Manual For The Preparation of Industrial Feasibility Studies
Manual For The Preparation of Industrial Feasibility Studies
PREPARATION OF
INDUSTRIAL
FEASIBILITY STUDIES
Newly revised and expanded edition
W. Behrens P. M. Hawranek
UNIDO
ID/372
UNIDO PUBLICATION
Sales No. E.91.III.E.18
ISBN 92-1-106269-1
iii
Acknowledgement
Special acknowledgement is due to the Federal Ministry of
Economic Cooperation of Germany for its generous financial support,
without which this second edition would not have become reality.
iv
Preface
The publication of this revised and expanded second edition of the
Manualfor the Preparationof IndustrialFeasibility Studies is the result of
the long and dedicated efforts of all those involved in this production.
The revision of the text required a careful analysis of voluminous
correspondence and comments from readers before a decision could be
made on its scope and contents. The complexities of drafting the final
version were increased by the inclusion of new subject-matter based on
contributions by selected experts.
In its conception, organization and scope, this Manual is due to the
close collaboration of its principal authors, Werner Behrens and Peter
M. Hawranek, of the UNIDO Division of Industrial Operations Support,
who drafted the bulk of the text and shared overall responsibility for its
final preparation. In carrying out this task, they received valuable
assistance and advice from numerous UNIDO consultants and staff. The
authors are particularly grateful to UNIDO consultants for the
contributions described below.
The introduction of the concept of strategic orientation was
proposed by H. R. Arm, who drafted the analysis of this concept
presented in part one, section B, and who also made a valuable
contribution to the contents and restructuring of part two, chapter III,
which covers market analysis and the marketing concept. R. Irvine
revised the annexes covering demand forecasting techniques, sampling
principles and field surveys, and helped with the revision of chapter III.
The analysis of maintenance and replacement requirements, as well as
various revisions in the treatment of organization, personnel training
and implementation planning, were drafted by B. Knauer, who also
checked the whole manuscript from the point of view of the practical
application of the Manual by engineers. Rana K. D. B. Singh, who had
already contributed to the first edition, drafted the revision of
chapter VI, which deals with engineering and technology. Increasing
concern about the environmental impact of industrial projects has led to
the expansion of chapter IV, which now covers location, site and
evironment. Valuable material, including information on the practical
application of environmental impact assessment, was provided by
R. Schoenstein, G. Schoerner and D. Sussman. The text of chapters IV,
V and VIII was reviewed by B. Andersson, and that of chapter X by
J. Bendekovic and G. Eckstein.
Although this Manual is based on the first edition, as well as on
contributions by consultants, responsibility for the final text remains
that of the authors, who hope that readers will find this revised and
expanded Manual as useful for their work as the first edition published
over 10 years ago.
v
Explanatory notes
vi
CONTENTS
Page
Forew ord ....................................................... iii
Preface ......................................................... v
Explanatory notes ................................................ vi
Introduction ..................................................... 1
PART ONE.
PRE-INVESTMENT STUDIES
AND THE INVESTMENT PROJECT CYCLE
PART TWO.
THE FEASIBILITY STUDY
vii
Page
Annexes
I. Case-study .................................................. ..... 344
II. Outlines of general opportunity studies ......................... ..... 349
III. Outline of pre-feasibility study ................................. ..... 352
IV. Types of decisions to be taken during different pre-investment stages .. ... 355
V. Status of an existing industrial enterprise ........................ .. ... 356
VI. Demand forecasting techniques ................................ ..... 362
VII. Sampling principles .......................................... ..... 372
V III. Field surveys ................................................ ..... 375
Index........................................·.... ....... ....... ..... 377
Tables
Figures
IX
Page
VI. Information flow chart for the preparation of industrial feasibility
stu dies ....................................................... 35
VII. Reliability of different types of pre-investment studies ............... 37
VIII. The phases of rehabilitation projects ............................. 42
IX. Marketing research and preparation of a marketing concept ......... 64
X. The m arketing m ix ............................................. 65
XI. Marketing research and the marketing system ...................... 67
XII. Problem classification .......................................... 69
XIII. Market volume and market share ................................ 73
XIV. Assessing the profile of possible reactions of competitors ............ 77
XV. The life cycle of a subsector ..................................... 78
XVI. Intensity of competition ................... ..................... 78
XVII. Outline of the project strategy and marketing concept ............... 82
XVIII. Types of geographical project strategy ............................ 83
XIX. Profitability and market share ................................... 84
XX. Basic strategic options .......................................... 84
XXI Product-market relation ........................................ 86
XXII. Competition and market expansion strategy ....................... 87
XXIII. Basic elements for the determination of a project strategy ............ 88
XXIV. Assessment of product-target-group fields ......................... 89
XXV. Development of a marketing concept ............................. 95
XXVI. Phases of environmental impact assessment ................... ..... 134
XXVII. Example of an organization chart for an industrial enterprise ........ 205
XXVIII. Structure of the balance sheet ................................... 267
XXIX. Origin of cost items for profitability calculation (return on equity) .... 270
XXX. NPV method and ranking problem ............................... 284
XXXI. Determination of the break-even conditions ....................... 305
x
Page
VIII-I. Human resource planning ........................................ 230
VIII-2. Computation of surcharges on wages and salaries ................... 231
IX-I. Sample breakdown of project implementation costs .................. 246
Schedules
xi
Page
X-7/4. Total debt service ............................................... 329
X-7/5. Total debt service: foreign or local components ..................... 330
X-7/6. Debt service: foreign or local currency loans ........................ 331
X-8/1. Cash-flow table for financial planning ............................. 332
X-8/2. Cash-flow table for financial planning: foreign or local components .... 334
X-9/1. Discounted cash flow - total capital invested ....................... 336
X-9/2. Discounted return on equity capital invested ........................ 338
X-10. Net income statement from operations ............................. 340
X-1 1. Projected balance sheet .......................................... 342
xii
Introduction
Since its first publication in 1978, the Manual for the Preparation of
Industrial Feasibility Studies has demonstrated the usefulness of its methodo-
logical approach by having been translated into 18 languages and applied
throughout the world, with 11 reprints of the English edition alone, and four of
the French.' In recent years many developing countries have standardized their
project planning in line with the UNIDO approach. Consulting firms, industrial
enterprises, banks and investment promotion agencies in developed countries
have also introduced the UNIDO procedure or have adapted it to their own
requirements.
Many new problems have emerged during the 1980s. In particular, there
has been a great change in the general economic situation, with high foreign
debts, low raw-material prices and a widespread shortage of foreign exchange
making it difficult for developing countries to secure fresh investment
resources. In addition, major projects completed in the 1970s very often failed
to generate the cash flow necessary to service the debt and finance new
investment in expansion, modernization, rehabilitation and other projects. A
shortage of international capital and foreign exchange earnings, combined with
a low level of national savings, have created a need for more efficient project
planning and for project design with a strategic orientation, on the basis of an
integrated financial and economic analysis.
UNIDO has had more than 10 years to accumulate wide experience in
applying the Manual in the preparation of a vast number of feasibility studies
carried out under its technical cooperation programme. The Manual is also
used in UNIDO institution-building and training programmes. The successful
identification, formulation, preparation, appraisal and promotion of industrial
investment projects rests to a large extent on the availability of national
institutions capable of performing such tasks. The UNIDO technical coopera-
tion programme, which focuses mainly on the establishment and strengthening
of consulting firms, investment promotion agencies, project appraisal units in
development finance institutions and industrial development centres, contributes
to the upgrading of national capabilities of developing countries in the
preparation of pre-investment studies and the appraisal of investment projects.
This activity has expanded considerably and led to the creation of an inter-
university cooperation network, with members from developing and developed
countries, using UNIDO manuals and guidelines on pre-investment studies as
student textbooks and conducting joint training programmes and research.
'After its publication in English, UNIDO provided translations of the Manual into Arabic,
Chinese, French, Russian and Spanish. Users of the Manual prepared translations into Czech, Dari,
Farsi, German, Greek, Hungarian, Japanese, Laotian, Polish, Portuguese, Serbo-Croatian, Turkish
and Vietnamese.
1
Practitioners working in the pre-investment field all over the world
provided UNIDO with many valuable suggestions on how to adapt the Manual
to the needs of contemporary investment consultancy. Its close dialogue with
readers and its own experience thus led to the preparation on the present
revised edition of the Manual.
The following new topics feature prominently: the strategic orientation of
business planning as a basis for the preparation of investment projects; and the
inclusion of environmental impact assessment in the selection of the project
location, sites and technologies. The market chapter has been completely
rewritten to reflect the increasing importance of the development of proper
marketing concepts for the feasibility of investments. Several chapters of the
original text were recast and a case-study was added to produce a coherent
whole and achieve even wider utilization for the Manual in training activities.
The use of computers for financial and economic analysis has become
commonplace. The working forms and schedules originally designed for
manual computations have therefore been adapted to reflect that change and
made fully compatible with the third generation of the UNIDO Computer
Model for Feasibility Analysis and Reporting (COMFAR).2
The Manual consists of three parts. The first deals with categories and
basic aspects of pre-investment studies. Part two-the main part-covers the
different chapters of the feasibility study, and part three contains additional
supporting material, including a case-study and descriptions of techniques used
for the assessment and projection of data.
