Chapter-4 1

Project Preparation
(Feasibility Analysis)
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 LEARNING OBJECTIVES

project feasibility studies such as the:

 Market analysis,
 Technical and institutional analysis,
 Financial analysis,
 Environmental analysis, etc.

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 Introduction
3

 Feasibility study aims to establish the justification of

the project in technical, economic, financial, social
and so on dimension.
 Analyzed separately and in relation to all others.
 Test different technical approaches for their economic
benefit and financial viability.
 The purpose of the analysis is not to determine
whether a particular idea is good enough to proceed
with but to arrive at the best one possible under
circumstances.
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 Meaning of feasibility study
4

 It is a detailed analysis of project ideas.

 It provides commercial, technical, environmental, financial,

economic and social information needed for investment

decision making.
 It needs all data for an investment decision.

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 Role of feasibility Studies
5

 It allows project managers to investigate the possible

negative and positive outcomes of a project before
investing too much time and money.
 Hence, feasibility study has the following contribution.
 help to determine the profitability of the business venture.
Entrepreneurs and investors would want to know if the
business would be worth their time, effort and resources.
 help to prove the entrepreneur, venture capitalists, lenders

and investors the existence of the market, the liquidity of

the business venture and the expected return on investment.

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 6

 Help to identify business challenges, strengths, weaknesses,

opportunities, threats & unforeseen circumstances that might
affect the success & sustainability of the business.
 Enable to estimate the financial, human and technological
resources that will be needed to ensure the successful launching
of the business.
 Help to determine the amount of capital required to start the
business.
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 7

 The feasibility study will mainly focuses on the

following areas:
 Market and Demand Analysis: Involves issues about the
 Potential size of the market and
 Market share of the firm.
 Technical Analysis: Analysis of
 Technical and engineering aspects of the project .
 Location and environmental impact assessment will made.
 Financial Estimates/analysis: Involves discussions on the
 Cost of the project
 Cost of production and
 Working capital requirements of the project.
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4.1 Market and Demand Analysis
8

It is concerned with two broad issues:

i. What is the likely aggregate demand for the product
proposed to be manufactured/service planned to be offered?
ii. What share of the market will the proposed project capture?
This task requires an in – depth study and analysis of
various factors such as: -
 Existing pattern of consumption and growth
 Nature of competition
 Income levels of the society
 Availability of substitutes
 System of distribution channels, etc.
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 Situational Analysis & Specification of Objectives
9

 Situational analysis is a way of generating data about

the market and demand informally by talking to
customers, competitors, middlemen, and others in the
industry.
 In most cases, a formal study is warranted. To conduct
such a study, it is necessary to spell out objectives
clearly and comprehensively.
 A helpful approach to spell out objectives is to structure
them in the form of questions.

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10

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 Collection of Secondary Information
11

 Secondary information is information that has been gathered in

some other context and is already available.
 Secondary information obtained from:-
 central statistics office
 economic survey
 national sample survey reports
 academic studies, etc.
However, their reliability, relevance, and accuracy for
intended purpose should be carefully examined.
It provides leads and clues for gathering primary information
required for further analysis.
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 Conducting Market Survey
12

A comprehensive basis for market and demand analysis

may be difficult to obtain from secondary information.
As such, primary information through a market survey
specific to the project being appraised is necessary.
There are two types of survey for this purpose:
 census survey and
 sample survey.
The typical market survey in practice is a sample
survey, for which a sample of population is drawn.

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 13

The information sought in a market survey may include:

 Totaldemand and rate of growth of demand
 Demand in different segments of the market

 Income and price elasticity of demand

 Motives for buying

 Unsatisfied needs

 Purchasing power of consumers,….etc.

