
determines
associations or
relationships
of variables in the
survey
using cross
tabulation
and
correlation.
5 Predictive nalysis - forecasts based
on
the results of the
survey.
Care should be taken in choosing the right analytical tool in
undertaking the market research for a PFS. Annex I presents a
comprehensive discussion of
procedures in market
research.
H. MARKETING PROGRAM
The marketing program should be the end product of
a
market
study. After defining the market and price targets,
the
marketing
program comes in as the
implementing
arm.
t
consists of the following procedures:
1. Determine the types of marketing programs prevalent in
the industry and gauge their respective effectiveness.
2 Draw up
a marketing
plan
that
identifies
and
defines
the target market, the selling price, the packaging of the
product, the distribution network,
the
sales
management
mechanism, and the advertising and promotions program.
The important components of the marketing program may
best be summarized
by
the four Ps: product, price, place,
and promotions. The first two
components
are essentially
determined
in the
previous
sections of the market
study.
Place refers to the way the product
is distributed
or made
available to the
end-user.
Promotions is
concerned
with
making the end-users aware of, and desire, the product.
3 Design the marketing organization which will implement
the
plan
and
determine
the
costs involved. The organization
12
How
to Prepare Project Feasibility Stud ies
would again depend greatly on the type of product being
marketed. In general, a consumer product would require
a sizable organization that concentrates
on distribution
channels
and
promotions. Non-consumer items
would
probably require a distribution network or a small-sized
sales force. In any case, the most ideal organization is one
that allows maximum efficiency
at
the lowest workforce
level possible.
The
sales promotion plan
and
the channels of distribution
should
be appropriate to the product and the market. Consumer
buying habits in the particular field should be considered in the
selection of outlets. Potential distributorsmay include retailers,
wholesalers, jobbers, industrial leaders, industrial distributors
and manufacturer s
agents. A plan for
consumer
credit
and
financing
and
for sales allowances can
be
formulated
on
the
basis of
marketing
channels selected.
I
PARTS OF A MARKETING PLAN
I Introduction
II
General Business
Condition
Ill. Competitive Conditions
IV Market Research Results
V Sales and Distributions Plan
VI. Advertising
and
Sales Promotions
VII. Other Related Aspects
(such as product
formulation,
packaging, legal clearance, raw material procurement,
etc.)
VIII. Budget Summary
IX
. Profitability net income targets)
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Technical tudy
AFTER
THE MARKET STUDY the technical aspect of the project
is analyzed. The technical
study
consists of the following:
1. Select ion of:
a. The manufacturing process.
b. The machinery capacity and design.
c. The machinery supplies.
d. The plant location.
e.
The
plant layout.
f The
building and structures specifications.
g. The raw materials and their sources.
2
Determination
of:
a The
quantity and quality
of
the products to be produced.
b. The
labor
needed both skilled and unskilled.
c The utilities required.
d. The waste disposal method.
e. The transportation necessary.
3
Computation
of the
total project cost
and
enumeration of
the
major items
of
capital cost.
4 Detailed listing of the estima ted production and overh ead costs
that
will be incurred in operating the
proposed
production
plant.
5. Consideration
of
any major technological development in
the industry which may affect the commercial or technical
soundness of the project.
The technical
study
covers the following topics, and
where
applicable, costs which
will
be
used in
the financial
study
should be computed.
14
How
to Prepare Project Feasibility Studies
A THE PRODUCT(S)
This portion describes
the
product(s) to be manufactured
and sold. The description specifies
the
products physical,
mechanical and chemical properties and identifies its
various uses,
both
as finished goods and as intermediate
inputs
as
raw
material to another process.
B
MANUFACTURING PROCESS
The selected manufacturing process must be described
simply
and
clearly, preferably with the aid
of
flow charts
and
diagrams. The existence of alternative processes and
how
they
compare
with
the chosen process
must be
discussed.
The analysis should further touch
on the
manufacturing
processes used in existing plants, both domestic and foreign.
Finally, a review of licensing agreements and patents, if
any
would
also
be
helpful.
C.
PLANT
SIZE AND PRODUCTION SCHEDULE
State the minimum and maximum rated capacities of
the
plant. The minimum capacity is that level of production
where the resources are
not
fully utilized, but are employed
at a
minimum
economical level.
In
general, the
minimum
economical level is that level
of
production where
the
firm s
fixed costs are
at
least covered by
the
resulting revenue.
The
firm s fixed costs
are determined in
the financial
study.
The maximum capacity is that level of production where all
resources are fully utilized.
From
there,
the
actual capacity utilization,
the
number of
shifts per day, and the number
of operating
days
per
year
are
then defined.
Finally, the factors in determining the plant size must be
i ~ n t i f i e described. The findings in the market study
will
be
a maJOr
input
in this section.
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Study
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The production schedule describes the projected scale of
operation for the next several years. Will production increase
in time? By how much? The factors that determine these
considerations are the expected growth in market share, the
availability of financing for possible expansion, the access to
more raw materials, and the level of utilization ofplant capacity.
D. MACHINERY
AND
EQUIPMENT
Machinery
and
equipment
required
must
be
identified
and
itemized according
to type and
use. Specifications,
capacities,
and
costs
should
be described
in
detail. Likewise,
the origin of the machinery,
whether
local
or
imported, as
well
as
the
manner and
cost of
transporting and
installing
them
must
be indicated.