New in part one is the introduction of the concept of strategic orientation
of business planning as a useful instrument for the preparation of pre-
investment studies. The different phases of the investment project cycle are
outlined and their interlinkages described, as well as the stages of the pre-
investment phase and the activities that should be carried out simultaneously,
such as investment promotion and planning of both investment financing and
project implementation. Part one also shows that the Manual applies not only
to the establishment of new industrial plants, but also to the rehabilitation and
expansion of existing factories. It closes with a brief introduction to the
institutional infrastructure for pre-investment studies and the use of electronic
data processing in the pre-investment phase.
Part two constitutes the core of the Manual and its outline corresponds to
the framework of a feasibility study. It includes a number of important changes
as compared with the first edition. Those changes are described below.
Chapter III was almost entirely rewritten and is now entitled "Market
Analysis and Marketing Concept". It is conceived in a much broader way and
presents marketing research as a basic tool for defining the marketing concept
to be adopted by the project. It concludes with the determination of the sales
programme and the forecast of sales revenues. The design of the production
programme and of the plant capacity is now covered in chapter VI.
Chapter IV, "Raw Materials and Supplies", deals with the classification
and specification of input requirements, contrasting them with supplies
available.
2
COMFAR is the property of UNIDO and protected by copyright 1982, 1984, 1985, 1988 and
1990
2
Chapter V, "Location, Site and Environment", has been considerably
revised with the addition of a new part dealing with the environmental impact
of industrial investment projects on the choice of location and site. Check-lists
and worksheets for the classification of different types of environmental impact
are provided in the appendix to chapter V. The coverage of environmental
aspects is extended throughout the Manual.
Chapter VI, "Engineering and Technology", now begins with the
determination of the production programme and the plant capacity which in
the earlier version were covered in chapter III. It is the task of the engineering
team to design the functional and physical layout required for the industrial
plant to meet production goals. This edition highlights the fact that project
engineering is concerned not only with engineering design, the computation of
investment expenditures and the determination, for the operational phase, of
human and material inputs, including their costs, but also with a wide range of
interrelated activities such as the choice, acquisition and transfer of technology,
which have to be carefully planned, assessed and coordinated.
In chapter VII, "Organization and Overhead Costs", the question of
organizational design received particular attention, whereas in chapter VIII,
"Human Resources", more emphasis is placed on the need, already at the
project planning stage, to identify training requirements and to estimate
ensuing costs during the investment and operational phases. In chapter IX,
"Implementation Planning and Budgeting", the stages of project implementa-
tion planning are presented in a coherent manner in order to facilitate the
projection of the implementation budget and the outflow of capital expenditures
during the construction period.
Chapter X, "Financial Analysis and Investment Appraisal", has been
restructured and expanded. After a discussion of the objectives and scope of
financial analysis, the basic criteria for investment and financing decisions are
introduced. Those criteria concern the role of private and public interests, the
impact of pricing of project inputs and outputs, the planning horizon and the
problems relating to risks and decisions in conditions of uncertainty. The
structure of investment, production and marketing costs is analysed, taking
into account the reliability of data and the need to identify critical variables as
a precondition for the appraisal of investment projects by investors and
financing institutions. Basic investment appraisal methods, including the
computation of the discounted cash flow (internal rate of return, net present
value) and conventional ratios, as well as the interpretation of figures, are
discussed in detail, with investment being defined 3 as a long-term commitment
of economic resources with the objective of producing and obtaining net gains
in the future, and with the transformation of financial resources (that is,
liquidity) into productive assets being viewed as the main aspect of that
commitment. After consideration of project financing and various aspects of
risk and uncertainty (sensitivity, break-even and probability analysis), chapter
X closes with a brief review of the objectives of economic analysis and a
bibliography of publications recommended for use in practical work.
To ensure clarity and facilitate its practical use, each chapter in the second
part of the Manual is presented in four parts, as follows: chapter review;
detailed examination of the subject, starting with basic principles and the
3
See part two, chap. X, sect. A.
3
definition of terms used, then continuing with the preparation of the
corresponding chapter of the feasibility study; bibliography; and check-lists,
working forms and schedules.
The detailed text given in each chapter is intended to acquaint the reader
with the conceptual problems to be faced in completing the study. These texts
have as much detail as is possible in a manual dealing with the many
multidisciplinary problems of a feasibility study. The bibliographies point the
way to further study of individual issues raised in the Manual.
This format allows a stage-by-stage analysis of the various study
components, with the sets of figures generated for each component gradually
converging to the most important totals. This method also allows any single
component of the entire study to be dealt with separately, within the overall
logic of the study. The format was designed in this way because the true
evaluation of an investment proposal can only be done correctly if data are
collected properly during the preparatory stage.
Each chapter of the Manual contains several pro-forma schedules suitable
for data collection.4 The schedules are designed in such a way as to correspond
to the timing requirements of cash-flow analysis. Furthermore, the schedules
are sequential and can ultimately provide an accounting of all the major
inflows and outflows of funds needed for financial evaluation and planning.
For a number of reasons the Manual does not address problems related to
economic evaluation. First of all, the subject would require too much space for
appropriate coverage. Secondly, when preparing an investment proposal, an
investor or promoter is normally not very much concerned with the costs and
benefits the projects may represent for the economy as a whole. Interest is
focused on commercial considerations, that is, the rate of return to be expected
from the investment involved, taking into account the prevailing market prices
to be obtained for the products and to be paid for material inputs, utilities,
labour, machinery and equipment and the like.
Another important reason why economic evaluation is not a part of this
Manual is that various publications 5 cover the subject at great length, paying
particular attention to socio-economic factors having an impact on project
choice. Only in the final chapter of this Manual is the value of subjecting any
major profitable investment proposals to economic evaluation emphasized in
order to promote an awareness of the significance of economic evaluation
among private and public investors.
The preparation of a feasibility study is a task which, if it is to be done
well, requires inputs from many professional disciplines for the various
4
The schedules in the first edition were designed basically with manual computations in mind.
Since then the use of personal computers has spread rapidly, and commercial as well as user-
developed programmes are now used for discounting, the computation of debt-service schedules
etc. With the development of computer applications in project analysis the scope and quality of
financial analysis has been increased considerably. The schedules were therefore redesigned to
better reflect this development, and also to correspond with the UNIDO COMFAR software of the
third generation, to be released with the publication of this Manual The figures shown in the
schedules contained in the appendix to chapter X are based on the data given in the example case
presented in annex I to this Manual
SIn particular, Guidelines for Project Evaluation (United Nations publication. Sales No
72.II.B. 11), Guide to PracticalProject Appraisal (United Nations publication, Sales No. E.78.II.B.3)
and Manualfor Evaluation ofIndustrial Projects (United Nations publication, Sales No. E 80 II.B.2)
4
components of the study, the most important of which are as follows: market
analysis and marketing; location, site and environment; engineering and
technology; and financial analysis. The intended audience of this Manual
therefore includes market and financial analysts, economists, engineers and
social scientists. Having such a wide readership, the Manual can deal with each
of the above-mentioned topics only in the depth required to present the
concepts and methodologies needed for the preparation of a feasibility study.
Each of the topics referred to could be the subject of separate publications. As
a compromise in this regard, a comprehensive bibliography is provided at the
end of each chapter in part two of the Manual.
5
PART ONE
Pre-investment studies
and the investment project cycle
A. Investment project cycle and types of pre-investment studies
9
Figure I. Pre-investment, investment and operating phases of the project cycle
Pre-selection Preparation
PRE-INVESTMENT
PHASE Negotiations and contracting
Expansion
Innovation
OPERATING
PHASE INVESTMENT
Engineering design
PHASE
Replacement
Rehabilitation
decisions (appraisal report). Support or functional studies are also a part of the
project preparation stage and are usually conducted separately, for later
incorporation in a pre-feasibility study or feasibility study, as appropriate. The
development of a project through several stages also facilitates investment
promotion and provides a better basis for project decisions and implementation
by making the process more transparent.
While it is easier to grasp the scope of an opportunity study, it is not an
oasy task to differentiate between a pre-feasibility and a feasibility study in view
of the frequently inaccurate use of these terms. In this Manual, therefore,
definitions are made general enough to be widely accepted and applied in
developing countries.
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 step by step or being able to present alternative solutions. This
also cuts out many superfluous feasibility studies that would presumably have
10
little chance of reaching the investment phase. And 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.
Opportunity studies
11
industry with a refinery, or an electric-arc steel plant with a steel
rolling-mill
* Possibilities for diversification, for example, from a petrochemical
complex into the pharmaceutical industry
* Possible expansion of existing industrial capacity to attain economies of
scale
* The general investment climate
* Industrial policies
* Availability and cost of production factors
* Export possibilities
Opportunity studies are rather sketchy in nature and rely more on
aggregate estimates than on detailed analysis. Cost data are usually taken from
comparable existing projects and not from quotations of sources such as
equipment suppliers. Depending on the prevailing conditions under investiga-
tion, either general opportunity studies (sector approach) or specific project
opportunity studies (enterprise approach), or both, have to be undertaken.
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 (annex III), the principal objectives of which are
to determine whether:
* All possible project alternatives have been examined;
* The project concept justifies a detailed analysis by a feasibility study;
* Any aspects of the project are critical to its feasibility and necessitate
in-depth investigation through functional or support studies such as
market surveys, laboratory tests or pilot-plants tests;
* The project idea, on the basis of the available information, should be
considered either non-viable or attractive enough for a particular
investor or investor group;
* The environmental situation at the planned site and the potential impact
of the projected production process are in line with national standards.
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
(annex III) should be the same as that of a detailed feasibility study.
