Chapter 4

Technical Analysis
Technical Analysis
1. Manufacturing process/technology
Choice of technology depends on:
 plant capacity
 principal inputs
 investment and production cost
 use by others-proven successful
 product mix
 latest developments
 Ease of absorption
The selected technology should be evaluated based on whether it:
 utilizes local raw materials and man power
 produces goods/services that cater to basic needs
 protects ecological balance
 harmonous with social & cultural conditions
2. Technical arrangements
-arrangements need to be made to acquire the technical know how for the manufacturing
process
-considerations should be given to the following aspects:
• nature of support to be provided by collaborators
• process and performance guarantees
• price of technology-one time price & royality
• benefits from R & D work of the collaborator
• period of agreement
3. Material inputs and utilities
 define materials and utilities needed
 specify their properties
 set up supply program
Types
I. Raw materials
II. processed industrial materials & components
III. auxiliary materials & factory supplies
IV. utilities
I. Raw materials
 Agricultural products
• quality
• quantities available
• present area under cultivation
• likely change in yield per hectar
 Mineral products
• quantity of exploitable deposit
• properties of the raw materials
 Livestock and forest products
• livestock population and possible future trends
• quantity of forest and future levels
 Marine products
• pottential availability
• cost of collection
II. Processed industrial materials & components
 properties and total required for the project
 quantity available from domestic/foreign sources
 dependability of supplies
 trends and prospects of price
III. auxiliary materials & factory supplies
 include factory supplies such as chemicals, additives, packaging materials, paint,
varnishes, oil , etc
IV. utilities
 include power, water, fuel etc
 Concerns include
  quantity available
 Source of supply
 Potential availability
 Likely shortages and measures to be taken
4. Product mix
 choice of product mix is determined by market requirement
 involves size and quality differences aimed at satisfying demands of different
category of customers
 enhances flexibility when market conditions change
5. Plant capacity
 the volume of goods that can be produced during a particular period.
 Feasible normal capacity Vs nominal Maximum capacity
 Feasible normal capacity is determined by considering:
 Technological requirement: the minimum amount of units the technology requires
 Input constraint: unavailability of RM in the desired quanitity, power shortage, lack of
foreign currency to import materials
 Investment cost: the relation between cost and capacity should be considered
 Market conditions: higher capacity if strong market is anticipated, lower capacity if
market is uncertain
 Resources of the firm: financial and managerial capacity of the firm
 Governement policy: anti-trust law
6. Location and site
Determinants of location selection
 Proximity to raw materials and markets
The rule is minimizing RM and Finished good transportation cost.
(a) Resource-based projects-close to where the resource is situated
(b) Imported material dependent projects- near the port
(c) Manufacturing perishable goods-near the market
 Availability of infrastructure
- power supply, transportation, water and communication
  Labor situation
- availability
- prevailing labor rate
- labor productivity
- state of industrial realtions (strikes and lockouts)
- degree of unionization
 Government policies
-for public projects based on regional dispersion
-for private projects governemts may offer incentives or impose restrictions
 Other factors
 climatic conditions
 general living conditions
 proximity to ancillary units
 ease in coping with pollution
 Site selection
- Consideration need to be given to cost of land, cost of site development and cost involved
in obtaining utility connection
7. Machineries and equipment
- Depends on plant capacity and production technology.
STEPS
(a) Level of production over time
(b) Number of machining operations
(c) Amount of machine hours required for each operation
(d) Select machineries and equipments required for each operation
8. Structures and civil works
 Site preparation and development
- Grading and leveling of land
- Demolition and removal of unwanted structures
- Relocation of existing pipelines,cables, roads,power lines
- Connection to utilities
  Buildings and structures
 Factory or process buildings
 Ancillery buildings(store, warehouse, laboratory, utilities supply,maintenance
services)
 Administrative buildings
 Staff welfare buildings(cafeteria & medical service buildings)
 Residential buildings
 Outdoor serevices
 Supply and distribution utilities
 Handling and treatment of emission,wastage, and effluents
 Transportation and traffic signals
 Outdoor lighting
 Landscaping
 Enclosure and supervision(boundary wall,fencing,gates,doors security posts...)
9. Environmental aspects
 a project may cause various environmental pollutions
 Gasious emissions
 Liquid and solid discharges
 Noise
 Heat
 Vibration
9. Environmental aspects
 Considerations
 Types of effluents and emmissions generated
 Ways of disposing effluents and treatment of emissions
 Ensuring that the project will meet all environmental clearances and
comply with statutory requirements
 Chapter 5
Land and site development
 cost of land lease including conveyance and other charges
 cost of levelling and development
 cost of laying approach roads and internal roads
 cost of gates
 cost of tube wells
Building and civil works
 building for main plant and equipment
 buildings for auxiliary services
 residential buildings
 garages
 sewers, drainage etc
Plant and machinery
 Cost of imported machinery =FOB+shipping+ frieght+insurance +import
duty+loading/unloading
 cost of locally purchased machinery =FOT+sales tax+ frieght
 Cost of stores and spares
 Foundation and installation charges
Technical know-how and engineering fees
 Consultants fees for advise in choice of technology,selection of plant and machinery,
structures and civil works, detailed engineering etc
 Cost for obtaining technical know-how is part of initial cost while annual royalities
are part of operating expenses
Expense on foreign technicians and training of local technicians abroad
 fee for services of foreign technicians including transportation, lodging, salaries and
allowances etc
 cost of training local technicians abroad including transportation, lodging, tuition fees
and etc

