PROJECT APPRAISAL

Project appraisal is the process of assessing, in a structured way, the case for proceeding with a
project or proposal, or the project’s viability. It often involves comparing various options, using
economic appraisal or some other decision analysis technique.

Some of the methods of project appraisal are as follows:

1. Economic Analysis:
Under economic analysis, the project aspects highlighted include requirements for raw material,
level of capacity utilization, anticipated sales, anticipated expenses and the probable profits. It is
said that a business should have always a volume of profit clearly in view which will govern other
economic variables like sales, purchases, expenses and alike.
It will have to be calculated how much sales would be necessary to earn the targeted profit.
Undoubtedly, demand for the product will be estimated for anticipating sales volume. Therefore,
demand for the product needs to be carefully spelled out as it is, to a great extent, deciding factor
of feasibility of the project concern.
In addition to above, the location of the enterprise decided after considering a gamut of points
also needs to be mentioned in the project. The Government policies in this regard should be taken
into consideration. The Government offers specific incentives and concessions for setting up
industries in notified backward areas. Therefore, it has to be ascertained whether the proposed
enterprise comes under this category or not and whether the Government has already decided any
specific location for this kind of enterprise.
2. Financial Analysis:
Finance is one of the most important pre-requisites to establish an enterprise. It is finance only
that facilitates an entrepreneur to bring together the labour of one, machine of another and raw
material of yet another to combine them to produce goods.
In order to adjudge the financial viability of the project, the following aspects need to be carefully
analysed:
1. Assessment of the financial requirements both – fixed capital and working capital need to
be properly made. You might be knowing that fixed capital normally called ‘fixed assets’
are those tangible and material facilities which purchased once are used again and again.
Land and buildings, plants and machinery, and equipment’s are the familiar examples of
fixed assets/fixed capital. The requirement for fixed assets/capital will vary from enterprise
to enterprise depending upon the type of operation, scale of operation and time when the
investment is made. But, while assessing the fixed capital requirements, all items relating to
the asset like the cost of the asset, architect and engineer’s fees, electrification and
installation charges (which normally come to 10 per cent of the value of machinery),
depreciation, pre-operation expenses of trial runs, etc., should be duly taken into
consideration. Similarly, if any expense is to be incurred in remodeling, repair and additions
of buildings should also be highlighted in the project report.
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2. In accounting, working capital means excess of current assets over current liabilities.
Generally, 2: 1 is considered as the optimum current ratio. Current assets refer to those
assets which can be converted into cash within a period of one week. Current liabilities
refer to those obligations which can be payable within a period of one week. In short,
working capital is that amount of funds which is needed in day today’s business operations.
In other words, it is like circulating money changing from cash to inventories and from
inventories to receivables and again converted into cash.
This circle goes on and on. Thus, working capital serves as a lubricant for any enterprise, be it
large or small. Therefore, the requirements of working capital should be clearly provided for.
Inadequacy of working capital may not only adversely affect the operation of the enterprise but
also bring the enterprise to a grinding halt.
The activity level of an enterprise expressed as capacity utilization, needs to be well spelt out in
the business plan or project report. However, the enterprise sometimes fails to achieve the
targeted level of capacity due to various business vicissitudes like unforeseen shortage of raw
material, unexpected disruption in power supply, inability to penetrate the market mechanism, etc.
Then, a question arises to what extent and enterprise should continue its production to meet all
its obligations/liabilities. ‘Break-even analysis’ (BEP) gives an answer to it. In brief, break-even
analysis indicates the level of production at which there is neither profit nor loss in the enterprise.
This level of production is, accordingly, called ‘break-even level’.
3. Market Analysis:
Before the production actually starts, the entrepreneur needs to anticipate the possible market for
the product. He/she has to anticipate who will be the possible customers for his product and
where and when his product will be sold. There is a trite saying in this regard: “The manufacturer
of an iron nails must know who will buy his iron nails.
This is because production has no value for the producer unless it is sold. It is said that if the
proof of pudding lies in eating, the proof of all production lies in marketing/ consumptio. In fact,
the potential of the market constitutes the determinant of probable rewards from entrepreneurial
career.
Thus, knowing the anticipated market for the product to be produced becomes an important
element in every business plan. The various methods used to anticipate the potential market, what
is named in ‘Managerial Economics’ as ‘demand forecasting’, range from the naïve to sophisticated
ones.
The commonly used methods to estimate the demand for a product are as follows:

1. Opinion Polling Method:

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In this method, the opinions of the ultimate users, i.e. customers of the product are estimated.
This may be attempted with the help of either a complete survey of all customers (called, complete
enumeration) or by selecting a few consuming units out of the relevant population (called, sample
survey).