The
total
cost of installed
imported
machinery
and
equipment
is
computed as
follows:
FOB: (In currency of
port of
origin
Add: Freight
and
Insurance* ( of FOB)
CIF Convert CIF cost of
Philippine pesos
using the
current foreign exchange)
Add: Tariff Rate*
( of
CIF)
Add: Import
Charges*( of CIF)
Total Cost
Add:
Compensating Tax* ( of Total Cost)
Landed Cost
Add:
Installation Cost*
(
of Total CIF)
Installed Cost
A balancing of capacities
must be presented
to
show that
the machinery
and equipment
are capable
of producing the
desired maximum output.
E.
PLANT LOCATION
A
thorough and comparative
analysis
of each potential
location
should be made
to
determine
the
ideal plant
site
for
the
project.
16
How
to Prepare Project Feasibility Studies
The
evaluation
process has to consider the following
factors:
1. The availability of
raw
materials and accessibility to their
sources.
2. The availability of cheap
or
moderately priced utilities
such as power, water,
or
fuel.
3. The combined cost
of
transporting
raw
materials
and
fuel
to the
plant
site.
4. The proximity to distribution outlets.
5. The availability of skilled
and
unskilled labor.
Maps
and charts of the
proposed plant
location
must be
included.
F. PLANTLAYOUT
The plant layout should be clearly depicted through diagrams
and
descriptions. A good
plant
layout is characterized by
minimum material handling,
effective space utilization,
smooth
workflow
throughout
the plant, safe
and
conducive
working
area for the workers, safety
and
sanitation facilities,
and flexibility of arrangements.
G. BUILDING
AND
FACILITIES
The
site, type,
and
costs
of the building
and
land, as
envisioned
in
the project,
should be
adequately described.
The construction cost of the building
and
facilities should
be
presented
as
adapted
to the machinery
and equipment
that
will
be used in
the project. Land improvements
such
as roads, drainage facilities, etc.
and
their respective costs
should be computed and
included as well.
H. RAW MATERIALS
AND SUPPLIES
The
required raw materials
and
supplies should be
itemized
and
the basis for their selection must be presented.
Descriptions
and
specificationsof their physical, mechanical,
and
chemical properties
must
also
be
given.
Current and
Technical S
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prospective costs of raw materials, the availability and
continuity of supply
and
the current as well as prospective
sources
should also
be
discussed. The
volume of such
materials
required at various
phases of operations must
likewise
be
presented.
I UTILITIES
This portion
indicates the amount
cost,
and sources
of electricity, fuel, water
an d
/or other potential energy
sources. These factors
must
be determined in relation
to
the production schedule and capacity utilization defined.
Alternative sources of these utilities and the feasibility of
their use
must
also
be
described.
J WASTE DISPOSAL
The quantity of production wastes, the
manner
of their
disposal,
and
the cost involved is discussed.
The
analysis
may
be expanded to consider the possibilities of further
utilizing these wastes.
K
PRODUCTION COST
How much will it cost to
produce
one unit of output?
To
arrive
at
this
computation the
following
must
be
determined
: a)
raw
material costs, b) labor cost,
c
overhead
cost fixed costs), d)
operating
costs variable costs), and
e
other
pertinent
costs.
L LABOR REQUIREMENTS
The
various
jobs
and
functions
necessary during the
operational stage
must be
described. For costing purposes,
labor
is
generally classified into three types - direct,
indirect, and administrative. Here, the number of
workers
to be employed for each job classification, the pay scales,
employee development programs, the organizational set
up and the aggregate labor costs are described in detail.
8 How
to Prep are Project Feasibility S tudies
SUGGESTED FORM T FOR THE TECHNIC L STUDY
I
Description of
the
Product Service
II. Manufacturing Process
A Process Flow Diagram
III. Plant Size Capacity)
and Production
Schedule
IV. Machinery and Equipment
V. Plant Location
VI. Plant
Layout
VII. Building and Facilities
VIII. Raw Materials and Supplies
IX.
Utilities
X. Waste Disposal
XI.
Production Cost
A. Direct Materials
B. Direct Labor
C. Manufacturing Overhead
XII.
Appendices
A Plant Layout Equipment
B. Equipment Listing and Cost
C.
Utilities Calculation
D. Plant Facilities Breakdown Cost
E. Projected
Cost
of
Production
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1\.)
0
::r::
0
0
~
..
( )
' lj
'
il
~
]
( )
(:).
'Tl
fE
'
g
q
[J
2
0 .
SAMPLE WAREHOUSE DISTRIBUTION CENTER
LAYOUT FOR A
CHAIN OF GROCERIES
Figure 1 Theoretical Warehouse Layout for a Chain of Groceries
The theoretical wareho use layout
shows
the left to right process flow, which starts
at
receiving inbound)
and ends
in
shipping (outbound)
0
Piece
1
0
Picking
('D
CfJ
1
~
fJ
0
~
1
~
ro
..... ..
J
Bulk
_
ro
>--
~
--
J
1
Area
('D
~
s
>--
Case
1
..........
('D
Picking
..... ..
('D
Figure 2. Warehouse Block Layout for a Chain of Groceries
Figure 2 follows
the
concept
of
the theoretical
warehouse layout
but
is more
space efficient, with less travel
or
transport
time. The less space interval there is, the better
the
quality
and
condition
of
the
product.
