UNIT- 4

PROJECT PREPARATION

An Overview
 After having identified a project that prima-facie (feasible)
appears to be a worthwhile (viable) project,
 the project promoter has to further analyze the project to ensure
that it has the potential and the investment on it would not go
waste, but would yield attractive returns.
 Project formulation/preparation consists of four stages viz,
 Pre-feasibility study
 Functional studies (or support studies)
 Feasibility study
 Project report
Pre-feasibility study
 A pre-feasibility study has be following main
objectives.
To determine whether the project offers a promising
investment opportunity.
To determine whether they are any aspects of the
project that are critical requiring in-depth investigation
by way of market surveys, laboratory test, pilot plant
test etc.
 The preliminary feasibility study should examine the following
contents.
 The market potential for the selected product/services, the
competitors in the field and their market share, the market
forecast, the trading practices in the industry in terms of pricing,
credit, distribution, govt. controls etc.
 The technologies available and the technology suitable for the
project, the manufacturing facilities required in terms of plant and
machinery.
 The availability, cost and sources of raw materials.
 The plant location.
 The plant capacity.
 The man power requirement in terms of labor, staff and
management personnel, their availability and cost.
 The investment required, the return on investment expected, the
means of financing the project, the cost of production and
commercial profitability.
 Pre-feasibility study usually arrives at major
parameters like location of project, production
capacity, raw material and other inputs etc.
 It also provides rough estimates of project cost,
means of financing, cost of production, sales
revenue, financial profitability, social benefits etc.
 If the pre-feasibility study indicates that the project is
a worthwhile proposition, a feasibility study is taken
up.
 If the pre-feasibility indicates certain areas of project
that need a detailed study, such studies are taken up
before taking up feasibility study.
 Such studies are also known as support studies or
functional studies.
Functional studies (or support studies)
 Support studies may be conducted in any of the
following areas.
Market study
Raw material/input study
Project location study
Plant size study
Equipment selection study etc.
 MARKET AND DEMAND ANALYSIS:
 Market analysis is a process of assessing the level of
demand for the product or service to be produced from
the project.
 Pre-feasibility study might arrive at a conclusion that
the success of the venture depends upon successfully
marketing the product in view of the stiff competition
prevailing.
 In such a case, the need for a detailed market study
arises.
 If the detailed market study reveals that marketing the
proposed product successfully would be a difficult
proposition, there is no point in taking up feasibility
study and the project can be better shelved.
Cont’d…………….
 The study of market and demand analysis, being the first
in project preparation, has the following main
objectives:
 To systematically assess the market and the market
environment to generate pertinent data.
 To collect, analyze, and report data about a specific
market situation
 To obtain insight about the target market structure
 To identify customers needs and behavior in the market.
 To design the marketing mix fit in the context
 To identify available distribution channels
 To identify competitors and their characteristics in the
Cont’d……………
 To determine the socio-economic aspects relevant
to the preparation and evaluation of the project’s
market strategy
 To identify the existing strengths and weaknesses in
the internal environment of the firm
 To project the level of demand expected
 To delineate marketing opportunities and threats
 To decide on subsequent aspects of a project
 To develop sales program of the firm.
 Raw material/input study:
 The need for a raw material study might arise
when there are many different raw materials
available for producing the same product and
whose cost of procurement, cost of
transportation, continuous availability, quality
etc., vary widely.
 Project location study:
 This study might look into aspects like
nearness of raw material source,
nearness of market for the finished products,
cost of transportation of raw material/finished
products,
nearness to air ports/sea ports,
availability of labor etc.
 Plant size study
 This study is undertaken when there are several
technologies available, each with a different
economic plant size.
 The study should also take into account the cost
of production with each technology, the extent of
market that is available for the finished product
etc.
 Equipment selection study:
 This study is undertaken when the sources of
supply of equipments and the costs vary very
much.
 The capital cost of the equipment, the operational
costs, the after-sales supports, the operational
efficiency of the plant etc., are some of the factors
that are studies under this study.
Feasibility study
 Before making a final decision to take up a
project, the technical, managerial, financial,
economic, commercial, ecological, safety, cultural
and political justification of the chosen project
shall be ascertained in concrete terms.