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Characterization of the Market
14

Based on the information gathered from a sample survey or secondary sources, the
market for the product or service may be described in terms of the following ways:
 Effective demand in the past and present
 Break down of demand
 Price
 Consumers
 Methods of distribution and sales promotion
 Supply and competition
 Government policy
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Effective demand in the past and present
15

To measure 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

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Break down of demand
16

To get a deeper insight into the nature or

aggregate of market demand, may be
broken down different segments of the
market.
Such as Geographically, demographic,
etc..
Segmental information is helpful because
the nature of demand tends to vary from one
segment to another. 10/19/2024
Price
17

Price statistics must be gathered with statistics

pertaining to physical quantities.
It may be helpful to distinguish the following types of
prices:
i. Manufacturer’s price quote as FOB (free on board) price or
CIF (cost, insurance, and freight) price
ii. Landed price for imported goods
iii. Average whole sale price, and
iv. Average retail price.

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Consumers 18
Consumers may be characterized along two dimensions
as follows:
Demographic and Attitudinal
sociological
Age Preferences
Sex Intentions
Income Habits
Profession Attitudes
Residence
Social background

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Methods of distribution and sales promotion
19

 The existing methods of distribution and sales promotion has to be analyzed.

 The methods of distribution may vary with the nature of the product.
 Methods used for sales promotion (advertizing, discounts, gift schemes, etc)
may also vary from product to product.
 Supply and Competition
It is necessary to know the existing sources of supply and whether
they are foreign or domestic.
Competition from substitutes and near – substitutes should be
specified.
Because, almost any product may be replaced by some other
product as a result of relative changes in price, quality, availability,
promotional effort, and so on. 10/19/2024
Government policy
20
 Government policy and/or plan may influence the market and
the demand for a product/service.
 These are reflected in:
 Production targets in national plans
 Import and export trade controls
 Import duties
 Export incentives
 Excise duties
 Sales tax
 Industrial licensing, etc

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 Demand Forecasting 21

 Aspect of the market and demand from primary and secondary

sources to estimate future demand.
 There are three broad categories of demand forecasting
methods.
I. Qualitative Methods
II. Time series projection methods
III. Casual methods

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 I) Qualitative/judgment Methods
22

These methods depend on the judgment of experts to

translate qualitative information into quantitative
estimates.
 It is used to generate forecasts if historical data are not available.
 There are 2 qualitative methods of demand forecasting:
1. Jury of Executive Opinion Method
 This method involves ask for the opinions of a group
of managers on expected future sales and combine into
sales estimate.

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The advantages of this method are:
23

 It is an speedy method for developing a demand forecast

 It has huge appeal to managers who tend to prefer their
judgment to mechanic forecasting procedures.
 Combine knowledge and expertise from various
functional areas
 People who have best information on future
developments generate the forecasts
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The disadvantages of this method are:
24

 The biases underlying subjective estimates

 This technique is not reliability.
 Risk that few people dominate the group
Rationale:- upper-level management has best information

on latest product developments and future product

launches.

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2. Delphi Method
25

 This method is used for draw out the opinions of group

of experts with help of a mail survey.

 The steps involved in this method are:
 A group of experts are sent a questionnaire by mail and asked to
express their views.
 The responses received from the experts are summarized.
 The process may be continued for one or more rounds till a
reasonable agreement emerge in the views of experts
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 26

 Main advantages
 Generate consensus or agreement
 Can forecast long-term trend without availability of historical data
 Main drawbacks
 Slow process
 Experts are not accountable for their responses
 Little evidence that reliable long-term forecasts can be generated

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 ii. Time series projection methods
27

These methods generate forecasts on the

basis of an analysis of the historical
time series.
The important time series projection
methods are:
1. Trend projection method

2. Exponential Smoothing method

3. Moving average method
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1. Trend Projection method
28

 This method involves

a. Determining the trend of consumption by analyzing past consumption
statistics and
b. Projecting future consumption by extrapolating or summarizing the past
trend.
 For trend projection, the most commonly employed relationship is
the linear relationship.
Yt = α + bt
Where;
Yt is the demand for year t
t is the time variable
α is the intercept of the relationship, and
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b is the slope of the relationship.
 Example
29

 The annual sales, in number of boats, for one

particular sailboat model for the past five years are:
Year (T) 1 2 3 4 5
Sales (Y) 11 14 20 26 34
Required:
Forecast demand for period 6 using trend projection
method.