A detailed review of available alternatives must take place at the stage of
the pre-feasibility study, since it would be too costly and time-consuming to
have this done at the feasibility study stage. In particular, the review should
cover the various alternatives identified in the following main fields (com-
ponents) of the study:
* Project or corporate strategies and scope of project
8
An outline of the types of decisions to be taken during different pre-investment stages is
presented in annex IV to this Manual.
13
* Market and marketing concept
* Raw materials and factory supplies
* Location, site and environment
* Engineering and technology
* Organization and overhead costs
* Human resources, in particular managerial (entrepreneurial) staff,
labour costs and training requirements and costs
* Project implementation schedule and budgeting
The financial and economic impact of each of the above-mentioned
factors should be assessed. Occasionally, a well-prepared and comprehensive
opportunity study may justify bypassing the pre-feasibility study stage. Such
cases should be confined to investors who have complete knowledge of the
project conditions. A pre-feasibility study is, however, conducted if the
economics of the project are doubtful. Short cuts may be used to determine
minor components of investment and production costs but not to determine
major cost items. The latter must be computed on the basis of reliable primary
sources.
Feasibilitystudies
Appraisal report
17
a whole. Thus, if a car manufacturing plant is to be appraised, the report will
also review the relationship of the plant to its feeder industry, the transport
sector, the availability of highways and the energy supply. For large-scale
projects, appraisal reports will require field missions to verify the data
collected 9 and to review all those factors of a project that are conditioned by its
business environment, location and markets and the availability of resources.
The investment project promotion process extends over the entire pre-
investment phase and may even enter into the investment phase proper (figure II).
It embraces a number of related activities such as the identification of potential
sponsors, negotiations and establishment of cooperation agreements for the
entire investment project or for limited areas of concern (export marketing,
transfer of managerial or technical know-how, critical supplies etc.) as well as
determining potential sources of finance. To be successful, investment
promotion also requires the conscientious collaboration of all parties concerned.
The success of investment promotion is largely dependent on the business
environment (prevailing investment climate), development objectives, industrial
development policies or strategies, the institutional infrastructure,'s and the
mechanisms adopted by decision makers. Government development objectives
and investment promotion policies need to be clearly defined, especially the
role that national private and foreign investors may play. Foreign participation
is usually sought to supply technical, managerial and marketing know-how,
and is rarely limited to loan or equity financing. The particular combination of
foreign inputs required varies naturally with the type of project and from
country to country. Another important factor is the "right" balance between
the public and the private sector. Whereas in many developing countries the
public sector played a dominant role up to the mid-1980s, its role is now being
reduced, leaving more room to the private sector.
As shown in figure II, the investment promotion process extends over the
entire pre-investment phase and may even enter into the initial investment
phase. The opportunity study," representing the project identification phase of
the project cycle, stands at the beginning of the promotional activities. Specific
project opportunity studies may be used to attract potential investors or to
search for national or international sponsors.
In order to succeed with investment promotion, the identified projects
must be studied in detail by the parties involved. This means that for a national
investment project the main local promoter and other eventual partners must
be associated as early as possible in the preparation of the feasibility study,
possibly also of the pre-feasibility study. If, however, foreign promoters are
needed, international contacts have to be established. On the other hand,
foreign investors may also search for local partners in developing countries. In
both cases, the promotion process may be set in motion through a number of
familiar instruments such as special investment project promotion meetings,
country presentation tours, attendance at international fairs or the distribution
of national investors' guides. Particularly for international joint ventures,
'Sources of data must always be quoted. See also part one, sect. B (3).
'°See also part one, sect E
"See also part one, sect A (1).
18
attention must be given to the joint conduct of feasibility studies by all parties
concerned, so as to ensure that the joint investment decision is based on the
results of a study agreed upon by everybody. The costs of the study are usually
shared by all parties.
Figure II shows also the distribution of capital expenditures during the
various stages of project development and promotion. The capital expenditures
continue to increase and reach a peak in the construction stage, while the
promotional activities usually peak during the preparation of the feasibility
study and the appraisal of the project.
As far as financing is concerned, investment in most developing countries
still depends on foreign funds, mainly because of their relatively low saving
capacity. Promotion of investment financing, however, has become very
difficult with the unhealthy accumulation of foreign debt-the debt crisis-in
many developing countries. Well-prepared project feasibility studies are
undoubtedly required to promote projects and find the necessary finance.
It has already been noted that sufficient institutional support is required
for the successful promotion of investment projects. In almost all developing as
well as many developed countries, specialized national investment promotion
and development agencies were set up for this purpose. The main objectives of
such agencies are not only to identify investment opportunities and to prepare
opportunity studies, but, more important, to find suitable national and foreign
partners interested in investing in such ventures. On the international level
UNIDO operates an Industrial Promotion Programme comprising the following
three main elements: the System of Consultations as an international forum to
initiate contacts between international, regional and non-governmental institu-
tions and to identify investment opportunities and cooperation projects; the
Development and Transfer of Technology Programme for assisting developing
countries in the acquisition of technology, know-how and negotiation
capability; and the Industrial Investment Programme, with offices in a number
of industrialized countries.12
'2UNIDO operates Investment Promotion Services at Cologne, Milan, Pans, Seoul, Tokyo,
Vienna, Warsaw, Washington, D.C., and Zurich, and Industrial Cooperation Offices at Beijing
and Moscow, which promote the flow of investment to developing countries.
'3 Most of these topics have been covered in UNIDO publications listed in the bibliography to
part one of this Manual.
19
* Pre-production marketing, including the securing of supplies and setting
up the administration of the firm
* Recruitment and training of personnel
* Plant commissioning and start-up
3. The operationalphase
4See W. C. Baum, The Project Cycle, Finance and Development (Washington, D.C., World
Bank, 1978).
21
B. Basic aspects of pre-investment studies
1. Strategic orientation
Understandingchange
Any enterprise or investment project should be understood as an integral
part of a socio-economic and ecological system. A relationship of inter-
dependence exists between the system and the enterprise. Although the
characteristics, in particular the objectives and requirements, of the project
depend on the system, which is superior to the enterprise, the project itself will
also have a certain impact on the system. This superior system is usually
referred to as the overall corporate or investment environment, which consists
of two interrelated environments, the socio-economic and the natural (or
ecological), as reflected in figure III.
22
•Figure III. The firm and its environment
Customers
Note: This diagram has been simplified by excluding the international dimension.
Development of skills
In order to survive in a competitive environment an enterprise needs
certain core skills that set it apart from competitors, because such skills enable
the enterprise to gain competitive advantages and, in the long run, to achieve
better results than its" competitors. Firms should develop and maintain core
skills centred on product design, reduced production costs, control of
distribution channels, short lead times etc. The feasibility study should try to
identify core skills that competitors will find difficult to imitate; that utilize
existing and future market forces in the best possible way; and that secure
long-term business success.
23
Importance and utility of a strategy
Concentrationofforces
The concentration of forces is presumably the most important principle of
strategic planning. In investment planning it means that projects are planned to
avoid weaknesses as far as possible, and to develop the forces needed to
concentrate on possible success areas. Forces may be concentrated on selected
product-market combinations and the development of essential skills, as well as
the provision of the necessary financial, personnel, material and managerial
resources. A successful strategy is characterized by a careful reconciliation of
objectives and means. When objectives are set too high, the enterprise may run
short of resources before those objectives are reached. If targets are too low,
however, the full potential of the enterprise will not be activated and utilized,
resulting in a failure to reach the best possible competitive position.
Risk balance
Each strategy entails risks that should be identified in the feasibility study.
Identifying risks makes it possible to determine how to manage and minimize
those risks. If this is not considered feasible, the decision to invest should not
be taken. Risk balance means that resources are not completely concentrated
on one strategy, and that the project design requires a sound balance between
the various risks, including those relating to the market, supply, technology and
political matters.
"When a new enterprise is to be founded, the basic project objective is identical to the
corporate objective, and so are the strategies to achieve that objective. Where expansion,
modernization or rehabilitation projects are concerned, the basic project objective and strategy
depend on the higher corporate objectives and strategies.
24
Cooperation
It is often very costly and time-consuming to build up all the means or
skills required to implement project objectives. By identifying and establishing
cooperation with others through a coalition strategy, each party could benefit
considerably. There are various forms of cooperation ranging from loose
agreements to partnerships, joint ventures, holdings and the acquisition or
merger of enterprises. The feasibility study should analyse the possibilities and
potential advantages of such cooperation.
Developing a strategy
Functional strategies
Substrategies
Research and develo pment Research and development Internal and external
development
Patents and licensing
26
Strategies Strategic objectives Substrategies
Financing Profits Financing
Liquidity Profits
Safety Efficiency
Liquidity
Risk and safety
1 1
Sales programme Material inputs Location, site and environment
Chapter III Chapter IV Chapter V
i
t > t
1 r
Technology engineering
Chapter VI
Financial analysis
choice of financing and investment appraisal
Chapter X
27
Whether a new enterprise is planned or a large and significant investment
is intended in an existing firm, in each case the optimal long-term position of
the project should be analysed and determined in the feasibility study. The
determination of the central objective of the project and the development and
selection of the project strategy is described in detail in part two, chapter III. It
is important to note that the project strategy determines the production
volume, the resources and technology required and the location of the project.
Figure V shows the interrelationship between the main subjects to be covered
by any pre-investment study.
