GAGE UNIVERSITY COLLEGE

FACULTY OF BUSINESS AND ECONOMICS

PROJECT ANALYSIS & EVALUATION

(MGT 4026)

Address

https://gagecollege.net/

Tel: +251 11 465 2067 /09 05818181 / 09 88415600

P.O. Box: 23115

Email: - [email protected]

ADDIS ABABA, ETHIOPIA

JANUARY, 2024
COURSE OUTLINE:
CHAPTER 1 - GENERAL INTRODUCTION ………………….…….…….……..1
1.1. Meaning and definition of project …………………………………………..…….1
1.2. Features of a project ………………………………………………………………3
1.3. Projects and Plans ………………………………………………………...………4

CHAPTER 2 - PROJECT CYCLE …………………………………...…………….9

2.1. Meaning and Definition of Project Cycle …………………….……..……………9

2.2. World Bank Project Cycle …………………………………….…….…………..10

2.3. UNIDO Project Cycle …………………………………………..…….…………15

CHAPTER 3 - PROJECT IDENTIFICATION …………………….….…………25

3.1. Project Idea – meaning ……………………………………………….………….25

3.2. Sources of Project Ideas ………………………………………….………..…….26

3.2.1. Macro sources …………………………………………….….…..26

3.2.2. Micro sources ……………………………………………...……..26
CHAPTER 4 - PROJECT PREPARATION …………………………..…………29
4.1. Markets and Demand Analysis ……………………………………..……………29

4.2. Raw Materials and Supplies Study ………………………………..……………..38

4.3. Location, Site and Environment Impact Assessment (EIA) ……………………..42
4.4. Production Program and Plant Capacity …………………………..……………..52
4.5. Technology Selection ….........................................................................................56
4.6. Organizational and Human Resource ……………………………..………………62
4.7. Financial and Economic Analysis ………………………………...……………….62
4.7.1. Initial investment cost ……………………………..……………….62
4.7.2. Production cost ….............................................................................63
4.7.3. Marketing cost …………………………………………….……….64
4.7.4. Projection of cash flow …………………………………………….65
4.7.5. Financial evaluation Tools …………………………………………66
4.7.5.1. Net present value (NPV) ……………………….……………66
4.7.5.2. Internal rate of return (IRR) …………………………………67

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 4.7.5.3. Benefit cost ratio (BCR) …………………….………………69
4.7.5.4. Payback period (PBP) ………………………….……………69
4.7.5.5. Accounting rate of return (ARR) …........................................72
4.7.5.6. Break – even analysis (BEA) ……………………..…………73
CHAPTER 5 - PROJECT IMPLEMENTATION, MONITORING & EVLAUATION ……..75
5.1. Organization: An Overview…………………………………………..……………75
5.1.1. Line and Staff Organization …………………………..……………76
5.1.2. Divisional Organization …………………………………………..78
5.1.3. Matrix Organization ……………………………………….……..78
5.2. Project Planning …………………………………………………………………..79
5.3. Project Control ……………………………………………………………………84
5.4. Human Aspects of Project Management ……………………………….…………88
5.5. Pre – requisites for Successful Project Implementation …......................................93

CHAPTER 6 - SOCIAL COST BENEFIT ANALYSIS (SCBA) .….….……..…..98

6.1. Rationale for SCBA ………………………………………………………..…….98

6.2. UNIDO Approach …............................................................................................101

6.3. Net Benefit in Terms of Economic Prices …………………………….….……..103
6.4. Savings Impact …………………………………………………………….…….105

CHAPTER 7 - PROJECT FINANCING …………………………………………109

6.1. Source of Project Finance ………………………………………………………110

7.1.1. Equity …........................................................................................110

7.1.2. Loan financing …………………………………………..……….110
7.1.3. Leasing ……………………………………………………..…….111
7.2. Cost of Capital …………………………………………….………..112
7.3. Public Policy and Regulations on Financing ……….……...……………………113

7.4. Financing Institutions ……………………………………….………………..114

III
 CHAPTER ONE
GENERAL INTRODUCTION
1.1. Meaning and definition of project

Organizations perform work. Work generally could be classified into either operations or projects,
although in some cases both of them may overlap. Both operations and projects share many
characteristics in common like:
 People perform both the activities.
 Both are constrained by limited resources.
 Both are planned, executed, and controlled.
However, operations and projects differ primarily in their repeatability. Operations are ongoing and
repetitive whereas projects are temporary and unique.
A project is a unique endeavor to produce a set of deliverables within clearly specified time, cost
and quality constraints.
Projects are different from standard business operational activities as they:

 Are unique in nature: They don’t involve repetitive processes. Every project undertaken is
different from the last, whereas operational activities often involve undertaking repetitive
(identical) process.
 Have a defined timescale: projects have a clearly specified start and end date within which the
deliverables must be produced to meet specified customer requirement.
 Have an approved budget: projects are allocated a level of financial expenditure within which
the deliverables must be produced to meet specified customer requirement.
 Have limited resources: at the start of a project an agreed amount of labor, equipment and
materials is allocated to the project.
 Involve an element of risk: projects entail a level of uncertainty and therefore carry business
risk.
 Achieve beneficial change: the purpose of a project, typically, is to improve an organization
through the implementation of business change.
For many organizations, projects are a means to respond to requests that cannot be addressed
within the organization’s normal operational limits.

Projects are undertaken at all levels of the organization. They may involve a single person or many
thousands. Their duration ranges from a few weeks to a few years.

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 Projects may involve a single unit of one organization or may cross-organizational boundaries. As
projects are often implemented as a means of achieving an organization’s strategic plan they are
critical for the organizations growth. Examples of projects could include:
 Developing a new product or service.
 Effecting a change in structure, staffing, or style of an organization.
 Developing a new or modified information system.
 Implementing a new business procedure or process.
Project management is the application of knowledge, skills, tools, and techniques to project
activities to meet project requirements. Project management is accomplished through the use of
the following 5 processes:
 Initiation
 Planning
 Execution
 Controlling and
 Closure

CLASSIFICATIONS OF A PROJECT
Projects are classified based on several criteria, including: ownership, source of finance, and
forces behind the projects.

1. Based on ownership:
a. Private sector- mostly projects undertaken by business enterprises.
b. Public sector- projects undertaken by national and local government bodies.
c. NGOs- development projects are most often undertaken by non-government and non- for profit
organizations.
2. Based on the Sources of Finance:
a. Government treasury- projects may be entirely financed by government budget as per its priority.
For instance, construction of regional airport.
b. Government treasury and external sources- most projects are financed by the joint partnership of
the government and donor groups. For example, a road project may be financed 50% by the
government and 50% by a foreign donor.
c. External sources of Finance- projects may be financed totally by parties other than the government
but established for the well-being of the citizens and the ownership may be for the government or the
public.

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 3. Based on the forces behind:

a. Demand driven/need driven- based on identified unsatisfied demand project can be created
or on unsatisfied basic needs like food, water and shelter.
b. Donor driven- the force behind the financing organization. Donors will have their own say
and influence the types of projects to be established.
c. Political Driven- Projects may be established in response to some political situation such as
for example because of national elections, projects by religious organizations.
4. Based on their nature:
a. Civil engineering, construction, petrochemical, mining, quarrying, projects far away from
the contractor’s home office, and involve special risk as well as problems of organizational
communication.
b. Manufacturing projects- conducted in a factory or other home based environment and
enable exercising on the spot management.
c. Research projects- established for pure research consuming large sum of money and lasting
over years resulting in dramatic profitable discovery or proving waste of money.
d. Management projects- projects that require the employment of an external project manager
or managing contractor for issues such as relocating headquarters, developing and
introducing a new computer system, preparing for a trade exhibition, producing a feasibility
or other study report, restructuring the organization etc.
1.2. Features of a project
1. A project involves the investment of scarce resources in the expectation of future benefits;
2. The project will have measurable Objectives. Projects have specific of benefits that can be
identified, quantified and valued, either socially or monetarily/commercially/.
3. Related to the specificity of objectives, the projects have specific beneficiaries or clientele group,
which needs to be specifically spelt out during project planning studies.
4. A project is the smallest operational element unit. A project can be planned, financed and
implemented as a unit. Often projects are the subject of special financial arrangements and have
their own management.
5. The boundaries of projects make them distinguishable from each other.

 Projects are conceptually bounded. The problem and specific objective (need) that justify
the project involves conceptual delimitations.

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  Projects are geographically bounded. Projects exist in space and we say that projects are
geographically (location ally) bounded.
 Projects are organizationally bounded. Projects require the establishment of a special
organization or the crossing of traditional organizational boundaries, meaning there should
be certain organizational unit responsible for project implementation.
 Projects are time bounded. One factor that makes projects bounded is the time (life cycle)
of a project. Projects have specific lifetime, with a specific start and end time in which a
clearly defined set of objectives are expected to be achieved.
6. Uncertainty and risks is inherent in any project. Achieving project objectives cannot be predicted
in advance with accuracy. The factors that make project risk are:
 Significant and multiple types of scarce resources committed today expecting outcome in
the future
 Benefits are expected to be generated in the future, which is less predictable
 Capital investments are irreversible; therefore, perfect exit assumption of the perfect
competition model is refuted.
7. It has a scope that can be categorized into definable tasks. Projects usually have well defined
sequence of investment and production activities
8. It may require the use of multiple resources. This has an implication on management of project
implementation. The more diverse the types of resources are mobilized the more complex will the
management be. The outcome of project and hence development endeavor is sensitive to the
management of each type of resources. Ill managed resource can contribute more to cost than to
benefit.
1.3. Project and Plan
Planning can be defined as a “continuous process that involves decisions or choices about
alternative ways of using available resources with the aim of achieving a particular goal or set of
goals at some time in the future.”

The rationale for planning is that it serves as a tool that enhances the effectiveness in mobilizing
resources and enables allocation of resources into priority areas of development. In this regard,
development planning can be regarded as an attempt to raise the rationality of decision-making.
The hierarchical relationship among development plans, programs, tasks, and work packages is
depicted below:

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 Development Plans

Programs

Projects

Tasks

Work Packages

Figure: Hierarchical Relationships

It is necessary to distinguish between projects and programs because there is sometimes a tendency
to use them interchangeably. A project refers to an investment activity where resources are used to
create capital assets, which produce benefits over time and has a beginning and an end with
specific objectives, while a program is an ongoing development effort (plan) involving a number
of projects. Programs may or may not necessarily be time bounded. Yet programs cannot live
forever, they have limited life cycle, which however, may or may not be explicitly stated. So in
effect in terms of time delimitation, there is only relative difference between programs and
projects. For instance, a health program may include a water project as well as construction of a
health center; both aimed at improving the health of a given community that previously lacked
easy access to these essential facilities.

Note that projects can stand alone without being part of certain program. So, one can visualize that
the linkage of policies, development plans, and projects. Projects, which are not linked with others
to form a program, are sometimes referred to as “stand alone” projects.

Development plans:
 Most forward looking (futuristic)
 Broad and require systematic thinking, preparation and appraisal
 Attempts to bring welfare in the society
Programs:
 Derived from development plans

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  Exceptionally large with long term objectives
 Explores specific area with broader scope
Projects:
 Derived from a program
 Unique investigative tool
 A development activity with specific objectives
 Funded by a program
 An implementation element (entity)
Tasks:
 Work elements under a project
 Specific approaches for doing things
 Set of activities comprising a project
Work packages:

 Sub elements of a given task (or undertaking)

 Something accomplished stage by stage
 Collection of work packages defines a given task

As it can be observed from the above framework, in general, the essence of development planning
is futuristic, i.e., it is most forward looking and involves systematic thought and preparation.
Virtually, every nation, be it developed or developing, should have a systematically elaborated
national plan to hasten economic growth and further a range of social objectives. Therefore:
1. Projects provide an important means by which investment and other development expenditures
foreseen in plans can be clarified and realized. Sound development plans require good projects,
just as good projects require sound planning. The two are interdependent.
2. A sound plan requires a great deal of knowledge about existing and potential projects. Sound
planning rests on the availability of a wide range of information about existing and potential
investments and their likely effects on growth and other national objectives. Thus, plans require
projects. Realistic planning involves knowing the amount that can be spent on development
activities each year and the resources that will be required for particular kind of project.
3. Effective project preparation and analysis must be set in the framework of a broader development
plan. Projects are part of an overall development strategy and a broader planning process.
4. The more elaborated the plans and policies of the governments are, the easier becomes the work
of the project planner. For example, the project planner will have to refer to such plans and policies

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 to see whether the project being considered fits well in the plan and contributes most to the
fundamental objectives of the government. These objectives can include self-sustaining growth,
promotion of employment, income distribution, etc.
5. As projects rightly called the “Cutting Edge” of development, they are powerful means to achieve
the development objectives; they are the crucial building blocks of a development structure.
6. Projects aim mainly at increasing the production of goods and services, which are fundamental
components of people’s welfare, and the main objective of any development effort is, of course,
to advance social well-being.

Differences:

PROJECTS PROGRAMS

specific objectives General objectives

Specific project areas No specific project areas

Specific beneficiaries group No Specific beneficiaries group

Clearly determined and allocated funds No clear and detailed financial resource allocation

Specific lifetime No specific lifetime

Similarities:
Projects and programs have similar characteristics in a way that both are:
 Having objectives;
 Requiring financial, human, material, etc. inputs (or resources);
 Generating outputs, (goods/services), of value;
 Serving as instruments for the execution of development plans in order to boost the
national economy.

Review Questions

Give correct answer for the following questions

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1. What is a project, and what are its main attributes? How is a project different from what most
people do in their day-to-day jobs? What is the triple constraint?
2. What is project management? Briefly describe the project management framework, providing
examples of stakeholders, knowledge areas, tools and techniques, and project success factors.
3. Discuss the relationship between project and program management and their contribution to
enterprise success.
4. What are the roles of the project and program? What are suggested skills for project managers?
What additional skills do program managers need?
5. Why is there a new or renewed interest in the field of project management

CHAPTER TWO
PROJECT CYCLE
2.1. Meaning and Definition of Project Cycle

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The way in which projects are planned and carried out follows a sequence that has become
known as the project cycle. The cycle starts with the identification of an idea and develops that

idea into a working plan that can be implemented and evaluated. Ideas are identified in the context
of an agreed strategy. It provides a structure to ensure that stakeholders are consulted and relevant
information is available, so that informed decisions can be made at key stages in the life of a
project.
The project cycle considers various stages in which each stage not only is grown out of the
proceeding one/those that are under way/but also leads into the subsequent ones. The planning
process does not contain such a stringent sequence of events since all the aspects of the project
have to be considered simultaneously and, if necessary, adjusted to one another. Therefore, a
project cycle is a self-renewing cycle in that new projects may grow out of the old ones in a
continuous process and self-sustaining cycle of activity.

These processes can usefully be considered as a comprehensive sequence in the sense that for the
project that is implemented, each stage naturally follows the proceeding one and leads on to the
next. Actually, the division into stages is artificial; but it helps us to understand that project
planning, though a continuous process over time, has distinct phases and stages. And therefore,
throughout the project cycle, the primary preoccupation of the analyst is to consider alternatives,
evaluate them, and to make decisions as to which of them should be advanced to the next stage in
the planning process.

Regarding the classification of the aspects for the purpose of project analysis, there are many
equally valid ways in which the project cycle may be divided and the identifiable stages may be
described. There are alternative models that deal with the project cycle. However, in this chapter,
more emphasis will be given to the two basic Models that are widely accepted as a model of project
by institutions, analysts, and mostly dealt in academic literatures.
These are: “The Baum Cycle (also called the World Bank Project Cycle)” and “The UNIDO Project
Cycle”. In addition to these two, a third model developed by Development projects Studies
Authority in Ethiopia (called “The DEPSAs Model”), which is more or less identical with the
UNIDO cycle, will be briefly discussed.

2.2. World Bank’s Project Cycle

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A project with the characteristic already outlined above typically run through at least several
separable stages of activities that can be thought of as constituting a definite sequence, which some
writers and institutions have called “a project cycle”. In this regard, the first basic model of a
project cycle developed by Warren. C. Baum in 1970 was by then adopted by the World Bank as
a project cycle. Initially, this model had recognized only four main stages in the project cycle,
namely:

 Identification
 Preparation
 Appraisal and Selection
 Implementation

Later in 1978, the author has added additional two stages called “Negotiation” and “Evaluation”.
In this version of the Baum model, negotiation comes after projects pass the appraisal process and
become a candidate for realization. It is after appropriate negotiations that projects become
implementation entity. And then, projects that are implemented will be the concern for evaluation,
which usually closes the cycle as it gives rise to the identification of new projects. This model,
therefore, includes a total of six identifiable stages in the project cycle. The World Bank accepted
the amendment and hence, this new version has been in use since then. Thus, each of Baum’s main
stages is discussed briefly below:

1. Identification

The first stage in the project cycle and in the planning process is to find potential projects. The
sources of projects may be one or more of the following:
 Some may be “resource based” and stem from the opportunity to make profitable use of
available resources.
 Some projects may be “market based” arising from an identified demand in home or overseas
markets.
 Others may be “need-based” where the purpose is to try to make available to all people in
an area of minimal amounts of certain basic material requirements and services.
 Well-informed “technical specialists” and “local leaders” are also common sources of
projects. Technical specialists could identify many areas where they feel new investments
might be profitable, while local leaders may have suggestions about where investments
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 might be carried out.
 Ideas for new projects also come from “proposals to extend and/or expand existing programs
and projects” as well as from identifying technological alternatives.

In general, most projects start as an elementary idea. Eventually, some simple ideas are elaborated
into a form to which the title “project” can be formally applied.

2. Preparation

Once projects have been identified, there begins a process of progressively more detailed
preparation and analysis of project plans. At this stage, the project is being seriously considered as
a definite investment action. Project preparation, (also called project formulation), involves pre-
feasibility and feasibility studies and covers the establishment of commercial, technical,
institutional, financial, and socio-economic feasibility. Decisions have to be made on the scope of
the project, location and site, soil and hydrological requirements, project size (farm or factory size),
etc.

Resource based investigations are undertaken and alternative forms of projects are explored.
Complete technical specifications of distinct proposals accompanied by full details of financial
and economic costs and benefits are the outcome of the project preparation stage. The project now
exists as a set of tangible proposals. Practically, project design and formulation is an area in which
local and international consultants are very active, especially for big projects that cover large areas
and have big budgets.

3. Appraisal and Selection

After a project has been prepared, it is generally appropriate for a critical review or to conduct an
independent appraisal. This provides an opportunity to re-examine every aspect of the project plan
and determine whether the proposal is appropriate and sound or not before large sums are
committed. Generally, internal government staffs only are used for this work and not consultants

and projects are appraised both in the field and at the desk level. Appraisals should cover at least
seven aspects of a project, each of which must have been given special consideration during the
project preparation phase:
a. Technical: here the appraisers concentrate in verifying whether what is proposed will work in the
way suggested or not.

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b. Financial: the appraisers try to see if the requirements of money needed by the project have been
calculated properly, their sources are all identified, and reasonable plans for their repayment are
made where necessary.
c. Commercial: the way the necessary inputs for the project are conceived to be supplied is examined
and the arrangements for the disposal of the products are verified.
d. Incentive: the appraisers see to it whether things are arranged in such a way that all those whose
participation is required will find it in their interest to take part in the project, at least to the extent
envisaged in the plan.
e. Economic: the appraisers here try to see whether what is proposed is good from the viewpoint of
the national economic development interest, all project effects (positive as well as negative) are
taken into account, and check if all are correctly valued.
f. Managerial: this aspect of the appraisal examines if the capacity exists for operating the project
and see if those responsible ones can operate it satisfactorily. Moreover, it tries to see if the
responsible are given sufficient power and scope to do what is required.
g. Organizational: the appraisers examine the project it is organized internally and externally into
units, contract, policy, institution, etc. so as to allow the proposals to be carried out properly and
to allow for change as the project develops.

The appraisal process builds on the project plan but may involve new information if the appraisal
team feels that some of the data used at preparation or some assumptions are faulty. The
implications of the project on the society and the environment are also more thoroughly
investigated and documented. Similarly, the technical design, financial measures, commercial
aspects, incentives, and economic parameters are thoroughly scrutinized. These issues are the
subjects of specialized appraisal report. On the basis of an appraisal report, decisions are made
about whether to go ahead with the project or not. The appraisal may also change the project plan
or develop a new plan, that is, comment made at the appraisal stage frequently give rise to
alternations in the project plan (project appraisal).

After appraisal, the viable project proposals are chosen for implementation on the basis of the
priorities of the stakeholders and the available resources. For instance, Treasury may impose a
ceiling on the ministries with a big portfolio of investments, calling for prioritization of the core
and lower priority projects. In practice, there can be quite a sequence of project selection decisions.
Following appraisal, some projects may be discarded. If the project involves loan finance, the

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lender will almost certainly wish to carry out its own appraisal before completing negotiations with
the borrower.

4. Negotiation and Financing

Once the project to be implemented is agreed on, for donor funded projects, discussions are held
on funding and associated aspects of funding such as conditions for grants, repayment period,
interest rates on loans, flow of funds, contributions from stakeholders, and whether there is co-
financing or not. This culminates into an “Agreement Document” for the project, which binds all
the parties involved during implementation of the project.

5. Implementation:

The objective of any effort in project planning and analysis clearly is to have a project that can be
implemented to the benefit of the society. Thus, implementation is, perhaps, the most important
part of the project cycle. In this stage, funds are actually disbursed to get the project started and
keep running. A major priority during this stage is to ensure that the project is carried out in the
way and within the period that was planned. Problems frequently occur when the economic and
financial environment at implementation differs from the situation expected during appraisal.

Frequently, original proposals are modified, though usually only with difficulty, because of the
need to get agreement between the parties involved. It is during implementation that many of the
real problems of projects are first identified. Because of this, the feedback effects on the discovery
and design of new projects and also the deficiencies in the capabilities of the project actor can be
revealed. Therefore, to allow the management to become aware of the difficulties that might
arise, recording, monitoring, and progress reporting are important activities during the
implementation stage.

Some of the aspects of implementation that are of particular relevance to project planning and
analysis are the following:
 The first is that, the better and more realistic a project plan is, the more likely it is that the
plan can be carried out and the expected benefits realized.
 The second is that, project implementation must be flexible. Circumstances will change and
project managers must be able to respond intelligently to these changes. The common ones
are: technical changes (soils, water logging, and nitrogen application); price changes;

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 economic policy and environmental changes; political changes, etc. and these all will alter
the ways in which projects should be implemented.
6. Evaluation:

The final phase in the project cycle is evaluation. Once a project has been carried out, it is often
useful, (though not always done), to look back over what took place, to compare actual progress
with the plans, and to judge whether the decisions and actions taken were responsible and
useful. The extent to which the objectives of a project are being realized provides the primary
criterion for an evaluation. The analyst looks systematically at the elements of success and
failure in the project experience to learn how better to plan for the future.

Evaluation is not limited only to completed projects. It is a most important managerial tool in
on-going projects and rather, formalized evaluation may take place at several times in the life
of a project. Evaluation may be undertaken when the project is in trouble as the first step in a
re-planning effort. Careful evaluation should precede any effort to plan for new projects and it
is also needed to follow-up the progress of projects. And, finally evaluation should be
undertaken when a project is terminated or is well into routine operation.

Different groups or units may do the evaluation of projects. Among others,

 Project’s management unit often continuously evaluates its experience as
implementation proceeds.
 The sponsoring agency, perhaps, the operating ministry, the planning agency, or an
external assistance agency may undertake evaluation.
In large and innovative projects, the project’s administrative structure may provide a separate
evaluation unit responsible for monitoring the projects implementation and for bringing problems to
the attention of the projects’ management. Evaluation can help not only in the management of the
project after the initial phase, but also help in the planning of future projects. Experience with one
project can give rise to new ideas for extension of the project, repetition, the need for “vertically”
associating projects that supply inputs to or process products from this project, and other ideas which
become the seeds to generate new project proposals.