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r
r
~ --
r r
DODD
How
to Prepare Project Feasibility Studies
DODD
--oo-o-o_
DODD
DODD
DODD
DODD
DODD
inancial Study
SINCE ALL PROJECTS
are considered
viable only when
they are
expected to be profitable to meet short-term obligations, to be
liquid
and
to remain liquid during adversity, t grow in their ability t
finance their operationsmostly from capital sources
rather
than credit
applications,
and
to service
their
financing charges,
the
financial
aspect is a v ry
import nt
part
of
every project feasibility
study.
As
such
the
Financial
Study
should show in
specific terms
whether the project willbe profitable even with existing competitio n
and in unfavorable economic conditions. Detailed figures showing
the improvement
of
the project s financial condition
over
time should
be presented.
This is done through
the
preparation
of
financial
statements
and
schedules
reflecting the expected profits, the modes of financing
needed
to
optimize
the project s performance, the
manner and period
of repaying creditors,
and
other financial considerations which are
vital for the success of
the
venture.
The
financial study of the project may be broken down
into
the
following major sections:
1
Major Assumptions
2 Total Project Cost
3. Key Forecast Variables
4
Sources
of
Financing the Project
5. Preparation of Financial Statements
6 Financial Analysis
7 Computation of
Net
Present Value
and
Internal Rate
of
Return
8. Sensitivity Analysis
9
With or
Without
a Project Analysis
A. MAJOR ASSUMPTIONS
In
the formulation of the financial projections, assumptions
play
an
important
role because
they
serve
as
the foundation
for
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estimating the future expenditures, expenses, and revenues of
the project as accurately as possible. These assumptions
must
be based on well-considered, realistic,
and
workable facts.
In
formulating assumptions, the analyst
must
consider the
following sources:
1.
Existing business practices in
the industry may provide
some
valuable
information and
insights
on
the
following:
a Credit terms
b. Credit extensions
c. Bad debt allocations
d. Bad debt write-off
e. Quality related costs
f Dividend policies
g. Sales returns, allowances,
and
discounts
h. Labor
and management
compensation
i. Overhead accounts
j
Inventory
costing
k Operating accounts
I Fixed-asset requirements
m.Method
of depreciation and amortization
n. Intangible-asset pre-requisites
2 Past feasibility studies directly related to the project may
reveal other factors
not yet
considered, specifically those
items involved in the
computations
of:
a Selling price
b. Sales forecasts
c. Unforeseen costs
d. Production volume
e. Product mix
3 Governmental regulations and incentives directly or
indirectly affecting the project, such as:
a Import policies
b. Export policies
c Tax rates
24 How to Prepare Project Feasibility Studies
d. Tax exemptions
e. Price ceilings
f Relevant presidential decrees
or
letters
of
instruction
4. Other pertinent
data
which can justify the assumptions of
the study, such as industry profiles, pre-feasibility studies,
proceedings of symposiums and conferences,
and
research
or
policy studies of
industry
associations.
n
general, assumptions in the preparation of the financial
study
should
be kept
at a minimum as
much
as possible
and
formulated only when necessary.
The
list of assumptions incorporated
in
the
study,
however,
should remain
intact
and
consistent
throughout
the
analysis and must have the following characteristics:
a. Factual
b. Justifiable
c
Realistic
d. Workable
B
TOTAL PROJECT COST
The second step in the preparation
of the
financial aspect
of
a
project feasibility study is an estimation of the project s total
cost or initial asset or capital requirements.
Based on the materials, supplies, equipment, physical plant,
and
manpower needs of the project specified in the technical
study,
the
total project cost is
composed
of
current
asset levels
and
planned
fixed asset acquisitions.
1 Fixed ssets - In computing
the project s
fixed-asset
requirements, the most approximate acquisition cost of the
following accounts
should be
determined:
a. Land and
land
improvements
b. Buildings, includ ing electricand water utilities, furniture
and
fixtures
c Equipment,
including
installation costs
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d. Purchase and installation of machinery
e. Trial-run associated with electric utilities,
equipment,
and
machinery
Land
and land
improvements consist of the cost of
land, the corresponding
notary s
fees associated
with
land acquisition,
registration
expenses,
transfer
taxes,
and
other related costs.
Building cost
includes
all
expenses
incurred
in
constructing the
building and
its foundations, wells,
water
pipes, electrical connections, gas suppl y, telephone
system, reservoir and tanks, waste water disposal,
fencing, roads and paths, employee housing, and fire
protection.
n
addition to
the
purchase price
of
machinery and
equipment,
sales taxes, freight charges, insurance and
customs duties
(for
imported equipment) are
also
included
in
the costs.
Significantand necessary
expenditures
on
foundation
setups, tests
and
startup operations, installation of
electricity and telephone lines, electrical equi pment, office
equipment, furniture and fixtures, employee benefits,
maintenance and cleaning
equipment should all be
considered and presented.
2 urrent ssets - n estimating the project s initial current
asset
needs,
it
is
advantageous to divide
this section
into
inventory investments, inventory-related costs,
and
cash
credits.
a Inventory investments include purchases of materials
and supplies, and the corresponding freight charges.
b.