28
3. Datafor pre-investment studies
29
Important data sources for pre-investment studies are reference data
published by specialized data banks, industrial associations, equipment
manufacturers, development banks and international organizations. They have
to be used carefully, taking into account their date of collection, the plant size
and possible economies of scale, the country of origin and applied technical
and economic conversion factors. As location, site and civil engineering data
are frequently collected in the field, it is recommended that the sources or
groups of related data be identified in order to verify or complete them. The
date of collection, the person or team in charge of the collection, and the
samples and methods used should be specified. If laboratory tests or pilot plant
processing were required, they should be described briefly and the results
communicated.
30
example, from sales of products or for services. After deducting the related
(direct and indirect) costs and direct taxes, the net income or net profit is
obtained. The terms revenue and gross income are often used synonymously,
and for the purposes of financial analysis it is usually assumed that the income
shown in the net income statement equals the cash inflow arising from selling
the produce.' 8 The term income, however, would also include interest received
or any extraordinary income (such as proceeds from the sale of assets). For the
purpose of financial analysis, only that income which arises from the
productive use of the investment should be considered.
The difference between costs and expenditures as well as between revenue
and income becomes clearer if the expenditures and the utilization of values (as
in the case of raw material costs) for a product within a specified period (for
example, one year) are compared. With regard to raw materials, the difference
lies between the purchase and processing that occur at different times or that
overlap; with regard to equipment, the difference between expenditures and
costs is taken care of by depreciating the investment expenditures within a
certain period (determined mainly by tax laws 19 ) in order to apportion
investment costs through annual depreciation charges in accordance with the
utilization of the equipment, that is, the fixed assets. The application of the
terms is described below.
For financial calculations (involving, for example, project financing and
liquidity) the terms expenditures and sales revenue or income from operations
should be used. The same applies to cash-flow analysis and related discounting
methods (internal-rate-of-return (IRR) and net-present-value (NPV) methods).
Depreciation charges, however, are a part of the annual costs, 20 but not of the
expenditures in the same year, as the entire sum of investment was already
entered as a cash outflow at the time the investment took place. The term costs
should be used only in the context of accounting, when calculating unit costs or
costs of products sold. When calculating the internal rate of return or the
present value, a simplification is frequently introduced regarding expenditures
and revenues, as well as costs and income, assuming that the difference between
annual revenues and expenditures is on average the same as annual net profits
(income less costs) plus annual depreciation charges. However, this simplifica-
tion is applicable only if there are no significant changes in the stock of fixed
and current assets.
8The annual sales revenue, or the cash received in one year, corresponds to the income from
sales, plus accounts receivable from the previous year, less accounts receivable from the current
year. Apart from the first year of production or the case of a considerable change in the accounts
receivable, the assumption that previous-year receivables equal current-year receivables is
sufficiently accurate for the purpose of a feasibility study.
9In some cases, tax law does not determine depreciation for reporting to stockholders
20
Annual depreciation charges do have an impact on the cash outflow related to the payment
of corporate or income taxes (see part two, chap. X, sect. E)
2
'The term investment is defined in part two, chap. X, sect A
31
separately according to project components. On the other hand, investment
costs for technology, equipment and civil works should be computed according
to project components and cost centres.
Investment cost items are dealt with in part two of this Manual as follows:
Subject Chapter
Fixed investment
Land and site preparation V and VI
Technology (lump sum and initial payments) VI
Equipment
Production VI
Auxiliary VI
Costs for environmental protection technology, waste disposal,
internal infrastructural services V and VI
Spare parts, wear- and tear-parts, tools VI
Civil works
Site preparation and development V and VI
Buildings VI
Outdoor works VI
Engineering and design costs (unless included in equipment) VI
Incorporated fixed assets (intangibles) VI and IX
Project design costs (engineering etc.) (unless included above groups)
Transport, handling costs and charges
Insurance
Duties, taxes
Pre-production expenditures
Cost of previous studies II
Preliminary and capital issue, legal costs etc. IX and X
Project and site management IX
Pre-production marketing costs III
Pre-production implementation costs IX
Personnel recruitment, training, administration and overheads VII and IX
Trial runs, start-up and commissioning IX
Interests on loan, accrued during construction X
Working capital X
Total Investment: costs X
The total costs of products sold are composed of the following two
different types of costs: total production or manufacturing costs (dealt with in
chapter VI); and marketing costs (dealt with in chapter III), also referred to as
costs of sales and distribution.
Production costs
32
taking into account the capacity of installed equipment and technical
conditions of the plant, such as normal stoppages, down time, holidays,
maintenance, tool changes, desired shift patterns and indivisibilities of major
machines as well as possible rejects. The feasible normal capacity is the number
of units produced during one year under the above conditions.
Conversely, the nominal capacity is the technically feasible capacity, which
frequently corresponds to the installed capacity as guaranteed by the supplier
of the plant. A higher capacity-nominal maximum capacity-may be
achieved, but this would entail overtime, excessive consumption of factory
supplies, utilities, spare parts and wear-and-tear parts, as well as dispropor-
tionate production cost increases.
Production and marketing cost items are dealt with in part two of this
Manual, as follows:
Subject Chapter
A. Factory costs
Material inputs (usually direct variable costs), in particular raw
materials and factory supplies IV
Human resource costs (wages, salaries, mostly direct costs,
either fixed or variable, depending on type) VIII
Products rejected or returned III and VI
Effluent and waste treatment, environmental protection costs V and VI
D. Operating costs (A + B + C) X
F. Cost of financing X
G. Production costs (D + E + F) X
33
Subject Chapter
Promotional costs (advertisements, samples etc.)
Distribution costs (transport, interim storage, insurance etc.)
Indirect marketing costs III
Overhead costs of the marketing department (personnel,
communications, materials and services, marketing research,
general promotional activities etc.)
Schedules
34
Figure VI. Information flow chart for the preparation of industrial feasibility studies
to Schedules X-8 ^
pre-investment phase to determine precisely the amount of raw materials,
factory supplies etc., the discrepancy is compensated by adding a certain
percentage (for example, between 5 and 10 per cent) to the physical volumes.
Although the margin of error in the estimates will vary from item to item, the
common practice is to apply a standard across-the-board rate. This approach
should not be overemphasized, as there is a danger that it might be used as a
means of evening out mistakes. Therefore, all main items of the investment
project should be estimated as precisely as possible and the degree of reliability
indicated. 22
The financial contingencies (such as inflation) that occur during the life of
a project may have a much stronger bearing on its financial viability than the
physical contingencies, since they influence the amount of fixed investments,
working capital, production and marketing costs and sales. It is very difficult to
estimate the impact of inflation on these five items, as sales, wages, salaries,
prices for equipment, utilities etc. may increase at varying rates.
The impact of inflation on investment costs is especially strong in the case
of projects with implementation periods extending over several years. In order
to adjust the financing plan for expected inflation, the estimated annual or
semi-annual disbursements of the total investment cost (including physical
contingencies, if applied) should be increased cumulatively by an estimated
inflation factor. The same approach applies to production costs.23
To summarize, it is recommended that, provided inflation would have a
significant impact on the outcome of the feasibility analysis, different inflation
rates be applied to different countries for the components of production costs,
fixed investments, working capital and sales. As the margins of error are wide,
it is difficult to make valid projections. A sensitivity analysis (see chapter X)
using computer programmes is therefore recommended.
When reviewing a project proposal under conditions of inflation, two
factors should be borne in mind: gearing (ratio of borrowed to owner funds)
and the real rate of return. With regard to gearing, if a project is financed by a
mixture of equity and loans, the equity holder gains by inflation. If a fixed-term
loan has to be paid back, it is easier with inflation since the real cost of the loan
declines. It may be observed, therefore, that inflation frequently encourages a
disproportionately high rate of loan financing. As far as the real rate of return
is concerned, it should be noted that if the internal rate of return (IRR) is
calculated using constant prices, then the IRR should be compared with the
real cost of money, in other words, if the borrowing rate is X per cent and the
inflation rate Y per cent, the real cost of capital is X minus Y per cent.
36
Figure VII. Reliability of different types of pre-investment studies
Reliability
ranges of reliability (see figure VII) can be considered acceptable for each of the
stages:
Opportunity study ± 30 per cent
Pre-feasibility study ± 20 per cent
Feasibility study ± 10 per cent
The above percentages may differ from project to project and according to
the applied method of cost estimates.24 They are not to be used for an
upgrading from one stage to the next, for instance by adding 30 per cent to the
estimated costs of the opportunity study without checking all relevant facts and
ascertaining their impact on the project and on costs.
"See also part two, chap. VI, sect. H.
37
6. Implementation of studies
38
As costs are a vital determinant of various types of pre-investment studies,
it is preferable to indicate the order of magnitude of the costs if such studies are
undertaken by outside agencies. Costs of pre-investment studies expressed in
percentages of investment costs are approximately as follows:
* 0.2-1.0 per cent for an opportunity study
* 0.25-1.5 per cent for a pre-feasibility study
* 1.0-3.0 per cent for a feasibility study for small to medium-sized
industrial projects
* 0.2-1.0 per cent in the case of large industries or large projects with
sophisticated technology or difficult markets
1. Rehabilitationstudies
41
Figure VIII. The phases of rehabilitation projects
PRE-DIAGNOSTIC STAGE
DIAGNOSTIC STAGE
(internal analysis)
SHORT-TERM MEASURES
I
APPRAISAL AND FUND-RAISING
I
PLANT REHABILITATION
42
Structure of rehabilitationstudies
General management
A major subject to be covered in a rehabilitation study is the existing
structure and performance of the general management of the firm. By applying,
in principle, the concepts referred to in the section on corporate or internal
analysis, 2 6 the strengths and weaknesses of the top and middle management
should be assessed, and recommendations drawn up, in cooperation with the
key personnel of the firm, on how to improve the management structures and
performance.