2.3. The UNIDO Project Cycle

The UNIDO has established a project cycle comprising the following three distinct phases:
1. The pre-investment phase

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2. The investment phase, and
3. The operating phase.

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 Pre-selection

Preparation
Identification

Opportunity study
Support Studies
Expansion Pre
investment
Innovation Operating Appraisal
phase
phase

Replacement Investment
phase Negotiations and
Rehabilitation contracting

Engineering Design
Commissioning and
startup
Construction

Pre-production marketing

Training
Each of these three phases is divided into stages, some of which constitute important
consultancy, engineering, and industrial (manufacturing) activities. In this regard, increasing
importance should be attached to the pre-investment phase as a central point of attention,
because the success or failure of an industrial project ultimately depends on the marketing,
technical, financial and economic findings and their interpretations, especially in the feasibility
study. To reduce wastage of scarce resources, a clear comprehension of the sequence of events
is required when developing an investment proposal from the conceptual stage by way of active
promotional efforts to the operational stage.

1. The pre-investment phase:

According to the UNIDO manual, the pre-investment phase comprises several stages:

 Identification of investment opportunities (opportunity studies)

 Analysis of project alternatives and preliminary project selection as well as project
preparation (pre-feasibility and feasibility studies), and
 Project appraisal and investment decision (specialized appraisal reports)

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Support or functional studies are also part of the project preparation stage and are usually
conducted separately, for later incorporation in a pre-feasibility study or feasibility study as
appropriate. Though it is easier to grasp the scope of an opportunity study, it is not an easy task
to differentiate between a pre-feasibility and feasibility study in view of the frequently
inaccurate use of these terms.

The division of the pre-investment phase into stages avoids proceeding directly from the
project idea to the final feasibility study without examining the project idea systematically or
being able to present alternative solutions. This cuts out many feasibility studies that would
have little chance of reaching the investment phase. Finally, it ensures that the project appraisal
to be made by national or international financing institutions becomes an easier task when
based on well- prepared studies. All too often, project appraisal actually amounts to project
preparation, given the low quality of the feasibility study submitted.

(A) Opportunity Studies

The identification of investment opportunities is the starting-point in a series of investment-

related activities, when potential investors (private or public) are interested in obtaining
information on newly identified viable investment opportunities. The main instrument used
to quantify the parameters, information, and data required to develop a project idea into
a proposal is the opportunity study, which should analyze:

 Natural resources
 The existing agricultural base (it may be the basis for agro-industries)
 Future demand for consumer goods
 Imports substitution and export possibilities
 Environmental impacts (mandatory or non-revenue producing projects)
 Expansions of existing capacity
 Manufacturing sectors (successful in other countries)
 Diversification
Opportunity studies are rather sketch in nature and rely more on aggregate estimates than on
detailed analysis. Opportunity studies could be general or specific.

 General opportunity studies (“sector approach") could be area studies designed to

identify opportunities on a given area (Administrative province, backward region);
industry studies to identify opportunities in delimited industrial branch; and resource-
based studies to reveal opportunities based on the utilization of natural, agricultural,

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 or industrial resources.
 Specific project opportunity studies (“enterprise approach”) are seen in the form
of products with potential for domestic manufacture. A specific project opportunity
study may be defined as the transformation of a project idea into a broad investment
proposition.

A project opportunity study should not involve any substantial cost in its preparation, as it is
intended primarily to flashlight the principal investment aspects of a possible industrial
proposition. The purpose of opportunity study is to arrive at a quick and inexpensive
determination of salient facts of an investment possibility.

(B) Pre-Feasibility Studies

The project idea must be elaborated in a more detailed study. However, formulation of a
feasibility study that enables a definite decision to be made on the project is a costly and time-
consuming task. Therefore, before assigning larger funds for such a study, a further assessment
of the project idea might be made in a pre-feasibility study. This is to see if:
 All possible project alternatives are examined,
 The project concept justifies detail study,
 All aspects are critical and need in-depth investigation, and
 The project idea is viable and attractive or not.

A pre-feasibility study should be viewed as an intermediate stage between a project opportunity

study and a detailed feasibility study, the difference being in the degree of detail of the
information obtained and the intensity with which project alternatives are discussed. The
structure of a pre-feasibility study should be the same as that of a detailed feasibility study.

(C) Support/Functional/Studies

Support or functional studies cover aspects of an investment project, and are required as
prerequisites for, or in support of, pre-feasibility and feasibility studies, particularly for large-
scale investment proposals. This may include:
 Market studies of products
 Raw material and factory supply studies Laboratory and pilot plant tests Location
studies
 Environmental impact assessment. Economies of scale studies Equipment selection
studies

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The contents of a support study vary, depending on the type and nature of the projects.
However, as it relates to a vital aspect of the project, the conclusions could be clear enough to
give directions to the subsequent stage of project preparation. In most cases, a support study
when undertaken either before or together with a feasibility study, form an integral part of the
latter and lessen its burden and cost.

(D) Feasibility Studies

A feasibility study should provide all data necessary for an investment decision. The
commercial, technical, financial, economic, and environment prerequisites for an investment
project should, therefore, be defined, refined and critically examined based on alternative
solutions already reviewed in the pre-feasibility study. The results of these efforts is then a
project whose background conditions and aims have been clearly defined in terms of its control
objective and possible marketing strategies, the possible market shares that can be achieved,
the corresponding production capacities, the plant location, existing raw materials, appropriate
technology and mechanical equipment and, if required, an environmental impact assessment.

The financial part of the study covers the scope of the investment, including the net working
capital, the production and marketing costs, sales revenue, and the return on capital invested.
Final estimates on investment and production costs and its subsequent calculations of financial
and economic profitability are only meaningful if the scope of the project is defined
unequivocally (clearly) in order not to omit any essential part and its related cost.

There is no uniform approach or pattern to cover all industrial projects of whatever type, size
or category. The emphasis on the components varies from project to project. For most industrial
projects, however, there is a broad format of general application bearing in mind that the larger
the project the more complex will be the information required. Although feasibility studies are
similar in content to pre-feasibility studies, the industrial investment project must be worked
out with the greatest accuracy in an iterative optimization process, with feedback and inter-
linkages, including the identification of commercial, technical, and entrepreneurial risks.

The sensitive parameters such as the size of the market, the production program, or the
mechanical equipment selected should be examined more closely. A feasibility study should
be carried out only if the necessary financing facilities, as determined by the studies, can be
identified with a fair degree of accuracy. There would be little sense in a feasibility study
without the reliable assurance that, in the event of positive study findings, funds could be made
available. For that reason, possible project financing must be considered as early as the

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feasibility study stage because financing conditions have a direct effect on total costs and, thus,
on the financial feasibility of the project.

(E) Appraisal Report

When a feasibility study is completed, the various parties will carry out their own appraisal of
the investment project in accordance with their individual objectives and evaluation of
expected risks, costs, and gains. Large investment and development finance institutions have a
formalized project appraisal procedure and usually prepare appraisal reports. This is the reason
why project appraisal should be considered an independent stage of the pre-investment phase,
marked by the final investment and financing decisions taken by the project promoters.

The appraisal report will prove whether the pre-production expenditures spent since the
initiation of the project idea were well spent or not. Project appraisal as carried out by financial
institutions concentrates on the health of the company to be financed, the returns to be obtained
by equity holders and the protection of its creditors. The techniques applied to appraise projects
in line with these criteria center around technical, commercial, market, managerial,
organizational, and financial and possibly also economic aspects.

2. The Investment/implementation Phase

The investment or implementation phase of a project provides wide scope for consultancy and
engineering work, first and foremost in the field of project management. The investment phase
can be divided into the following stages:

 Establishing the legal, financial, and organizational framework

 Tendering, evaluation of bids, and negotiations
 Technology acquisition and transfer
 Detailed engineering design and contract, including tendering, evaluation of bids
and negotiations
 Acquisition of land, construction work and installation
 Pre-production marketing, including the securing of supplies and suppliers and setting
up the administration of the firm.
 Recruitment and training of personnel
 Plant commissioning and start-up

Detailed engineering design comprises preparatory work for site preparation, the final
selection of construction planning and time scheduling of factory construction, as well as the
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preparation of flow charts, scale drawing, and a wide variety of layouts.

During the stage of tendering and evaluation of bids, it is especially important to receive
comprehensive tenders for goods and services for the project from a sufficiently large number
of national and international suppliers of proven efficiency and with good delivery capacity.

Negotiations and contracting are concerned with the legal obligations arising from the
acquisition of technology the construction of buildings, the purchase and installation of
machinery and equipment and financing. This stage covers the signing of contracts between
the investor or entrepreneur, on the one hand, and the financing institutions, consultants,
architects and suppliers of raw materials and required inputs, on the other.

The construction stage involves the site preparation, construction of buildings and other civil
works, together with the erection and installation of equipment in accordance with proper
programming and scheduling.

The personnel recruitment and training stage, which should proceed simultaneously with
the construction stage, may prove very crucial for the expected growth of productivity and
efficiency in plant operations.

Of particular relevance is the timely initiation of marketing arrangements to prepare the

market for the new products (pre- production marketing) and secure critical supplies (supply
marketing).

Plant commissioning and start up is usually a brief but technically critical span in project
implementation. It links the proceeding construction phase and the following operational
(production) phase.

In general, it is to be noted that in the pre-investment phase, the quality and dependability of
the project are more important than the time factor, while in the investment phase, the time
factor is more critical in order to keep the project within the forecast made in the feasibility
study.

3. The Operating Phase

The problem of the operating phase needs to be considered from both a short and a long-term
view point.
 The short-term view relates to the initial after commencement of production when a

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 number of problems may arise concerning such matters as the applications of production
techniques, operation of equipment, or inadequate labor productivity owing to lack of
qualified staff and labor. Most of these problems have their origin in the implementation
phase.
 The long-term view relates to chosen strategies and the associated production and
marketing costs as well as sales revenues. These have a direct relationship with the
projections made at the pre-investment phase. If such strategies and projection prove
faulty, any remedial measures will not only be difficult but may prove highly expensive.

The given outline of the investment and operating phases of an industrial project is undoubtedly
an oversimplification for many projects, and, in fact, certain other aspects may be revealed that
even greater short or long term impacts.

There are various ways in which the project cycle may be viewed and portrayed depending on
the purpose, emphasis, and detail required to illustrate. According to the Guidelines to project
planning in Ethiopia (1990) of Development Project Studies Authority (DEPSA), the project
cycle comprises three major phases,

1. Pre-investment
2. Investment, and
3. Operating phase

Each of these three phases may be divided into stages. The Guidelines has divided the Project
cycle into six stages as follows:

1. Identification 4. Implementation
2. Preparation 5. Operation
3. Appraisal/decision 6. Ex-post evaluation
The pre-investment phase consists of the first three stages, the investment phase includes the
fourth stage, and the operation phase covers the last two stages. The project cycle means the
various stages of information gathering and decision-making, which take place between a
project’s inception and completion.

In reality, these are somewhat artificial, but do serve to emphasize the need to think of project
planning as a process of decision-making taking place overtime. Broadly speaking, what is
important about this process is that it should begin with the identification of number of
alternatives, using existing information and gathering new data in such a way as to limit
alternatives under consideration to those few, which are more promising.
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 Throughout the project cycle, the primary preoccupation of the analyst is to consider
alternatives, evaluate them, and to make decisions as to which of them should be advanced to
the next stage. In short, the project planning process is essentially a task of eliminating less
viable ideas and

Alternatives; and in the continuum, planner naturally hopes that the best alternative will
emerge.
In this process:

 The results and/or outputs of a given stage serve as the input or part of the input of the
next stage, if it is decided to proceed to the next stage;
 The output or part of the output of one stage may be used as new input (feedback) to
reconsider or revise, where necessary, the result of proceeding stages; and
 Most importantly, the results of the implementation, operation, and ex-post evaluation
stages of a project constitute valuable experienced for the preparation of subsequent
projects provided these inputs are systematically documented and analyzed.
REVIEW QUESTIONS

For the following question provide the required solution neatly and clearly.

1. Describe the Meaning and Definition of Project Cycle.

2. What are the different phases in the project cycle?
3. Eexplain the benefits of good project cycle management.
4. Draw a simple project cycle including key decision points.
5. Eexplain the importance of participation in project cycle management.
6. Explain the main differences of the following six phases
A. Identification
B. Preparation
C. Appraisal/decision
D. Implementation
E. Operation
F. Ex-post evaluation

CHAPTER THREE
PROJECT IDENTIFICATION
Introduction
Project identification is the first step of a new venture. Theoretically, an investor has an infinitely

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 wide choice with respect to investment opportunities. The important dimensions of choices are;
Products/ services, Technology, Equipment, Scale of production, Location, Incentives and Time
phasing. The task of identifying a feasible and promising project is somewhat difficult.
Moreover, it is interrelated with the government policies, infrastructural developments and skill
of people. Project identification is concerned with collection, compilation and analysis of
economic data for the purpose of locating possible opportunities for investment and with
development of such opportunities.
The term "Project Idea" refers to a concept or proposal for a potential project. It represents a
preliminary and often high-level description of the project's objectives, scope, and expected
outcomes. A project idea is typically developed during the initial stages of project planning and
serves as a starting point for further exploration and development.
3.1. Project Idea meaning
The main purpose of a project idea is to identify a problem, need, or opportunity that can be
addressed through a project. It provides a broad vision of what the project aims to achieve and
guides the subsequent project planning and execution processes. A well-defined project idea
helps stakeholders, such as project sponsors, managers, and team members, understand the
purpose and potential benefits of the project.
A project idea should be clear, concise, and aligned with the organization's goals and strategies.
It should also consider factors such as feasibility, resources required, potential risks, and the
expected impact on stakeholders. The development of a project idea often involves conducting
research, analyzing data, and considering various options before selecting the most viable and
promising idea to pursue.
Overall, a project idea serves as the foundation for the project and sets the direction for
subsequent project activities, including the development of a detailed project plan, resource
allocation, and implementation strategies.
3.2. Sources of Project Ideas
Good project ideas are the key to success. Therefore a wide variety of sources should be tapped to
analyze them. To have a wide range of options, the sources of project ideas can be categorized into
two they are: micro level sources and macro level sources.

3.2.1. Macro sources: refers to the source of project idea, which is reflected from national,
regional and sectorial level sources.
Example
• Lack of foreign exchange (trade deficit) requires export oriented projects or import
substitution oriented projects
• Natural disaster such as drought, earthquake or flood requires resettlement projects and

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 flood control projects like dam
• Multilateral or bilateral development agencies,
• Regional or international agreements in which a country participates, etc.
3.2.2 Micro source: refers to the source of project idea, which is reflected from community
or individual level sources
Example
• Identification of unsatisfied demand at community level. Example ; Drinking water
problems require water supply projects
• Existence of unused or underutilized natural or human resources. Example; Using various
rivers for irrigation purpose.
During identification, the analyst should eliminate project proposals that:
 Are technically unsound and risky
 Have no market for the output
 Have inadequate supply of inputs
 Are very costly in relation to benefits
 Assume over ambitious sales and profitability, etc.
As a result, some of the project alternatives will be rejected and those the are promising will be
advanced to the next stage called project preparation.

Another way of classifying sources of project ideas is:-.

 Some may be “resource based” and stem from the opportunity to make profitable use of
available resources.
 Some projects may be “market based” arising from an identified demand in home or
overseas markets.
 Others may be “need-based” where the purpose is to try to make available to all people in
an area of minimal amounts of certain basic material requirements and services.
 Well – informed technical specialists and local leaders are also common sources of
projects. Technical specialists will have identified many areas where they feel new
investment might be profitable, while local leaders may have suggestion about where
investment might be carried out.
 Ideas for new projects also come from proposals to extend existing programs.

In general, most projects start as an elementary idea. Eventually, some simple ideas are
elaborated into a form to which the title “project” can be formally applied.

Scouting for project ideas

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  Analyse the performance of the existing industries
 Examine the inputs and outputs of various industries
 Review import and export options
 Study plan outlays and government guidelines

 Look in to the suggestions of financial institutions and development agencies

 Investigate local materials and resources
 Attend trade fairs
Good project ideas are the key to success. The above variety of sources should be considered to
identify good project ideas
Project Ideas and Opportunity Studies

Opportunity Studies: The identification of investment opportunities is the starting – point in a

series of investment – related activities, when potential investors (private or public) are interested
in obtaining information on newly identified viable investment opportunities.
The main instrument used to quantify the parameters, information and data required to develop
a project idea into a proposal is the opportunity study, which should analyze:
1. Natural resources
2. The existing agriculture (basis for agro- industry)
3. Future demand for consumer goods
4. Imports substitution and export possibilities
5. Environmental impact
6. Expansions of existing capacity
7. Manufacturing sectors (successful in other countries)
8. Diversification
Opportunity studies are rather sketch in nature and rely more on aggregate estimates than on detailed
analysis. Opportunity studies could be general or specific.
General opportunity studies (sector approach) could be area studies designed to identify
opportunities on a given area (Administrative province, backward region), industry studies to
identify opportunities in delimited industrial branch and resource – based studies to reveal
opportunities based on the utilization of natural, agricultural or industrial.

REVIEW QUESTIONS
For the following question provide the required solution neatly and clearly.
1. What are the key elements or characteristics of a well-defined project idea?

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2. How does a project idea differ from a general goal or objective?
3. How can a strong project idea contribute to project success and stakeholder engagement?
4. What are some external factors or trends that can serve as macro sources of project ideas?
5. How can monitoring industry trends and market demands inspire project ideas?
6. How can technological advancements at a larger scale drive project ideas?
7. How can analysing internal processes and operations generate micro-level project ideas?
8. How can customer feedback and needs be utilized as micro sources of project ideas?
9. In what ways can employees contribute to generating micro-level project ideas through their
expertise or suggestions?
10. What role does brainstorming and collaboration play in identifying micro-level project ideas?

CHAPTER FOUR
PROJECT PREPARATION
4.1. MARKET AND DEMAND ANALYSIS
In most cases, the first step in project analysis is to estimate the potential size of the market
for the product proposed to be manufactured (or the service planned to be offered) and get

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 an idea about the market share that is likely to be captured. Put differently, market and
demand analysis is concerned with two broad issues;
1. What is the likely aggregate demand for the output? and
2. What share of the market will the proposed project enjoy?
For all investment projects market analysis is the key activity for determining the scope of
an investment, the possible production programs, the technology required and often the
choice of location. Two important implications of market study are:
Influence the accept / reject decision- if the demand of the project output is very low, the
project may not be accepted. Error in the assessment of market may lead to accepting of a
project that should be rejected or rejecting a project that should be accepted. Or if it is
wrongly projected, it may lead to wrong investment decision.
 Influence the determination of plant capacity. It may lead to wrong choice of capacity –
 Excess capacity- over investment, idle capacity
 Cost of small capacity – loss of opportunities, loss of the advantage of economy of scale.

Example- The introduction of mobile phone by ETC and the subsequent expansion to
meet the demand seems to be because of error in estimating demand. Initially demand was
under estimated (15,000). Currently the corporation, even after going through many
expansion, it couldn’t satisfy the demand.
Demand analysis requires the market analysis a wider varieties of information and
appropriate forecasting. The kinds of information required to answer the above two critical
questions include:
A. Consumption trends in the past and the present consumption levels
B. Past and present supply position
C. Production possibilities and constraints
D. Import and exports
E. Structure of competition
F. Cost structure
G. Elasticity of demand
H. Consumer behavior, intentions, motivations, attitudes, preferences and
requirements
I. Distribution channels and marketing policies
J. Administrative, technical and legal constraints
These are very important questions in project analysis. Because it calls for in-depth study
and assessment of various factors like patterns of consumption, growth, income and price

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 elasticity of demand, composition of the market, nature of competition, and availability of
substitute so on and so forth. Yet, in many cases project feasibility studies seems to make
a short shrift of market and demand analysis. It is not uncommon to find cursory statement
like "the market is attractive" or "the demand is expected to exceed supply".
Given the importance of market and demand analysis, it should be carried out in an orderly
and systematic manner. The key steps in such analysis are as follows:

 Situational analysis and specification of objectives

 Collection of secondary information
 Conduct market survey
 Characterization of the market
 Demand forecasting and market planning

SITUATIONAL ANALYSIS AND SPECIFICATION OF OBJECTIVES

In order to get a 'feel' for the relationship between the product and its market, the project
analyst may informally talk to customer competitors, intermediaries, and others in the
industry. Wherever possible, he may look at the experiences of the company to learn about
the preferences and punishing power of customers, actions and strategies of competitors.
If such a situational analysis generates enough data to measure the market and enable us
to have a clear picture over projected demand and revenue, a formal study need not be
carried out, particularly when time and cost consideration so suggest. In most cases, of
course a formal study of market and demand is warranted.
To illustrate, suppose that a small but technological competent firm has developed an air
cooler based on a new principle that appears to offer several advantage over the
conventional (former) air cooler.

The chief executive of the firm needs information about where and how to market the new
air cooler. The objectives of market and demand analysis in this case may be to answer the
following questions:
1. Who are the buyers of air cooler?
2. What is the total current demand for air cooler?
3. How is the demand temporarily distributed (pattern of sales over the year) and
geographically?
4. What is the break-up of demand for air coolers of different size?
5. What prices will the customers be willing to pay for the improved air cooler?

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 6. How can potential customers be convinced about the superiority of the new cooler?
7. What price and warranty will ensure its acceptance?
8. What channels of distribution are most suited for the air cooler? What trade margin
will induce distributors to carry it?
9. What are the prospects of immediate sales?

COLLECTION OF SECONDARY INFORMATION

In order to answer the questions listed while delineating the objective of the market study,
information may be obtained from secondary and/or primary sources. Secondary
information is information that has been gathered in some other context and is already
available. Primary information, on the other hand, represents that information which is
collected for the first time to meet the specific purpose on hand. Secondary information
provides the base and the starting point for market and demand analysis. It indicates what
is known and often provides leads and cues for gathering primary information required for
further analysis.
The important source of secondary information useful for market and demand analysis in
Ethiopia is mentioned below.
• census of Ethiopia
• national sample survey reports
• statistical abstracts
• annual survey of industries/agriculture and export
• economic survey
• annual report by national bank of Ethiopia
• bulletin on import and export
• other publications

CONDUCT OF MARKET SURVEY

For undertaking a market survey there is a need to have a sample, which represents the
entire market. Thus, sampling is the process of drawing a limited number of subjects from
a larger population or universe. Since, the researcher cannot survey the entire universe or
population that they are interested, they usually draw a sample of subjects from the
population for investigation.
STEPS IN A SAMPLE SURVEY

Typically, a sample survey consists of the following steps:

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A. Define the target population: in defining the target population, the important terms should be
carefully and unambiguously defined. The target population may be divided into various
segments which may have differing characteristics. For example, all television owners may
be divided into three to four income brackets.
B. Select the sampling scheme and sample size: there are several sampling schemes, simple
random sampling, cluster sampling, sequential sampling, stratified sampling, systematic
sampling and non-probability sampling. Each scheme has its advantage and limitations. The
sample size, other things being equal, has a bearing on the reliability of the estimates – the
larger the sample the greater reliability.
C. Develop the questionnaire: the questionnaire is the principal instrument for eliciting
information from the sample of the respondent. The effectiveness of the questionnaire as a
device for eliciting the desired information depends on its length, the type of questions, and
the wording of questions. Developing the questionnaire require a thorough understanding of
the product, and its usage, imagination, insights into human behavior, appreciation of subtle
linguistic nuances, and familiarity with the tools of descriptive and inferential statistics to be
used later for analysis.
D. Since the quality of the questionnaire has an important bearing on the results of market survey,
the questionnaire should be tried out in a pilot survey and modified in the light of problems/
difficulties noted.
E. Recruit and Train the Field Investigators: recruiting and training of field investigators must be
planned well since it can be time consuming. Great care must be taken for recruiting the right
kind of investigators and imparting the proper kind of training to them.
F. Obtain information as per the questionnaire from the sample respondent: respondent may be
interviewed personally, telephonically, or by mail for obtaining information. Personal
interview ensure a high rate of responses. They are, however, expensive and likely to result in
biased responses because of the presence of the presence of the interviewer. Mail survey is
economical and evokes fairly candid responses. The response rate, however, is often law.
Telephonic interview, common in western countries have very limited applicability in
Ethiopia because telephone tariffs are high and low telephone connection.
G. Scrutinize the information gathered: information gathered should be thoroughly scrutinized to
eliminate data which is internally inconsistent and which is of dubious validity. Sometimes
data inconsistencies may reveal only after some analysis.
H. Analyze and Interpret the Information: information gathered in the survey need to be analyzed
and interpreted with care and imagination. After tabulating it as per a plan of analysis, suitable
statistical investigation may be conducted, wherever possible and necessary. For the purpose
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 of statistical analysis, a variety of methods is available. They may be divided into two broad
categories; parametric and non-parametric methods.
I. Parametric methods assume that the available or the attribute under study conforms to some
unknown distribution. Non-parametric methods do not presuppose any particular
participation.