Classified
under
inventory-related costs
are such
accounts as direct
and
indirect labor
with
related fringe
benefits; heat, light,
and
power;
plant
maintenance; and
warehousing expenses related to raw materials, materials
in process,
and
finished goods.
c Cash credits include pre-paid expenses, intangible assets,
26
How
to Prep are Project Feasibility Studies
operating salaries, wages, and fringe benefits, engineering
costs, operating taxes, office supplies, communication
facilities, office utilities, billing costs, transporta tion costs,
expenses for advertising, borrowing costs, and provisions
for unforeseen costs.
Intangible assets include patents, licenses, goodwill,
reproduction
rights,
and
organization
and
pre-operating
expenses,
if
he latterare amortized for a period extending
to more than one year.
Organization expenses include fee requirements of
the Securities and Exchange Commission, cost of issuing
shares
of
stock
such
as broker s fee, interim interest, initial
advertising, personnel recruitment and training, etc.
Pre-operating expenses include costs of
initial
investigations, pre-feasibility studies, research and
technical studies, economic
and
marketing
studies,
financial and profitability studies, design studies, and
engineering consultant fees.
The total
Current
Asset costs are
then
multiplied
by
the
assumed current ratio, which is ideally 2:1, to arrive
at
the total cost
of Working
Capital.
The Total Project Cost is the sum
of
Total Fixed Assets
and
Working Capital.
In general, the
computation
for project cost estimates
should be as detailed as possible. Five percent of these
itemized projections are usually allocated to unforeseen
costs.
C
SOURCES OF PROJECT
FINANCING
n determining the financing scheme for the project, one should
take the following steps:
1
List
down
all available
sources of funds
for
both short
term and long-term financing. Funding options
range
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from
bank credit,
insurance
term loans, mortgage loans,
leasing arrangements, issuance ofbonds and stocks, private
placements, investment banking arrangements, etc.
2.
Select
the
source(s) for both long-term and short-term
financing according to its maximum profitability.
3. Finalize
the amount and terms
for
each
selected source,
together with
an
indication of the currency, security,
repayment period, interests, and other features. I t should be
noted that the security, repayment period,
and
interest rates
of loans differ from one lending or investing institution to
another. Bonds are also settled prior to stock dividends, and
preferred
stocks
are issued
dividends first before common
stocks.
4.
Determine the status of
financing from
each source by
relating
it to
actual
releases already made,
applications
already approved,
applications
pending,
and
applications
still to be made.
5. Provide
allowances
for
financing
of
contingencies and
fluctuations in working capital so that the project s liquidity
and cash solvency are assured during each operating year
of the project s early stages.
6.
Identify alternative sources of financing in order of priority,
in case variances from
the expected
outcome result, due to
external conditions which affect the project.
D. PREPARATION OF FINANCIAL STATEMENTS
Financial statemen ts present in an orderly and understandable
form
the
financial
condition of
a
business enterprise,
its
operating performance,
as
well
as
the status of its liquidity.
Financial statements
depict
the progress of a firm
in
monetary or financial terms.
8 How to Prepare Project Feasibility Studie s
There
are
three types of financial
statements
needed for
the
project feasibility presentation:
the
Income Statement,
the
Cash
Flow Statement, and the Balance Sheet.
1.
The ncome
Statement
is a
summary
of the project s total
revenuesand total costs for one period
or
fiscal year, thereby
arriving
at the net income or loss for the period.
In
Exhibit
2-1, a model format for income statement preparation is
presented
.
An
analysis of each account in the presentation follows:
a.
The
amount of net
sales in
pesos
is
arrived
at by
subtracting sales
returns,
allowances, and
discounts
from gross sales. Sales returns represent goods sold
which
do not
meet customer requirements
and thus
have
been
returned . Allowances refer to goods which
cannot
be
sold due to spoilage,
wrong
specifications,
and
similar causes. Sales discounts are price reductions
occasionally given in favor of customers.
b. Cost of sales is a function of
raw
materials used,
direct labor expenses, and factory overhead, less cost
of
ending inventory for the period. Factory overhead
includes a
materials and labor expenses indirectly
related with production; b)
heat,
light, and power
required for manufacturing; c repair and maintenance
costs associatedwith productive fixed assets; d) various
supplies needed to produce goods; the depreciation
of productive fixed assets;;
and
e) insurance expenses
related to the productive operations.
2. The ash Flow Statement or the cash budget is a
presentation of cash receipts and disbursements for a given
operating period or fiscal year. Exhibit 2-2 illustrates a cash
budget
model, showing
the
inflow and outflow
of
cash
during
project operations . It likewise indicates how the
ending cash
balance in
the Balance Sheet
was arrived
at.
The cash
budget is also used to predict or anticipate when
loans
will
need
to
be drawn
during an operating period
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to optimize the
timing
of project financing,
and
maximize
profitability by efficient cash utilization.
a. Cash receipts are classified into two: cash from project
financing and cash from sales revenues. Cash flows
from financing
may
take the form of stocks issued,
bond issues, and long-term loans.
b. Cash disbursements include payments for intangible
assets, fixed assets acquisitions and actual operating
expenses. Payments for credit purchases,
bank
loans
as well as cash purchases of inventories fall under
this
category. Cash dividends issued
and
income tax
payments are also
part
of cash disbursements.