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
2. Exponential Smoothing Method
31

 In exponential smoothing, forecasts are modified in the

light of observed errors.
 If the forecast value for year t, Ft, is less than the actual
value for year t, St, the forecast for the year t + 1, Ft + 1,
is higher than Ft.
 If Ft > St, Ft + 1 is lower than Ft. In general,
Ft + 1 = Ft + α et
Where: Ft + 1 = Forecast for year t + 1
α = Smoothing Parameter (which lies between 0 and 1)
et = Error in the forecast for year t = St – Ft
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 32

Example
Eg.1 Based on the data given below, forecast demand for
period 2 and 3 using exponential smoothing method.
Given: F1 = 29, S1 = 28, S2 = 30, and α = 0.2
F2 = 29 + 0.2(-1) = 28.2
F3 = 28.2 + 0.2(1.8) = 28.56

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 33

Eg.2 Assume a demand forecasted for 2019 for

coffee was 18000 quintals per year and actual
demand for the coffee was 15000 quintals and
smoothing constant of 0.7. what will be
demand forecasted for 2020.

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3. Moving Average Method 34
 This method smoothes out fluctuations when the data set show irregular

variations.
 The forecast for the next period is equal to the average of the sales for

several preceding periods. Hence, the moving average is ‘centered’ against

the mid – point of the averaging period.

Ft+1 = St + St-1 + … + St-n+1

n
Where, Ft+1 is the forecast for the next period, St is the sales
for the current period, and n is the period over which
averaging is done.

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 iii. Casual methods
35

 These methods are more analytical than the previous

methods.
 Casual methods seek to develop forecasts on the basis of
cause – effect relationships specified in an explicit,
quantitative manner.
The important casual methods are:
- Chain ratio method
- Consumption level method
- End use method
- Leading indictor method
- Econometric method 10/19/2024
1. Chain Ratio Method
36

Under this method, the potential sales of a

product is estimated by applying a series
of factors to a measure of aggregate
demand.
The reliability of this method critically
depends on the ratios used in the process
of determining the sales potential.

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Example

37
Suppose Warner Communications Company wants to
estimate the total annual sales of recorded compact discs. A
common way to estimate total market demand is as
follows:-
Q=nxqxp
Where Q = total market demand n = number of buyers in
the market q = quantity purchased by an average buyer per
year p = price of an average unit.
Thus, if there are 100 million buyers of compact discs each
year, the average buyer buys six discs a year, and the
average price is $17, then what is the total market demand
for discs? 10/19/2024
2. Consumption Level Method
38

 This method is useful for a product which is directly

consumed.
 The method estimates consumption level on the basis of
elasticity of income and price elasticity of demand.
Income elasticity of demand;
Refers the extent to which demand changes in response
to variations in income. It is measured as follows:
EI = Q2 – Q1 × I1 + I 2
I2 – I 1 Q2 + Q1

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39

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 Cont’d
40

e.g 1; By using the following data determine EI?

Q1 = 50, Q2 =55, I1 = 1,000, and I2 = 1,020 EI =?
 Demand forecast can be determined based on the information of
income elasticity of demand along with projected income.
 e.g 2; Suppose the present per capital annual demand for product
X is 1kg and the present per capital annual income is Br. 16,400.
 The income elasticity of demand for product X is 2. The
projected per capital annual income after two years is expected to
be 15 percent higher than what it is now.
Instruction
 What will be the projected per capital annual demand and the
aggregate demand for product X after two years? 10/19/2024
 41

 The projected per capital annual demand for product X after two
years will be:
present Per capital annual DD Income
+ change in income level  elasticity of demand
 The aggregate demand for product X after two years will be:
=(1 + 0.15 x 2) = 1.3 kg
 Projected per capital demand of X will be______?

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 Price Elasticity of Demand;
42

Measures the responsiveness of demand to variations in

price. It is expressed as follows:
Ep = Q2 – Q 1 × P1 + P2
P2 – P 1 Q2 + Q1
Example:- The following information is available about a
certain product:
P1 = Br 800, Q1 = 20,000, P2 = Br. 1,000, Q2 = 19,000.
What is the price elasticity of demand?
EP = 19,000 – 20,000  800 + 1,000 = - 0.23
1,000 – 800 19,000 + 20,000
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 3. End – Use Method
43

 The end – use method is particularly suitable for

assessing the demand for intermediate products.
 This method utilizes the consumption coefficient
method, It involves the following steps:
1. Identify the possible uses of the product.
2. Define the consumption coefficient of the product for
various uses.
3. Plan the output levels for the consuming industries.
4. Derive the demand for the product.