Results of data based on sample survey will have to be extrapolated to the target
population. Here it should be noted that the results of the market survey can be affected
by:

• non representativeness of sample

• imprecision and inadequacies in the questions,
• failure of the respondent to comprehend the questions
• deliberate distortion in the answer given by the respondent
• checking on the part of the investigators
• slip shod scrutiny of data
• Incorrect and inappropriate analysis and interpretation of data
CHARACTERISTICS OF THE MARKET
Based on the information gathered from secondary sources and through the market survey,
the market for the product may be described in terms of the following:

• Effective demand in the past and present

• Breakdown of demand
• Price
• Methods of distribution and sales promotion
• Consumers
• Supply and competition
• Government policy
 Effective Demand in Past and Present

To gauge the effective demand in the past and present, the starting point typically is
apparent consumption, which is defined as:
Production + Imports – Exports – Changes in Stock Level
In a competitive market, effective demand and apparent consumption are equal. However,
in most of the developing countries, where competitive markets do not exist for a variety

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of products due to exchange restrictions and controls on production and distribution. The
figure of apparent consumption may have to be adjusted for market imperfections.

 Breakdown of Demand

To get a deeper insight into the nature of demand, the aggregate (total) market demand
may be broken down into demand for different segments of the market. Market segments
may be defined by (a) nature of product, (b) consumer groups and (c) geographical
division.
 Nature of product: one generic name of subsumes many different products: for example,
commercial vehicles covers trucks and buses of various capacities and so on and so
forth
 Consumer groups: consumers of product may be divided into industrial consumers and
domestic consumers. Industrial consumers may be sub-divided industry wise.
Domestic consumers may be further divided into different income groups.
 Geographical divisions: a geographical breakdown of consumers, particularly for
products, which have a small value to weight relationship, and products which require
regular, efficient after sales services is helpful.
Why is segmental analysis required? Segmental information is helpful because the nature
of demand tends to vary from one segment to another (the demand for consumers in high
brackets may not be sensitive to price variation) and different marketing strategies may be
appropriate to different market segments.
 Price
Price statistics must be gathered along with statistics pertaining to physical quantities. It
may be helpful to distinguish the following types of prices.
• manufacturer's price quoted as FOB (Free on board) price or CIF (Cost,
insurance and freight) price
• landed price for imported goods
• average wholesale price, and
• average retail price
 Method of Distribution and Sales Promotion
The method of distribution may vary with the nature of product. Capital goods, industrial
raw materials or intermediates, and consumer products tend to have differing distribution
channels. Further, for a given product, distribution methods may vary. Likewise, methods
used for sales promotion (advertising, discount gift schemes etc.) may vary from product

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to product.
The method of distribution and sales promotion employed presently and their rationale
must be specified. Such a study may explain certain patterns of consumption and highlight
the difficulties that may be encountered in marketing the proposed products.

 Consumers
Consumers may be categorized along two dimensions as follows:

Demographic and Sociological Attitudinal

Age Preference
Sex Intentions
Income Habits
Profession Attitudes
Residence Responses
Social background

 Supply and Competition

It is necessary to know the existing source of supply and whether they are foreign or
domestic. For domestic sources of supply, information along the following lines may be
gathered location, present production capacity, planned expansion, capacity utilization
level, bottlenecks in production and cost structure.
Competition from substitute and near substitute should be special because almost any
product may be replaced by some other product may be replace by some other product as
a result of relative charges in price, quality, availability, promotional effort and so on.
 Government Policy
The role of government in influencing the demand and market for a product may be
significant. Governmental plans, policies, legislation and fiats which have a bearing on the
market and demand of the product under examination should be spelt out. These are
reflected in: production target in national plans, import and export trade controls, import
duties, export incentives, excise duties, sales tax, industrial licensing, preferential
purchase, credit controls, financial regulation and subsidies/penalties of various kinds.
 Demand Forecasting and market planning
After gathering information about various aspects of the market and demand from primary
and secondary sources, an attempt may be made to estimate future demand. A wide range
of forecasting method is available to the market analyst. This may be broadly divided into
two categories: qualitative and quantitative methods.
4. Qualitative Methods
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These methods rely essentially on the judgment of experts to translate qualitative information
into quantitative estimate. The important qualitative methods are:
• Jury of executive opinion method: very popular in practice, this method calls for
the pooling of views of a group of executive on expected future sales and
combining them into sales estimates.

• Delphi method: this method involves converting the views of a group of experts,
who do not interact face to face into a forecast through an iterative process.
5. Quantitative methods- uses a formal mathematical method to fit cost functions to past
data observations. Examples include Time series analysis, Regression (correlation)
analysis, Moving average, exponential smoothing etc.
7. Trend projection method (Time series analysis) Time series analysis forecasts based
on an analysis of how variables of interest have moved historically over the past
periods. It does not make a real attempt to analysis why the variables has changed as
they did in the past. The change is only related to time. It helps to forecast about the
future based on what has happened in the past. It is more suitable when changes have
a certain pattern and the same pattern is expected in the future too.
Time series analysis is becoming a very simple task with advancement of computer
spreadsheet technologies. When the trend projection method is used, the most commonly
employed relationship is the linear relationship. Y= a + bx, y= demand for the year
(dependent variable) x= time variable (Independent variable) a =intercept of the
relationship b= Slope of the relation

4.2. Raw Materials and Supplies Study

The different materials and inputs required for the operation of the plant are identified in
this part of the feasibility study, and their availability and supply as well as the method of
estimating the resulting costs, are analyzed and described.

There is a closer relationship between the definition of input requirements and other
aspects of the project formulation, such as the definition of plant capacity, location and
selection of technology and equipment, as these inevitably interact with one another. The
selection of raw materials and supplies depends primarily on the technical requirements of
the project and the analyses of supply markets.

Market and demand analysis

Forecasted demand/period

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 Production policy inventory policy

Labor
Inventory policy requirement
Material
requirement

Inputs for finance

Issues includes,

What types of materials are needed? The requirements of raw materials and factory supplies
should be identified. Where are the sources of the materials and supplies?
 The sources and the constant availability of basic production materials are crucial to the
determination of the technical and economic viability as well as the size of most industrial
projects. A feasibility study must show how the materials and inputs required will be provided.
 Supply risks what are the costs of each material? Not only the availability but also the unit
Estimated costs
costs of basic materials and factory supplies have to be analyzed in detail, as this is a critical
factor for determining project feasibility.
 Relative costs of materials especially when the technology allows the use of different types
of materials
 In the case of domestic materials, current prices have to be viewed in the context of past trends
and future projections of the elasticity of supplies.
 For imported material inputs, CIF (including costs, insurance, and freight) should considered
together with clearing charges (including loading and unloading), port charges, tariffs, local
insurance and taxes, and costs of internal transport to the plant.
Environmental factors such as resources depletion and pollution concern Approach in

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materials and supplies study
1. Classify raw materials and supplies needed into different categories
a. Unprocessed and semi-processed raw materials
b. Processed industrial materials and components
c. Factory supplies, spare parts etc.
2. Prepare specification of requirements (type, quality and quantity of materials) considering
a. Technical factors such as technology and production process, type of machinery and
equipment, production capacity and program.
b. Commercial and financial factors such as market demand regarding products quality,
competition for materials.
c. Socio-economic factors such as skill of work force, environmental policies and regulations
etc.
3. Determine the availability and supply and classify into local and imported categories.
a. Local sources (location and area of supplies, concentrated or dispersed, alternative uses,
transportability and transport costs)
b. Imported (sources , foreign exchange restrictions, reliability of supplies)
4. Estimation of the current and projected prices in the context of past trends and future
prospective. This may include CIF (cost, insurance and freight for imported items) An
important aspect of technical analysis is concerned with defining the materials and utilities
required, specifying their properties in some detail and setting up their supply program.
Material inputs and utilities may be classified into four broad categories:
1. Raw Materials, 2. Processed Industrial Materials and Components, 3 Auxiliary Materials and
Factory Supplies and 4 Utilities
1. Raw Materials

Raw materials (processed and/or semi processed) are those materials which can be taken
as an input to product an output. Raw material could be: agricultural products, mineral
products, livestock and forest products, and marine products.
2. Processed Industrial Materials and Components

Processed industrial materials and components (base metal, semi-processed materials,

manufactured parts, components and sub-assemblies) represents important input for a
number of industries. In studying them, the following questions needs to be answered. In
the case of industrials materials; what are their properties? What is the total requirement
of the project? What quantity would be available from domestic sources? What quantity
would be procured from foreign sources? How dependable the supplies are? What has been
the past trend in price/ what is the likely future behavior of price?

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 3. Auxiliary Materials and Factory Supplies

In addition to the basic raw materials and processed industrial materials and components,
a manufacturing project requires various auxiliary materials and factory supplies like
chemicals, additives, packaging materials, paints, varnishes, oil, greasing, cleaning
materials, etc. The requirement of such auxiliary material should be taken into account in
the feasibility study.
4. Utilities

A broad assessment of utilities (power, water, steam, fuel, etc.) may be made at the time
of input study though a detailed assessment can be made only after formulating the project
with respect to location, technology, and plant capacity.
Manufacturing Process/Technology
It is to be ensured that the manufacturing process to be adopted is modern and at the same
time appropriate to the level of economic development of the country. Where
sophisticated or new process is to be adopted, the advice of a committee of technical
experts is also sought before the project is cleared.
Normally the choice of technology is influenced by a variety of consideration:
 Plant capacity: there is a close relationship between plant capacity and production
technology. To meet a given capacity requirement perhaps only a certain production
technology may be viable.
 Principal Inputs: the choice of technology depends on the principal inputs available for the
project. In some cases, the raw materials available influence the technology chosen.
 Investment outlay and production cost: the effect of alternative technologies on investment
outlay and production cost over a period should be carefully assessed.
 Use by other units: the technology adopted must be proven by successful use by other units.
Latest development: the technology adopted must based on the latest development in order
to ensure that the likelihood of technological obsolescence in the near future, at least, is
minimized.
Ease of absorption: the case with which a particular technology can be absorbed can
influence. The choice of technology, sometimes a high-level technology may be beyond the
adoptive capacity of a developing country, which may train personnel to handle the
technology.
Another issues related with technology is acquiring technology, and appropriateness of
technology. The company can acquire technology by way of
A. Technology licensing

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 B. Outright purchases

C. Joint ventures arrangement

Technology licensing: this gives the licensee (the one who receive the technology) the
right to use patented technology and get related know how on a mutually agreed bases.
The contract for technology licensing should be carefully scrutinized with respect to
i. Definition of technology to be acquired,
ii. Cost of technology licensing,
iii. Guarantees provided by the licensor,
iv. Duration of technology licensing,
v. Purchase of intermediate products, components etc.
Outright purchase (purchase of technology): this mode of acquiring technology may
be used in certain kinds of industries. It’s appropriate when
vi. there is no possibility of significant improvement in technology in the
foreseeable future and
vii. There is hardly any need for technological support from the seller of
technology
Joint venture agreement: the supplier of technology may participate technically as well
as financially in the project. Financial participation is typically in the form of equity
holding. It’s argued that financial participation may strengthen the motivation of
technology supplier to transfer improvement promptly.
Appropriateness of Technology

Appropriate technology refers to those methods of production, which are suitable to local
economic, social and cultural conditions. Those who advocate the appropriateness of
technology urge that the technology should be evaluated in terms of the following
questions:

 Whether the technology utilizes local raw materials?

 Whether the technology utilizes local manpower?
 Whether the goods and services produced cater to the basic needs?
 Whether the technology protects the ecological balance?
 Whether the technology is harmonious with social and cultural conditions?
PRODUCT MIX
The choice of product mix is guided by market requirements. In the production of most of

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the items, variation in size and quality are aimed at satisfying a broad range of customers.
For example, a garment manufacturer may have a wide range of choices in terms of size and
quality to cater to different customers. It may be noted that the variation in quality can enable
a company to expand its market and enjoy higher profitability. Hence, product mix as an
element of technical analysis has to be done well in light of the needs and wants of customers.
4.3. Location, Site and Environment Impact Assessment (EIA)
Location, Site, and Environment Impact Assessment (EIA) is a crucial aspect of project
management that involves evaluating the potential effects of a project on the surrounding location
and environment. It plays a vital role in ensuring sustainable and responsible project development.
When embarking on a new project, selecting the right location and site is essential. The location
of a project can have significant implications for its success, efficiency, and impact on the
environment and surrounding communities. By conducting a thorough assessment of the location
and site, project managers can identify potential risks, opportunities, and mitigation measures to
minimize adverse effects and maximize positive outcomes.
The Environment Impact Assessment (EIA) is a systematic process that examines the potential
environmental consequences of a proposed project. It involves evaluating various environmental
factors, such as air quality, water resources, biodiversity, noise levels, waste management, and
socio-economic aspects. The EIA provides valuable insights into the potential impacts of the
project and helps identify measures to prevent, mitigate, or compensate for any adverse effects.
The process of conducting a Location, Site, and EIA involves gathering relevant data, conducting
field assessments, engaging with stakeholders, and analyzing the findings to make informed
decisions. It requires collaboration between project managers, environmental experts, regulators,
and local communities to ensure a comprehensive and transparent assessment.
By integrating Location, Site, and EIA into project management, organizations can minimize
negative environmental impacts, enhance sustainability, comply with regulatory requirements, and
foster positive relationships with stakeholders. It enables project managers to make informed
decisions, design effective mitigation strategies, and optimize project outcomes while considering
the broader environmental and social context.
In conclusion, Location, Site, and Environment Impact Assessment are integral components of
project management that promote sustainable development and responsible decision-making. By
carefully evaluating the location, site, and potential environmental impacts, project managers can
ensure that projects are implemented in an environmentally and socially responsible manner,
benefiting both the project itself and the surrounding environment and communities.

Location Analysis

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Location analysis has to identify locations suitable for the industrial project under consideration.
A project can potentially be located in a number of alternative regions and it is made from a wide
geographical area within which several alternative sites may have to be considered.

The choice of location is not always based on systematic step by step analysis and assessment of
a gradually reduced number of possible locations ending with the optimum solution. A location
may sometimes be suggested at an early stage by the project promoter.

However, the methodology of analysing such a suggestion is the same and the location in question
will still have to fulfil the key requirements identified as essential or critical for a feasible and
viable implementation, and operation of the project.

The strategic orientation of the choice of suitable locations requires an assessment of

i. Market and marketing aspects,

ii. The availability of critical project inputs, such as raw materials and factory supplies,
iii. Technical project requirements,
iv. The type of industry,
v. Technology and process
vi. Characteristics of products and outputs
vii. Size of the plant
viii. Organizational requirements and management structure

The identification of key requirements helps reduce the number of potential locations and sites at
an early stage. An analysis of key aspects is basically made in qualitative terms and does not enter
into any financial calculations.

The primary task at this stage is rather to sort out unrealistic and less attractive alternatives through
preliminary analysis than to make the correct rating. In the next discussions some of the basic
aspects of location selection are considered.

The Natural Environment: selecting a location for a project, two issues related to the natural
environment shall be critically observed: Climatic conditions and Ecological requirements.

Climatic Conditions: Climate is one of the important factors in the choice of location.

 On the one hand, there is a direct impact on the project costs of such factors as
dehumidification, air conditioning, refrigeration, or special drainage.
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 On the other hand, the environmental effects of the project may be significant. Hence,
information shall be gathered on temperature, rainfall, flooding, dust, fumes, and other
factors for different locations.

In general climatic conditions are relevant in different ways depending on the type of the project.

 Agro industrial projects may for instance experience fluctuating quantities and qualities
of raw materials owing to extreme weather conditions. Means of transport may become
less reliable in the case of heavy snow or rainfall, causing interrupted supplies of
perishable products to distant market.
 In projects with heavy transport and large construction works, extreme climatic
conditions are critical factors making the projects more complicated and expensive.

Climatic conditions can also determine the success of a project in an indirect way. The
construction, operation and management of the plant may be less efficient or more expensive if an
adequately skilled labor force is reluctant to work in areas with extreme climatic conditions.

Thus, climatic conditions shall be specified in terms of

 air temperature,  winds,

 humidity,  precipitation,
 sunshine hours,  Hurricane risk etc.

Each of these can be specified in great detail such as maximum, minimum, and average
temperatures on an average day in particular months or over a period of ten years.

Ecological Requirements

Some projects may not have a negative environmental impact themselves. But they may be
sensitive to such effects. For example, an agro industrial project clearly depends on the use of raw
materials that have not been degraded by contaminated water and soil.

A project using huge volumes of process water with strict quality requirements will suffer if nearby
industries use a river as a recipient of waste water. Management and labor may be reluctant to
work in a factory located in a polluted area with health risks.

Environmental Impact Assessment (EIA)

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Environmental impact assessment (EIA) is an assessment which aims at ensuring that development
projects are environmentally sounded (friendly). Environmental impact assessment is designed to
develop an understanding of the environmental consequences of a newly planned or existing
project and of any project-related activities. This is another critical factor for the selection of
location for a project.

This issue is becoming very sensitive these days, especially, when project feasibility is developed
for applying for international funding. So the feasibility study should include a thorough and
realistic analysis of the environmental impact of industrial investment projects. Environmental
impact assessment is part of the project planning process. Environmental benefits or costs of a
project are usually externalities or side effects that affect the society in whole or in part.

Actual economic actors take decisions in the pursuit of their maximum benefit. When the
identification, measurement and valuation of externalities are not translated into prices via tax and
subsidy arrangements, these actors, while acknowledging the presence of externalities, will take
decisions without taking them into account.
Some examples of tax and subsidy treatment of externalities will help understanding the case:
1. The manufacture of paper pulp demands large quantities of water. In the process, such water
washes away chemical products thus becoming polluted. If the firm throws away that polluted
water as it come out of the process, over-ground and/or underground rivers will become
polluted too. As a consequence:
a. Drinking water will become dangerous for humans and cattle.
b. Fishes will become contaminated too and thus useless as food.
c. Water may become unsuitable for irrigation.
d. Water may become unsuitable for further use in other industrial processes.
e. Tourism and nautical and fishing activities may suffer.
The paper pulp firm will not compute these damages as part of its costs unless a tax is imposed on
the disposal of polluted water.
2. The building of dams for irrigation and electricity results in large artificial lakes that make for
the possibility of
Tourism and water sports developments.
Increase in rainfalls.

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The firm that manages the irrigation and electricity project will not compute these benefits in its
balance sheet unless a subsidy is paid.
3. A further example is a family that repairs and paints the front of its house, planting a garden as
well. All neighbors will benefit but none will pay.
In order to make prices reflect these externalities, in example one a tax may be imposed, calculated
per cubic meter of polluted water. Such tax, by increasing the price of polluted water disposal,
would be giving the right signal to the decentralized decision-making units, in this case the paper
pulp manufacturing firm. The tax would internalize in the polluting unit the cost born by other
decentralized units as a result of that pollution. As a consequence the polluters will face an option
between: Building a system to purify out-flowing water, or paying taxes that will be used either to
purify the water, or to compensate those damaged by the polluted water
In example two the government may either, Grant the rights to exploit tourism and water sports to
the irrigation and electricity company if this is institutionally unfeasible, Sell those rights to
another company and pay the proceedings to the irrigation and electricity company
In example three the state may Grant prizes to the nicest houses in the neighborhood, levying a
tax on real state to finance them, and legislate on the maintenance of pavements and house fronts.
None of those taxes and subsidies is a simple transfer of funds. Tax and subsidy arrangements are
meant to internalize externalities, charging (taxing) decentralized units (firms and families) for the
damages, and paying them for the benefits (subsidies, prizes). These instruments have a role that
was simply non-existent in the past.

Environmental impact assessment is required by law in some countries and could be critical if
international financing is sought for the project. It is also a requirement to include an EIA in a
project feasibility study to get permit.

The general objective of environmental impact assessment being ensuring that development
projects are environmentally sound, to arrive at appropriate decisions, public participation from
the earliest stage throughout the project development cycle is essential.

Environmental impact assessment as a result will have the following specific objectives:

 Prompting a comprehensive, interdisciplinary investigation of the environmental

consequences of the project and its alternatives. Interdisciplinary persons are required because
the environmental impact may have various forms.

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 Developing an understanding of the scope and magnitude of environmental impacts of the
project under alternative designs. Different design may have different impact and costs.
 Incorporating any existing regulatory requirements in the project design, standards,
environmental audit…
 Identifying measures for reducing adverse environmental impacts and enhancing beneficial
impacts.
 Identifying critical environmental problems which require further investigation.
 To assess environmental impacts qualitatively and quantitatively, as required, for the purpose
of determining the overall environmental merit of each alternative.

The environmental impacts of each phase of the project development cycle will usually differ.
During the planning phase for instance, the environmental effects will be strictly social and
economic. New political and social alignments may arise among proponents and opponents.

The impacts of the construction phase are one time effects, while that of those of the operational
phase are recurring. In addition, all the environmental impacts of a project may not be known
immediately. Some of the impacts may be known after a longer period of time.

Socio-Economic Policies

The other factor influencing choice of location is socioeconomic policies. Socio economic policies
encompass two basic factors:

1. Public policies- Government regulations and restrictions about public policies may be
critical for the location of a project. Public policies such as identification of industry zones,
incentives to encourage investment projects etc. are important locational factors.

For example, some area may be prioritized for a certain project and / or tax holiday may be given
for projects in a certain area. Hence investors will consider such advantages in selecting the
location

The impact of public policies has increased considerably in recent years and the extent to which
such policies are applicable to a particular investment proposal should be clearly defined.

Apart from the element of persuasion, public policies may directly determine industrial locations
when there is a substantial involvement of public or institutional finance. Hence the location of
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some public financed projects may be decided by the government regardless of economic, market,
and inputs consideration.

This is because the project may be targeted to balance resource distribution among the society
through locating projects in a backward regions or it may be based on a wider policy for regional
dispersion of industries.

2. The fiscal and legal regulations and procedures- applicable for alternative locations should
be defined. The various national and local authorities to be contacted in respect of power and
water supplies, building regulations, fiscal aspects, security needs, etc. should be listed.

The corporate and individual income taxes, excise taxes, purchases taxes, and other national or
local taxes should be ascertained for different locations together with the incentives and
concessions available for new industries. These could differ considerably for different areas and
may be significant locational determinants in some case. It would also be useful to list any building
and other standards and regulations to which the project need to conform.

Infrastructural Conditions

Relevance of Infrastructure- The availability of a developed and diversified economic and social
infrastructure is often of key importance for a project. The feasibility study should identify such
key infrastructural requirements because they are vital to the operation of any project.

Quantitative and qualitative requirements for energy, utilities, labor, land etc during construction
and operation might be met only in a few locations if the project is of relatively big size. Technical
infrastructure and transport and communication will be seen here.

Technical Infrastructure- the study should analyze whether project requirements regarding
technical infrastructure imply a constraint for the choice of the location. The analysis should cover
the quantities required and other characteristics such as reliability, quality and physical aspects.
The study must distinguish between desirable and critical requirements and demands. Example:
Water, electricity, insurance, banks, academic institutions etc.