The beginning cash balance for the period is then
added to the
net
cash flow to arrive
at
the ending cash
balance
in
the Balance Sheet.;
3.
The alance
heet
reflects the assets acquired by the project
and the corresponding liabilities it incurr ed and the owners
equity (net worth)_as of a specific date. Exhibit 2-3 presents
a model balance sheet.
a.
The Assets are
broken down
into
the
following:
current
assets, fixed assets, and intangible assets. Current assets
include cash accounts and other accounts expected to be
converted into cash within one year, such as marketable
securities, receivables,
and
inventories. Prepaid expenses
and
deferred charges are also classified under Current
Assets, except that, for accounting purposes, they will
be
adjusted
as an
expense within one
year.
An
example of
a prepaid expense
is
insurance premiums good for
one
year.
b. Fixed Assets are tangible assets of an enterprise,
the
service life
of
which usually extends to over one year.
Land, building,
machinery and
equipment are typical
example s of fixed assets.
30 How to Pr epare Project Feasibility Studies
c. Other Assets include the
organization s pre-operating
expenses and intangible assets suchas patents, copyrights,
leases, licenses and franchises. Intangible assets, like fixed
assets, have a service life of more
than
one year.
d.
Liabilities are
classified
into
current and
long-term
liabilities. Current liabilities are those
which
are expected
to be paid
for
within one
year.
Typical current liabilities include accounts payable
(for credit purchases of materials
and
supplies), short
term bank loans, taxes payable, and accrued expenses.
Accrued expenses refer to cost of services rendered but
have not yet been paid such as salaries payable, interest
payable, etc.
Long-term liabilities are expected to be paid over a
period
of
more
than
one
year. M ortgage
bonds
payable
and long-term notes payable are typical representatives
of
this
category.
e. Equities are asset claims due to owners of the firm. If
the firm is a corporation, the Equity is further
divided
into Capital Stock, Paid in capital
surplus, and
Retained
Earnings.
f
ownership
is
one individual or several
partners (single proprietor ship or partnership), the Equity
accoun t is simply stated as the name(s) of the proprietor
or
partners, followed
by
,
he
term capital
such
as De
la Cruz
and
Pedro Capital.
E.
FINANCIAL ANALYSIS
This aspect of the financial study evaluates the project s
profitability, liquidity, cash solvency, and growth over time.
I t should
be
noted that
the
functions
elaborated below
are
meaningful only
when
compared
with other functions of
the
same type computed
in one year
intervals. Charts and other
illustrative 9 eviceE>
m lv
be used to present the analysis more
effectively.
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1 Tests o
liquidity -
These financial measures are used to
determine a firm s ability to meet short-term obligations,
and
to remain solvent
during
hard times. They include:
a. Current ratio = Current assets
Current
liabilities
b.
Quick or
acid-test
ratio= Current
assets
-inventories
Current liabilities
c Liquidity of inventories=
Cost of
sales
Average inventory
d. Defensive
position=
Cash+
marketable securities+
receivables
Projected operating expenditure/number of days
2 Tests o debt service - These ratios are used to test the
project s ability to
meet
long-term obligations.
a Debt-to-net
worth
ratio = Total liabilities
Total equities
b. Total capitalization ratio= Long-term liabilities
Long- term liabilities
and
equities
3. Tests o profitability - These
show
the
operational
performance
and efficiency of
the
project.
a. Net profit
margin=
Net income after tax
Sales
b. Operating profit
margin=
Profit before interest and taxes
Sales
c Gross profit margin =Gross r o i t
Sa es
d. Return
on
financier s
investment= Net
income
Stock
equity
3 How to Prepare Project Feasibility Studies
e. Return
on
owner s investment= Net income
Stock
equity
f Return
on
common stock
equity
=
Net income-
preferred
stock dividends
Net
worth- par value of preferred stock
g. Return on
net
operating profit=
Profit before interest
and
taxes
Total tangible assets
h. Asset turnover = Sales
Total tangible assets
1. Return
on
assets,
or
earning power=
Net
income
Total tangible assets
4
Test
o
otal debt coverage = Profit before
interest
and taxes
(Interest+ principal payments)
1/1 -
income tax rate)
5
Funds flow analysis -
This technique is
used
to determine
the major uses and sources of funds within one year in a
project s life.
a. Cash-flow analysis:
1)
Source of funds:
a Net decrease in
an
asset
other than
cash
b.
Net
increase in a liability
c. Proceeds from
the
sale
of
stocks
d. Funds provided by operations
2) Uses of funds:
a Net increase in
an
asset other
than
cash and fixed
assets
b. Gross increase in fixed assets
c Net decrease in any liability
d. R etirement of stock
e. Cash dividends
Exhibit 2-4 prese nts a
model presentation
of
cash-flow
analysis.
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b. Working-capital flow analysis.
1) Sources
of
funds:
a. Net decrease in any asset other than current assets
b. Net increase in long-ter m liabilities
c. Proceeds from the sale of stock
d.
Funds provided
by operations
2 Uses
of
funds:
a.
Net increase in other assets
b. Gross increase in fixed assets
c. Net decrease in long-te rm liabilities
d. Retirement of stock
e.
Cash
dividends
Exhibit 2-4 presents the financial ratios for the financial
statements in Exhibits 2-1 to 2-3.