43
Location, site and environment
The given site of a plant normally limits the flexibility of the study team.
Heavily polluting industries may in extreme cases have to be relocated or even
closed.
Human resources
The main focus will be on staffing and training. Plants are frequently
overstaffed because of governmental labour regulations. The findings of the
rehabilitation study have to be presented to management in special seminars,
and skill levels may need upgrading in order give effect to the recommendations
of the rehabilitation programme.
Project implementation
In cases where projects never came on stream, the reasons might have to
be found in improper implementation planning, causing cost overruns, faulty
construction etc. Such problems often arise from insufficient project prepara-
tion, as reflected in the choice of technology, engineering design, errors in data
assessment and over-optimistic forecasts, as well as from an incomplete
assessment of the resources required and available. Identifying the causes
would help to determine possible rehabilitation measures.
Financialevaluation
Directly linked to organizational matters is the analysis of the present
financial structure and performance. Balance sheets, income statements,
sources and the use of funds, debts, equity, working capital requirements and
44
cash flow management are to be studied. The financial merits of the
rehabilitation programme have to be highlighted, paying particular attention to
the provision of sufficient working capital, the main cause of liquidity
bottlenecks faced by ailing plants. Once the rehabilitation study has been
completed and an action plan is designed, the physical rehabilitation of the
plant will be initiated and implemented. Close monitoring of the result should
guarantee that the provisions and forecasts made in the action plan are
measured and achieved.
2. Expansion studies
This Manual is concerned with new industrial projects, but it may equally
be applied to the expansion of existing production plants to determine the
feasibility of, for example:
* An increase in the quantitative output of products and by-products
without changing the range of products
* A change in the production programme by adding new products of the
same line
* A combination of the foregoing
The quantitative expansion may be achieved by the following means:
* Introduction of shift work
* Raising the capacity of the weakest sections of a production line in
order to increase its total capacity
* Upgrading the technology or increasing the capacity of entire produc-
tion lines
The introduction of new products may lead to the installation of new
production lines within the existing plant or, depending on their scale, to the
erection of new production facilities at a separate location. Such expansion
should, however, be treated as a new project. The procedure for the
preparation of a feasibility study for expansion projects of the same product
line is analogous to that given in the Manual, taking into account the
determinant factors of the existing enterprise.
In order to formulate a comprehensive project proposal, the data of the
expansion project must be synchronized and consolidated with those of the
existing plant. Depending on the size of the expansion project, it should be
clear whether the existing internal organizational structure and supporting
facilities (such as utilities, administration and sales department) will be
sufficient or need adjustments, or whether the expansion proposal should allow
for a new structure that will absorb all existing ones. The extreme case may
even be the selection of a new location.
The financial impact of an expansion may be expressed in terms of the
marginal costs and benefits, as well as by comparing the overall economic
implications of undertaking the expansion project with those of not doing so.
A list of data to be collected on an existing enterprise is provided in annex V.
In order to facilitate the integration of the data into the feasibility study, the
check-list is structured in the same way as the feasibility study.
45
D. Role of institutions, consultancy services and information systems
Nationalfinancingagencies
46
contribution to investment consultancy (through risk identification, evaluation
and control). Such services would reduce the risk for the commercial banks and
their customers, since the clarity of the projects would increase as a result, and
uncertainty would thus be reduced. In recent years, commercial banks have
therefore mainly financed working capital and, to a lesser extent, fixed capital
investment, so that they have neglected a large field for business and industrial
development.
Development banks, on the other hand, have emerged actively as
investment consultants. In this role, they not only evaluate the bankability of
projects, but also frequently prepare investment and profitability calculations
for those of their customers who cannot perform such tasks. Only through even
closer cooperation 29 between development and commercial banks will it be
possible in future to counterbalance the narrower approach of the commercial
banks and bring into play the greater project specialization of the development
banks as an up-to-date form of investment consultancy.
National consultingfirms
Internationalorganizations
47
(ILO), as well as the World Bank. All of these organizations provide the
consultancy services required, either themselves, through their own staff, or by
using the services of national and international consulting firms and consultants.
Equipment suppliers
Many dexeloping countries are confronted with the problem that they
must often make investment decisions on the basis of feasibility studies that
sometimes e\en haxe to be prepared free of charge by equipment suppliers.
This procedure is difficult to prevent, since no third party who could indicate
the dangers of this t pe of investment consultancy is involved in direct contacts
between ianestors and suppliers of equipment. The negative experience of
African developing countries in particular indicates that studies prepared by
suppliers are xerx often only expanded bids or "sales aids", and are offered in
48
many countries simultaneously, with only slight alterations specific to the
country in question. In many cases this procedure has led to misdirected
investment and to the creation of excess capacity-cases now up for
rehabilitation.
Investment consultancy on the part of equipment suppliers also has the
disadvantage that no genuine alternatives for the selection of the technology
and machines are discussed in such project proposals (which rarely meet with
the minimum requirements for an unbiased feasibility study). In conducting
pre-feasibility studies, investors or promoters may obtain alternative project
proposals3 0 worked out by several suppliers for one and the same project. In
such cases, the proposals should be prepared under the same terms of reference
to ensure that the studies are comparable. It should be further noted that many
equipment suppliers, even from developed countries, still have too little
experience of feasibility studies.
Information systems
The purpose of information systems is to allow retrieval of selected
information previously stored in the system or data bank. A data bank contains
data in an organized and well-structured format, and the user of the system can
30
The proposals would usually focus on technical or technological matters It is therefore
essential in such cases to ensure that the other critical aspects are also considered, as described in
this Manual.
49
retrieve information, in other words, data defined by certain conditions. For
example, the user may ask for a list of the total investment costs of all textile
manufacturing projects prepared after 1982, or for data relating to investment
projects implemented in a certain country between 1976 and 1985 with initial
investment costs of over $5 million etc. When designing a data bank the
following considerations are of utmost importance: objectives and volume of
information; data bank structure; user interface (query language); data
exchange with other systems (compatibility); and data bank maintenance.
Project data banks can facilitate both the preparation and the evaluation of
feasibility studies.
Statisticalanalysis systems
Statistical analysis systems often form part of an integrated software tool
and allow the analysis of data series using statistical methods. Typical
applications are time-.series analyses for trend extrapolation, reliability tests and
probability analysis.
Simulation models
For the analysis of the feasibility of investment projects it is important to
have an answer to the following question: what is the impact of a change of
project parameters? Simulation models used for feasibility studies include
market models, production models and financial statements such as projected
balance sheets and net income statements. With a cash-flow model it is
possible, for example, to calculate changes in the net present value or internal
rate of return as a function of varying sales prices.
Decision models
While simulation models help decision makers by showing how the
feasibility of an investment would probably be affected by a change of the
scenario, decision models help to determine which project alternative is
preferable under certain conditions or constraints. Projects not fulfilling those
conditions would be rejected.
50
UNIDO software for project preparationand appraisal
Soon after the publication of the first edition of this Manual, UNIDO
decided to develop COMFAR,31 a software system that has evolved since 1982
from a model for financial analysis at the enterprise level into a complex system
for financial and economic analysis of investment projects. This UNIDO
software supports the preparation, appraisal and evaluation of pre-investment
studies. Being available in the official languages of UNIDO as well as a number
of other languages, it has been well accepted by development planning and
financing institutions, consulting companies, banks and training institutions in
most of the Member States of the United Nations.
COMFAR is basically a standardized simulation model for financial and
economic analysis, directing the user through the physical operation of the
personal computer on which COMFAR is installed and guiding him also in the
entry of data and the computation of statements and various financial and
economic indicators and ratios as required for project analysis. The new
COMFAR generation, developed in conjunction with this second edition of the
Manual, allows the exchange of data with spreadsheet and data-bank software
available from leading software producers. With the new method of, on the one
hand, guiding the user through the data entry system by requesting exactly the
input required for the computation of the system output as predefined by the
user, and, on the other hand, assisting with the analysis of the data by allowing
a comparison with key data from similar investment projects previously stored
in a COMFAR DataBank, the third generation of this UNIDO-developed
computer software can be expected to contribute further to the improvement of
financial and economic analysis and appraisal of investment projects.
The schedules contained in chapters III to X of part two of this Manual
have a format compatible with COMFAR, although the UNIDO software
incorporates many additional features permitting, for example, entries in
different currencies and the preparation of economic cost-benefit analysis
following different methodologies.
Bibliography
51
Mennes, L.B.M. Investment planning for economic cooperation among developing
countries. Rotterdam, Erasmus Universiteit Rotterdam, Centrum voor Ontwikkelings-
programmering, 1985.
Organisation for Economic Cooperation and Development. Development Centre.
Manual of industrial project analysis in developing countries, v. 1. Rev.ed. Paris,
1972.
Sen, A. Resources, values and development. Oxford, Blackwell, 1984.
United Nations. Guide to practical project appraisal; social benefit/cost analysis in
developing countries. [Prepared by John R. Hansen]
Sales no.: 78.II.B.3.
Guidelines for project evaluation. [Prepared by P. Dasgupta, S. Marglin and
A. Sen]
Sales no.: 72.II.B.11.
Manual for evaluation of industrial projects. Prepared jointly by the United
Nations Industrial Development Organization and the Industrial Development Centre
for Arab States. (ID/244)
Sales no.: E.80.II.B.2.