Let us discuss these in some details:

(a) Complete Enumeration Survey:
In this survey, all the probable customers of the product are approached and their probable
demands for the product are estimated and then summed. Estimating sales under this method is
very simple. It is obtained by simply adding the probable demands of all customers. An example
should make it clear.
Suppose, there are total N customers of X product and everybody will demand for D numbers of
it. Then, the total anticipated demand will be:
N ∑ i=1 DiN
Though the principle merit of this method is that it obtains the first-hand and unbiased
information, yet it is beset with some disadvantages also. For example, to approach a large number
of customers scattered all over market becomes tedious, costly and cumbersome. Added to this,
the consumers themselves may not divulge their purchase plans due to the reasons like their
personal as well commercial/business privacies.

(b) Sample Survey:

Under this method, only some number of consumers out of their total population is approached
and data on their probable demands for the product during the forecast period are collected and
summed. The total demand of sample customers is finally blown up to generate the total demand
for the product. Let this also be explained with an example.
Imagine, there are 1000 customers of a product spread over the Faridabad market. Out of these,
50 are selected for survey using stratified method. Now, if the estimated demand of these sample
customers is Di, i.e., it refers to 1 2 3….50, the total demand for the entire group of customers
will be
50 ∑ ni Di = n1 D1 +n2D2 + n3 D3…….. n50 D50
Where n, is the number of customers in group I, and n1 +n2 + n3….n50 = 1000.
But, if all the 1000 customers of the group are alike, then the selection may be done on a random
basis and total demand for the group will be:
(D1 D2 + D3 +D4…D5) 1000 /50
No doubt, survey method is less costly and tedious than the complete enumeration method.
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(c) Sales Experience Method:

Under this method, a sample market is surveyed before the new product is offered for sale. The
results of the market surveyed are then projected to the universe in order to anticipate the total
demand for the product.
In principle, the survey market should be the true representative of the national market which is
not always true. Suppose, if Delhi is selected as a sample market, it may not be a true representative
of a small place, say Silchar in Assam simply because the characteristic features of Delhi are
altogether different from those of a small town like Silchar.
Again, if we select Agra as a sample market, sales in Agra would be influenced by the size of the
floating tourist’s population throughout the year. But this feature is not experienced by many
other places again like Silchar in Assam.
(c) Vicarious Method:
Under the vicarious method, the consumers of the product are not approached directly but
indirectly through some dealers who have a feel of their customers. The dealers’ opinions about
the customers’ opinion are elicited. Being based on dealers’ opinions, the method is bound to
suffer from the bias on the part of the dealers. Then, the results derived are likely to be unrealistic.
However, these hang-ups are not avoidable also.
2. Life Cycle Segmentation Analysis:
It is well established that like a man, every product has its own life span. In practice, a product
sells slowly in the beginning. Backed by sales promotion strategies over period, its sales pick up.
In the due course of time, the peak sale is reached. After that point, the sales begin to decline.
After, some time, the product loses its demand and dies. This is natural death of a product. Thus,
every product passes through its ‘life cycle’. This is precisely the reason why firms go for new
products one after another to keep themselves alive.
Based on above, the product life cycle has been divided into the following five stages:
1. Introduction
2. Growth
3. Maturity
4. Saturation
5. Decline
The sales of the product vary from stage to stage and follows S-shaped curve as shown in Figure
16.1:
Time Period
Considering the above five stages of a product life cycle, the sales at different stages can be
anticipated.
3. Technical Feasibility:
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While making project appraisal, the technical feasibility of the project also needs to be taken into
consideration. In the simplest sense, technical feasibility implies to mean the adequacy of the
proposed plant and equipment to produce the product within the prescribed norms. As regards
know-how, it denotes the availability or otherwise of a fund of knowledge to run the proposed
plants and machinery.