6.
Tests
o
operating leverage
-
these indicate
how
the project
uses its assets for which it pays a fixed cost.
Before these tests are
discussed,
t
is important to
differentiate fixed costs from variable costs.
Generally,
fixe
costs are
expenses
incurred
by
the
company irrespective of its production volume. These
are depreciation charges on machinery, equipment,
buildings,
and land
improvement; the amortization cost of
prepaid expenses, deferred charges,
and
intangible assets;
real estate taxes; insurance of fixed assets; general and
administrative salaries, wages and fringe benefits; research
and development; donations, office supplies; administrative
light
and
power;
and
borrowing costs.
On the other hand, variable costs increase or decrease
according to changes in production volume. These are the
costs of direct and indirect materials, direct labor,
power
requirements of
production
machinery, maintenance of
factory machinery, supplies for manufacturing, etc.
4 How
to Prepare Project Feasibility Studies
a. Break-even volume analysis
BEV = Fixed costs
Sellmg pnce - vanable cost/umt
b. Break-even cash analysis
BEC = Cash fixed costs
Sellmg
pnce-
cash vanable cost/umt
c. Break-even selling price analysis
BESP =Variable costs+ fixed costs
Omtvolume
=Total cost x Selling price
Sales
d. Break-even sales analysis
BES
= BESP x
unit
volume
Fixed cost
= 1- Variable cost/
net
sales)
7.
Tests of inancial
leverage
- These ratios present
ho
w a project
employs funds
which
pay a fixed return.
a. Earnings per share =
Net
income
Shares
Dividends per
share=
Net income-preferred stock
dividends-retained earnings
Common share
8
Tests
of
capital
investment .-
~ h s
f i n ~ c i l
tools evaluate
the justification for
in
vestmg m the proJeCt.
a. Average rate of return= Average net income
Average net mvestment
b. Payback period in years =
Initial
fear
cash outflow
c. Capital recovery or
cash
pay off
period
in years) =
Stocks
Annual cash dividends
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F. DECISION CRITERIA
After revie
wing
all three financial statements, the Income
statement, the Ca sh Flow Statement, and
the
Balance Sheet,
the
prospective investor must now decide if the project is feasible
or not.
If he
project s Cash Flow Statement shows positive cash
flows, this is a good indicator that the project is acceptable.
However, the
smart
investors
would want
to compute a
project s Payback Period, Net
Present
Value, Inte rnal Rate
of
Return, and Cost-Benefit Analysis before they finally decide
to go on with
the
project or not.
a Payback Period
The Payback Period
is
a capital-budgeting decision criterion
that is defined as the number of years
required
to recover the
initial cash investment. It generally measures
how
quickly
the
project will
return one s investments
.
The
investor will
go ahead
with
the project I
it
will return investment
on or
before the required payback period. The time period required
by the
investor is
based on
the
industry s
performance.
b et Present Value
The
Net
Present Value (NPV) criterion is a decision tool
which is most favored
in
business. There are three reasons
why the
NPV is widely
used in
almost all industries:
t
deals with cash flows and not accounting profits
t considers the time value of
money
and allows
comparison of the
benefits and costs in a logical
manner
It uses a
hurdle
rate
that
is acceptable to the investor
and would increase the
value of
the firm if
NPV were
positive.
36
How to Prepare Project Feasibility Studies
The
Net
Present Value
can be
expressed
as
follows:
Where:
ACF =
t
k
1
n
JV PY= i ACE - / {
t=l 1
k)
the annual after-tax cash flow in time period t
hurdle
rate; discount rate; required rate of return
of the investor
initial outlay (initial cash outlay necessary to
purchase assets to
put
the business into an
operating manner)
the project s expected life
Initial Outlay includes the after-tax cash flows such as:
Cost of purchase
of
the asset plus the shipping/
transportation
and installation expenses
Working capital
requirements
(normally equal to
one or
two
months of cash outflow from operations
which includes additional inventory, cash
on
hand,
and overhead expenses)
In a decision to replace an old asset,
the
after-tax cash
flows associated with
the
sale
of
the old asset
The project s
net
present value is
an
indicator of the net
value (the difference of the summation
of
the present value
of
the cash flows
and
the initial outlay)
of an
investment
proposal in
terms
of today s
peso
.
Whenever
the
NPV
is
greater than or equal to zero,
the
project should be accepted;
and rejected, if the NPV is negative.
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Steps to compute NPV manually:
1. Determi ne the after-tax cash flows
of
the project.
2. Determine
the
hurdle rate or
the
discount rate acceptable
to the investor.
3. Multiply the after-tax cash flows with the present value
factor at the given
hurdle
rate.
4.
Get
the product for each year and
the
sum of
the present
value of cash flows.
5.
The
amount of
the
initial outlay is then deducted from
the sum of the present value of cash flows.
c. Benefit
I
Cost Analysis (Profitability Index)
The
Benefit I
Cost
Analysis or
the
Profitability Index (PI)
is a tool for measuring the ratio
of the
present value
of
the
future cash flows to its initial cost. Using this tool will allow
the investor to accept the project if the ratio is greater than
or
equal
to
one
and
reject if
the index
is
zero
or
less
than
one.