Manual on the establishment of industrial joint-venture agreements in
developing countries. (ID/68)
Sales no.: 71.II.B.23.
52
PART TWO
United Nations. Extracts of industrial feasibility studies, v.l. Industrial planning and
programming series, No. 7. (ID/SER.E/7)
Sales no.: 73.II.B.4.
See also the bibliographies provided for the individual chapters.
58
II. Project background and basic idea
To ensure the success of the feasibility study, it must be clearly understood
how the project idea fits into the framework of general economic conditions
and industrial development of the country concerned. The project should be
described in detail and the sponsors identified, together with a presentation of
the reasons for their interest in the project.
Projectpromoter or initiator
* Names and addresses
* Financial possibilities
* Role within the project
* Other relevant information
Project history
* Historical development of the project (dates of essential events in
project history)
32
See part one, sect. A, and part two, chap. III.
59
* Studies and investigations already performed (titles, authors,
completion dates, ordering parties)
* Conclusions arrived at and decisions taken on the basis of former
studies, and investigations for further use within the current study
Feasibility study
* Author, title
* Ordering party
"Provided they form part of the pre-production project expenses (schedule X-2) covered by
the project and not by third parties.
60
Schedule II. Costs of pre-investment studies and
preparatory investigations
(insert in schedule X-2)
Project:
Date:
Source:
Currency: Units:
Preparatory investigations
Grand total
61
IE. Market analysis and marketing concept
The basic objective of any industrial investment project is to benefit either
from the utilization of available resources or from the satisfaction of existing or
potential demand for the output of the project. As already discussed in part
one, a project may also serve certain corporate strategies, such as strengthening
the market position of a company or securing future supplies of necessary
resources. However, for all investment projects, including those with the
primary objective of resource utilization, market analysis is the key activity for
determining the scope of an investment, the possible production programmes,
the technology required and often also the choice of a location. As the
preparation of a feasibility study is not a linear but an iterative process, market
analysts must have an understanding of the quantity and quality of the
products and by-products involved, and of possible alternatives with regard to
the economic size, as determined by input availability and requirements, as well
as by technological and locational constraints.
Once the present effective demand for the envisaged project output, the
characteristics of the corresponding markets (unsatisfied demand, competition,
imports, exports etc.) and possible marketing concepts have been determined,
the desired production programme, including the required material inputs,
technology and human resources, as well as suitable locations, can be defined.
The demand or market analysis must be carefully structured and planned in
order to obtain the required information within the time and cost limits, and to
determine the possible marketing and production strategies required to reach
the basic or corporate objectives. Planning of marketing research requires an
understanding of the marketing system, the determination of the objectives and
scope of the research, and proper structuring of the market to be analysed.
In this chapter the analyst will be guided through market analysis and the
elaboration of a marketing concept, including the definition of a sales
programme, the projection of revenues and marketing costs. Ideally the
marketing experts should communicate and cooperate with the other members
of the feasibility study team from the very beginning of the work, so as to avoid
isolated marketing or engineering solutions that could prove to be financially
unsound.
A. Marketing
The basic structure of this chapter and the integration of the marketing
concept within the project strategy are shown in figure IX below. The pyramid
shows how the planning process becomes more and more specific and detailed
from the top (strategies) to the bottom (means and actions). It should be noted
that the final marketing concept of the project can be developed only when the
market data are assessed and scrutinized systematically, as described in the
following sections. Only then will it be possible to minimize the risks related to
uncertain future developments.
Project strategy
MARKETING RESEARCH
extends from top to bottom
Geographical area
Market share
Cost leadership
Differentiation
Market niche
OUTLINE OF THE MARKETING CONCEPT
Marketing concept
The marketing concept comprises the marketing strategy and the operative
measures required to implement the project strategy and reach the project or
corporate objectives. When a project strategy has been defined, a suitable
marketing concept can be designed in accordance with the phases described
below.
64
Strategic dimensions of marketing
The principal question is as follows: which marketing strategy is suitable to
achieve the marketing targets within the conditions defined by the project
strategy? The elaboration of the marketing strategy requires long-term
orientation of project planning as well as long-term operation in the market
after the project has become operational (the opposite concept being that of
ad hoc reactions based on daily business). The marketing strategy to be
considered involves the following dimensions: identification of target groups
and of the products likely to win their favour; and determination of
competition policies, that is, whether a low-price strategy or a differentiation
strategy should be pursued to defeat competitors.
PRODUCT PRICE
Scope of product mix Price positioning
Depth of product mix Rebates and conditions of payment
Quality Financing conditions
Design
Packaging
Maintenance
Service
Warranty service
Possibility of returning a purchase
PROMOTION PLACE
Advertising Channels of distribution
Public relations Distribution density
Personal sale Lead time
Sales promotion Stock
Brand policy Transport
65
Marketing measures and the marketing budget. For the feasibility study it is
necessary to determine the marketing activities and to prepare a time schedule
indicating the starting-point and duration of those activities which are essential
for the project. The objective of marketing activities planning is to determine
the means and resources required, and to coordinate and control pre-
production marketing as well as marketing during the operational phase of the
project. The marketing activities plan is therefore the main precondition for the
projection of both marketing costs and sales revenue (sales volume and prices),
which are discussed later in this chapter.
B. Marketing research
For the development of the project strategy and the marketing concept,
careful marketing research, that is, a concise and systematic assessment of
information on the market and market environment, is essential. It is the task
of marketing research to obtain, analyse and interpret this information, and to
provide the basis for decisions of a strategic or marketing nature. Marketing
research consists mainly in the analysis of demand (end-use and trading) and
competition, customer behaviour and consumer needs, competitive products
and marketing instruments, taking into account the interdependencies between
the individual subjects themselves, their relation to the market as a whole, and
the impact of social, ecological and economic factors.
The scope of marketing research required for a feasibility study is
determined by the need to select and justify a project strategy (and alternatives)
and the development of a corresponding marketing concept. The research work
proceeds step by step, in line with the planning process, as reflected in figure
IX. Logically, the quality of all subsequent decisions depends on the quality of
data assessment. Any errors made in the research phase would result in wrong
marketing concepts, and may place the whole project in jeopardy.
Present New
Project under
study Competitors
MARKET
t t
Marketing mix Marketing mix
for target market for target market
I I
Sales agents
Brokers
t
Marketing mix of
sales agent
I
Consumer or end-user group
There are three principal aims of demand and market analysis that are
valid for the pre-investment study phase and the operational phase. First,
market-project relations should be made transparent for the management;
secondly, strategic constraints and problems should be identified; and finally,
strategic options for the project should be outlined.
The work should be organized along the following lines:
* Assessment of the target market structure
* Customer analysis and market segmentation
* Analysis of the channels of distribution
* Analysis of the competition
* Analysis of the socio-economic environment
* Corporate (internal) analysis
* Projections of marketing data
* Conclusions, prospects and risks
The depth or degree of detail of the analysis should be determined
according to the complexity of each problem and its importance for the project
or the project evaluation. The matrix presented in figure XII may be used for
guidance.
The problem classification matrix may be interpreted according to the
requirements of each problem type, as follows:
* Type I requirements
A very precise and comprehensive analysis
A thorough market and competition analysis
A detailed consideration of further strategic options
Gradual refining of functional strategies (marketing, production etc.),
with checking or justification of underlying critical assumptions
* Type II requirements
A thorough analysis of problems
A rough consideration of the most important strategic alternatives
A gradual refining of critical functional strategies
Importance for
the project
Novelty or" High Medium Low
complexity
of the problem
High
Medium
Low IV
• Type IV requirements
A simple assessment of the project conditions
Preparation of a concept based on the most important or critical
aspects only
A feasibility study would by definition fall under type I, although not all
problem areas of the study would finally be in this category. For example, some
problem areas in the market analysis may have little importance for the project
and be of medium or low complexity. As a general rule, pre-feasibility studies
would be of type II, and opportunity studies of type III or IV.
Data assessment
There are basically two options for obtaining the required data, and in
most cases both options are combined. Whereas overall quantitative estimates
are based entirely or mainly upon results of desk research,35 more detailed
quantitative findings and those of a qualitative nature emerge typically from
the other principal form of market research, the field survey.36 Overlapping
between these two means of data assessment occurs because, when assessing
market size and characteristics, written sources will quite commonly have to be
supplemented by interviewing, tests and observations. Interviewing of carefully
selected key persons is an efficient way to extract the necessary market know-
how. No field survey should be undertaken before the full potential of desk
research has been exhausted. All relevant written material from within and
outside the enterprise should be collected and then analysed, in order to
minimize, on the one hand, the various financial costs incurred in field surveys,
and, on the other, the possibility of straining the tolerance of respondents by
undue consumption of time at interviews. Sampling principles are explained in
annex G, while annex H deals with the details of field surveys.
"Desk research is the assessment of existing information contained, for example, in statistics
and reports that were originally collected or prepared for other purposes
36
A field survey is the assessment of information directly by interviews, tests and
observations.
69
Two types of market information can be distinguished, namely general
market data and specific data for a particular market segment (consumer
group, product or product group). Most marketing studies include data on the
following:
* General economic indicators relating to product demand, such as
population level and growth rate, per capita income and consumption,
gross domestic product per capita and annual growth rate, and income
distribution
* Government policies, practices and legislation, to the extent directly
related to consumption, production, imports and exports of the
products in question, standards, restrictions, duties, taxes, as well as
subsidies or incentives, credit control and foreign exchange regulations
* Present level of domestic production, by volume and value, including
production intended for internal consumption and not placed on the
market
* Present level of imports, by volume and value (c.i.f. and local costs)
* Production and imports of substitutes and near-substitutes
* Critical inputs (see also chapter IV) and complementary products
* Production targets determined in national economic plans, where
applicable for products in question, substitutes and complementary
products
* Present level of exports, by volume and value (f.o.b.)