Miscellaneous fixed assets

  are not part of direct manufacturing process
 include furnitures, office machinery and equipments, tools, vehicles, transformers,
laboratory equipments etc
Preliminary and capital issue expense
 cost of project identification,market survey, preparation of feasibility report etc
 cost of raising capital such as underwriting expenses, brokerage fees,legal fees etc
Pre-operative expense
 expenses incurred before commencement of commercial production
 includes rents, interest on debt,insurance charges, mortgage expenses, start-up
expenses etc
Margin money and working capital
 money set aside for initial working capital investment
 working capital financing can be obtained from financial institutions once a project
starts operation
Initial cash losses
 provision for losses of a project during early years
5.2 Means of finance
 equity capital
 debt capital
 incentives by governments
Considerations:
 Norms of regulatory bodies and financial institutions
 Business considerations including
- Cost - Risk
- Control - Flexibility
5.3 Estimates of sales & production, Considerations
 do not assume high capacity utilization level in the first year
 a reasonable assumption would be
- 1st yr ............................40-50%
- 2nd yr........................... 50-80%
-3rd yr & onwards......... 80-90%
  selling price should be net of exise tax
 adjustments for stocks may not be necessary if net increase(decrease) is
insignificant.
 selling price may be present selling price, and increase in price will be matched by
increased production cost
5.4 Cost of production
 Material cost
 Labor cost
 Factory overhead cost
Material cost
- include cost of raw materials,
chemicals,components, and etc
Determining material cost
(1) Determine material consumption rate per unit of output
(2) Total requirment= per unit rqt x annual output
(3) Determine price in CIF terms. Present cost considered
(4) Seasonal fluctuation should be considered
Utilities cost
 detemine amount of usage by the help of consultants and use present rates
Labor cost
 classify labor into groups
 differentiate between piecerate earners
 determine allowances and other benefits
Factory overhead cost
 repairs and maintenance
 rents
 taxes
 insurance on factory assets

5.5 Working capital requirement

Considerations
1. WC requirement includes:
 RM and components
 Inventory of goods-in-process
 inventory of finished goods
 accounts recievable
 inventory of materials and supplies
2. Sources of WC financing:
 WC advances by commercial banks
 Trade credit
 accruals
 long-term financing
3. Net WC = CA-CL
5.6 Profitability projections
 Revenue from sales
 Main product
 By-product
 Costs and Expenses
 Production costs
 Distribution costs
 Administrative expenses
attention should be paid to the following I/S figures:
1. Gross profit
2. General and administrative expenses
3. Profit before tax
4. Profit after tax
5. Dividend and Retained Profit

5.7 Projected cash flow statement

Why a cash flow statement?
 Cash is what ultimately counts
 Profit measurement is subjective
 Cash is used to pay dividends
Sources and uses of cash flow
1. Operating activities
2. Financing activities
3. Investing Activities
Formulating the CFS
I. Adjust net income to determine Cash flow from Operation
=NI+Depreciation+Amortization
II. Identifiy Cash flow from Financing and Investing Activities
5.8 Project analytical tools
Investment criterias
1. Pay Back Period
2. Net Present Value (NPV)
3. Internal Rate of Return (IRR)
 Chapter 6
Sources, measures and perspectives on risk
Sources of Risk
 Project specific risk-estimation error or poor management
 Competitive risk-adverse effect on project cash flows driven by unanticipated
action by competitors
 industry-specific risk-unexpected technological or regulatory changes adversly
affecting project cash flows
 Market risk-unanticipated changes in macroeconomic variables like inflation,
interest rate, GDP, foreign exchange rate having impact across projects.
 International risk- changes in cash flows due to exchange rate movements and
political risk
 Measures of Risk
 Standard deviation – measures variability of values from the mean. The higher the
standard deviation the higher the risk.
 Coefficient of variation– the ratio of standard deviation to the mean( expected value)
6.2 Methods of Risk Analysis
1. Sensitivity analysis
 invloves analysis of change in NPV when certain variables change( like sales,
investment cost, cost of capital etc)
 only the effect of change in one variable at a time is analyzed
2. Break-even analysis
 the level at which no profit or loss is made
 Accounting break even is where Sales = VC+FC and BE sales = FC/Contribution
margin ratio
 Financial break even is where PV of cash flows=Initial investment
Example
 Suppose a project with initial investment of Br 500mill has the following information
on sales and cost structure:
Sales Br 800 mill
Variable costs 200 mill
Fixed costs (including depreciation) 400 mill
Net cash flow 200 mill
Assume also that funds are raised at a cost of capital of 10%.
Accounting BE sales
= Br 400mill/ 0.75
= Br 533 mill
Financial BE sales
CF is 25% of sales (Br 200mill/800mill)
PV of CF = 0.25 x PV of annuity factor @10% and
n=10 (6.14)
= 1.54 sales
1.54sales = Br 500mill
Sales = Br 324.6mill
3. Decision Tree Analysis
 is a tool for analyzing situations where sequential decision making in face of risk is
involved.
STEPS
1. Identifying the problem and alternatives
2. Delineating(draw) the decision tree
3. Specifying probabilities and monetary outcomes
4. Evaluating various decision alternatives
 The decision tree, exhibiting the anatomy of the decision situation, shows
(i) The decision points and the alternative options available for experimentation and action
at these decision points.
(ii) The chance points where outcomes are dependent on a chance process and the likely
outcomes at these points.
 Evaluation of Alternatives
1. Start at the right-hand end of the tree and calculate the expected monetary value at
various chance points that come first as we proceed leftward.
2. Given the expected monetary values of chance points in step 1, evaluate the alternatives
at the final stage decision points in terms of their expected monetary values.
3. At each of the final stage decision points, select the alternative which has the highest
expected monetary value and truncate the other alternatives
4. Proceed backward (leftward) in the same manner, calculating the expected monetary value
at chance points, selecting the decision alternative with the highest expected monetary value
at various decision points.
6.3 Managing Risk
 Fixed and variable cost
 Pricing strategy
 Sequential investment
 Improving information
“Don’t test the depth of a river with both feet”
 Financial leverage
 Insurance
 Long-term arrangements
 Strategic alliance