It can be expressed
as:
Where:
ACF
=
t
k
1
n
fACE;
P /=
t=
l
1
k)
/0
the annual
after-tax cash flow
in
time
period
t
the discount
rate I
required
rate of return
the initial outlay
the
project s expected life
In most cases,
when net
present value results in
an accept
decision net cash flow is greater
than
its initial cash outlay.
This
would
also
be
the decision given
by
the benefit/cost
analysis, as the
value of
the numerator (present value
of
net
cash flows) is
greater
than its denominator (initial outlay).
38
How to Prepare Project Feasibility Studies
d. Internal Rate of Return
The Internal
Rate of Return (IRR)
is
the fourth decision
criterion used in determining the viability of a project. This
process of measurement attempts to answer the question:
What rate of return does this project earn? Given the internal
rate of return
of
a project based
on
the computation, the
investor can immediately compare his required
rate
of
return, which
is
normally based on the current market
standards, and decide whether it is beneficial to
pursue
the project or not. Normally,
an
investor
would
accept the
projectonly i he internal rate of return is equal to or greater
than
his requir
ed
rate
of
return.
Mathematically,
the internal
rate
of
return is defined as
the
value of IRR in
the equation
below:
Where:
ACF =
t
IO
n
IRR
O=f
ACE;
t=l
( 1 + / ~
the annual after-tax cash flow in time period t
the initial cash outlay
the
project s expected life
the project s in ternal rate of return
The challenge in this equation is to find the rate of return
or
the discount rate that will equate the present value of
the
project s
future net
cash flows
with
the
project
s
initial
cash outlay. Solving for IRR is
quite easy using
a financial
calculator or spreadsheet.
In
any case, the IRR can be
computed manually as follows:
1 Assign
an
arbitrary rate (make
an
assumption for the
discount rate)
2. Use the arbitrary rate to discount the after-tax cash
flows
of the
project
to
present value
3.
Get the sum
of
all the present values
of the future
cash
flows
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4.
If
the sum of the
present
values of the future cash flows
is equal to the initial outlay, then the arbitrary rate is
the IRR;
5 Otherwise, the analyst must assign another arbitrary
rate,
and then repeat steps
2-4
until equal
values are
computed.
Exhibit 3 shows the application of internal rate of return to
the case model: Casa Fernandina.
G. OTHER APPROACHES IN EVALUATING PROJECT RISKS
Simulation
Simulation is the process of evaluating the perf ormance of the
project in different scenarios. This is sometimes called scenario
analysis , which identifies
the
range of possible outcomes
under
the worst, best,
and
most likely case. In simulation, one
randomly
selects
and
combines all
the
values from the different
factors that affect the NPV and IRR of the project such as the
following:
Market size
Selling price
Fixed costs
Market growth rate
Investment required
Residual value
of
investment
Share of
market
Operating
costs
Usefu l life of facilities
Sensitivity nalysis
Sensitivity analysis
is
similar
to
simulation
in
determining
how
the
distributi on of possiblenet present values and internal rates
of return for a particular project
is
affected by a change in
one
partic ular variable from the factors listed above.
t
is the most
40
How
to Prepar e Project Feasibility Stud ies
commonlyused process of evaluation other than the net present
value, internal rate of return, payback period, and benefit/
cost analysis. This analysis requires changing one variable
while holding all other variables constant. The distribution of
possible net present values
and
internal rates of return that is
generated
is then compared with the distribution of possible
returns
generated
before the change was
made.
For some, this
analysis is also called the What if? analysis. See Exhibit 4 for
an
example ofa Break-even
and
Sensitivity Analysis as
appli
ed
to the financial condition
of
the case model, Casa Fernandina.
Probability Tree
The probability tree is a graphic illustration of the sequence
of possible outcomes.
t
presents the decision maker with a
schematic representation
of
the problem in which all possible
outcomes are account ed for. The computations and results of
the
computations
are shown directly
on
the tree, giving a clear
picture
of
the different scenarios.
H. WITH OR WITHOUT A PROJECT ANALYSIS
The With
or
Without a Project analysis (WP and WOP) is
used
to compare
two scenarios,
one
in
which
a project
is
initiated
with
another
where no project is undertaken. The technique
can be used for the following:
A new project
Rehabilitation Modernization project
Loss
prevention
project
Improvement rehabilitation project
In a new project scenario the investor is not involved in any
business and this is the first time that he or she
would
be
putting money in a project. Therefore, the investor will receive
an
additional benefit, given that the project
has
been assessed
to
be
acceptable
using
the decision criteria. Figure 4 illustrates
this scenario:
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Figure 4:
New
Project No Other Activities)
PROJECT
BENEFITS
PROFITS
+
Project
Cost
2
Additional Benefit
3
4
Year
WP
WOP
5
In
a Rehabilitation/Modernization project
scenario an
existing
business
is doing well except that, to keep up with
competition, it has to undertake some modernization and/or
rehabilitation.
Normally,
the business
is
doing
well
but
with competition
the
growth
of the business is hampered.
This then calls for
some
modernization to st y competitive or even ahead of
the
competitors.