 Technical feasibility:
 Feasibility study of the technical and engineering aspects of a
project needs to be done continuously when a project is
formulated.
 Technical feasibility study seeks to determine whether the
prerequisites for the successful commissioning of the project
have been considered and reasonably good choices have been
made with respect to location, size, process, etc.
 The important questions raised in technical feasibility study
are:
 Whether the supportive or functional studies have been done
or provided for?
 Whether the availability of raw materials, power, and other
inputs has been established? (yes, from support studies)
 Whether the selected scale of operation is optimal? (no, from
 Whether the production process chosen is suitable? (no,
from the support studies)
 Whether the equipment and machines chosen are
appropriate? (yes, from support studies)
 Whether the auxiliary equipments and supplementary
engineering works have been provided for?
 Whether provision has been made for the treatment of
effluents?
 Whether work schedules have been realistically drawn
up?
 Whether the technology proposed to be employed is
appropriate from the social point of view?
Note: Answers for the above questions may give some from
the supportive studies and for other questions should be
answered through this technical feasibility study).
 Managerial feasibility:
 Managerial feasibility involves the capability of the
infrastructure of a process to achieve and sustain process
improvement.
 Management support, employee involvement, and commitment
are key elements required to ascertain managerial feasibility.
 Managerial feasibility include assessment of availability of:
 Sound internal organizational structure of the project,(line of
authority and decision making)
 Competent management and supervisory personnel,
 Adequate technical and skilled personnel,
 Provision of any necessary training facilities,
 Effective channels of communication and good relationships
with contributory agencies, e.g., national research
organizations.
 Financial feasibility(Financial Cost-Benefit
Analysis):
 Financial feasibility involves the capability of the
project organization to raise the appropriate funds
needed to implement the proposed project.
 Loan availability, credit worthiness, equity, and
loan schedule are important aspects of financial
feasibility analysis.
 It seeks to ascertain whether the proposed project
will be financially viable in the sense of being able
to meet the burden of servicing debt and whether
the proposed project will satisfy the return
expectations of those who provided the capital.
 The aspects which have to looked into while making
financial feasibility are:
 Investment outlay and cost of project
Means of financing
Cost of capital
Project profitability
Break – even point
Cash flows of the project
Investment worthwhileness judged in terms of various criteria of merit.
Projected financial position.
Level of risk
 The primary purpose of doing a financial analysis of a project is to
evaluate the project’s profitability or cost-effectiveness relative to
Cont’d…………
This is analyzed using various ratios and capital budgeting
techniques like Net Present Value (NPV), Pay Back Period
(PBP), Internal Rate of Return (IRR), etc.
I. PAYBACK PERIOD METHOD: Payback period is the
easiest method to assess financial feasibility. It is the time
period in which the investor gets back his/her invested
money in fixed assets from the project.
When deciding between two or more competing projects the
usual decision is to accept the one with the shortest payback.
The decision rules are: If payback < acceptable time limit,
accept project. If payback > acceptable time limit, reject
project
Cont’d………..
II. NET PRESENT VALUE METHOD (NPV):
It is the most widely accepted criterion for selecting between
projects.
 It is defined as the difference between the present value of cash
inflows and the present value of cash outflows.
It is the method of evaluating projects that recognizes that the
Birr received immediately is preferable to a Birr received at some
future date.
 It is the sum of all of the discounted net benefits (benefits
minus costs) associated with a project(.
It discounts the cash flows to take into account the time value of
money.
NPV = Present value of cash inflows – Present value of cash outflows
If the NPV is positive, the project will be accepted; if negative, it
should be rejected.
Cont’d…………..
III. INTERNAL RATE OF RETURN METHOD (IRR):
The IRR is the estimated rate of return for a proposed
project, given its incremental cash flows. OR the discount
rate that makes the present value of a project’s cash flows
equals its initial investment. OR The IRR is the discount rate
that makes the NPV equal to zero.
The criterion for project acceptability is that IRR > ARR.
The IRR assumes that all of the profits (net revenues after
accounting for costs) from a project should be counted as a
return to the capital used in the project.