Chapter 7
Social cost-benefit analysis
 is a technique of evaluating projects from social/economic perspectives
 primarily used in evaluating public sector projects
7.1 Why social cost-benefit analysis?
Market Imperfections
 market prices do not reflect social values
Externalities
 are beneficial or harmful effects of a project to the society
 benefits generated by the project and the damages inflicted on the society are ignored
in financial analysis
Taxes and subsidies
 are irrelevant from social point of view as they merely represent transfer payments
Concerns for Savings
 a project may have a consumption and saving effect, and savings are more preferred
as they lead to investment
Concern for redistribution
 fair distribution of income among different groups of the society is a concern in
SCBA
Merit goods
  are preferences and golas not expressed in terms of market prices. Eg. Adult
education program
7.2 UNIDO Approach
It involves the following steps
1. Calculate financial feasibility based on market prices
2. Obtain net benefits measured in economic(efficiency) prices
3. Adjust for impact on savings and investment
4. Adjust for impact on income distribution
5. Adjust for impact on merit and demerit goods
Net benefits in terms of economic(efficiency) prices
 economic (efficiency) prices are also called Shadow prices.
Issues related to shadow prices
 Numeraire-unit of account in which value of inputs and outputs are expressed
 Tradability of goods-measured using international price
Sources of Shadow price
Consumer willingness to pay, Production cost, Foreign exchange value
Impact of a project
Consumption, Production, International trade
Shadow pricing for specific goods
(a) Tradable inputs and outputs
 are goods for which increase in consumption results in increase in import and a
decrease in export, and increase in production leads to increase in export and
decrease in import
 shadow price is border price in local currency translated at market exchange rate
(b) Non-tradable inputs and outputs
 are goods for which import price exceeds domestic cost of production and export
prices is less than domestic cost of production.
 shadow price is determined based on consumers willingness to pay or cost of
production
(c) Externalities
 are goods that are not deliberatly created, are beyond the control of persons
affected, and are not traded in the market.
  value is determined indirectly
(d) Labor inputs
 by hiring labor a project can have impact on the rest of the economy in the following
THREE ways
i) may take labor from other employments
ii) may induce production of new labor
iii) may involve import of workers

 Shadow price is as follows

If labor is taken from other employments
 rate others are willing to pay
If production of new labor is induced
 marginal product of labor in previous employment
 value of liesure time
 additional consumption of food when working
(e) Capital inputs
 investment in capital goods involves conversion of financial resources into
physical assets and a reduction in national savings that could have been used for
financing other projects
 shadow price therefore includes shadow price of physical assets and the opportunity
cost of a project given up
Measurement of the impact on distribution
 first, income gained or lost by individual groups within the society is determined
 income gained or lost is the difference between shadow price and market price
Saving impacts and its value
Value of Saving
 is the present value of additional consumption produced when a saving is invested
at the margin.
 additional consumption generated by investment depends on marginal productivity
of capital and rate of investment from additional income.
Income distribution Impact
  involves weighing the net gain/loss by each group to reflect value of income for
different groups and summing them.
 Weights are determined as follows
wi = (b/ci)^n
where wi =weight attached to income at ci level
b = base level of income that has a weight of 1
n = elasticity of the marginal utility of income

Adjustment for merit and demerit goods

 merit goods have more social value than economic value eg. Production of Oil
 demerit goods have more economic value than social value eg. Production of
Cigarette.
 the difference between social value and economic value is adjusted by (i) estimating
economic value (ii) calculating adjustment factor as the difference between the ratio
of SV to EV and one (iii) multiplying economic value by the adjustment factor(iv)
add the value in (iii) to NPV