The
rehabilitation modernization project is best
illustrated in Figure 5
PROJECT
BENEFITS
PROFITS
Project
Cost
Figure 5: Rehabilitation
Project
Additional Benefit
Foregone Benefit
l
2
3
4
Year
42
How
to Prepare Project Feasibility Studies
WP
WOP
5
In
the
case of a Loss Prevent ion Project scenario, a particular
business
may
be
suffering losses
over
a period of time
due to
an econom ic crisis and other factors. Its owners may consider
looking for projects to prevent
further
losses and possiblyhelp
recover past losses. See Figure 6
PROJECT
BENEFITS
PROFITS
Project
Cost
+
Figure 6: Loss Prevention Project
Additional Benefit
- ~ ~ ~ ~ ~ ~ ~ ~ ~ r r r r n n n n ~ m o m m W P
WOP
2
3
4 5
Year
Finally,
an Improvement
Project scenario exists when a firm that
has been experiencing poor
business
initiates a project
that
will
help
improve the performance
of the
ailing company, and where foregoing
such
a project will
mean
certain
bankruptcy
for
the
business.
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PROJECT
BENEFITS/
PROFITS
Project
Cost
Figure 7:
Improvement
Project
Additional Benefit
WP
Foregone Benefit
WOP
SUGGESTED FORMAT FOR A FINANCIAL STUDY REPORT
I.
Presentation of Major Assumptions
II. Summary of Project Cost
III. Sources of Financing the Project
IV. Financial Statements
V. Financial Analysis
VI.
Decision Criterion (Computation of Net Present Value,
Payback Period,
Internal rate of
Return, Benefit-Cost
Analysis)
VII. Sensitivity Analysis
VIII. Analysis of With and Without a Project
How to Prep are Project Feasibility Studies
SAMPLE FINANCIAL STATEMENT
HOTEL CASE: CASA FERNANDINA
A.
Key Assumptions:
1. Sales Forecast:
a.
Hotel-
based
on
seasonality (annual
hotel
occupancy
rates)
illustrated
in
the marketing plan
. Room rates
increase every
two
years by
10
percent.
b. Coffee Shop-based
on
seasonality
and
seating capacity
(15 pax)
2. Cost
of Goods
Sold and Operating Expenses to increase
every year
by
3 to 4 percent
based
on inflation.
3.
Cost of Goods Sold
a. Free Breakfast for guests based on seasonality (annual
occupancy rates)
b. Materials projected at 36
percent
on
average of
sales
revenue
of
the coffee
shop
4. Operating Expenses
a.
Salaries and Wages- based on human resource plan
b. Depreciation:
Building s useful life - 15 years
Equipment s useful life - 5 years
Landscaping and interior design - 5 years
c. Promotional
materials-
based
on
marketing
plan
d. Rent Expense- refers
to
the rent of the 2,500 square meter
lot currently being occupied by the antique shop,
and
where Casa Fernandina will
be
erected.
e. Utilities - includes air
conditioners,
lights, other
electricity, water, and
phone
charges
5. Other
Income-
refers
to
use of function room
50
pax) and
rent from concessionaire
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Exhibi t 2 1
Casa Fernandina Pro-forma Income Statement
for
the
Year
Ended
December 31,
2004
Year1
Year2 Year3
Year4
Sales Revenue
Hotel
1,920,000.00
2,028,000.00
3,030,000.00
3,030,000.00
Coffee Shop
889
,
560.00
889,560.
00
1,
317
,501.90 1,317,501.90
Total Sales Revenue
2,809,560.00
2,917,560.00
4,347,501.90 4,347,501.90
Cost o Goods Sold
Free Breakfast
85,536.00
91,368.
00
112,752.00
112,752.
00
Pastries, etc 241 ,069
50
321.426.00
467,283.96
386,717
76
Total Cost of Goods
Sold
406,962.00 412,794.00 580,035.96
580,035.96
Gross Revenue
2.402,598.00
2,504
,
766
.00 3,767,465.
94
3,767,465.94
Operating Expenses
Salaries & Wages
1,568,486.85
1,615,54146
1,777,095
60
1
,830
,408.47
Depreciation
321,472.69
321,472.69 321,472.69
321.472.69
Promotional Materials
17,600.00 18,128.00
18,671 .84
19,232.0
0
Rent
Expenses 139,392.00 143,573.76
147,880.97
152,317.40
Utilities
ir
con 176
,000.
00
195,520.00 250,931.20
260,968.45
Lights 22,000.00 24,440.00 31 ,366.40 32,621.06
Water
165,000.00 183,30000
235,248.00 244,657.92
Other Electricity
16,500.00 18,330.00
23,524.80 24,465.79
Phone
43,200.00 47,520.00
47,520.00
52,272.00
Office Supplies 27,500.00 30,550
.00 39,208.00
40,776.32
Housing Supplies 53,240.00 59,144.80 75,906.69
78,942.96
Total Operating
Expenses
2,550,391.54 2,657,520.71
2,968,826.19 3,058,135.05
Operating Income 147,793.54) 152,754 71)
798,639.75 709,330.89
Other Income
Function
Room
314,000.00 314,000.00
314,000
.0
0 578,000.00
Rent from
Concessionaire
240,000.00
240,000.00
240,000.00
300,000.00
Gross Income 406,206.46 401,245 29 1,352,639 75
1,587,330.89
Tax Expense 150,424.
75 144,699
.65 432,
844 72
507,945.89
Net Income
255,781.71 256,545.64 919,795.03
1,
079,385.01
6
How
to Prepa re Project Feasibility Studies
YearS
4,0