* Behavioural patterns, such as consumer habits and responses, individual
and collective, and trade practices
The specific demand and market data for a particular market segment
should be identified and its availability for the feasibility study ascertained. The
range of the data, however, depends on the nature of the product and the type
and degree of market research that it may involve (see figure XII). It is not
practicable to make any classification or prescribe any guidelines in this regard.
In one case, past production figures may be decisive; in another, they may be
misleading. The same holds true for data on imports, past consumption and
prices. The determinants in each case should be considered, since in most
developing countries free market forces are hardly operative, and varying
controls can result in considerable distortion of data. The demand for a
product may have been suppressed by market imperfections such as mono-
polistic or oligopolistic competition and trade policies involving high import
tariffs, which would not be payable on domestic products. Artificially high
domestic prices may be imposed on certain products whose imports are severely
restricted, but the pattern of demand, and consequently of product pricing,
would change materially once the product became available in large quantities.
It is, however, necessary to identify the specific demand and market data
required for a particular product, the extent to which such data are available
and could be utilized in the feasibility study, or the alternative data on which
the conclusions of the study have to be based. Sources of information have to
be identified and located in each case. Considerable information may be
available from official published data, including statistical handbooks, census
reports and resource, area or sectoral opportunity studies conducted by
governmental agencies, institutions or associations such as chambers of
70
commerce. Such data are seldom complete or broken down for the purpose of
marketing research, and may serve rather as a starting-point for the work. In
developing countries it is common for data to be available on general economic
indicators but inadequate or not readily available on existing production
figures. In some developing countries such information is considered con-
fidential as far as production in particular industries is concerned. Import data,
for example, may not always be accessible and up-to-date, and in many cases a
number of items are lumped together and disaggregation may be difficult, if not
impossible. Should recent statistics on imports be unavailable from one
Government, a picture may in some instances be deduced from the export
statistics of others. Desk research is normally decisive in establishing the
quantitative parameters, and recourse to all conceivable written sources,
including special government statistical compilations, is often necessary.
The period to be covered by a demand and market study varies. In one
case, data over 10 years may be barely adequate because of abnormal
fluctuations during the period; in another, it may not be possible to cover a
period of more than three or four consecutive years. Figures for a single recent
year may be exceptional in some way, and should not be used as a basis for
projections.
After the assessment of the market structure, the customers and their needs
and behaviour must be identified. The following aspects should be analysed:
* What is bought on the market?
* Why is it bought? What is the purchasing motive?
* Who are the buyers, the purchasing decision makers and persons
participating in the decision?
* When is it bought (decision-making process, purchasing practices such
as seasonal purchases)?
* How much is bought (purchasing quantity and frequency)?
* Where is the purchase made?
71
The above questions must be studied carefully before the marketing mix is
designed. Different markets have different characteristics as regards customer
behaviour. There is normally a difference between consumer-goods markets
and capital-goods markets.
Consumer-goods markets show the following characteristics:
* The customer has complex needs that he or she is often only partially
aware of;
* The performance offered has not only a functional, but also an
emotional significance to the customer;
* There is often no real decision-making process, but rather brand-
oriented, routine or impulse buying;
* Customer opinion is highly important.
Capital-goodsmarkets show the following characteristics:
* The items purchased are intended for further use in a production
process;
* Customer needs are most frequently based on a clearly defined purpose;
* There is often a complicated decision-making process within organiza-
tions with many internal opinion leaders;
* The customer often has a deep or expert knowledge of the product;
* There is a relatively long period of time between the first customer
contact and the conclusion of the contract.
Market segmentation
A market analysis can be made for either the market as a whole or each
market segment separately. It is advisable, however, to divide the market into
certain segments, on the basis of differentiated customer behaviour. Market
segmentation is, moreover, a central prerequisite for efficient use of the
marketing tools.
A market segment has to meet three requirements:
* Customer behaviour within the segment has to be as uniform as
possible;
* The segment has to be clearly distinct from others;
* The size of the segment has to be big enough to ensure that a
differentiated market treatment by the enterprise would pay off.
Segmentation can be based on the following factors:
* Geographical or linguistic criteria, such as nationality, region, urban or
rural predominance etc.;
* Socio-demographic criteria for individuals (age, sex, income, education,
profession, size of household etc.) or enterprises (corporate size,
industrial branch etc.);
* Psychological criteria (innovativeness of customers, purpose, status
etc.).
72
Market analysis
In general, the first step is the preparation of a detailed estimate of the
actual market volume (for example, current sales in a certain market or market
segment) and the market potential, or maximum possible demand of the total
market (see figure XIII). The second step is to project the development of the
future market volume, dealt with below in the section on the projection of
marketing data. This is the basis for the question of the actual or envisaged
market share of the enterprise. The targeted market share provides the basis for
the projection of sales quantities, and therefore for the production programme,
plant capacity and derived requirements for materials and inputs, labour,
investment etc., as shown elsewhere in this Manual.
Market segmentation and market analysis are highly interrelated, and
should therefore always be linked and not carried out separately.
Market potential
Market volume
Expected demand
Current sales
Market share |
Current or
planned share of the
enterprise or project
Export markets
37
Except for small projects designed solely for local markets, there is a close relationship and
interaction between the domestic and foreign manufacture of a product. Domestic products are
frequently in competition with imported products except in countries imposing severe import
controls. But even in the latter case, the price, quality and delivery of equivalent imported products
has a considerable impact on the price and quality of domestic products. In some countries, a direct
relationship is established in the matter of pricing, and domestically manufactured products.have to
sell at a certain percentage (approximately 20-25 per cent) below equivalent imported products.
Even in the case of public sector projects, it is attempted to relate product pricing to the pricing of
comparable imported products.
74
* What will be the future extent of the advantage of the enterprise
operating on a geographically limited field?
The possibility of extending the market to other countries should be
explored for most projects. After delineation of the geographical division of
possible export markets on the basis of reasonable projections as to the degree
of penetration, a special market survey may need to be undertaken in selected
countries. The scope of such a survey would vary depending on the degree of
export orientation contemplated for the project.
The factors governing export markets tend to be more complex than those
governing domestic markets. While the techniques of estimating and fore-
casting are basically the same, they need to be considered in a selective way by
analysing certain countries. The scope of such a survey varies according to the
degree of export orientation contemplated for the project. Thus, export surveys
could range from projections of past imports in an external market with general
projections for the future to a detailed demand forecast in any particular
external market using the forecasting techniques described later (see annex VI
to this Manual). This should, however, be undertaken rarely, and only when the
export prospects of a particular product justify such an expensive course.
For customer analysis and market segmentation see check-lists III-1, III-2
and especially III-3 in the appendix to chapter III.
Sales or distribution channels are the chain connecting producers and end-
users. This mediation function is usually performed by specialized enterprises,
agencies or representatives, using their own marketing instruments. In addition,
these channels are also lines of information between manufacturers and
consumers. Either separately or in combination, the three main routes to the
end-customer are as follows: through wholesalers to retailers; through retailers
only; directly to consumers. The choice of distribution channels should be
based on the results of the market research.
Distributionthrough wholesalers
This channel performs a particularly valuable function where many
different articles are involved, and when distribution must be made to many
small retail outlets. The advantages of this distribution channel are as follows:
* The wholesaler often accepts large commodity consignments to hold in
stock or inventory;
* The wholesaler reaches a majority of the small shopkeepers;
* The transport problems of the manufacturer, invoicing and credit
control are comparatively simple;
* Relatively few salespersons are needed by the manufacturer.
Distributiondirectly to consumers
Direct sale is the usual channel for industrial products and capital goods,
for which it is ordinarily most cost-effective, although the appointment of
distributors can be necessary in certain industries. Manufacturers' agents may
be appointed by an existing or emergent manufacturing enterprise, by a larger
one entering distant markets or within a restricted market. Such agents can be
responsible for distribution but not usually for warehousing; they order from
the factory as they sell, earning a commission. In an export territory the
importer will carry out the functions of a manufacturer's agent, and others such
as customs clearance, but the importer buys the goods for resale.
If the manufacturer takes over all distributive functions, there may be
resulting advantages of closer control of relations with, and better service to,
users. Other direct sales channels are house-to-house selling and mail orders.
As reflected in figure XI, the sales agent services as a channel through
which the producers can reach the consumer. The project marketing measures
have to support the marketing mix of the sales agents, whose interests, mainly
in packaging and promotion, have to be taken into account from the very
beginning.
Assessing the project situation must also take into account the intentions
of competitors. In analysing the competitors it is essential to focus on
important individual competitors or on groups displaying similar behaviour.
The questions raised in figure XIV must be confronted.
In a second step the analysis will have to be further elaborated, giving
special attention to the following questions:
* How do the competitors use their marketing tools?
* Which target groups (segments) do they work on and how extensively?
* In which segments have they special strengths and where are their
weaknesses?
Check-list III-4 in the appendix to chapter III shows the most important
information to be identified in the analysis of the competitors.
Competitors'
Aims of the competitors ? own
assessment?