Transport and Communication- Transport facilities such as by water, rail, air, or road may be
available for the inflow of various inputs and for the marketing of products. As a result, a project

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that is judged as critically dependent on access to certain means of transport may have limited
number of possible locations.

The availability of good communication facilities including telex and telephone should also be
ascertained for alternative locations. The same reasoning is usually applicable for projects based
on a big consumption of power, water, factory supplies, human resources and waste disposal
mechanisms.

Availability and cost shall be detailed for the total volume of inputs into the proposed plant and
the total outputs leaving the plant with comparisons for various alternative locations. This can be
viewed as tradeoff between proximity to supplies/inputs and proximity to markets for products.

Factory Supplies

Water
The water supply and the water required for a project can be ascertained from the plant capacity
and technology. First the availability of water and costs should be determined, including the
condition of supply price. Second, the quality of the water at various locations should be assessed.
Electricity
The inadequate supply of electricity or its high unit cost may constitute a major constraint for a
project of particular technological process. Power requirement can be defined in relation to plan
capacity, and the supply and cost for location should be studied.

Fuel: The existence of fuel should be assessed.

Human Resources
The availability of managerial staff and skilled labor could be critical factor. When considering
alternative locations, the availability of human resources, including skilled and semi-skilled
worker, should be taken into account.
Choice of Site
Once the location or alternative locations are decided upon, a specific project site or alternative
sites should be defined in the feasibility study. This will require an evaluation of the characteristics
of each site.

The feasibility study should analyze and assess alternative sites on the basis of key aspects and site
specific requirements. Qualitative as well as quantitative considerations are to be taken into
account like that of location selection.
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Differences in existing social infrastructure facilities are sometimes as important as transport costs
for material inputs and product distribution. The analysis should result in a selection of a specific
site and conclusions regarding the feasibility and viability.

The structure of site analysis is basically the same as that of location analysis and the key
requirements identified for the location of the project may give guidance also for site selection.
The selection of specific site for the project could also be done simultaneously with choice of
location and it shouldn’t necessarily be done after location has been selected. Hence, when
considering factors for location analysis, the factors used to evaluate potential sites may also be
listed.

For sites available within a selected area, the following requirements and conditions are to
be assessed:

 Ecological conditions of sites- these include factors such as soil type, site hazards, seismic
history etc.
 Environmental impacts – these include the nature of the project in relation to restrictions,
standards and guide lines of the government concerning noise, air pollution, effects if it is
close to residential areas etc.
 Socio–economic conditions (restrictions, incentives, requirements)
 Costs of land – cost of land differs from site to site depending on of course its proximity to
main streets and other transport facilities, major markets, customers etc. Hence, there will be
some trade off in here. To minimize cost of land, other qualities of the site may be
compromised or vice versa.
 Infrastructure – this concerns the work involved in obtaining utility connections such as
markets, resources, customers etc. and the cost associated with them.
 Site preparation and development costs- some areas are more appropriate for construction
without much preparations and development efforts while other areas may need several works
to make them ready for use. This will contribute to the cost of land.
 Strategy of the projects such as future expansion- some sites may be attractive with the
existing planned capacity but may not enable future expansion. As was discussed previously,
after the project is in operation, the owners may think of expanding it in the future. Hence, a
site that enables such an expansion will be preferred.

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  Cost of utility lines extension
 Size and shape of the available area
 Nature of goods (products) produced (perishables or no)
 Proximity of centers of consumption (market orientation
 Distance to seaport (import and export)

The importance of each of these characteristics varies depending on the nature of the project, the
type of civil construction completed, the weight of the heavier equipment items, the type of effluent
and the number of workers. Hence, different areas within the same region can be subject to various
restrictions and incentives, and environmental conditions may discourage the selection of sites
close to an existing polluting industry such as abattoirs or sites with urban settlements in the
immediate neighbourhood.

4.4. Production Program and Plant Capacity

Production program
After projecting of sales during different stages of production, a feasibility study should define the
detailed production program. A production program should define the levels of output to be
achieved during specified periods and, from this viewpoint, should be directly related to the
specific sales forecasts.
1. The production program should indicate the basic products, by – products, and wastes
during the process.
The demand and market analysis specify the sales program, which should be transformed into the
plant production program taking into account losses of production within the production plant site,
in storage, transportation and by warranty service.
2. The production program (capacity utilization) changes in time during project life. Initially
the production may not be higher than 40 to 50% of the overall design capacity for the first
one or two years of operation because market is not ready to acquire large amounts of new
product or the technological difficulties obstruct the full – capacity operation of the equipment.
Full production capacity is being reached usually towards the third or fourth year and stabilizes for
about 10 to 15 years. The growth of the demand continuous improvement in technology usually
encourages modernization of project, which enables the production growth. After certain period
(probably 30 or more years) the project is terminated due to the low market competitiveness, DE
capitalization of the equipment or sometimes, environmental reasons.

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To plan such a program the various production stages should be considered in detail, both in terms
of production activities and timing. Within the overall plant capacity, there can be various levels
of production activities during different stages determined by various factors in different projects.
It would be prudent to recognize that the full production may not be practicable for most projects
during the initial production operations. The reasons could be:
i) Even if full production were to be achieved in the first year, marketing and sales might prove a
bottle – neck.
ii) At the initial years production may be programmed at well below the full capacity in order to
adjust a gradual growth of demand for a particular product.

iii) Growth of skills in operations can also be a limiting factor in a number of industries and
production has to be tailored to the development of such skills and productivity.
iv) The determinants of a production program during the initial production years vary considerably
from project to project. Thus different approaches would have to be adopted for different
industries:
a) Single – product – continuous process manufacture as a cement production.
b) Multiple – product – continuous process production as in an oil refinery
c) Batch/job order production such as in an engineering workshop and
d) Assembly/mass manufacture as for the production of motor cars
In the first case, the growth of sales may not be a great problem unless production capacity is in
excess of local demand but production problems may be more critical. In the second case, both
production and sales problems may arise. In the third case, though production aspects may present
difficulties, obtaining a satisfactory order book would be critical. In the fourth case, the sales
aspects in relation to price would be dominant.
3) Extraction rates and operating ratios should be effectively determined and adequately
planned.
4) Once a production program defines the levels of outputs in terms of end product, and possibly
of intermediate products and the operating ratio between various production lines and processes,
the specific requirements of materials and labor should be qualified for each stage.
The specific quantities needed for each stage of the production program and costs that these entail
should be determined. The input requirements and costs have to be assessed for:
a) Basic materials such as materials, semi – process, bought – out items etc.
b) Auxiliary materials and factory supplies

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 c) Major utilities and
d) Direct labor requirements
Detailed estimates in this regard should be prepared for the stage of initial production and for stage
of full production.
Determination of Plant capacity
The term “plant capacity” can be generally defined as the volume or number of units that can be
produced during a given period. This definition implies the output expectation from the production
of a plant. Several factors have a bearing on the capacity decision:
 Technological Requirement
 Input constraints
 Investment cost
 Market conditions
 Resources of the firm
 Government policy

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Technological Requirement: For many industrial projects, there is certain Minimum Economic size
determined by the technological factor. For example, a cement plant should have a capacity of at least
300 tons per day in order to use the rotary kiln method, or else it has to employ the vertical shaft
method, which is suitable for lower capacity.
Input Constraints: In developing countries, there may be constraints on the availability of certain
inputs.
 Power supply may be limited
 Basic raw materials may be scarce
 Foreign exchange available for imports may be inadequate
These constraints should be borne in mind while choosing the plant capacity.
Investment Cost: Typically, the investment cost per unit of capacity decreases as the plant capacity
increases.
Market Conditions: the anticipated market for the product has an important bearing on plant
capacity. If the market for the product is likely to be very strong, a plant of higher capacity is
preferable. If the market is likely to be uncertain, it might be advantageous to start with a small
capacity. If the market starting from a small base, is expected to grow rapidly, the initial capacity may
be higher than the initial level of demand, - further addition to capacity may be effected with the
growth of market.
Resources of the Firm: The resources, managerial and financial, available to a firm define a limit on
its capacity decision.
Government Policy: The capacity level may be influenced by the policy of the government. The
minimum Economic capacity policy could be applied in several industries.
The following two capacity terms are used:
Feasible Normal Capacity:
This capacity is achievable under normal working conditions taking into account the installed
equipment and technical conditions of the plant, such as
- Normal stoppages
- Downtime
- Maintenance
- Tool checks
- Desired shift patterns

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 - Indivisibilities of major machines and the management system.
Thus, the feasible normal capacity is the number of units produced during one year under the above
conditions. Feasible Normal Capacity (FNC) is defined by Human Factors and system engineering
that is Plant plus Human.
Nominal Maximum Capacity (NMC):
This is the technically feasible capacity and frequently corresponds to the installed capacity as
guaranteed by the supplier of the plant. Nominal Maximum capacity is defined by system engineering,
that is Equipment installed capacity includes reserve and stand – bye capacity.
To reach maximum output figures, overtime as well as excessive consumption of factory supplies,
utilities, spare parts and wear tear parts, will inflate the normal level of production costs.
FNC < NM
4.5. Technology Selection
It is task of engineering to design the functional and physical layout for the industrial plant necessary
to produce the defined output and to determine the corresponding investment expenditures as well as
the costs arising during the operational phase.
The scope of engineering also includes the plant site and all activities required to deliver both inputs
and outputs and to provide the necessary infrastructure investments
An integral part of engineering at the feasibility stage is
1. The selection of an appropriate technology, and
2. Planning of the acquisition and absorption of this technology and the corresponding know – how.
Technology Choice
 An important factor in determining the production program and plant capacity is the
technology and the know how to be utilized in the project. Therefore, the selection of
appropriate technology and know
 How is a critical element in any feasibility study?
Definition:
The words “technology” or “manufacturing technique” mean a sum of patented and unpainted
knowledge, know how, experience and skills needed for the transformation of raw materials into the
product. In the course of feasibility study preparation the project planner should define technology
required for a particular project through the evaluation of all alternatives and selecting the most
appropriate.

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The selection of technology should be based on a detailed consideration and evaluation of
technological alternatives and the selection of the most suitable alternative in relation to the project or
investment strategy chosen and to socio – economic and ecological condition.
The choice of technology is influenced by a variety of considerations:
 Plant capacity
 Principal inputs
 Investment outlay and production cost
 Use by other units
 Product mix
 Latest developments
 Ease of absorption

Appropriate technology choice is directly related to the conditions of applications in particular

situations.
Technology Evaluation and Selection
Appropriate technology refers to the methods of production, which are suitable to heal economic,
social and cultural conditions. Technology should be evaluated in terms of:
 Whether the technology utilizes local raw materials
 Whether the technology utilized local man power
 Whether the goods and services produced cater the basic needs
 Whether the technology protects ecological balance
 Whether the technology is harmonious with social and cultural conditions
What may be appropriate in industrialized economies with high labor costs may not necessarily be the
optimum for low – wage developing countries, with severe constraints on infrastructure and
availability of inputs.
Industry for export needs to be automated and capital intensive to be competitive. The project planner
should, therefore, have a good knowledge of the present trends in technology development and local
conditions to evaluate all possible technological alternatives.
The most common mistakes at this stage of the evaluation are:
1. Choice of technology which already is or is going to become obsolete in the near future
2. Choice of the new version of existing technology not sufficiently proved and tested.

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3. Choice of technology heavily dependent on the supplies of special semi – products, sub –
assemblies or additives available from a monopoly supplier (i.e. the licensor)
4. .Adoption of technology incompatible with the local conditions (climate, special raw material,
properties, local personnel qualifications)
5. .Under estimation of environmental hazards.
The fundamental question of the technology selection problems is the trade – off between the capital
and labor intensive technologies.
Alternative techniques should be evaluated in order to determine the most suitable technology for the
plant. The alternatives should be compared from capital investment and production costs point of view.
The technology to be selected must be fully proven and utilized in the manufacturing.
Obsolescent technology should be avoided, which means technological trends and the possibility of
using more developed techniques should be studied. The selection of technology has to be related to
the principal inputs that may be available for a project and to an appropriate combination of factor
resources for both the short and the long term.
In countries with a shortage of labor, or where labor is very expensive, capital – intensive techniques
may be appropriate and economically justified. In countries with excess labor, labor saving techniques
may prove unnecessarily expensive. Alternative technologies should also be evaluated with regard to
their environmental impacts. Critical elements such as;
 Economic use of raw materials
 Low emission technologies, and
 Low – waste production processes must be considered for the selection of suitable
technologies.
Technology Acquisition and Transfer
Together with the selection of technology, alternative sources of supply of such technologies should
be located.
A. Industrial Property Rights:
Where a desired technology is patented or covered by registered trademarks, it is necessary to secure
industrial rights from their holders. The management of technology acquisition and transfer largely
consists of ensuring efficient operations and maintenance of the equipment. In several industries,
technology is increasingly found to be only partially embodied in equipment and often comprises
specialized knowledge that may either be covered by industrial property rights such as patents,

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trademarks, copyright and proprietary technology or be in the form of un-patented know – how that is
available from only a limited number of sources. The acquisition of technology in such cases involves
negotiations and contractual arrangements for technology licensing and transfer, apart from purchase
of equipment for particular technological processes.
B. Means of Technology acquisition
The means of acquisition of technology have to be determined. These can take the form of:
A. Technology licensing
B. Outright purchase of technology,
C. A joint venture involving participation in ownership by the technology supplier
1. Technology – licensing:
 Gives the licensee the right to use patented technology and get related know – how on a mutually
agreed basis.
 Often suppliers of technology tend to provide a technology package, which may consist of some
elements, which are not essential.
 Efforts should be made to acquire only the essential components of the technology package
offered by the licenser.
2. Purchase of Technology – it is appropriate when:
 There is no possibility of significant improvement in technology in the foreseeable future, and
There is hardly any need for technological support from the seller technology
3. Joint Venture Arrangement:
 The supplier of technology may participate technically as well as financially
 Financially is typically in the form of equity holding
D. Contract Terms and Conditions:
The contractual terms and conditions for technology acquisition and transfer need to be highlighted in
the Feasibility Study. The contract for technology licensing should be carefully scrutinized with
respect to:
 Definition (process, products, documentation)
 Duration (adaptation, upgrade and renewal)
 Warranty (guarantee to technological and know – how)
 Access to improvement (access to improvement made by licenser)
 Industrial property right (patents and usage right)

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  Payments (a lump sum, or royalties or both)
 Territorial sales right (exclusive and non – exclusive)
 Training (in the plant of licensor or supply of expert)
 Supply of imported input (intermediate products or components)
Selection of Machinery and Equipment
The selection of equipment and technology are interdependent. The requirement of machinery and
equipment should be defined on the basis of the plant capacity and the selected production technology.
Equipment selection should broadly define the optimum group of machinery and equipment necessary
for a specific production capacity by using a specific production technique. The selection of machinery
and equipment could be affected by different factors, that is there are constraints in selecting
machineries and equipment:
 Plant capacity and technological processes
 Infrastructural constraints (the availability of electric power for a large electric furnace, the
transport of heavy equipment to remote area)
 The length of time required for training (highly sophisticated equipment)
 Investment constraints and the availability of foreign exchange
 Maintenance requirements and the availability of maintenance facilities
 Government policies such as import controls (restrict the import of certain types of equipment)
 Another important issue in equipment choice is the degree of automation that may be required.
 Computerized equipment may be required, but the capital costs of automation tend to be high (this
could be viable in developed countries because it replaces high – cost labor)
 The competitive nature of production may require the use of automated equipment, thus necessary
skills must be developed.
In equipment selection, a list of spare parts and tools with their estimated prices are included.
Generally, it is sufficient to stock a three to six month supply though higher stock may be needed.
Stock requirement must be critically evaluated. Machinery and equipment requirements including
spare parts should be broken down in terms of imported equipment and domestically available
machinery.
Cost estimates for imported equipment should be on the basis of C.I.F and landed cost, as well as
internal transport, insurance and other cost up to the plant site. Transport and other cost of domestic
equipment should be incorporated up to the plant site.

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The cost of erection of equipment should be estimated, particularly when this is undertaken as an
independent operation. The lowest installation cost ranges from 1 to 2% and the highest from to 15%
depending on the equipment.
Procurement of plant and machinery could be made from different suppliers or a turnkey contract may
be given for the entire plant and machinery to a single supplier. The factors to be considered in
selecting the suppliers of plant and machinery are:
1. The desired quality of machinery
2. The level of technological sophistication
3. The reputation of the suppliers,
4. The expected delivery schedules
5. The preferred payment term and
6. The required performance guarantee.
Detailed Plant Layout and Basic Engineering
Once data is available on the principal dimension of the project:
 Market size
 Plant capacity
 Production technology
 Machineries and equipment
 Building and civil works
 Conditions obtaining at plant site and
 Supply of inputs to the project, then Project charts and layouts may be prepared.
These define the scope of the project and provide the basis for detailed project engineering and
estimation of investment and production costs. The plant layout is concerned with the physical layout
of factory. In process industries the plant layout is dictated by the production process adopted, while
in manufacturing industries, however, there is much greater flexibility in defining the plant layout.
The important considerations in preparing the plant layout are:
a. Consistency with production technology
b. Smooth flow of goods from one stage to another
c. Proper utilization of space
d. Scope of expansion
e. Minimization of production cost

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 f. Safety of personnel.
Detailed final plant layout needs to be prepared prior to project implementation. The detailed plant
layout and basic engineering design are required in a feasibility study to allow the preparation of cost
estimates, while detailed engineering work would usually not start before a project enters the
implementation phase.
Civil Engineering Works
The feasibility study should provide plans and estimates for the civil works related to the project. This
should cover:
1. Site preparation and development
2. Factory and other buildings
3. Civil engineering works relating to utilities, transport, emissions and effluent discharge,
internal roads, fencing and security, and other facilities and requirements of the plant.
The plans and estimated for civil engineering works should be detailed for costs estimates and
implementation scheduling. The estimates for building and other constructions should be based on
unit costs such as building costs per square meter in the plant surroundings.
Maintenance and Replacement Requirements
An important aspect of project engineering is the determination of critical maintenance and
replacement requirement for the project. Maintenance requirements should be assessed in terms of
both the maintenance equipment that may be necessary for efficient maintenance of the plans and
facilities and the maintenance skills and capability that need to be developed. Replacement
requirements need to be determined for wear – and – tear parts, tools and fixtures and for space parts,
components and materials for plant.
4.6. Organizational and Human Resource
Organizational and Human Resource feasibility study is an essential component of project
management that focuses on assessing the viability and readiness of an organization to undertake a
specific project from a structural and human resource perspective. It involves evaluating the
organization's capacity, capabilities, and human resource requirements to successfully execute the
project.
The organizational feasibility study examines the organization's overall structure, resources, and
processes to determine if it is well-positioned to support the project. It assesses factors such as the
organization's strategic alignment, project management capabilities, financial resources, technology

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infrastructure, and operational readiness. By conducting a thorough organizational feasibility study,
project managers can identify any gaps or challenges that may hinder project implementation and
develop strategies to address them.
The human resource feasibility study focuses on assessing the organization's workforce and talent
requirements for the project. It involves evaluating the availability of skilled personnel, their expertise,
training needs, and the potential need for hiring or outsourcing specific roles. By assessing the
organization's human resource capacity, project managers can ensure that the right people with the
necessary skills and competencies are available to drive project success.
Conducting an organizational and human resource feasibility study provides several benefits. It helps
project managers align the project's objectives with the organization's strategic goals and ensures that
the project is in line with the organization's overall vision. It also helps identify any potential risks or
constraints related to the organization's structure, resources, or workforce early on, allowing for proper
planning and mitigation.
Furthermore, the feasibility study assists in resource allocation and budgeting, as it provides insights
into the financial and human resource requirements of the project. It also highlights any training or
development needs that may arise, allowing for proactive measures to enhance the skills and
capabilities of the workforce.
In conclusion, conducting an organizational and human resource feasibility study is crucial for
effective project management. It enables project managers to assess the organization's readiness,
identify potential challenges, and develop strategies to optimize the utilization of resources and ensure
project success. By considering the organizational and human resource factors, project managers can
enhance the project's chances of meeting its objectives and delivering value to the organization.
4.7. Financial and Economic Analysis
Financial & Economic Analysis Basically, financial analysis should accompany the design of
the project from the very beginning. This is only possible when the financial analyst is integrated
into the feasibility study team at nearly stage. From a financial and economic point of view, investment
can be defined as a long term commitment of economic resources made with the objectives of
producing and obtaining net gains (exceeding the total initial investment) in the future.
4.7.1. Initial investment cost
Initial investment costs are defined as the sum of fixed assets (fixed investment costs plus pre-
production expenditures) and net working capital. Fixed assets constituting the resources required for

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constructing and equipping an investment project, and net working capital corresponding to the
resources needed to operate the project totally or partially.
a) Investment required during plant operation. The economic life time is different for the various
investments (buildings, plant, machinery and equipment, transport equipment etc.). In order to
keep a plant in operation, each item must therefore be replaced at the appropriate time and the
replacement costs must be included in the feasibility study.
b) Pre-production expenditures in every industrial project certain expenditure due, for
example, to the acquisitions or generations of assets are incurred prior to commercial
production. These expenditures, which have to be capitalized, include a number of items
originating during the various stages of project preparation and implementation. These are:
i. Preliminary capital-issue expenditures. These are expenditures incurred during the
registration and formation of the company, including legal fees for preparation of the
memorandum and articles of association and similar documents and for capital issues.
ii. Expenditures for preparation studies. There are three types of expenditures for
preparatory studies:
 Expenditures for pre-investment studies; consultant fees for preparing studies,
 engineering and supervisor of erection and construction;
 other expenses for planning the project
iii. Other pre-production expenditures. Included among other pre-production expenditures are the
following:
 Salaries, fringe benefits and social security contributions of personnel engaged during the
pre-production period.
 Travel expenses
 Preparatory installation, such as workers, camps, temporary offices and stores.
 Pre-production marketing costs, promotional activities, creation of the sales network etc.
 Training costs including fees, travel, living expenses, salaries and stipends of the trainees
and fees payable to external institutions;
 Know-how and patent fees
 Interest on loans accrued or payable during construction
 Insurance costs during construction
iv. Trial runs, start-up and commissioning expenditures.