Cont’d…………
IV. PROFITABILITY INDEX:
Profitability index (PI), also known as profit
investment ratio (PIR) and value investment ratio
(VIR), is the ratio of payoff to investment of a
proposed project.
 It is a useful tool for ranking projects because it
allows you to quantify the amount of value
created per unit of investment.
 Profitability index is an investment appraisal
technique calculated by dividing the present
value of future cash flows of a project by the
initial investment required for the project.
Cont’d……….
Cont’d………….
 The various steps involved in financial analysis are:
Estimation of cost of project: The cost of project includes all costs
incurred before commissioning of commercial production
(manufacturing projects) or operations (service projects).
Estimation of project cash flows: This estimate involves all the project
cash flows during the life cycle of the project. It includes the initial
investments, cash flows generated during operations, and at the
termination of a project
 Estimation of expected rate of return: After careful evaluation,
design optimum capital structure for the firm. The expected return
from the project includes two components, risk free component
(weighted average cost of capital) and risk component (risk premium
due to the investments).
Application of decision rule: The last stage of financial analysis is to
apply various tools for checking the financial feasibility of a project.
Capital budgeting techniques are applied to ascertain profitability
and expected returns from the project.
 Economic feasibility:
 In simple terms, economic viability is a cursory
examination as to whether the investment made
on the project will give a satisfactory return to the
economy.
 The major aspects to be looked into are as to:
whether the project will make better use of available
raw material,
whether the project will reduce/eliminate the use
some scarce/valuable resources,
whether the community as a whole will stand to gain
as a result of the project etc.
 Commercial feasibility:
 Before embarking upon any product/service, the
scope for successfully marketing the
product/service shall be carefully and accurately
assessed.
 If the product/service proposed in new to the
industry, conducting a systematic market survey is
a pre-requisite for assessing the probable
estimates of likely sales.
 The likely sales estimated shall be well above the
proposed plant capacity in order to overcome
pitfalls if any that may remain unnoticed in the
estimates made.
 Ecological feasibility:
 It should be done particularly for major projects
which have significant ecological implications (like
power plants and irrigation schemes, and
environment polluting industries (like bulk drugs,
chemical and leather processing).
 The key questions raised in this feasibility are:
 What is the likely damage caused by the project to
the environment?
 What is the cost of restoration measures required
to ensure that the damage to the environment is
contained within acceptable limits?
 Safety feasibility:
 Safety feasibility refers to an analysis of whether
the project is capable of being implemented and
operated safely with minimum adverse effects on
the environment.
 Cultural feasibility:
 Cultural feasibility deals with the compatibility of
the proposed project with the cultural setup of
the project environment.
 In labor – intensive projects, planned functions
must be integrated with the local cultural
practices and beliefs.
 For example, religious beliefs may influence what
an individual is willing to do or not do.
 Political feasibility:
 It requires an evaluation of the compatibility of
project goals with the prevailing goals of the
political system.
Project Report
 The main idea of preparation of the project report
is to formally communicate the project promoter's
decision of venturing a new project to financial
institutions/funding agency/NGOs/Govt. for their
perusal and for getting their approvals.
 Contents of project report
 General information about the project (Name, justification &
purpose, beneficiaries, impacts, support, output of the project)
 Background and experience of the project promoters
 Details and working results of industrial concerns already
owned/promoted by the project promoters
 Details of the proposed project:
 Plant capacity
 Manufacturing process
 Technical know-how/tie-up
 Management team for the project
 Details of land, building and plant and machinery
 Details of infrastructural facilities (water, power, transport)
 Raw material requirement/availability
 Effluents produced by the project/effluent treatment arrangements
 Labor requirements/availability
 Schedule of implementation of the project
 Project cost
 Means of financing the project
 Working capital requirements/arrangements
made
 Marketing and selling arrangements
 Profitability and cash-flow estimates
 Mode of repayment of term loan
 Government approvals, local body consents and
other statutory permissions
 Details of collateral security that can be offered to
the financial institution
QUIZE (5%)
1.List all general cycle or stages of a project…2%
2. List all stages of formulations by its own……2%
3. What mean by a) ecological feasibility?
b) technical feasibility?
discuss them briefly