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 3. End – Use Method

A certain industrial chemical, Indchem, is used by four

industries, Alpha, Beta, Gamma, and Kappa. The
consumption coefficients for these industries, the
projected output levels for these industries for the
year X, and the projected demand for Indchem are
shown in following table.
 4. Leading Indicator Method
45

 Leading indicators are variables which change ahead of

other variables, the lagging variables.
 Observed changes in leading indicators may be used to
predict the changes in lagging variables.
 E.g. The change in the level of urbanization ( a leading
indicator) may be used to predict the change in the
demand for air conditioners.(a lagging variables).
 There are two basic steps which are involved in this
method: (i) identify the appropriate leading indicator (s).
(ii) establish the relationship between the leading
indicator (s) and the lagging variable to the forecast.
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 5. Econometric Method
46

 An econometric method is all about a mathematical

representation of economic relationship(s) derived from
economic theory.
 The primary objective of econometric analysis is to forecast
the future behavior of the variables incorporated in the model.
 Practically, two types of econometric models are employed; the
single equation model and the simultaneous equation model.

 The single equation model assumes that one variable, the

dependent variable is influenced by one or more independent
variables.
 An example of the single equation model is given below:
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 47

 Dt = a0 + a1Pt +a2Nt
Where Dt = demand for a certain product in year t, Pt = Price for
the product in year t, and Nt = income in year t.
 Simultaneous equation model depicts economic relationships
in terms of two or more equations. Example;
GNPt = Gt + It + Ct
It = a0 + a1 GNPt
Ct = b0 + b1GNPt
 Where GNpt = gross national product for year t, Gt =
governmental purchases for year t, It = gross investment for year
t, and Ct = consumption for year t.
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 Uncertainties in demand forecasting
48

 Demand forecasts are subject to error and uncertainty which arise

from:
1. Data about past and present market
2. Method of forecasting, and
3. Environmental change
1. Data about past and present market
 The analysis of past and present market, which serves as the
springboard for the projection exercise, may be vitiated by the
following inadequacies of data:
 Few observation
 Influence of abnormal factors.
 Lack of standardization which are lack of consistency, regularity
and, homogeny. 10/19/2024
 2. Method 49 of forecasting
Methods used for demand forecasting are
characterized by the following limitation:
Inability to handle unquantifiable factors
Unrealistic assumptions
Excessive data requirement

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 3. Environmental change
50
 The environment in which a business operates is
characterized by numerous uncertainties.
 The important sources of environment uncertainty are
mentioned below:
 Technological change
 Shift in government policy
 Discovery of new sources of raw material.
 Developments on the international landscape

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 4.1.6. Market Planning
51

 An appropriate marketing plan should be formulated to

reach the proposed product/service to a desired level of
customers.
 The prime purpose of the marketing plan is meeting the
customer needs better than their competitors.
 The marketing plan should focus on customer needs,
nature of product or service offering, channel function
and coverage.
 In planning the market the detailed information that has
been collected and analyzed should be targeted on the
following:
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 Cont’d
52

 Customer, consider core needs and ancillary needs.

 Distribution, indicate role of distributors, whole sellers and retailers

 Promotion which includes advertising, branding, own sale efforts.

 Pricing, indicate final price to customers, trade margins, duties on the intended

price.

 Services, state warranties, after sale service, training, setting up, etc

 Market segmentation, breakdown markets into meaningful groupings or

segments giving emphasis on distinguished characteristics, size of segment,

accessibility, and degree of competition.

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 4.2 Technical Analysis
53

 Technical aspect of the project provides the basis for all other

forms of project design and analysis

 The broad purpose of technical analysis is (a) to ensure that the

project is technically feasible in the sense that the inputs required

to set up the project are available, and (b) to facilitate the most
optimal formulation of the project in terms of technology, size,
location, and so on.
 The following are basic issues pertaining to technical analysis of a

project; 10/19/2024
 i. Manufacturing process /technology

Two or more alternative technologies are available.