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This item includes fees payable for supervision of starting-up operation, wage, salaries, fringe benefits
and social security contributions of personnel employed, consumption of production materials and
auxiliary supplies, utilities and other incidental start- up costs.
Operating losses incurred during the running period up to the stage when satisfactory levels are
achieved also have to be capitalization. In allocating pre-production expenditures one of two practices
is generally followed:
 All pre-production expenditures may be capitalized and amortized over a period of time that
is usually shorter than the period over which equipment is depreciated.
 A part of the pre-production expenditures may be initially allocated, where
attributable to the respective fixed assets and the sum of both amortized over a certain number
of years
4.7.2. Production cost
i. Plant and equipment replacement costs. Such costs included all pre-production expenditures
described above and related to investment needed for the replacement of fixed assets. A gain the
estimates include the supply, transport, installation and commissioning of equipment,
together with any costs associated with down time, production losses as well as allowance for physical
contingencies.
ii. End-of life costs. The costs associated with the decommissioning of fixed assets at the end of the
project life, minus any revenues from the sale of the assets at end of the assets life.
 Major items are the costs of
 dismantling,
 disposal and
 Land reclamation.
It is often reasonable to assume that these costs can be offset against the salvage value of the
corresponding asset
A. Fixed assets
As indicated above fixed assets comprise fixed investment costs and pre-production
expenditures. Fixed investment costs:
Fixed investment should include the following main cost items, which may be broken down further,
if required
 Land purchases, site preparation and improvements

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  Building and civil works
 Plant machinery and equipment, including auxiliary equipment
 Certain incorporated fixed assets such as industrial property rights and lump sum payments
for know-how and patents.
B. Net working capital Net working capital is defined to embrace current assets (the sum of
inventories, marketable securities, prepaid items, accounts receivable and cash) minus
current liabilities (accounts payable). It forms an essential part of the initial capital outlays
required for an investment project because it is required to finance the operations of the plant.
Accounts receivable (debtors)
Accounts receivable are trade credits extended to product buyers as a condition of sale; the size of this
item is therefore determined by the credit sales policy of the company.
It is given by the following formula
Debtors = (credit, terms in month ÷12) x values of annual growth sale
4.7.3. Marketing cost
Marketing cost comprises the costs for all marketing activities. It may be divided into
1. Direct marketing costs for each product or product group, such as:
 packaging and storage (if not included in the production costs)
 Sales costs (salesmen commissions, discounts, returned products, royalties, product
advertisement etc.)
 Transport and distribution costs.
2. Indirect marketing costs such as:
 overhead costs of the marketing department (personnel material and communications,
 markets research,
 public relations, and
 Promotional activities are not directly related is a product etc.)
The analysis of these costs involves their assignments to various cost group such as territories, certain
classes of customers (wholesalers, retailers, government institutions etc.) and products or product
group. Marketing and distribution costs fall into the category of period costs even if variable and as
such-are charged against the operations of the accounting period in which they are occurred. For
depreciable investments as required, for marketing and distribution (for example delivery
trucks), depreciation charges are to be included in the computation of total marketing costs

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 4.7.4. Projection of cash flow
Cash flows are basically either receipt of cash (cash inflow) or payments (cash outflows).Typical
operational cash flows for a project are shown below.
Operational cash outflows
 Increase in fixed assets (investment)
 Increase in net working capital
 Operating costs (less depreciation)
 Marketing expenses
 Production and distribution costs
 Corporate (income taxes)
 Operational cash inflows
 Revenues from selling of fixed assets
 Recovery of salvage value (end of project)
 Revenues from decrease of net working Capital
 Sales revenues
 Other income due to plant operations
Basic assumptions underline cash flow discounting in financial evaluation
 The basic assumption underlying the discounted cash-flow concept is that money has a time
value.
 A sum of money available now is worth more than an equal sum available in the future
 This difference can be expressed as a percentage rate indicting the relative change for a
given period which, for practical reasons, is usually a year.
 Considering that a project may obtain a certain amount of funds (F).
 If this sum is repaid after one year including the agreed amount of interest (I) the total sum
to be paid after one year would be (F+I) where, F+I= F (1+r) and r is defined as the interest
rate (in percentage per year) divided by 100 (if the interest rate is, for example12.0 per cent
then r equals 0.12).
4.7.5. Financial evaluation Tools
4.7.5.1. Net present value (NPV)
Difference between the PV of the net cash flows (NCF) from an investment, discounted at the required
rate of return, and the initial investment outlay. Measuring a project’s net cash flows:

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  Forecast expected net profit from project.
 Estimate net cash flows directly.
The standard NPV formula is given by
n

 1 
Ct
NPV   C0
t 1 k t

where:
C0 = initial cash outlay on project
Ct = net cash flow generated by project at time t
n = life of the project
k = required rate of return
NPV = present value of cash flow – present value of initial cost
Decision criteria for NPV
 NPV > 0, Accept the project – it maximizes investors wealth
 NPV < 0, Reject the project
 NPV = 0, Indifferent
Illustration: A firm is considering investing in a project which costs 6,000 Br and has the following
cash flows.
Solution
Year 1 2 3 4
Cash flow 1500 3000 2000 2500

The cost of capital is 10% and the project has no salvage value. Using the NPV method advise the
firm on whether to invest in the project

Year Cash Flow PVIF (10%) PV

1 1500 0.9091 1363.65
2 3000 0.8264 2479.20
3 32000 0.7513 1502.60
4 2500 0.6830 1707.50
Total PV 7053.00

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 Less Project Costs (6000.00)
NPV = 1053.0
 Advantages of NPV
 Considers time value of money
 Gives a decision criteria
 Recognizes uncertainty of cash flow by discounting
 Uses all project cash flows
 Disadvantages of NPV
 Gives absolute values which cannot be used to compare project of different sizes
 There is difficulty in selecting the discount rate to use
 It does not show the exact profitability of the project
4.7.5.2. Internal rate of return (IRR)
The internal rate of return (IRR) is the discount rate that equates the PV of a project’s net cash flows
with its initial cash outlay.
 IRR is the discount rate (or rate of return) at which the net present value is zero.
 The IRR is compared to the required rate of
return (k).
 If IRR > k, the project should be accepted.
Calculation of Internal Rate of Return

 1 k 
Ct
t
 C0  0
t 1

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 where:
C0 = initial cash outlay on project
Ct = net cash flow generated by project at time t
n = life of the project
r = internal rate of return
Where;
R = IRR
 It should be noted that IRR is computed using a trial and error method. However,
financial calculators are programmed to compute IRR
Steps in the IRR trial and error calculation method
 Compute the NPV of the project using an arbitrary selected discount rate.
 If the NPV so computed is positive then try a higher rate and if negative try a lower
 continue this process until the NPV of the project is equal to zero
 Use linear interpolation to determine the exact rate Linear interpolation is given by

Calculation of Internal Rate of Return use the above illustration

Then the IRR Will be

5090 4500 4000

   9000  
1  IRR (1  IRR ) 2
(1  IRR ) 3

IRR  25%
Multiple and Indeterminate Internal Rates of Return
 Conventional projects have a unique rate of return.
 Multiple or no internal rates of return can occur for non-conventional projects with more than
one sign change in the project’s series of cash flows.
 Thus, care must be taken when using the IRR evaluation technique.
 Under IRR: Accept the project if it has a unique IRR > the required rate of return.
4.7.5.3. Benefit cost ratio (BCR)

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The profitability index is calculated by dividing the present value of the future net cash flows by the
initial cash outlay:

PV of net cash flows

Benefit Cost Ratio 
Initial cash outlay
Decision rule:
 Accept if benefit–cost ratio > 1
 Reject if benefit–cost ratio < 1
 PI = 1, Indifferentt
 Advantages of PI
 Recognized time value of money
 Compares projects of different sizes
 Gives a decision criteria
 Disadvantages of PI
 Does not indicate the risk
4.7.5.4. Payback period (PBP)

The payback period is the number of years required to return the original investment from the net cash
flows (net operating income after taxes plus depreciation). When deciding between two or more
competing projects the usual decision is to accept the one with the shortest payback.

Payback is commonly used as a first screening method. It is more popular and easy to apply. The
decision rules are:
 If payback < acceptable time limit, accept project
 If payback > acceptable time limit, reject project

In the simplified case of a project with equal annual cash inflows, it is easy to find the payback period.
Example if a Birr 2 million is invested to earn Birr 500,000 per annum for 7 years, the payback period
is computed as follows:

 Payback period = Br 2million/500,000= 4years

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However, if cash inflows are uneven (a more likely state of affairs), the payback has to be calculated
by working out the cumulative cash flow over the life of a project.

The shorter the payback period is the better the project. However, the limitations of the technique can
be seen when it is used to appraise several projects together and hence compare them.

Merits of payback period as an investment appraisal technique

a. Simplicity- as a concept it is easily understood and is easily calculated,

b. Rapidly changing technology, If new plant is likely to be scrapped in a shorter period because of
obsolescence, a quick payback is essential,
c. Improving investment conditions, When investment conditions are expected to improve in the near
future, attention is directed to those projects which will release funds soonest, to take advantage
of the improved climate,
d. Payback favors projects with a quick return, It is often argued that these are to be preferred for
three reasons
1. Rapid project payback leads to rapid company growth- but in fact such a policy will lead to
many profitable investment opportunities being overlooked because their payback period does
not happen to be particularly swift,
2. Rapid payback minimizes risk (the logic being that the shorter the payback period, the less
there is that can go wrong), Not all risks are related to time, but payback is able to provide a
useful means of assuring time risks (and only time risk), It is likely that earlier cash flows can
be estimated with greater certainty,
3. Rapid paybacks maximize liquidity, But liquidity problems are best dealt with separately,
through cash forecasting,
Critics of payback period as an investment appraisal technique include the following:

a. Project return may be ignored- in particular, cash flows arising after the payback period are
ignored.
b. Timing is ignored-Cash flows are effectively categorized as pre-payback and post payback- but
no more accurate measures is made. In particular, the time value of money is ignored.

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c. Lack of objectivity-There is no objective measures as to what length of time should be set as the
minimum payback period, Investment decisions are therefore subjective.
d. Project profitability is ignored-Payback takes no account of the effects on business profits and
periodic performance of the project, as evidenced in the financial statement. This is critical if the
business is to be reasonably viewed by users of the accounts.

Example: Assume that there are two projects that need initial outflow of Br30 million each and having
the following expected net cash inflows to be evaluated using the payback technique. Required: which
project shall be undertaken if a) They may be undertaken together b) They are mutually exclusive,

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ARR is also known as accrual accounting rate of return, unadjusted rate of return model and the book
value model. Its compilations is related with conventional accounting models of calculating income
and required investment It also shows the effect of an investment on project’s financial statement.

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Advantages of using ARR include the following:
 It is simple to calculate using accounting data
 Earning of each year is included in the calculating the profitability of the project

Disadvantages of using ARR include the following:

 It is inconsistent with wealth maximization as the objective of the firm

 Since it uses the accounting data it includes the amount of accruals in calculating the earnings “net
profit”.

 It is based on the familiar accrual accounting.

 It ignores the time value of money i.e. expected future dollars are erroneously regarded as equal
to present dollars.

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 4.7.5.5. Accounting rate of return (ARR)
Earnings (after depreciation and tax) from a project expressed as a percentage of the investment outlay.
he calculation involves:
 Estimating the average annual earnings to be generated by the project.
 Investment outlay (initial or average).
Fundamental problems of ARR in project valuation:
 Arbitrary measure — based on accounting profit as opposed to cash flows, depends on some
accounting decisions such as treatment of inventory and depreciation.
 Ignores timing of the earnings stream — no time value of money concepts are applied, as equal
weight is given to accounting profits in each year of the project’s life.
Strengths:
 It is a simple method to apply.
 It identifies how long funds are committed to a project.
Weaknesses:
 Inferior to discounted cash flow techniques because it fails to account for the magnitude and
timing of all the project’s cash flows.
 Does not consider how profitable a project will be, just how quickly outlay will be recovered.
4.7.5.6. Break – even analysis (BEA)
Break-even analysis (BEA) is a financial tool commonly used in project management analysis to
determine the point at which a project's total revenue equals its total costs, resulting in neither profit
nor loss. It helps project managers assess the feasibility and profitability of a project by analysing the
relationship between costs, sales volume, and pricing.
Here are some key points to consider when discussing break-even analysis in project
management analysis:
Cost Components: Break-even analysis requires identifying and categorizing the various costs
associated with a project. These costs can include fixed costs (such as rent, salaries, and equipment)
and variable costs (such as raw materials, labour, and utilities). Understanding the cost structure is
crucial for determining the break-even point.
Break-Even Point: The break-even point is the level of sales or production volume at which total
revenue equals total costs. At this point, there is no profit or loss. It serves as a benchmark for project
managers to evaluate the minimum level of sales or output required to cover all costs.

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Contribution Margin: The contribution margin is the difference between the sales price per unit and
the variable cost per unit. It represents the portion of each sale that contributes to covering fixed costs
and generating profit. Understanding the contribution margin is essential in break-even analysis, as it
helps project managers determine how much sales volume is needed to cover fixed costs.
Breakeven Analysis Techniques: Various techniques can be used to perform break-even analysis, such
as the breakeven formula, breakeven charts, and mathematical models. These techniques provide
visual representations and numerical calculations to determine the break-even point and assess the
project's financial viability.
Sensitivity Analysis: Break-even analysis can be enhanced through sensitivity analysis. This involves
examining how changes in key variables, such as sales price, variable costs, or fixed costs, impact the
break-even point. Sensitivity analysis helps project managers understand the project's sensitivity to
different scenarios and make informed decisions.
Decision-Making: Break-even analysis assists project managers in making critical decisions related to
pricing strategies, cost management, sales forecasts, and resource allocation. It helps determine the
required sales volume to achieve profitability, assess the impact of changes in costs or prices, and
evaluate the financial implications of different project scenarios.
Limitations: It is important to consider the limitations of break-even analysis. It assumes a linear
relationship between costs, sales volume, and revenue, which may not always hold true in complex
projects. Other factors, such as market demand, competition, and external economic conditions, can
also influence project profitability and should be taken into account.
In summary, break-even analysis is a valuable tool in project management analysis that enables project
managers to assess the financial viability and profitability of a project. By determining the break-even
point, project managers can make informed decisions regarding pricing, cost management, and
resource allocation to achieve profitability and success.

REVIEW QUESTIONS
For the following question provide the required solution neatly and clearly.
1. Calculate the production cost per unit for a project with total production costs of $50,000 and a
production volume of 10,000 units.
2. Define net present value (NPV) and discuss its usefulness in project evaluation.
3. Calculate the internal rate of return (IRR) for a project with an initial investment of $100,000 and

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 cash inflows of $30,000 per year for five years.
4. Calculate the BCR for a project with total benefits of $500,000 and total costs of $400,000.
5. Define the accounting rate of return (ARR) and discuss its limitations.
6. Calculate the ARR for a project with an average annual profit of $50,000 and an initial investment
of $200,000.
7. Explain the concept of break-even analysis and its significance in project management.
8. Calculate the break-even point for a project with fixed costs of $50,000, a sales price per unit of
$10, and a variable cost per unit of $5.

CHAPTER FIVE
Project Implementation, Monitoring and Evaluation

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 5.1. Organization an overview
The basic building blocks of the traditional form of organization are a functional division of
management and a well-defined hierarchical structure. Typically, a firm is organized in to various
departments, such as production, purchasing, marketing, finance, personnel, engineering, and R&D.
Some of these departments have a line function and others a staff function. Line managers have the
principal responsibility for achieving the goals of the firm and are vested with decision making
authority. Staff managers primarily serve in an advisory capacity-of course, within the staff
departments they enjoy administrative powers.
The traditional form of organization is quite appropriate for handling established operations which
are characterized by continuous flow of repetitive work, with each department attending to its specific
functions-in such a setting, relatively stable inter departmental and inter-personal relationships
emerge. However, the traditional form of organization is not suitable for project management for the
following reasons.
 A project is a non-routine, non-repetitive undertaking often plagued/overwhelmed with
many uncertainties;
 The relationship in a project setting are dynamic, temporary, and flexible; and
 A project requires a coordination of the efforts of person drawn from different functional
areas and contributions of external agencies.

Due to these reasons, project management calls for a different form of organization, sharper tools of
planning and control, and improved means of coping with human problems. This chapter, concerned
with various issues relating to project management is divided into five sections:

 Form of Project Organization

 Project Planning
 Project Control
 Human Aspects of Project Management
 Pre-requisites for successful Project Implementation.
Forms of Project Organization
The traditional form of project organization is not suitable for project work for the following reasons:
1. It has no means of integrating different departments at levels below the top management, and
2. It does not facilitate effective communication, coordination and control, when several functional

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 departments, with different professional backgrounds and orientations are involved in the project
work under time and cost pressures, which often call for overlap, at least partial, of the
development, design, procurement, construction, and commissioning work.

Hence, there is a need for ensuring an individual (or group) with the responsibility for integrating
the activities and functions of the various departments and external organizations involved in the
project work. Such an individual may be called the project manager or project coordinator.
Depending on the authority that is given to the person responsible for the project, the proper
organization may take one of the following three forms:
a. Line and staff organization
b. Divisional organization
c. Matrix organization
5.1.1. Line and staff organization
In this form of organization, a person is appointed with the primary responsibility of coordination
the work of the people in the functional departments. Such a person referred to commonly as the
project coordinator, acts essentially in a staff position to facilitate the coordination of line
management in functional departments. The project coordinator does not have authority and direct
responsibility of the line management. He serves as a focal point for receiving project related
information and seeks to promote the cause of the project by rendering advice, sharing information
and providing assistance. He may gently coax line executives to strive for the fulfillment of
project goals. Deprived of formal organizational authority, he may find it difficult to exert
leadership and feel unsure of his role. His influence would depend on his professional competence,
closeness to top management, and persuasive abilities. Clearly, this is a weak form of organization
which may be employed mostly for small projects- it is certainly not suitable for large projects.
5.1.2. Divisional organization
Under this form of project organization, a separate division is set up to implement the project.
Headed by the Project Manager, this division has its complement of personnel over whom the
project manager has full line of authority. In effect, this form of organization implies the creations
of a separate goal oriented division of the company, with its own functional departments and
typically manage their own hiring, budgeting and advertising. Divisions are more autonomous,
each with its own top executive. While the project manager still has the problem of coordinating

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the inputs of the organizations involved in the project, he has total formal control over the division
he heads.

Advantages:
 It is a very strong form of project organization.
 It facilitate the process of planning and control
 It brings better integration of efforts
 It strengthens the commitment of project related personal to the objective of the project, and
 It considerably improves the prospect of fulfilling the time and budget targets.
Limitations:
 It may entail an inefficient use of the resources of the firm.
 It may result in an unnecessary duplication of specialist in the company, because of the
necessity to allocate them in total to each project.
 It may be difficult to achieve higher degree of specialization of experts because the
divisional project organization may have to be managed with, say, one mechanical
engineer, rather than two specialists.

5.1.3. Matrix organization

The line and functional form of organization is conducive to an efficient use of resources but is not
suitable for an effective realization of project objectives. The divisional form of organization, on
the other hand, is suitable for an effective realization of project objectives but is not conducive to
an efficient use of resources. The matrix form of organization, the third form of project
organization, seeks to achieve the twin objectives of efficient use of resources and effective
realization of project objectives-at the cost of greater organizational complexity of course.

They focus on project teams, bringing skilled individuals together from different parts of the
organization. In a matrix organization, the personnel working on the project have a responsibility
to their functional superior as well to the project manager. This means that the authority is shared
between the project manager and the functional managers. The authority and influence of the
project manager cut across the traditional vertical line of command. While the personnel maintain
the departmental affiliation and are responsible to their functional superiors; they are responsible
to the project manager as well.

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The advantages of a pure matrix organizational form, to project management, include:
 Because key people can be shared, the project cost is minimized
 Conflicts are minimal, and those requiring hierarchical referrals are more easily
resolved
 There is a better balance between time, cost and performance
 Authority and responsibility are shared
 Stress is distributed among the team
Limitations:
 There is dual subordinations
 Responsibility and authority are not commensurate
 The hierarchical principle is ignored.
This is clearly implies that the matrix form of organization involves greater organizational
complexity and creates an inherently conflict full situation. Yet it seems to be better vehicle for
simultaneous pursuit of the twin objectives-efficient utilization of resources and effective
attainment of project objectives.

5.2. Project Planning

Projects involving few activities, resources, constraints and inter-relationships can be visualized
easily by the human mind and planned informally. However, when a project crosses a certain
threshold level of size and complexity, informal planning has to be substituted by formal planning.
The need for formal planning is indeed much greater for project work than for normal operations.
Without effective planning there may be chaos.

Functions of planning
Planning, a vital aspect of management, serves several important functions.
 It provides a basis for organizing work on the project and allocating responsibilities to
individuals.
 It is a means of communication and coordination between all those involved in the project.
 It induces people to look ahead.
 It instills a sense of urgency and time consciousness.
 It establishes the basis for monitoring and control.
Areas of planning

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Comprehensive project planning covers the following:
a) Planning the Project work: the activities relating to the project must be spelt out in detail.
They should be properly scheduled and sequenced.
b) Planning the manpower and organization: the manpower required for the project must be
estimated and the responsibility for carrying out the project work must be allocated.
c) Planning the money: the expenditure of money in a time phased manner must be budgeted.
d) Planning the information system: the information required for monitoring the project must
be defined.

Project Objectives and policies

Often, the focus of project planning is on questions like who does what and when. Before such
operational planning is done, the objectives and policies guiding the project planning exercise must
be articulated. The questions to be answered in this context are: What are the technical and
performance objectives? What are the time and cost goals? To what extent should the work be
given to outside contractors? How many contractors should be employed? What should be the terms
of contract?

Well-defined objectives and policies serve as the framework for the decisions to be made by the
project manager. Throughout the life of the project, he has to seek a compromise between the
conflicting goals of technical performance, cost standard, and time target. A clear articulation of
the priorities of management will enable the project manager to take expeditious actions.

Work -break down structure

The work breakdown structure, as its name suggests, represents a systematic and logical
breakdown of the project into its component parts. It is constructed by dividing the project into its
major parts, with each of these being further divided into sub parts. This is continued till a
breakdown is done in terms of manageable units of work for which responsibility can be defined,
thus the work breakdown structure helps in:
 Effective planning: by dividing the work into manageable elements, which can be
planned, budgeted and controlled.
 Assignment of responsibility for work elements to project personnel and outside agencies.
 Development of control and information system.
Work Breakdown Structure and Project Organization: The project organization represents
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formally how the project personnel and outside agencies are going to work. The work breakdown
structure defines the works to be done in a detailed manner. To assign responsibility for the tasks
to be done, the work breakdown structure has to be integrated with the project organization
structure. This calls for blending the vertical breakdown of the work (as arrived in the work
breakdown structure) with the project organization structure. The result of delineation of a project
tasks which are the specific responsibilities of organizationalunits/managers. The technical name
given to such a project task is cost account. A cost account represents a unit of work (i) which is
defined in fairly concrete terms, (ii) foe which asingle person is responsible, and (iii) for which a
budget of expenditure and manpower requirement can be prepared meaningfully.

Life cycle of a project

The important stages in the life cycle of a project are:

 Project development and preliminary engineering

 Bidding and contract negotiation
 Engineering design
 Purchase and procurement
 Construction
 Commissioning
In planning these stages, one has to bear in mind two concepts: the rolling wave concept and the
integration concept. According to the rolling wave concept, when detailed planning is done for
project development and preliminary engineering, summary planning would be done for the
remaining steps. When the actual work on project development and preliminary engineering
commences, detailed planning would be done for the next stage which is concerned with bidding
and contract negotiation, and so on. According to the integration concept, planning for all stage
must be integrated, even though detailed planning would be done in accordance with the rolling
wave concept. The need for integrative planning stems from the inter-relationship among various
stages of project work. This need is further reinforced when the compulsion to reduce the project
duration leads to overlap at least partial, of various stages of the project.

Tools of project planning

The oldest formal planning tool is the bar chart, also referred to as the Gantt chart or the multiple
activity charts. In the last five decades, network techniques have received considerable attention.

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 This section briefly describes the nature of these tools of planning.

Bar Chart: This is a pictorial device in which the activities are represented by horizontal bars on
the time axis. The left-hand end of the bar shows the beginning time, the right-hand end the ending
time. The duration of the activity is indicated by the length of the bar. The manpower required for
the activity is shown by a number of the bar.

The advantages of the bar chart are:

1. It is simple to understand;
2. It can be used to show progress; and
3. It can be used for manpower planning.
The bar chart, however, suffers from some disadvantages which limit its usefulness:
1. It cannot show interrelationship among activities on large, complex projects;
2. There may be a physical limit to the size of the bar chart, which may limit the size of the
project that can be planned with this technique; and
3. It cannot easily cope with frequent changes or updating
Network Techniques: These are more sophisticated than the traditional bar chart. In these
techniques, the activities, events, and their inter-relationships are represented by a network
diagram, also called an arrow diagram. (Show the network diagram).

The advantages of network techniques are:

a. They can effectively handle inter-relationships among project activities;
b. They identify that activities which are critical to the completion of the project on time
and indicate the float (or spare time) for other activities;
c. They can handle very large and complex projects; and
d. They can be easily computerized and updated.
While the network techniques are a superior tool for project planning, they suffer from several
drawbacks. These are:
a. Being more complicated than the traditional bar chart they are not easily understood by the
project personnel; and
b. They do not define an operational schedule which tells who does what and when.
PERT chart (Program Evaluation Review Technique)
A PERT chart is a project management tool used to schedule, organize, and coordinate tasks within
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a project. PERT stands for Program Evaluation Review Technique a methodology developed by the
U.S. Navy, in the 1950s to manage the Polaris submarine missile program.A similar methodology,
the Critical Path Method (CPM) was developed for project management in the private sector at about
the same time.