It should be ensured whether that know-how is available with the entrepreneur or is to be

procured from elsewhere. In the latter case, arrangement made to procure it should be clearly
checked up. If project requires any collaboration, then, the terms and conditions of the
collaboration should also be spelt out comprehensively and carefully.
In case of foreign technical collaboration, one needs to be aware of the legal provisions in force
from time to time specifying the list of products for which only such collaboration is allowed
under specific terms and conditions. The entrepreneur, therefore, contemplating for foreign
collaboration should check these legal provisions with reference to their projects.
While assessing the technical feasibility of the project, the following inputs covered in the project
should also be taken into consideration:
(i) Availability of land and site.
(ii) Availability of other inputs like water, power, transport, communication facilities.
(iii) Availability of servicing facilities like machine shops, electric repair shop, etc.
(iv) Coping-with anti-pollution law.
(v) Availability of work force as per required skill and arrangements proposed for training-
in-plant and outside.
(vi) Availability of required raw material as per quantity and quality.

4. Management Competence:
Management ability or competence plays an important role in making an enterprise a success or
otherwise. Strictly speaking, in the absence of managerial competence, the projects which are
otherwise feasible may fail. On the contrary, even a poor project may become a successful one
with good managerial ability. Hence, while doing project appraisal, the managerial competence or
talent of the promoter should be taken into consideration.

