How to Develop Project Feasibility Studies

8/9/2019 How to Develop Project Feasibility Studies

1/56

How to

evelop

Project

Feasjbility

StUdieS

Revised dition


2/56

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


3/56

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


4/56

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


5/56

How

to

Prepare

Project easibility Studies


6/56

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

1


7/56

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

3


8/56

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?

Project Summary 5


9/56

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

7


10/56

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.

Market Study

9


11/56

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.

Market Study

11


12/56

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)

Market Study 13


13/56

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


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.

Technical

Study

15


14/56

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


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

tudy 17


15/56

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

Technical Study 9


16/56

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.


17/56

r

r

~ --

r r

DODD

How


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

3


18/56

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


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

Financial Study 25


19/56

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

Financial Study 27


20/56

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

Financial Study

29


21/56

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.

Financial Study

31


22/56

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


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


1. Return

on

assets,

or

earning power=

Net

income


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.

FinancialStudy 33


23/56

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


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

Finan

ci

al Study 35


24/56

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.

Financial Study

7


25/56

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

Financial Study 39


26/56

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:

Financial Study 41


27/56

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


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.

Financial Study 4


28/56

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

Financial Study

5


29/56

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

Documents

How to Develop Project Feasibility Studies