A PERT chart presents a graphic illustration of a project as a network diagram consisting of numbered
nodes (either circles or rectangles) representing events, or milestones in the project linked by labeled
vectors (directional lines) representing tasks in the project. The direction ofthe arrows on the lines
indicates the sequence of tasks. In the diagram, for example, the tasks between nodes 1, 2, 4, 8, and
10 must be completed in sequence. These are called dependent or serial tasks. The tasks between
nodes 1 and 2, and nodes 1 and 3 are not dependent on the completion of one to start the other and
can be undertaken simultaneously.

5.3. Project Control

Project control involves a regular comparison of performance against targets, a search for the
causes of deviation, and a commitment to check adverse variances. It serves two major functions:

i. It ensures regular monitoring of performance; and

ii. It motivates project personnel to strive for achieving project objectives.
Reasons for ineffective control
Effective control is critical for the realization of project objectives. Yet, control of projects in

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practice tends to be ineffective. There seems to be three reasons for poor control of projects.

a) Characteristics of the project: Most of the projects are large, complex undertakings
involving many organizations and people. This renders the task of control difficult because:
i. Keeping track of physical performance and expenditure on hundreds or thousands (or tens
of thousands) of activities which are often non-routine is a stupendous task.
ii. Coordination and communication problems multiply when several organizations are
involved in the project.
b) People Problem: To control a non-routine project, a manager requires an ability to monitor a
wide range of disparate factors, sensitivity to symptoms indicative of potential problems, and
a faculty for comprehending the combined effect of multiple forces. Naturally most of the
operational mangers, used to the steady rhythm of normal operations and routine work lack
the experience, training, competence and inclination to control projects.
c) Poor control and information system: One of the factors which inhibit effective control is
the poor quality of control and information system. Some of the weakness observed in the
control and the information system are:
i. Delay in reporting performance: Often there is a delay in the reporting of performance.
This prevents effective monitoring of the project and initiation of timely action to check
adverse developments.
ii. Inappropriate level of details: Generally cost information for control is collected in terms
of cost codes found in the company’s cost accounting system, irrespective of the level of
detail employed for project planning and budgeting. Consider an extreme example wherein
cost and volume of work done are reported for the project as a whole. What is the value of
such information for identifying where slippages are occurring and who is responsible for
them?
iii. Unreliable information: One of the major problems in project control is unreliable and
inaccurate data and information. Often project managers receive reports which suggest that
“everything is okay” or things are “reasonably within control” when the reality is otherwise.
Further, for months after the project is completed, costs dribble in to change a favorable
variance into an unfavorable one or to aggravate an unfavorable variance.

Variance Analysis Approach

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The traditional approach to project control involves a comparison of the actual cost with the
budgeted cost to determine the variance. An example of variance analysis follows:

Costs Activity -A Activity-B

Budgeted cost in the period 50,000 30,000

Cumulative budget to date 200,000 75,000

Actual cost in the period 55,000 28,000

Cumulative actual cost to date 240,000 80,000

Variance for the period (5,000) 2,000

Cumulative variance to date (40,000) (5,000)

The variance analysis approach is inadequate for project control for the following
reasons:
i. It is backward looking rather than forward looking: It tells only what happened in the past
but does not answer the following questions: What will happen in future? Is the rate of work
accelerating or decelerating?
ii. It does not use the data effectively to provide integrated control: The traditional variance
analysis shows whether in the time period under analysis more or less resources were
expended than budgeted. However, it does not indicate the value of work done. This
information is vital for purpose of control.

Performance Analysis: Modern Approach to Control

Effective control over a project requires systematic „Performance Analysis‟. This calls for

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answering the following questions:
 Is the project as a whole (and its individual parts) on schedule, ahead of schedule, or behind
schedule? If there is a variation, where did it occur, why did it occur, who is responsible for
it, and what would be its implications?
 Has the cost of the project as a whole (and its individual parts) been as per budget estimates,
less than the budget estimates, or more than the budget estimates? If there is a variation,
where did it occur, why did it occur, who is responsible for it, and what would be its
implications?
 What is the trend of performance? What would be the likely final cost and completion date
for the project and its individual parts?

For small and simple projects, the project managers would do performance analysis for the project
as a whole, or for its major components. As the project becomes larger and more complex,
performance analysis needs to be done for individual segments of the projects which are referred
to as „cost account‟. A „cost account‟ is a logical management center.

Methods of Analysis: For analyzing the performance at cost account and higher levels of the work
breakdown structure, we employ a method of analysis which takes in to account the value of work
that has been done. In the traditional methods of analysis, the project manager measured the actual
progress against the predetermined schedule and the actual cost against the budget estimate. This
did not enable him to know systematically whether the expenditure incurred was commensurate
with progress. He perhaps relied on subjective estimates.

Performance analysis seeks to remove this subjectivity by employing an analytical framework

based on the following terms.
 BCWS (Budgeted cost for work scheduled): It represents the total of three components
(i) budgets for all work packages, scheduled to be completed
(ii) budgets for the portion in-process work, scheduled to be accomplished and
(iii) Budgets for the overheads for the period.
 BCWP (Budgeted Cost for Work Performance): This is equal to the sum of three
components
(i) Budgets for work packages actually completed

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 (ii) budgets applicable to the completed in-process work and
(iii) overhead budgets
 ACWP (Actual Cost of Work Performed): This represents the actual cost incurred for a
accomplishing the work performed during a particular time period.
 BCTW (Budgeted Cost for Total Work): This is simply the total budgeted cots for the entire
project work.
 ACC (Additional Cost for Completion): This represents the estimate for the additional cost
required for completing the project.

Given the above terms, the project may be monitored along the following lines:
Cost Variance: = BCWP – ACWP

Schedule variance in cost term: = BCWP-BCWS

Cost performance Index: = BCWP/ACWP

Scheduled performance Index: = BCWP/BCWS

Estimate cost performance Index: = BCTW/(ACWP+ACC)

Performance Analysis: An Illustration
A project was begun on 1st January 2008 and was expected to be completed by 30th September
2008. The project is being reviewed on June 30th 2008 when the following information has been
developed.
Items Acronym Cost in Birr

Budgeted cost for work scheduled BCWS 1,500,000

Budgeted cost for work performed BCWP 1,400,000

Actual cost of work performed ACWP 1,600,000

Budgeted cost for total work BCTW 2,500,000

Additional cost for completion ACC 1,200,000

Analysis:
Cost variance: BCWP-ACWP = (1,400,000 – 1,600,000) = - 200,000

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Schedule variance in cost terms: BCWP-BCWS = (1,400,000-1,500,000)= -100,000
Cost performance index: BCWP/ACWP = 1,400,000/1,600,000 = 0.8075
Schedule performance index : BCWP/BCWS = 1,400,000/1,500,000 = 0.933
Estimated cost performance index: BCTW/(ACWP+ACC)

=2,500,000/(1,600,000+1,200,000) = 0.893
5.4. Human Aspects of Project Management
A satisfactory human relations system is essential for the successful execution of a project. Without
such a system, the other systems of project management, however sound they may be by
themselves, are not likely to work well. While technical problems can often be solved with
additional investment of resources, people’s problems may not be amenable to a satisfactory
solution on the short span of the project life.

To achieve satisfactory human relations in the project setting, the project manager must
successfully handle problems and challenges relating to:
 Authority
 Orientation
 Motivation
 Group functioning
Authority
Except in the divisional organization, the project manager whose activities cut across functional
lines of command lacks the desired formal authority over project-related personnel. Without
conventional leverage of hierarchical authority, the project manager has to coordinate the efforts
of various functional groups (within the organization) and outside agencies. While he often has
formal control emanating from contracts and agreements, as far as outside agencies involved in
the project work are concerned, in his own organization he has to contend with split authority and
dual subordination.

Since the project manager works largely with professionals and supervisory personnel, the basis
of the authority would be different from that found in simple superior-subordinate relationships.
For exercising leadership and influence over professional people, he has to explain the logic and
rational for the project activities; show receptivity to the suggestions made by others; avoid

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unilateral imposition of decision; eschew/avoid dogmatic postures; and search for areas of
agreement which can be the basis of acceptable solutions.

His effective authority would stem from his ability to develop a rapport/understanding or (bond)
with the project personnel, his skill in resolving conflict among various people working on the
project, his professional reputation and stature, his skills in communication and persuasion, and
his ability to act as a buffer between the technical, engineering, financial, and commercial people
involved in the project.

Orientation
Most of the managers working for the project are usually engineers (or technologists). Typically,
an engineer:
 Work with physical laws, characterized by mathematical precision, as his tools.
 Adopts a structured, mechanical approach to his problems.
 Seeks an enduring solution to his problem.
 Attaches a high value on technical perfection.
When an engineer assumes managerial responsibilities, he faces a very difficult world in which he
is supposed to:
 Perform the tasks of planning, organizing, directing, and controlling the resources of the
firm in a world of uncertainty.
 Adopt more creative approach to solve non-programmed and unstructured problems.
 Attach greater importance to efficient utilization of resources and resolution of human
relation problems.

Thus the project manager has to strengthen the managerial orientation of project personnel so that
the project goals and objectives can be efficiently achieved within the constraint of time and
budget. Clearly for achieving this task he must himself be an accomplished engineer- manager.

Motivation
The project manager functions within the boundaries of a socio-technical system. Most of the
factors of this system-organizational structure, technical requirements, and competencies of project
personnel-are more or less „given‟ for him. The principal behavioral factor which hecan influence
is the motivation of the project personnel. In this context, he should bear in mind the following:

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  Human beings are motivated by a variety of needs: physiological needs, social needs,
recognition needs, and self-actualization needs. Individuals differ greatly in the importance
they attach to various need satisfaction. Further, their attitudes tend to change with time and
circumstances, and are significantly influenced by their peers and superiors.
 The traditional approach to management was based on the assumption that human beings
regard work as unpleasant, shirk responsibility, and ordinarily employ inefficient and
wasteful methods. Such a conception of human behavior suggests that a great deal of
pressure has to be applied. Behavioral research, however, has shown that while some
pressure is beneficial, an excess of it is undesirable. Beyond a certain point, pressure is
dysfunctional.
 Motivation trends to be strong when the goal set is challenging, yet attainable. If the goal is
too demanding, it results in frustration and conflict; if too lax, it induces complacency.
 Expectation of reward, rather than fear of punishment, has a greater bearing on individual
behavior. Further, the effectiveness of reward or punishment depends on how quickly it is
administered.
 In a project setting where hygiene factors (like pay, physical working conditions, etc.) are
reasonably taken care of, the principal motivators would be a sense of accomplishment and
professional growth. In this setting, the project manager should rely more on participative
methods of management.

In order to succeed in motivating project personnel, the project manager must be a perspective
observer of human beings, must have the ability to appreciate the variable needs of human beings,
must have still in several styles of management suitable to different situation, and must be sensitive
to the reaction of people so that he can act supportively ratherthan threateningly.

Understandably, the project manager has a difficult task. In this endeavor, he can, however, count
on one blessing: the stimulating and satisfying nature of project work. In established organizations
many professional and supervisory personnel find it difficult to see how their efforts redound to
the realization of organizational goals. Separated from top management by several layers of
organizational hierarchy, they are unable to relate their work to the missions of the firm (which
themselves often may be blurred to them). In addition, the jobs in established organizations are
somewhat dull and routine. All this creates a sense of alienation and frustration which dampens

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motivation. Fortunately, in a project setting, where the super ordinate goals are clearly defined and
visible to all involved, where there is usually a great emphasis on participative style of
management, where the layers in the organizational hierarchy are few, and where the jobs are more
challenging, project personnel tend to have greater commitment. Being able to relate their work
easily to the goals of the project, their motivation is usually high.

Group functioning
In a large complex project, many persons drawn from different functions, departments, and
organizations are involved. This leads to formation of groups, formal and informal. In a typical
project organization many interlocking and interdependent groups are formed.

The group formed in a project setting may be of three types: vertical groups, horizontal groups
and mixed groups. A vertical group consists of people drawn from different levels in the same
department, or function, or company. A horizontal group consists of people drawn from different
functions, departments, and companies, but occupying similar hierarchical positions. A mixed
group consists of people drawn from different levels from various functions, departments and
companies.

A vertical group tends to form most naturally because of departmental/functional/ organizational

affinities. However, the existence of such groups may lead to a pronounced “we/they” attitude and
accentuate conflicts. A horizontal group is a useful instrument in linking the overall project
organization. The members of the horizontal group, occupying keypositions in their respective
fields, serve as channels of communication. By their influence, they can strengthen the
commitment to the project. The mixed group tends to promote greatercohesion of the total project
organization. It is very conducive to creating a „project‟ attitude and developing an overriding
commitment for the project. Hence the project manager should strive to establish a mixed group as
the principal group of the project. However, it is difficult to establish such a group because of the
temporary nature of a project-when members of a group know that the group would be dissolved
sooner or later, they retain strong links with their parent company or department.

Building Effective Group: An effective group consists of members who are satisfied and
committed and who strive for the attainment of project objectives, without dissipating their
energies in inter-personal and inter-group conflicts. The manifest signs of an effective group are:

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esprit de corps, pride in the project, supportive behavior, coordinated endeavor, mutual respect,
and resilience during trying periods. An ineffective group, on the other hand, consists of
disgruntled members who are more involved in inter-personal and inter-group rivalries and less
concerned about project goals. Such a group is characterized by apathy, animosity, mutual
bickering, disjointed efforts, cynical attitudes, and low morale.

How can effective groups be established? Studies in group dynamics suggest several stages, which
are partially overlapping, in the formation of an effective group:
 Development of mutual trusts
 Diminution of offensive behavior
 Openness and candor in communication.
 Cooperation and supportive behavior.
 Resolution of differences by mutual negotiation.
For building an effective group, the firm must pursue a genuinely participative style of
management. With this managerial philosophy, the project manager can facilitate the development
of mutual trust and acceptance, open communication, cooperation, and project attitude. In this task,
he needs leadership capabilities, sensitivity to human nature, perceptiveness, concern for welfare
of others, maturity, and impartial approach. Clearly thisis a difficult and challenging task.

5.5. Pre-requisites for successful project implementation:

Time and cost over-runs a project are very common in Ethiopia, particularly in the public sectors.
Due to such time and cost over-runs, projects tend to become uneconomical, resources are not
available to support other projects and economic developments are adversely affected. What can
be done to minimize time and cost over-runs and thereby improve the prospects of the successful
completion of projects? While a lot of things can be done to achieve this goal, the most important
ones appear to be as follows.

 Adequate formulation.
 Sound project organization
 Proper implementation planning.
 Advance action
 Timely availability of funds.

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  Judicious equipment tendering and procurement.
 Better contract management.
 Effective monitoring.
Adequate formulation
Often project formulation is defiant because of one or more of the following shortcomings:

 Superficial field investigation

 Cursory assessment of input requirements
 Slip-shod method used for estimating costs and benefits.
 Omission of project linkages
 Flawed judgments because of lack of experience and expertise
 Undue hurry to get started
 Deliberate over-estimation of benefits and under-estimation of costs.
Care must be taken to avoid the above deficiencies so that the appraisal and formulation ofthe
project is through, adequate and meaningful.

Sound Project Organization

A sound organization for implementation of the projects is critical to its success; the characteristics
of such an organization are:

 It is led by a competent leader who is accountable for the project performance.

 The authority of the project leads and his team is commensurate with theirresponsibility
 Adequate attention is paid to the human being in the project
 System and method are clearly defined
 Rewards and penalties to individuals are related to performance.
Proper implementation Planning
Once the investment decision is taken-and often even while the formulation and appraisal are being
done-it is necessary to do detailed implementation planning before commencing the actual
implementation. Such planning should, inter alia, seek to:

 Develop a comprehensive time plan for various activities like land acquisition, tender
evaluation, recruitment of personnel, construction of buildings, erection of plant,
arrangement for utilities, trial production run, etc.

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  Estimate meticulously the resource requirements (manpower, materials, money, etc.) for
each period to realize the time plan.

 Define properly inter-linkages between various activities of the project.

 Specify cost standards
Advance Action:
When the project appears prima facie to be viable and desirable, advance action on the following
activities may be initiated:
i. Acquisition of land
ii. Securing essential clearance
iii. Identifying technical collaborators/consultants,
iv. Arranging infrastructure facilities ,
v. Preliminary design of engineering, and
vi. Calling of tenders.
To initiate advance action with respect to the above activities, some investment is required. Clearly,
if the project is not finally approved, this investment would represent an in fructuous outlay.
However, the substantial savings (in time and cost) that are expected to occur, should the project
be approved. (a very likely event, given the prima facie desirability of the project) often amply
justify the incurrence of such costs.

Timely availability of fund

Once a project is approved adequate funds must be made available to meet its requirements as per
the plan of implementation-it would be highly desirable if funds are provided even before the final
approval to initiate advance action.

It is a common observation that firms which have a comfortable liquidity position are, in general,
able to implement projects expeditiously and economically. Such firms can initiate advance action
vigorously, negotiate with suppliers and contractors aggressively, organize impute supplies
quickly, take advantages of opportunities to effect economies, support suppliers in resolving their
problems so that they can in turn redound to the successful completion of projects, and sustain the
morale of project-related personnel at a high level.

Judicious equipment tendering and procurement

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To minimize time over-runs, it may appear that a turnkey contract has obvious advantages. Since
these contracts are likely to be bagged by foreign suppliers, when global tenders are floated, a very
important question arises. How much should we rely on foreign suppliers and how much we
depend on indigenous suppliers? Over-dependence on foreign suppliers, even though seemingly
advantageous from the point of view of time and cost, may mean considerable outflow of foreign
exchange and inadequate incentive for the development of indigenous technology and capability.
Over-reliance on indigenous suppliers may mean delays and higher uncertainty about the technical
performance of the project. A judicious balance must be sought which moderates the outflow of
foreign exchange and provides reasonable fillip to the development of indigenous technology. In
many case, the number of contract packages should be kept to a minimum in order to ensure
effective coordination.

Better contact Management

Since a substantial portion of a project is typically executed through contracts, the proper
management of contracts is crucial to the successful implementation of the project. In this context,
the following should be done:
 The competence and capability of all contracts must be ensured-one weak link can jeopardize
the timely performance of the contract.
 Proper discipline must be inculcated among contractors and suppliers by insisting that they
should develop realistic and detailed resource and time plans which are congruent with the
project plan.
 Penalties must be imposed for failure to meet contractual obligations. Likewise, incentives may
be offered for good performance.
 Help should be extended to contractors and suppliers when they have genuine problems-they
should be regarded as partners in a common pursuit.
 Project authorities must retain latitude to off-load contracts (partially or wholly) to other parties
well in time where delays are anticipated.

Effective monitoring
In order to keep a tab on the progress of the project, a system of monitoring must be
established. This helps in:
 Anticipating deviations from the implementation plan.

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  Analyzing emerging problems.
 Taking corrective action.
In developing a system of monitoring, the following points must be borne in mind:
 It should focus sharply on the critical aspects of project implementation.
 It must lay more emphasis on physical milestones and not on financial targets.
 It must be kept relatively simple. If made over-complicated, it may lead to redundant paper
work and diversion of resources. Even worse, monitoring may be viewed as an end in itself
rather than as a means to implement the project successfully.
REVIEW QUESTIONS
For the following question provide the required solution neatly and clearly.
1. Explain the difference between line and staff roles in a project.
2. Define a divisional organization structure and explain its characteristics.
3. Identify two industries where a divisional organization structure is commonly used.
4. Describe a matrix organization structure and its key features.
5. Define project planning and its significance in project management.
6. Discuss the importance of project control in project management.
7. Explain the role of effective communication in managing human aspects of a project.
8. Discuss two challenges that project managers may face when managing teams.
9. Identify three pre-requisites that contribute to successful project implementation.
CHAPTER SIX
SOCIAL COST BENEFIT ANALYSIS (SCBA)
6.0. INTRODUCTION
The term "social costs" refers to all those harmful consequences and damages which the community
on the whole sustains as a result of productive processes and for which private entrepreneurs
are not held responsible. The definition of the concept is comprehensive enough to include
even certain "social opportunity costs", avoidable wastes and social inefficiencies of various kinds.
Implicit in such an appraisal is the assumption that the principal objective of investment decision-
making is to maximize the net present value of monetary flow or some variant of it.
The social cost-benefit analysis is a tool for evaluating the value of money, particularly of public
investments in many economies. It aids in making decisions with respect to the various aspects of a

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project and the design programs of closely interrelated projects. Cost benefit analysis has become
important among economists and consultants in recent years.
6.1. Rationale for SCBA
The essence of the theory of social cost-benefit analysis is that it does not accept that the actual receipts
of a project adequately measure social benefits and actual expenditures measure social costs. The
reason is that actual prices may be an inadequate indicator of economic benefits and costs. For
example, in developing countries like India, the prices of necessities are set low, despite their
economic importance, while the prices of less essential goods are set high (through a system of taxes
and duties). As a result, some projects which appear very profitable when their outputs and inputs are
valued at actual prices are, in fact, unattractive from the viewpoint of the national economy, while
other apparently unprofitable projects have high economic returns. But the theory accepts that
actual receipts and expenditures can be suitably adjusted so that the difference between them,
closely analogous to ordinary profit, will properly reflect the social gain.
In Social-Cost Benefit Analysis (SCBA) the focus is on social costs and benefits of a project. These
often tend to differ from the costs incurred in monetary terms and benefits earned in monetary terms
by the project.
The principal reasons for discrepancy are:
a. Market Imperfections:
Market prices, which form the basis for computing the monetary costs and benefits from the
point of view of project sponsor, reflect social values only under conditions of perfect
competition, which are rarely, if ever, realized by developing countries. When imperfections obtain,
market prices do not reflect social values.
The common market imperfections found in developing countries are:
(i) Rationing, (ii) prescription of minimum wage rates, and (iii) foreign exchange regulation.
Rationing of a commodity means control over its price and distribution. The price paid by a consumer
under rationing is often significantly less than the price that would prevail in a competitive market.
When minimum wage rates are prescribed, the wages paid to labor are usually more than what the
wages would be in a competitive labor market free from such wage legislations. The official rate of
foreign exchange in most of the developing countries, which exercise close regulation over foreign
exchange, is typically less than the rate that would prevail in the absence of foreign exchange
regulation. This is why foreign exchange usually commands premium in unofficial transactions.

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b. Externalities:
A project may have beneficial external effects. For example, it may create certain infrastructural
facilities like roads which benefit the neighboring areas. Such benefits are considered in SCBA, though
they are ignored in assessing the monetary benefits to the project sponsors because they do not
receive any monetary compensation from those who enjoy this external benefit created by the
project. Likewise, a project may have a harmful external effect like environmental pollution. In
SCBA, the cost of such environmental pollution is relevant, though the project sponsors do not incur
any monetary costs. It may be emphasized that externalities are relevant in SCBA because in such
analysis all costs and benefits, irrespective to whom they accrue and whether they are paid for or
not, are relevant.
C. Taxes and Subsidies:
From the private point of view, taxes are definite monetary costs and subsidies are definite
monetary gains. From the social point of view, however, taxes and subsidies are generally
regarded as transfer payments and hence considered irrelevant.
d. Concern for Savings:
Unconcerned about how its benefits are divided between consumption and savings, a private firm does
not put differential valuation on savings and consumption. From a social point of view, however,
the division of benefits between consumption and savings (which leads to investment) is relevant
particularly in capital-scarce developing countries. A rupee of benefits saved is deemed more valuable
than a rupee of benefits consumed. The concern of society for savings and investment is duly reflected
in SCBA wherein a higher valuation is placed on savings and lower valuation is put on
consumption. (v) Concern for redistribution: A private firm does not bother how its benefits are
distributed across various groups in the society. The society, however, is concerned about the
distribution of benefits across different groups. A rupee of benefit going to a poor section is considered
more valuable than a rupee of benefit going to an affluent section.
e. Merit Wants:
Goals and preferences not expressed in the market place, but believed by policy makers to
be in the larger social interest, may be referred to as merit wants. For example, the government
may prefer to promote adult education or a balanced nutrition program for school-going children
even though these are not sought by consumers in the market place. While merit wants are not
relevant from the private point of view, they are important from the social point of view.