TYPES OF PROJECT APPRAISAL

Different types of appraisal include technical, economic, organiational and managerial,
commercial.
Type # 1. Technical Appraisal:
The status of the technical know-how and design as envisaged in the project should be fully
assessed.
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The cautions in general in this area are:
(i) Project committing with technology and design only in the preliminary stage should be
avoided.
(ii) The details of the designs involved should be attended to minimise the technical risk.
Innovative design should be distinguished and recognised as tougher than mere
uncertainty. It may appear innocuous and less costly but later on may escalate up to an
awkward situation when it is too late.
(iii) In technically complex and sensitive designs all design proposals should be fully
investigated.
(iv) The appraisal should ensure that the project has minimum of technical uncertainty and
resolve uncertainty, if any, on a priority basis.
(v) Design should not have unnecessarily burdensome specifications.
The technology and design should be one already tested and established. The know-how already
available within the country and currently in use should be explored and compared with that
envisaged in the project. It is desirable to find the ‘state-of-the-art’ technology relevant to the
project and weigh and measure the same vis-à-vis the technology proposed in the project
appraised.
The aim is to have the best possible know-how (most suitable with the economic environment)
already established with higher grade quality and productivity, if possible, from the relevant
technical collaborator.
In carrying out the technical appraisal of the project, we should guard recalling the old adage ‘all
that glitters is not gold’ technology from a multinational does not necessarily mean the most
appropriate.
Experiences suggest that many MNCs get rid of their obsolete technology/designs and
machineries by giving the same to others at a very high cost. This situation can best be tested
where the technical collaborator is to buy-back a substantial part of the products.
The appraisal should ensure that the ‘project schedule’ does not incorporate ‘concurrency’ to
hasten the project. “Concurrency” known as the practice of initiating production activities prior
to the completion of full scale development should be avoided.
While carrying out the technical appraisal, it is necessary to appraise the terms for the know-how
as agreed with the collaborator as such terms have a direct bearing on the cost and financial impact
on the operation of the project. The financial institution providing the term loan for the project
also appraises the terms before agreeing to finance the project.
The major clauses are:
(i) Ensure necessary training of personnel by the technical collaborator, the trainees being
the key personnel in the plant;
(ii) To have a buy-back arrangement with the technical collaborator ensuring collaborator’s
commitment towards the know-how process and the quality of the output;
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(iii) Such buy-back arrangement also releases the pressure on the need for valuable foreign
exchange;
(iv) Payment of know-how fee should be by stages, not in one go.
Type # 2. Economic Appraisal:
The economic appraisal of the project covers the following areas:
To ensure:
(i) The project’s compatibility with the macroeconomic environment in the relevant
industry and fitting in with the government’s concerned policy.
(ii) That the current situation in the industry involved permits such a project, mainly
emphasising the appraisal in respect of the following points :
a. Existence of a growing market with increasing gap between the demand and the
supply of such product/service as envisaged in the project.
b. When the product is ‘intermediate.’ In nature and the customer is in particular
Iindustry/organisation, which is a stable one;
c. There is reasonable amount of market research/study on the product and the project
is having a back-up with reliable support study and report.
d. The possible market share that can be arrested with the implementation of the
project as revealed by the market report.
(iii) An overall appraisal of the competitors fielding in the area with their strength and
weaknesses.
(iv) Availability of the resources required for the project. The alternatives for employment
of such resources cannot compete with the estimated project profitability. In this regard,
the various techniques for financial appraisal of the project, discussed later, are helpful.
(v) Facilities to the extent available, including monetary assistance for such project, such as
:
a. Value based advance licencing (VABAL) for imports required for the project; (Value
based advance licenses were scrapped in the 1997-2002 Exim Policy, because of its
widespread misuse by exporters. The new policy came into effect from April 1,
1997, known as Duty Entitlement Pass Book (DEPB) scheme.
b. Various duty exemption scheme applicable to the project;
c. Government subsidy; helps for procurement of land/space at suitable location;
d. Benefits for the export oriented units (EOU)/and for being located at export
promotion zones;
e. Tax holidays.
Type # 3. Organisational and Managerial Appraisal:
A project report contains an organisation structure drawn along with the suggested number of
employees and their levels and grades. These organisations recommended in the reports are,
however, impersonal and primarily deal with the functional relationship within the project team,
taking care of the work-load involved in the respective areas.
The organisational and managerial appraisal is carried out recognising that:
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(i) The complexities in project management require a well-knit project organisation
structure, which again depend upon the volume and nature of the project as well as the
culture and motive of the project owner. For example, in case of a owner-managed small
project, the structure is simple and the appraisal is limited to the assurance that the
owner is assisted whole-time/part-time by other functionaries.
In case of a medium sized project the owner still holds the rein for the project management but
prefers to carry out the implementation with the help of a project manager. The situation is
different for complex and large projects.
(ii) Experience suggests that the project organisation should have an overall in-charge as
project manager with the quality of strong leadership and effective communicating
ability besides the required theoretical and technical skill.
(iii) The organisation structure should be interlaced so that the project work is carried out
in a unified way.
(iv) The managerial personnel heading the different functions should be duly skilled in their
respective functions to carry out the project implementation and operation. The
appraisal is to ensure that the key managerial personnel have been fixed before the start
of the work; it is also desirable to appraise the backgrounds of such personnel.
As a matter of practice, the financial institutions in the process of project appraisal also look out
for the background of the key managerial personnel in the relevant project management.
(v) Organisation takes care of the technical training required for the production process.
(vi) The strength of the organisation takes care of the project volume with the number of
employees.
(vii) Considering the projected organisation, estimated as sufficient to match the project, the
payroll is evaluated in terms of money considering the grades, rates and numbers. These
are incorporated in the project’s operation cost. The organisational and managerial
appraisal should extend to this area as well to ensure the acceptability of the financial
aspect of the organisation. The additional personnel cost which can be about 30% of
the salary (representing P.F., medical benefit, leave with pay, uniform, canteen subsidy,
bonus etc.) should also be considered while taking into account the personnel cost in
the project.
(viii) The organisation should institute a well-balanced standard personnel policy before large
scale recruitments. This necessitates the requirement of a skilled Personnel Manager in
the organisation who should be well-conversant with the factory environments as well
as the statutory rules and regulations.
(ix) Other key personnel requiring early recruitments for manning the organisation include
Plant Manager, Maintenance Engineer, Security Manager, etc.
Type # 4. Commercial Appraisal:
Appraisal is made about the marketability of the product including the volume considered in the
project. The project should be supported by market research/statistics from competent and
reliable organisation or professional consultants like India Market Research Bureau.
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The points for consideration are:

(i) The size of the market and its growth; the gap between the demand and supply.
(ii) Information about major competitors, their capacities installed, their market share, their
strength and weaknesses, if any.
(iii) The international market and the possibility of export;
a. International standard quality;
b. International prices.
(iv) Whether the product is an import substitute having the prospect of saving valuable
foreign exchange.