 For instance, cement can be made either by the dry process

or the wet process.

 Similarly, a soap can be manufactured by the semi – boiled

process or the fully – boiled process.

Technology Choice
 based on a detailed consideration and evaluation of
technological alternatives and the most suitable
alternative in relation to the project to investment
strategy chosen
 A plant in a developing country that produces primarily
for export to industrialized countries may need to utilize
the latest automated and capital – intensive production
processes in order to compete in such markets.
Generally, technology choice must be directly related
to market, resource and environmental conditions.
The choice of technology is influenced by a variety of
considerations:
 Plant Capacity:
 Principal Inputs:
 Investment Outlay and Production Cost
 Product Mix: The chosen technology must be
judged in terms of the total product – mix
generated by it, including saleable by – products.
 Latest Developments: The technology adopted

must be based on the latest developments.

 Ease of Absorption: The ease with which a

particular technology can be absorbed can

influence the choice of technology.
ii. Technical Arrangements
To obtain the technical know–how needed for the
proposed manufacturing process, suitable arrangements
must be made.
When collaboration is sought, among other things, the
following aspects of the arrangement must be worked
out in detail:
 The nature of support to be provided by the

collaborators during the designing of the project,

selections and procurement of equipment, installation
and erection of the plant, operation and maintenance
of the plant, and training of the project personnel.
iii. Material Inputs and Utilities

 Material inputs and utilities may be

classified into four broad categories:
 Raw materials
 Processed industrial materials and
components
 Auxiliary materials and factory
supplies, and
 Utilities.
v. Location and Site

Location refers to a relatively broad area like a city, an industrial zone,

or a costal area;
 Site refers to a specific piece of land where the project would be set up.

 Choice of Location
 In a feasibility study, suitable location is

 the location of raw materials and factory supplies,

 the location of the principal consumption centers in relation to the
plant.
 This will be influenced by a variety of considerations:

 proximity to raw materials and markets

 availability of infrastructure
 labor situation
 governmental policies, etc
Site Selection

 The following requirements and conditions are to be

assessed:
 Ecological conditions on site (soil, site hazards,
climate etc.)
 Environmental impacts (restrictions, standards,
guidelines)
 Local infrastructure at site location
 Cost of land
 Site preparations and development, requirements and
costs
vi. Structures and Civil Works

These may be divided into three

groups:

(a) Site preparation and

development,

(b) Buildings and structures, and

(c) Outdoor works.

vii. Environmental Aspects

 Underestimation of the environment has resulted

in negative consequences such as poor human
health, social disruption, reduced productivity and
ultimately, the undermining of development.
Environmental Impact Assessment
 Environmental benefits or costs of a project are

usually externalities or side effects that affect the

society wholly or partially.
 In principle, environmental impacts should be

assessed on the basis of legal regulations and

emission standards and guidelines established in
the country where the project is located.
 4.3 Financial Estimates
63

Cost of a Project
 The cost of a project represents the total of all items of
outlay associated with a project that can be financed by
long-term funds.
 It is the sum of the outlays on the following:
 Land and site development
 Buildings and civil works
 Plant and machinery
 Technical know – how and engineering fees
 Expenses on foreign technicians and training,….etc.
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 Cost of Production
64

Given the estimated production, the cost of

production may be worked out.
The principal components of cost of
production are:-
Material cost
Utilities cost
Labor cost
Factory overhead cost
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 Working Capital Requirement

65

 In estimating the working capital requirement and planning for its

financing, the following points should be considered;
1. The working capital requirement consists of the following: (i) raw
materials and components (indigenous as well as imported), (ii)
stocks of goods – in – process (work – in – process), (iii) stocks of
finished goods, (iv) debtors, (v) operating expenses and (vi)
consumable stores.
2. The principal sources of working capital finance are:
(i) working capital advances provided by commercial banks, (ii)
accruals and provisions, (iii) trade credit, and (iv) long term
sources of financing.

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END OF CHAPTER 4

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