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 PROCEDURE OF SCBA
The objective of social cost-benefit analysis is, in its widest sense, to secure and achieve the value of
money in economic life by simply evaluating the costs and benefits of alternative economic choices
and selecting an alternative which offers the largest net benefit, i.e. the highest margin of benefit over
cost.
Very broadly, social-cost benefit analysis involves the following steps:
1. Estimates of costs and benefits which will accrue to the project implementing body.
2. Estimates of costs and benefits which will accrue to individual members of society as consumers or
as suppliers of factor input.
3. Estimates of costs and benefits which will accrue to the community
4. Estimates of costs and benefits which will accrue to the National Exchequer.
5. Discounting the costs and benefits which accrue over a period of time to determine the feasibility of
the project.
Here again, the non-quantifiable benefits are stated only in descriptive terms. These strategies
will work towards the appropriate calculation of the profitability ratio. While this is the general
approach to project formulation, implementation and evaluation, the same may be modified to suit the
circumstances.
MAIN FEATURES OF SOCIAL COST-BENEFIT ANALYSIS
Prest and Turvey defined cost-benefit analysis as "a practical way of assessing the desirability of
projects, where it is important to take a long view in the sense (looking at repercussions in the future
as well as the near future and a wide view in the sense of allowing side-effects of many decisions
relating to industries, regions etc.), i.e., it implies the enumeration and evaluation of all the
relevant cost and benefits". This definition focuses attention on the main features of cost-benefit
analysis.
It covers five distinct issues:
1. Assessing the desirability of projects in the public, as opposed to the private sector.
2. Identification of costs and benefits.
3. Measurement of costs and benefits.
4. The effect of (risk and uncertainty) time in investment appraisal.
5. Presentation of results- the investment criterion.

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 6.2. UNITED NATIONS INDUSTRIAL DEVELOPMENT ORGANISATION (UNIDO)
APPROACH
Towards the end of the sixties and in the early seventies two principal approaches for SCBA emerged:
the UNIDO approach and the Little-Mirrlees approach. This section discusses the UNIDO approach;
the following discusses the Little-Mirrlees approach.
The UNIDO method of project appraisal involves five stages:
1. Calculation of financial profitability of the project measured at market prices.
2. Obtaining the net benefit of project measured in terms of economic (efficiency) prices.
3. Adjustment for the impact of the project on savings and investment.
4. Adjustment for the impact of the project on income distribution.
5. Adjustment for the impact of project on merit goods and demerit goods whose social values differ
from their economic values.
Each stage of appraisal measures the desirability of the project from a different angle.
The measurement of financial profitability of the project in the first stage is similar to the
financial evaluation. So, skipping the first stage, the remaining stages are being discussed here.
Net benefit in terms of Economic (efficiency) Prices Stage two of the UNIDO approach is concerned
with the determination of the net benefit of the project in terms of economic (efficiency) prices, also
ref erred to as shadow prices.
The UNIDO approach suggests three sources of shadow pricing, depending on the impact of the
project on national economy. A project as it uses and produces resources may for any given input or
output
(i) increase or decrease the total consumption in the economy,
(ii) decrease or increase production in the economy,
(iii) decrease imports or increase imports, or
(iv) Increase exports or decrease exports.
If the impact of the project is on consumption in the economy the basis of shadow pricing
is consumer willingness to pay. If the impact of the project is on production in the economy, the basis
of shadow pricing is the cost of production. If the impact of project is on international trade
increase in exports, decrease in imports, increase in imports, or decrease in exports- the basis
of shadow pricing is the foreign exchange value.

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 Shadow pricing of tradable inputs and outputs: A good is fully traded when an increase in its
consumption results in a corresponding increase in import or decrease in export or when an
increase in its production results in a corresponding increase in export or decrease in import. For
fully traded goods, the shadow price is the border price, translated in domestic currency at market
exchange rate. The above definition of a fully traded good implies that domestic changes in demand
or supply affect just the level of imports or exports.
Non-transferable inputs and outputs: A good is non-tradable when the following conditions are
satisfied:
I) its import price (CIF price) is greater than its domestic cost of production and
(ii) Its export price (FOB price) is less than its domestic cost of production.
Adjustment for the impact of the project on income distribution
Adjustment for the impact of project on merit goods and demerit goods whose social values differ from
their economic values
Each stage of appraisal measures the desirability of the project from a different angle. The
measurement of financial profitability of the project in the first stage is similar to the financial
evaluation. So, skipping the first stage, the remaining stages are being discussed here.
6.3. Net Benefit in Terms of Economic Prices
Stage two of the UNIDO approach is concerned with the determination of the net benefit of the project
in terms of economic (efficiency) prices, also referred to as shadow prices.
The UNIDO approach suggests three sources of shadow pricing, depending on the impact of the
project on national economy. A project as it uses and produces resources may for any given input or
output
(i) increase or decrease the total consumption in the economy,
(ii) decrease or increase production in the economy,
(iii) decrease imports or increase imports, or
(iv) Increase exports or decrease exports.
If the impact of the project is on consumption in the economy the basis of shadow pricing
is consumer willingness to pay. If the impact of the project is on production in the economy, the basis
of shadow pricing is the cost of production. If the impact of project is on international trade
increase in exports, decrease in imports, increase in imports, or decrease in exports- the basis
of shadow pricing is the foreign exchange value.

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 Shadow pricing of tradable inputs and outputs: A good is fully traded when an increase in its
consumption results in a corresponding increase in import or decrease in export or when an
increase in its production results in a corresponding increase in export or decrease in import. For
fully traded goods, the shadow price is the border price, translated in domestic currency at market
exchange rate. The above definition of a fully traded good implies that domestic changes in demand
or supply affect just the level of imports or exports.
Non-tradable inputs and outputs: A good is non-tradable when the following conditions are
satisfied: I) its import price (CIF price) is greater than its domestic cost of production and (ii) its export
price (FOB price) is less than its domestic cost of production.
The valuation of non-tradable is done as per the principles of shadow pricing discussed earlier. On the
output side, if the impact of the project is to increase the consumption of the product in the economy,
the measure of value is the marginal consumers' willingness to pay; if the impact of the project
is to substitute other production of the same non- tradable in the economy, the measure of
value is the saving in cost of production. On the input side, if the impact of the project is to reduce
the availability of the input to other users, their willingness to pay for the input represents social value;
if the project's input requirement is met by additional production of it, the production cost of it is the
measure of social value.
Externalities: An externality, also referred to as an external effect, is a special class of good which
has the following characteristics: (i) It is not deliberately created by the project sponsor but is an
incidental outcome of legitimate economic activity; (ii) It is beyond the control of the persons who are
affected by it, for better or for worse. (iii) It is not traded in the market place.
An external effect may be beneficial or harmful. Examples of beneficial external effects are:
i. An oil company drilling in its own fields may generate useful information about oil
potential in the neighboring fields.
ii. The approach roads built by a company may improve the transport system in that area.
iii. The training program of a firm may upgrade the skills of its workers thereby enhancing
their earning power in subsequent employments.
Examples of harmful external effects are:
a. A factory may cause environmental pollution by emitting large volume of smoke and
dirt. People living in the neighbourhood may be exposed to health hazards and put to
inconvenience.

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b. The location of an airport in a certain area may raise noise levels considerably in the
neighbourhood.
c. A highway may cut a farmer's holding in two, separating his grazing land and his cowsheds,
there by adversely affecting his physical output.
Since SCBA seeks to consider all costs and benefits, to whomsoever they may affect, external effects
need to be taken into account. The valuation of external effects is rather difficult because they are
often intangible in nature and there is no market price, which can be used as a starting point.
Their values are estimated by indirect means the above examples serve to emphasize the difficulties
in measuring external effects. In view of this, some economists have suggested that these effects be
ignored. In order to justify their suggestion, they argue that ince a project is likely to have both
beneficial and harmful external effects, one may not err much in assuming that the net effect
would be zero. This argument, seemingly a rationalization for one's ignorance, lacks validity. External
effects must be taken into account wherever it is possible to do so. Even if these effects cannot
be measured in monetary terms, some qualitative evaluation must be attempted.
Measurement of the Impact on Distribution
Stages three and four of the UNIDO method are concerned with measuring the value of a project in
terms of its contribution to savings and income redistribution. To facilitate such assessments we must
first measure the income gained or lost by individual groups within the society.
For income distribution analysis, the society may be divided into various groups. The UNIDO
approach seeks to identify income gains and losses by the following:
(i) Project,
(ii) Other private business, (iii) Government, (IV) Workers, (v) Consumers, (VI) External sector.
There are, however, other equally valid groupings.
The gain or loss to an individual group within the society as a result of the project is equal to the
difference between shadow price and market price of each input or output in the case of
physical resources or the difference between price paid and value received in the case of financial
transaction.
6.4. Savings Impact and its Value
Most of the developing countries face scarcity of capital. Hence the governments of these countries
are concerned about the impact of a project on savings and its value thereof.
Stage three of the UNIDO method, concerned with this, seeks to answer the following questions:

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(i) Given the income distribution impact of the project what would be its effect on savings?
(ii) What is the value of such savings to the society?
Impact on savings of a project is equal to
Where, Yi = change in income of group i as a result of the project
I MPS = marginal propensity to save of group i
Value of savings of a Birr is the present value of the additional consumption stream produced when
that Birr of savings is invested at the margin. The additional stream of consumption generated by a
Birr of investment depends on the marginal productivity of capital and the rate of reinvestment from
additional income. If the marginal productivity of capital is “r” and the rate of reinvestment from
additional income “a”, the additional stream of consumption generated by a Birr of investment can be
worked out. The consumption stream starts with r (1-a) “are” and grows annually at the rate of “are”
forever. Its present value when discounted at the social discount rate k is:
Value of savings of a Birr is the present value of the additional consumption stream produced when
that Birr of savings is invested at the margin. The additional stream of consumption generated by a
Birr of investment depends on the marginal productivity of capital and the rate of reinvestment from
additional income. If the marginal productivity of capital is “r” and the rate of reinvestment from
additional income “a”, the additional stream of consumption generated by a Birr of investment can be
worked out. The consumption stream starts with Where,
I = social value of a rupee of savings (investment)
r = marginal productivity of capital
a = reinvestment rate on additional income arising from investment
k = social discount rate.
Income distribution impact- Many governments regard redistribution of income in favor of
economically weaker sections or economically backward regions as a socially desirable objective.
Due to practical difficulties in pursuing the objective of redistribution entirely through the tax, subsidy,
and transfer measures of the government, investment projects are also considered as instruments for
income redistribution and their contribution toward this goal is considered in their evaluation. This
calls for suitably weighing the net gain or loss by each groups, measured earlier, to reflect the
relative value of income for different groups and summing them.
Adjustment for Merit and Demerit Goods

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In some case, the analysis has to be extended beyond stage four to reflect the difference
between the economic value and social value of resources. This difference exists in the case of merit
goods and demerit goods. A merit good is one for which the social value exceeds the economic value.
For example, a country may place a higher social value than economic value on production of oil
because it reduces dependence on foreign supplies. The concept of merit goods can be extended to
include a socially desirable outcome like creation of employment. In the absence of the project, the
government perhaps would be willing to pay unemployment compensation or provide mere make-
work jobs.
In the case of a demerit good, the social value of the good is less than its economic value. For example,
a country may regard alcoholic products as having social value less than economic value.
The procedure for adjusting for the difference between social value and economic value is as follows:
i. Estimate the economic value.
ii. Calculate the adjustment factor as difference between the ratio of social value to economic value
and unity.
iii. Multiply the economic value by the adjustment factor to obtain the adjustment.
iv. Add the adjustment to the net present value of the project as calculated in stage four.
LITTLE- MIRRLEES APPROACH
I.M.D. little and J.A. Mirrlees have developed an approach (hereafter referred to as the L-M approach)
to social cost benefit analysis. The LM technique assumes that a country can buy and sell any
quantity of a particular good at a given world price. Hence, all traded inputs and outputs are valued
at their international prices (CIF for importable and FOB for exportable) which is the opportunity
cost/value of the particular good to the country. Every input is treated as a fore x outgo and every
output is treated as a fore x inflow. All non-tradable inputs are valued at accounting prices. These costs
are broken up into tradable goods and other non-traded goods. Following this chain of production,
commodities that are either exported or imported are determined for application of accounting
prices. The theory assumes that non-tradable form an insignificant part of operating costs.
Despite considerable similarities there are certain differences between the two approaches:
1. The UNIDO approach measures costs and benefits in terms of domestic rupees whereas
the L-M approach measures costs and benefits in terms of international prices, also referred
to as border prices.
2. The UNIDO approach measures costs and benefits in terms of consumption whereas the

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 Little-Mirrlees approach measures costs and benefits in terms of uncommitted social income
3. The stage-by-stage analysis recommended by the UNIDO approach focuses on efficiency,
savings and redistribution considerations in different stages. The Little-Mirlees approach,
however, tends to view these considerations together.
REVIEW QUESTIONS
For the following question provide the required solution neatly and clearly.
1. Explain the rationale behind conducting a Social Cost-Benefit Analysis (SCBA) for a project.
2. Discuss the key steps involved in conducting an SCBA.
3. Describe the UNIDO approach to project analysis.
4. Discuss the advantages of using the UNIDO approach in project analysis.
5. Define net benefit in terms of economic prices and its significance in project analysis.
6. Explain how economic prices differ from market prices in project analysis.
7. Discuss the concept of savings impact in project analysis.
8. Identify three factors that can influence the savings impact of a project
CHAPTER SEVEN
PROJECT FINANCING
Introduction

Project Finance can be characterized in a variety of ways and there is no universally adopted definition
but as a financing technique, the author’s definition is: “the raising of finance on a Limited Recourse
basis, for the purposes of developing a large capital intensive infrastructure project, where the
borrower is a special purpose vehicle and repayment of the financing by the borrower will be
dependent on the internally generated cash flows of the project”

This definition in itself raises a number of interesting questions, including:

 What do we mean by ‘Limited Recourse’ financing – recourse to whom or what?

 Why Project Finance is typically used to finance large capital intensive infrastructure projects?
 Why is the borrower a special purpose vehicle (SPV) under a project financing?
 What happens if the internally generated cash flows of the project are not sufficient to repay
the financiers of the project?

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Project financing is a funding approach where a lender provides financing to a specific project, and
the project’s cash flows are used to repay the loan. It is commonly used to fund large-scale capital
investments, such as infrastructure and energy projects.

In more detail, project finance involves the public funding of long-term infrastructure and other
capital-intensive projects. Here are some key points:

Definition: Project finance is the funding of long-term infrastructure, industrial projects, and public
services using a non-recourse or limited recourse financial structure. The debt and equity used to
finance the project are paid back from the cash flow generated by the project. Project financing is
especially attractive to the private sector because companies can fund major projects off-balance sheet
(OBS).

How It Works: The funding required for these projects is based entirely on the projected cash flows.
Sponsors of project finance include contractor sponsors, financial sponsors, industrial sponsors, and
public sponsors. During the construction phase of new-build projects, there is no revenue stream, so
debt service only occurs during the operations phase. Project finance structures often involve special
purpose vehicles (SPVs) and off take agreements or power purchase agreements.

Risk and Collateral: Because project finance relies primarily on the project’s cash flow for
repayment, the project’s assets, rights, and interests serve as secondary collateral. Additionally, project
debt is typically held in a sufficient minority subsidiary that is not consolidated on the balance sheet
of the respective shareholders, making it an off-balance sheet item.

In summary, project financing allows for the efficient funding of major projects by aligning repayment
with the project’s cash flow and leveraging the project’s assets as collateral.

7.1.Source of Project Finance

Project finance may come from a variety of sources. The main sources include equity, debt and
government grants. Financing from these alternative sources have important implications on project's
overall cost, cash flow, ultimate liability and claims to project incomes and assets.

Just as with any form of financing, lenders to a project financing extract a return commensurate with
the level of risk. In itself this is a motivation for any form of lending. Lenders to a project financing

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also typically extract additional returns through the provision of the associated products and services
required by the Project Company (e.g. project accounts, trustee roles, hedging and advisory services).
Moreover, ‘behavioral’ studies of project finance loans confirm that as a class of asset, they are
generally robust. A Moody’s survey of 2,639 projects from 1983-2008 showed that 213 of the projects
had a senior loan default, of which the average ultimate recovery rate was 76.4%

7.1.1. Equity Investment: Equity investors, such as private equity firms, venture capitalists, or
individual investors, provide capital in exchange for ownership stakes in the project. They
share in the project’s profits and losses.

7.1.2. Loan Financing: Project debt can be obtained from various sources:

 Commercial Banks: Traditional bank loans are a common source of project financing. The
project’s assets and cash flows serve as collateral.
 Bond Issuance: Companies can issue bonds to raise capital for large projects. These bonds are
typically secured by the project’s assets.
 Export Credit Agencies (ECAs): ECAs provide loans or guarantees to support exports and
international projects. They are often government-backed.
 Multilateral Development Banks (MDBs): Organizations like the World Bank provide long-term
loans for development projects.
 Project Finance Institutions: Specialized institutions focus on project financing, offering tailored
solutions.
 Private Placements: Private investors or institutional investors provide direct loans to the project.
 Infrastructure Funds: These funds invest in infrastructure projects, including energy,
transportation, and utilities.
1. Government Grants and Subsidies: Governments may provide grants, subsidies, or tax
incentives to promote specific projects, especially in areas like renewable energy or public
infrastructure.

2. Off take Agreements: These agreements guarantee a buyer (often a utility company) for the
project’s output. They provide revenue certainty and can attract financing.

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 3. Public-Private Partnerships (PPPs): Collaborations between public and private entities allow
joint financing and risk-sharing for infrastructure projects.

4. Internal Cash Flow: Some companies fund projects using their own retained earnings or
operating cash flow.

7.13. Leasing

Leasing can be utilized as a form of project financing, particularly in cases where acquiring assets
through traditional financing methods may not be feasible or advantageous. Project financing refers
to the long-term financing of infrastructure or capital-intensive projects, where the repayment is
primarily based on the project's cash flow rather than the creditworthiness of the project sponsors.

In a leasing arrangement for project financing, the lessor (leasing company) purchases the necessary
assets for the project and then leases them to the lessee (Project Company) for a specified period. The
lessee makes regular lease payments to the lessor, typically over the project's useful life. These lease
payments are often structured to align with the project's cash flow, making it a suitable financing
option for projects with long payback periods or uncertain revenue streams.

Here are some key characteristics and benefits of using leasing as project financing:

Asset Ownership: The lessor retains ownership of the leased assets, which can be beneficial for the
lessee as it avoids the need for large upfront capital investments and the associated risks of asset
ownership.

Cash Flow Alignment: Lease payments can be structured to match the project's cash flow, making it
easier for the lessee to manage its financial obligations and ensure that payments are affordable based
on project revenue.

Off-Balance Sheet Financing: In certain lease structures, the lessee may be able to keep the lease
obligations off its balance sheet, which can improve financial ratios and borrowing capacity.

Flexibility: Leasing allows for flexibility in terms of lease duration, end-of-lease options, and potential
equipment upgrades or replacements during the lease term.

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Tax Benefits: Depending on the jurisdiction and applicable tax laws, leasing may offer tax advantages
such as deductibility of lease payments.

Risk Transfer: By leasing assets instead of owning them, the lessee can transfer risks associated with
asset ownership, such as maintenance, obsolescence, and disposal, to the lessor.

It's worth noting that leasing as project financing may not be suitable for all types of projects or
industries. The viability of using leasing as a financing option should be assessed on a case-by-case
basis, considering factors such as the nature of the project, asset types, cash flow projections, and
applicable legal and tax regulations. Consulting with financial and legal professionals experienced in
project financing can help determine the most suitable financing structure for a specific project

7.2. Cost of Capital

Cost of Capital refers to the return a company expects on a specific investment to justify the
expenditure of resources. In other words, it determines the rate of return required to persuade investors
to finance a capital budgeting project. Here are the key points:

 Definition: The cost of capital accounts for the returns and investment risks associated with
expanding or facilitating business operations. Businesses may incur this cost from profits, debt,
or equity financing. When a company uses both debt and equity financing, the overall cost of
capital is measured by the Weighted Average Cost of Capital (WACC).
 WACC Calculation: WACC considers the cost of both debt and equity capital. It is calculated by
taking a weighted average of the costs incurred in employing capital. This blended rate accounts
for various types of debt and equity on the company’s balance sheet, including common and
preferred stock, bonds, and other forms of debt.
o Importance:

 Investor Perspective: Investors assess the cost of capital to determine whether an investment’s
potential return justifies the risk. They look at factors like a company’s financial position and
volatility (beta) to evaluate stock prices.
 Company Value: A higher debt level demands greater returns from investors. The weighted
average of equity or debt capital reflects the total premium costs a company owes its investors for
the risk taken.

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 Project Evaluation: Companies use the cost of capital to evaluate new projects. Any investment
decision should generate a return exceeding the firm’s cost of capital. Otherwise, the project won’t
yield returns for investors.
Note, minimizing risks and seizing opportunities ensure future business growth and higher profits. A
healthy investment generates increasing returns that surpass the costs of capital employed.

7.3. Public Policy and Regulations on Financing

To explore the public policy and regulations related to project financing. These guidelines play a
crucial role in shaping how projects are funded, managed, and executed. Here are some key aspects:

1. Project Finance Laws and Regulations:

o The ICLG (International Comparative Legal Guides) provides comprehensive reports on

project finance laws and regulations across 21 jurisdictions. These reports cover various critical
areas, including security, bankruptcy, restrictions, insurance, and arbitration. They offer insights
into legal frameworks that impact project financing.

o These regulations address issues such as:

 Security: How assets are secured to support project financing.

 Enforcement of Security: Procedures for enforcing security interests.
 Foreign Investment and Ownership Restrictions: Rules governing foreign participation.
 Government Approvals/Restrictions: Necessary approvals and limitations.
 Taxation, Insurance, and Arbitration.
2. Handbook for Small and Medium Practitioners:

o For practitioners, understanding contractual arrangements is essential. This includes:

 Designing Contracts: Creating effective contractual structures to support project financing.

 Host Government Legislation: Navigating legislative provisions related to project financing.
 Public-Private Infrastructure Partnerships: Understanding collaboration models.
 Credit Requirements: Assessing lenders’ credit requirements.
 Determining Borrowing Capacity: Evaluating the project’s borrowing capacity.
3. Typical Project Finance Structure:

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In project financing, a common structure involves a Special Purpose Vehicle (SPV) or project
company. Key elements include:

 SPV: A separate legal entity created solely for the project.

 No Previous Business Record: the SPV has any prior business history.
 Financing Sources: Debt and equity financing.
 Risk Allocation: Determining risk-sharing mechanisms.
 Project-Specific Funding: Funding tied directly to the project’s cash flows.
In summary, public policies and regulations shape the landscape of project financing, ensuring
transparency, risk management, and legal compliance. Understanding these guidelines is crucial for
successful project execution.

7.4. Financing institutions

A financial institution (FI) is a company engaged in the business of dealing with financial and
monetary transactions such as deposits, loans, investments, and currency exchange. These institutions
are vital to a functioning capitalist economy, as they match people seeking funds with those who can
lend or invest it. Financial institutions encompass a broad range of business operations within the
financial services sector, including banks, insurance companies, brokerage firms, and investment
dealers. Virtually everyone living in a developed economy has an ongoing or at least periodic need for
a financial institution’s services

At the most basic level, financial institutions allow people to access the money they need. For example,
although banks do many things, their primary role is to take in funds—called deposits—from those
with money, pool the deposits, and lend the money to others who need funds. Banks act as
intermediaries between depositors (who lend money to the bank) and borrowers (who the bank lends
money to). This system works well because while some depositors need their money at any given
moment, most do not. So banks can use deposits to make long-term loans. This applies to almost every
entity and individual in a capitalist system: individuals and households, financial and nonfinancial
firms, and national and local governments. Without financial institutions, businesses could not grow,
and households could only buy goods, education, and housing that the families have cash for today.
Financial institutions serve most people in some way as a critical part of any economy whether in
banking, insurance, or securities markets. Individuals and companies rely on financial institutions for

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transactions and investing. For example, the health of a nation’s banking system is a linchpin of
economic stability. Loss of confidence in a financial institution can easily lead to a bank run

Role of Financing Institutions depending on the interest and privilege of the leaders

 Investment Banks: Investment banks often play a crucial role in structuring project financing
deals. They assist in raising capital through debt issuance, equity offerings, and syndication.
 Development Banks: These institutions specialize in financing projects that contribute to
economic development. They provide long-term loans, grants, and technical assistance.
 Private Equity and Venture Capital: For innovative projects or startups, private equity firms and
venture capitalists may invest directly in the project.
 Public-Private Partnerships (PPPs): These involve collaboration between public entities (such as
governments) and private investors. Financing institutions participate in PPPs to fund
infrastructure projects like highways, airports, and utilities.
 Challenges: Project financing can be complex due to risk assessment, legal agreements, and
ensuring cash flow stability.
Risk Mitigation:

 Financing institutions assess project risks and implement strategies to mitigate them:
 Credit Risk: Evaluating the borrower’s ability to repay debt.
 Market Risk: Assessing market conditions and demand for the project’s output.
 Operational Risk: Ensuring efficient project management and execution.
 Political Risk: Considering regulatory changes, geopolitical stability, and government
support.
 Currency Risk: Managing exposure to foreign exchange fluctuations.
 Project managers collaborate with financing institutions to align risk management efforts.
Project Management and Funding:

 Budgeting and Cost Control: Project managers work closely with financing institutions to create
realistic budgets, monitors expenses, and control costs.
 Cash Flow Management: Ensuring a steady cash flow is critical for project success. Financing
institutions help structure payment schedules.
 Reporting and Compliance: Project managers provide financial reports to financing partners,

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 demonstrating progress and adherence to terms.
 Change Management: When project scope changes, financing institutions must be informed to
adjust funding arrangements.
 Contingency Planning: Both project managers and financing institutions prepare for unexpected
events that may impact project finances.
Sustainable Finance:

 Environmental, Social, and Governance (ESG) Considerations: Financing institutions

increasingly focus on sustainable projects aligned with ESG criteria. Project managers need to
incorporate these principles into project design.
 Green Bonds and Impact Investing: Financing institutions issue green bonds to fund
environmentally friendly projects. Project managers can tap into this growing market.
In summary, the collaboration between financing institutions and project managers is essential for
successful project execution. It involves financial structuring, risk management, and alignment with
broader economic and environmental goals.

REVIEW QUESTIONS
For the following question provide the required solution neatly and clearly.
1. Explain the concept of equity financing in project finance.
2. Discuss the advantages and disadvantages of using equity as a source of project finance.
3. Discuss the concept of leasing as a source of project finance.
4. Define the cost of capital and its significance in project finance.
5. Discuss the factors that can influence the cost of capital for a project.
6. Explain the role of public policy and regulations in project financing.
7. Identify three types of financing institutions involved in project finance.

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 Appendix Review Answers
Unit one answer for review question
1. Project is a temporary endeavour with a specific goal, defined scope, and set time frame. Its main
attributes include being unique, having a defined start and end date, involving multiple
stakeholders, and requiring dedicated resources. Projects differ from day-to-day jobs as they are
temporary and focused on achieving specific objectives.
The triple constraint in project management refers to the interconnected relationship between three
key factors: scope, time, and cost. Changing one of these factors will have an impact on the other two.
For example, increasing the scope of a project might require more time and resources, thus affecting
the overall cost.
2. Project management is the application of knowledge, skills, tools, and techniques to project
activities in order to meet project objectives. It involves planning, organizing, and managing
resources to complete a project within defined constraints.
The project management framework consists of various components, including stakeholders
(individuals or groups with an interest in the project), knowledge areas (such as scope, time, cost,
quality, risk, etc.), tools and techniques (e.g., Gantt charts, critical path analysis, risk assessment), and
project success factors (such as delivering the project on time, within budget, and meeting stakeholder
expectations).
Example stakeholders can include the project sponsor, team members, customers, end-users, and
regulatory bodies. Knowledge areas encompass various aspects of project management, and tools and
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techniques refer to specific methodologies or approaches used for planning, executing, and controlling
projects.
3. Project management and program management are closely related disciplines. Project
management focuses on the management of individual projects, while program management
involves overseeing a group of related projects to achieve strategic objectives.
Program management contributes to enterprise success by aligning multiple projects with the
organization's strategic goals, optimizing resource utilization, managing interdependencies between
projects, and ensuring effective communication and coordination.

4. The role of a project manager is to plan, execute, and manage a specific project, ensuring its
successful completion. They are responsible for defining project goals, creating a project plan,
managing resources, monitoring progress, and addressing risks and issues.
Suggested skills for project managers include leadership, communication, problem-solving, and
organizational abilities. They should also have expertise in specific areas related to the project, such
as technology, construction, or marketing.
Program managers, in addition to the skills required for project management, need to have a broader
perspective and strategic thinking. They focus on organizational goals, manage multiple projects, align
resources, coordinate stakeholders, and ensure the overall success of the program.
5. There is a renewed interest in project management due to several factors. Firstly, organizations
have recognized the importance of effective project management in achieving strategic objectives
and delivering successful outcomes. Project management helps improve efficiency, minimize
risks, and enhance project success rates.
Secondly, the increasing complexity and globalization of projects have led to a greater need for
structured approaches and methodologies to manage them effectively. Project management provides
a framework for planning, executing, and controlling projects, ensuring that they are completed within
defined constraints.
Lastly, the recognition of project management as a profession and the availability of certifications and
professional development opportunities have contributed to the growing interest in the field.
Professionals are seeking to enhance their project management skills and credentials to advance their
careers and increase their value in the job market.
Unit two answer for review questions

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1. The project cycle refers to the sequential and iterative process of planning, implementing,
monitoring, and evaluating a project from its inception to its completion. It involves various stages
and activities aimed at achieving project objectives within defined constraints.
2. The different phases in the project cycle are:
a. Identification: In this phase, the need for a project is identified, and its feasibility is assessed.
b. Preparation: This phase involves developing a comprehensive project plan, including defining
the project scope, objectives, activities, and resources required.
c. Appraisal/Decision: During this phase, the project proposal is reviewed, analysed, and evaluated
to determine its viability and alignment with organizational goals. A decision is made regarding
project approval.
d. Implementation: In this phase, the project plan is executed, and the project activities are carried
out according to the defined schedule and allocated resources.
e. Operation: This phase involves the operation and maintenance of the project deliverables,
ensuring their sustainability and functionality after completion.
f. Ex-post evaluation: Also known as project evaluation or post-project evaluation, this phase
assesses the outcomes, impacts, and effectiveness of the project after its completion. Lessons
learned are documented for future projects.
3. The benefits of good project cycle management include:
 Clear understanding of project objectives, activities, and timelines.
 Efficient allocation and utilization of resources.
 Effective monitoring and control of project progress.
 Improved decision-making based on timely and accurate information.
 Enhanced stakeholder engagement and collaboration.
 Increased likelihood of achieving project goals and desired outcomes.
 Facilitates learning and continuous improvement through evaluation and feedback.
4. A simple project cycle with key decision points can be represented as follows:
Identification -> Preparation -> Appraisal/Decision -> Implementation -> Operation -> Ex-post
evaluation
↑↑
Decision Point 1 Decision Point 2
Decision Point 1: Assessing the feasibility and viability of the project proposal.

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Decision Point 2: Evaluating the project outcomes and determining its success.
5. Participation in project cycle management is important because it:
a. Enhances stakeholder ownership and commitment to the project.
b. Facilitates the inclusion of diverse perspectives and expertise.
c. Improves the quality and relevance of project decisions.
d. Fosters collaboration, cooperation, and mutual understanding among stakeholders.
e. Increases the likelihood of sustainable project outcomes and community acceptance.
f. Empowers stakeholders by involving them in decision-making processes.
g. Promotes transparency, accountability, and trust in project management.
6. Main differences between the six phases of the project cycle:
a. Identification: In this phase, the need for a project is identified and its feasibility is assessed,
including its alignment with organizational goals and the availability of resources.
b. Preparation: This phase involves developing a comprehensive project plan, including defining the
project scope, objectives, activities, and resources required. It focuses on detailed planning and
resource allocation.
c. Appraisal/Decision: During this phase, the project proposal is reviewed, analysed, and evaluated
to determine its viability, potential risks, and benefits. A decision is made regarding project
approval or rejection.
d. Implementation: In this phase, the project plan is executed, and the project activities are carried
out according to the defined schedule and allocated resources. It involves project execution, team
coordination, and monitoring of progress.
e. Operation: This phase focuses on the operation and maintenance of the project deliverables,
ensuring their sustainability and functionality after completion. It involves activities to support
the on-going use and effectiveness of project outcomes.
f. Ex-post evaluation: Also known as project evaluation or post-project evaluation, this phase
assesses the outcomes, impacts, and effectiveness of the project after its completion. It involves
analysing project success, identifying lessons learned, and documenting recommendations for
future projects.
Unit three answer for review questions
1. The key elements or characteristics of a well-defined project idea include:
 Clear objectives , Feasibility, Stakeholder alignment, Scope and boundaries, Value

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 proposition and Sustainability
2. A project idea differs from a general goal or objective in that it is a specific concept or proposal
for a project, whereas a goal or objective is a broader outcome or target that may encompass multiple
projects. A project idea is more concrete and actionable, providing a basis for project planning and
implementation.
3. A strong project idea contributes to project success and stakeholder engagement by:
 Providing a clear and compelling vision
 Guiding project planning and decision-making
 Generating support and resources
 Addressing stakeholder needs
4. Some external factors or trends that can serve as macro sources of project ideas include:
 Economic trends: Changes in the economy, such as emerging markets, industry growth, or
technological advancements, can create opportunities for new projects.
 Social and demographic trends: Shifts in demographics, consumer preferences, or societal values
can inspire projects that cater to changing needs and demands.
 Environmental factors: Concerns about sustainability, climate change, or resource management
can drive projects focused on environmental conservation or renewable energy.
 Regulatory changes: New laws, regulations, or policies can create project opportunities in areas
such as compliance, safety, or public services.
5. Monitoring industry trends and market demands can inspire project ideas by:
 Identifying gaps or unmet needs: Analysing market trends and customer demands can reveal areas
where new products, services, or solutions are needed.
 Spotting emerging opportunities: Keeping track of industry developments and technological
advancements can uncover opportunities for innovative projects.
 Adapting to market changes: Monitoring market trends helps organizations stay agile and
responsive, enabling them to initiate projects that address evolving market demands.
6. Technological advancements at a larger scale can drive project ideas by:
a. Enabling innovation: New technologies often create possibilities for disruptive or transformative
projects, such as implementing automation, artificial intelligence, or block chain solutions.
b. Improving efficiency and effectiveness: Technological advancements may inspire projects aimed
at streamlining processes, enhancing productivity, or optimizing resource utilization.

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c. Addressing emerging challenges: Projects driven by technological advancements can help
organizations adapt to changing digital landscapes, cyber security threats, or data management
requirements.
7. Analysing internal processes and operations can generate micro-level project ideas by:
 Identifying areas for improvement: Assessing internal processes can uncover inefficiencies,
bottlenecks, or gaps that could be addressed through targeted projects.
 Enhancing operational effectiveness: Micro-level project ideas can focus on optimizing specific
functions, improving workflows, or implementing new systems or tools to enhance organizational
performance.
 Streamlining internal communication and collaboration: Projects can be initiated to improve
internal communication channels, knowledge sharing, or teamwork, leading to increased
efficiency and collaboration.
8. Customer feedback and needs can be utilized as micro sources of project ideas by:
I. Listening to customer feedback: Actively seeking and analysing customer feedback can provide
insights into their needs, preferences, and pain points, generating project ideas aimed at
addressing those concerns.
II. Conducting market research: Gathering data on customer behaviour, market trends, and
competitor analysis can reveal opportunities for new projects that cater to specific customer
segments or market niches.
III. Co-creation and customer involvement: Engaging customers in the project ideation process
through co-creation or participatory design approaches can generate project ideas that directly
address their needs and expectations.
9. Employees can contribute to generating micro-level project ideas through their expertise or
suggestions by:
 Tapping into their knowledge and insights: Employees possess valuable expertise and industry-
specific knowledge that can inspire project ideas or improvements to existing processes.
 Encouraging suggestions and feedback: Creating a culture that values and encourages employee
suggestions can generate project ideas that leverage their unique perspectives and frontline
experiences.
 Empowering employees: Providing opportunities for employees to contribute to project ideation,
such as through brainstorming sessions or innovation challenges, allows them to actively

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 participate in generating micro-level project ideas.
10. Brainstorming and collaboration play a crucial role in identifying micro-level project ideas
by:
a. Stimulating creativity: Brainstorming sessions and collaborative discussions create an
environment where diverse perspectives and ideas can emerge, sparking creativity and innovation.
b. Building on collective knowledge: Collaboration allows team members to build on each other's
ideas, refining and expanding upon initial concepts to generate more robust project ideas.
c. Enhancing problem-solving: Brainstorming and collaboration enable teams to collectively
analyse challenges, identify potential solutions, and develop project ideas that address specific
issues.
d. Fostering ownership and engagement: Involving team members in the ideation process through
brainstorming and collaboration fosters a sense of ownership and engagement, increasing their
commitment to the project's success.
Unit four answer for review questions
1. To calculate the production cost per unit, divide the total production costs by the production volume:
 Production cost per unit = Total production costs / Production volume
 Production cost per unit = $50,000 / 10,000 units
 Production cost per unit = $5 per unit
2. Net Present Value (NPV) is a financial metric used in project evaluation to assess the profitability
of an investment over time. It calculates the present value of cash inflows and outflows associated
with a project, considering the time value of money. The usefulness of NPV lies in its ability to
determine whether a project is expected to generate positive or negative net cash flows and whether it
is financially viable. A positive NPV indicates that the project is expected to generate more value than
the initial investment, making it desirable from a financial perspective.
3. To calculate the internal rate of return (IRR), one need to find the discount rate that makes the net
present value (NPV) of the project equal to zero. In this case, the cash inflows are $30,000 per year
for five years, and the initial investment is $100,000. We can use a financial calculator or spread sheet
software to find the IRR, which turns out to be approximately 19.56%.
4. The Benefit-Cost Ratio (BCR) is calculated by dividing the total benefits of a project by the total
costs. In this case, the BCR is calculated as follows:
BCR = Total benefits / Total costs

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BCR = $500,000 / $400,000
BCR = 1.25
A BCR greater than 1 indicates that the project's benefits outweigh the costs, making it financially
favourable.
5. Accounting Rate of Return (ARR) is a financial metric used to evaluate the profitability of an
investment by comparing the average annual accounting profit to the initial investment. However,
ARR has limitations. It does not consider the time value of money, ignores cash flows beyond the
average annual profit, and relies on accounting measures that can be manipulated. ARR also fails to
account for the project's risk or the opportunity cost of capital, making it a less reliable measure for
investment decision-making.
6. To calculate the Accounting Rate of Return (ARR), divide the average annual profit by the initial
investment and express it as a percentage:
ARR = (Average annual profit / Initial investment) x 100%
ARR = ($50,000 / $200,000) x 100%
ARR = 25%
The ARR in this case is 25%.
7. Break-even analysis is a financial analysis tool used in project management to determine the point
at which total costs equal total revenues, resulting in neither profit nor loss. It helps identify the sales
volume or level of activity needed to cover all costs. Break-even analysis is significant in project
management as it provides insights into the minimum level of performance required for a project to
be financially viable, assists in pricing decisions, and helps assess the project's risk and potential
profitability.
8. To calculate the break-even point, divide the fixed costs by the difference between the sales price
per unit and the variable cost per unit:
Break-even point (in units) = Fixed costs / (Sales price per unit - Variable cost per unit)
Break-even point (in units) = $50,000 / ($10 - $5)
Break-even point (in units) = $50,000 / $5
Break-even point (in units) = 10,000 units
Therefore, the break-even point for this project is 10,000 units.
Unit five answer for review question
1. Line roles in a project refer to positions directly involved in the core activities and operations of the

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project. They have authority and responsibility for achieving project objectives. Staff roles, on the
other hand, provide support, expertise, and advisory services to the line roles. They assist in specialized
areas such as project planning, quality assurance, HR, finance, or legal matters.
2. A divisional organization structure is a hierarchical structure where different divisions or business
units operate as separate entities, each with its own functions, resources, and leadership.
Characteristics of a divisional structure include decentralized decision-making, divisional autonomy;
focus on specific products or markets, and efficient coordination within each division.
3. Two industries where a divisional organization structure is commonly used are:
a. Consumer goods industry: Companies in this industry often adopt a divisional structure to manage
different product lines or brands effectively. Each division focuses on a specific product category,
allowing for specialized expertise and efficient management.
b. Pharmaceutical industry: Due to the complex nature of drug development and commercialization,
pharmaceutical companies often adopt a divisional structure. Divisions may be organized based
on therapeutic areas or specific stages of the drug development process.
4. A matrix organization structure combines functional and project-based reporting lines. It features
dual reporting, where employees report to both a functional manager (based on their expertise) and a
project manager (based on the project they are working on). Key features of a matrix structure include
cross-functional teams, shared resources, increased communication, and a balance between functional
specialization and project focus.
5. Project planning is the process of defining project objectives, determining the necessary tasks,
estimating resources and timelines, and creating a roadmap for project execution. It involves
developing a comprehensive project plan that outlines the project scope, activities, milestones,
deliverables, and resource allocation. Project planning is significant in project management as it
provides clarity, sets expectations, guides project execution, and helps manage risks and uncertainties.
6. Project control refers to the on-going monitoring, measurement, and adjustment of project activities
to ensure that the project is progressing as planned and meeting its objectives. It involves tracking
project performance, comparing it against the project plan, identifying deviations or variances, and
taking corrective actions when necessary. Project control is important in project management as it
helps maintain project quality, manage risks, optimize resource utilization, and ensure timely delivery
of project outcomes.
7. Effective communication plays a crucial role in managing the human aspects of a project. It involves

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clear and timely exchange of information, ideas, and feedback among project stakeholders. Effective
communication fosters collaboration, builds trust, aligns expectations, resolves conflicts, and enhances
team morale. It also facilitates the understanding of project goals, promotes stakeholder engagement,
and supports effective decision-making.
8. Two challenges that project managers may face when managing teams are:
a. Team dynamics: Project managers need to address issues related to team dynamics, such as
conflicts, lack of cohesion, or differences in work styles. They must foster a positive team culture,
promote effective communication, and facilitate collaboration among team members.
b. Resource allocation: Project managers often face the challenge of allocating and managing
resources efficiently. They must balance competing demands, address resource constraints, and
ensure that team members have the necessary skills and support to perform their tasks effectively.
9. Three prerequisites that contribute to successful project implementation are:
c. Clear project objectives and scope: Projects require well-defined and achievable objectives to
provide a sense of direction and purpose. A clear project scope helps manage expectations and
ensures that project deliverables are well-defined.
d. Adequate resources: Sufficient resources, including funding, personnel, equipment, and materials,
are essential for successful project implementation. Project managers need to ensure that resources
are allocated effectively to support project activities.
e. Stakeholder support and engagement: Projects involve various stakeholders, including sponsors,
clients, team members, and end-users. Their support and engagement are critical for project
success. Project managers should actively involve stakeholders, manage their expectations, and
communicate effectively throughout the project lifecycle.
Unit six review exercise
1. The rationale behind conducting a Social Cost-Benefit Analysis (SCBA) for a project is to assess
the overall societal impact of the project. It goes beyond considering only financial costs and benefits
and takes into account the broader social and environmental implications. SCBA helps decision-
makers evaluate whether a project's benefits outweigh its costs from a societal perspective and aids in
making informed decisions that maximize social welfare.
2. The key steps involved in conducting an SCBA are as follows:
a. Identify and quantify project costs: This includes both direct and indirect costs associated with
the project.

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 b. Identify and quantify project benefits: Assess the positive impacts of the project in terms of
economic, social, and environmental benefits.
c. Assign monetary values: Convert costs and benefits into monetary terms to enable comparison.
d. Discounting: Adjust future costs and benefits to account for the time value of money.
e. Calculate net present value (NPV): Compare the total present value of benefits to the total present
value of costs.
f. Sensitivity analysis: Assess the robustness of the analysis by evaluating the impacts of changes in
key assumptions or parameters.
3. The UNIDO (United Nations Industrial Development Organization) approach to project analysis
involves a comprehensive evaluation framework for industrial projects. It emphasizes the economic,
social, and environmental dimensions of project impacts. The approach considers direct and indirect
effects, as well as long-term sustainability aspects, to provide a holistic perspective on project
evaluation.
4. The advantages of using the UNIDO approach in project analysis include:
a. Holistic evaluation: The UNIDO approach considers economic, social, and environmental
dimensions, providing a comprehensive assessment of project impacts.
b. Long-term sustainability: It emphasizes the long-term sustainability of projects, taking into
account environmental conservation and social well-being.
c. Consistency: The UNIDO approach provides a standardized framework for project analysis,
ensuring consistency and comparability across different projects.
5. Net benefit, in terms of economic prices, refers to the difference between the total benefits and the
total costs of a project, expressed in monetary terms. It represents the overall economic gain or loss
resulting from the project. Net benefit is significant in project analysis as it helps decision-makers
assess the economic viability and desirability of a project. Positive net benefits indicate that the project
is expected to generate more value than the costs incurred, while negative net benefits suggest that the
costs outweigh the benefits.
6. Economic prices differ from market prices in project analysis because economic prices incorporate
both market prices and externalities. Market prices reflect the value of goods and services in the
marketplace, whereas economic prices consider the additional costs or benefits imposed on society
beyond the market transactions. Economic prices account for external factors such as environmental
impacts, social benefits or costs, and other spill over effects, which are not fully captured by market

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prices alone.
7. Savings impact in project analysis refers to the financial benefits generated by a project through
cost savings or efficiency improvements. It measures the reduction in costs compared to a baseline
scenario without the project. Savings impact can be realized through factors such as reduced energy
consumption, streamlined processes, optimized resource utilization, or cost-effective technologies.
8. Three factors that can influence the savings impact of a project are:
a. Project design and implementation: The effectiveness of project design and the successful
implementation of cost-saving measures can significantly impact the savings generated.
b. Technological advancements: The adoption of new technologies or innovative practices can lead
to improved efficiency and cost savings.
c. External factors: Factors such as changes in input prices, market conditions, or regulatory
frameworks can influence the potential savings impact of a project.
Unite seven answer for review question
1. Equity financing in project finance involves raising funds by selling ownership shares or equity
stakes in a project to investors. It allows investors to become shareholders and participate in the
project's profits and assets.
2. Advantages of using equity as a source of project finance:
 No repayment obligation.
 Shared risk.
 Potential for higher returns.
3. Disadvantages of using equity as a source of project finance:
 Dilution of ownership.
 Higher cost compared to debt financing.
 Reduction in retained earnings.
Leasing, as a source of project finance, involves obtaining assets or equipment through lease
agreements rather than purchasing them outright. The lessor provides the assets to the lessee in
exchange for regular lease payments.
4. The cost of capital in project finance refers to the average rate of return required by investors to
provide funding. It is significant as projects need to generate returns higher than the cost of capital to
be considered financially viable.
5. Factors influencing the cost of capital for a project:

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  Market conditions.
 Project risk profile.
 Project-specific factors.
 Financing structure.
6. Public policy and regulations in project financing provide a framework for project development,
financing, and operations. They ensure fairness, transparency, environmental sustainability, social
welfare, and economic development.
Three types of financing institutions involved in project finance:
 Commercial banks.
 Development finance institutions (DFIs).
 Export credit agencies (ECAs).

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