I I
Profile of reactions:
t t
What are the specific
Competitors' behaviour? strengths and weaknesses
of competitors?
answer to the following main question: what are the key success factors in a
competitive environment, and what significant opportunities and risks are
sector-specific? The analysis should in principle concentrate on the life cycle of
the subsector, its profitability and the wider socio-economic environment of
which the industrial subsector is a part.
77
Figure XV. The life cycle of a subsector
Market volume
I I I
INTENSITY OF COMPETITION
t t
Negotiating power Negotiating power
of buyers of suppliers
78
Height of entry and exit barriers. Entry barriers prevent new competitors
from entering the subsector. The risk of other competitors entering the market
mainly depends on the reaction by established competitors and the height of
entry barriers. Entry barriers include experience and size of the established
firms, strong existing customer relations, franchises, legal protective barriers,
high investment etc.
High exit barriers also intensify competition in a subsector and tend to
reduce prices and margins. Exit barriers exist when:
* Capacity utilization should be as high as possible owing to high fixed
expenditure;
* It is difficult to lay off employees;
* Political considerations have to be made.
Corporateor internalanalysis
79
The following questions must be answered first, in order to determine
proper project strategies:
* Which aims and strategies does the enterprise currently pursue?
* What strengths and weaknesses does the enterprise have?
* With regard to strengths and weaknesses of the enterprise, which are the
current core skills?
A check-list and form (1-6) for the analysis of an existing enterprise is
given in the appendix to chapter III.
Projectingmarketing data
The projection of future developments is, perhaps, the most significant and
certainly the most complex element of marketing research, as it is the critical
factor for determining both the scope of the project and the resources required.
Essentially, such projections need to cover quantitative and qualitative data
concerning supply and demand in the markets, the market shares envisaged, the
competitive situation etc., as previously described. The basis for quantitative
methods is always a thorough understanding of how a certain subsector is
developing, and all figures produced with statistical methods should always be
interpreted with regard to any possible reasons or causes underlying a trend.
No forecast method can substitute for a wrong or incomplete understanding of
market and subsector characteristics and trends.
Where a particular product is to be manufactured in a country for the first
time and a system of licensing and import controls is operating, consumer
reactions and the possibility of product substitution would be the determining
factors. For instance, market penetration of the first synthetic fibres produced
in a country would depend on the substitution of such fabrics for natural fibres.
As successive units are established, however, the competitive element would be
the principal determining factor and price considerations would be dominant,
although other aspects, such as quality and brand names, could also have some
impact.
The various forecasting techniques are described briefly in annex F, to
facilitate the selection of those methods which are the most suitable for the
preparation as well as for the evaluation of feasibility studies. The following
techniques may be used for demand forecasting:
* The trend (extrapolation) method
* The consumption-level method (including income and price elasticities
of demand)
* The end-use (consumption coefficient) method
* The leading indicator method
* Regression models
Whatever method or combination of methods is used, forecasts necessarily
involve various assumptions and probabilities. Some factors relating to demand
are not apparent, and full account cannot be given of them. Unpredictable
events, such as the energy crisis of the 1970s, can cause an enormous change in
input costs, indirectly altering effective demand for many products. Some of the
uncertainties are as follows: the rate of increase of national and per capita
80
incomes; perceptible changes in the structure of family budgets; the discovery
of new sources of raw materials for the subject industry; emergence of a
substitute; technological developments inside or outside the subject industry or
in the production of inputs; inflationary price rises or price declines; the
discovery of new applications for a product; changes in import quotas or tariff
rates; emergence of industrial cooperation among neighbouring countries; and
the emergence or disappearance of a dominant competitor.
At this stage, after having summarized all results obtained so far by the
marketing research, the market opportunities that can make the project
feasible, as well as the market risks endangering it, can be summed up. These
potential opportunities and risks, which are the critical variables of the project
or its alternatives, provide the bases for the following development of the
project strategy and marketing concept, as well as for any decision concerning
the final choice of the scope of the project, human and material resources,
location, engineering and technology, management, organization, and the
financial evaluation and appraisal of the investment project.
After the introduction of marketing and its dimensions for the manage-
ment of enterprises in general and for feasibility studies in particular, the scope
and structure of marketing research have been described. The preparation of a
marketing concept for an investment project requires, as shown in figure IX,
that a project strategy has been determined beforehand. For this purpose it is
necessary to differentiate between objectives and strategies. The objectives
indicate the direction of the investment project (for example, import substitu-
tion, utilization of national resources, earning of foreign exchange), while a
strategy defines the means and activities required to reach the project objectives
(for example, cost leadership, differentiation, market niche). The main steps for
defining the project strategy and corresponding marketing concept are shown
in figure XVII.
Assessment of the situation and analysing the initial position are the first
steps required for the determination of a project strategy. This includes, but is
not limited to, demand and market analysis. In the case of expansion or
rehabilitation projects, for example, the internal analysis of strengths and
weaknesses would be as essential for the preparation of a feasibility study as the
market analysis. A check-list for the internal analysis (111-6) is shown in the
appendix to chapter III.
The purpose of determining a project strategy is to identify and reflect
systematically the basic strategic problems of a project. Usually the significance
of such problems varies from project to project, and it is essential for the
preparation and appraisal of a project to identify such critical elements and
analyse them carefully. For example, a project applying well-known basic
technology in a market that is in the maturity stage of the life cycle may have to
focus especially on problems concerning distribution channels and how to gain
any advantages over existing competitors. The objective of penetrating
81
Figure XVII. Outline of the project strategy and marketing concept
Environment
Resources Corporate analysis
Location •<> Market analysis
Technology Corporate objectives
Finance
I
Defining the project objectives and strategies
t
MARKETING CONCEPT
international markets for capital goods, for example, could require cooperation
in research, and product or technology development might become a central
question for the determination of a project strategy. When developing a project
strategy, special emphasis should be given to the following four elements by
which it can be determined: the targeted geographical area; the market share;
product-market relations; and competition and market development.
Key 1 Example of a geographically limited local or regional market on which all segments are dealt
with
2 Example of a selected segment (a product group) that is dealt with on all national and
international markets
3 Selected segments are dealt with in selected geographical areas
4 All segments are promoted in all geographical areas In the extreme case this would mean
world-wide competition involving all product segments or aimed at all customer segments
This strategy would require enterprises with a very strong financial potential
_
cu
Q.
J3
ra
O
CL
Low High
may be lower than the marginal cost of a production increase (for a certain
production capacity and technology). Profitability is therefore reduced. A
further increase in the market share would then make it possible to benefit
from economies of scale, and consequently profitably would improve. A
company trying to extend its market share even further may pay a considerable
price for the acquisition of additional territory or the excessive use of
marketing instruments (such as price discounts, advertising and personal
selling), a price that could extend to customer fears of depending entirely on a
dominant seller. Profitability may then turn down again. However, since each
market has its individual characteristics, the feasibility study should analyse
each profitability and market-share relationship very carefully. Figure XX
shows three types of (generic) project strategy with regard to the envisaged
market share.
84
Strategy of cost leadership
Achieving and maintaining lower costs than those incurred by competitors
is central to the entire strategy. The cost advantage attributable to the learning
and experience curve39 provides protection against competition because
competitors incurring higher costs tend to disappear first. In order to achieve
cost leadership, it is often necessary to have a considerable market share or
other important advantages such as access to low-cost raw materials.
The assets usually required for a cost leadership strategy are as follows:
* High investment capacity, that is, access to capital
* Process innovations and improvements
* Thorough supervision of labour force
* Products designed for easy manufacturing
* Low-cost distribution system
Differentiation strategy
The niche strategy is based on the fact that focusing on a strictly confined
aim is more efficient than operating in a broad field of competition. Emphasis
may be placed on a limited group of buyers, parts of the product line or a
geographically limited area. The skills usually required result from the strategic
objective emphasized. They cannot be defined in general.
In order to achieve a concentration of forces, it is usually necessary to opt
for one of the three generic types of strategy. This always implies a certain
position in the market (market-share) and a preliminary determination of the
price level. A cost leadership strategy will aim at low sales prices in the market
for a certain product. A differentiation strategy will aim at a middle range or
relatively high level of sales prices. A high price level can only be achieved with
39
The experience curve includes the empirically proven fact that total unit costs are reduced
by 20 to 30 per cent whenever the cumulative quantity of a product manufactured and sold is
doubled.
85
the strategy of niches, because the market segment for a high price is relatively
small, and an enterprise would not focus on that segment and at the same time
aim at a high plant capacity (that is, economies of scale).
PRODUCT
MARKET
Old New
PRODUCT
MARKET
Old New
not advisable to plan for an enlargement of the total market volume, which
would be the case, for example, when the market has reached saturation or
maturity. Existing enterprises, if they had adopted a market development
strategy, should then return to a competition strategy. It is interesting to note
that often the company with the largest market share is the last to change its
strategy.
Market expansion strategy. A market development strategy implies that the
means of the marketing mix of an enterprise are primarily geared towards the
creation of a new market or the enlargement of the existing market volume. It
would generally imply a change of habits (utilization or consumption habits,
norms etc.). The principal idea of this strategy is to obtain a leading position
vis-a-vis competitors already during the first phase of the development of a new
market.
Market determination
Segmentation by
Customers
Geography
Products
The marketing concept for the project comprises the specific marketing
strategies (focus on target market and customer needs), measures and means
(coordinated marketing) required to achieve the project objectives in a chosen
88
market. This marketing concept is developed within the framework of the
project strategy determined in accordance with the findings of marketing
research. The marketing concept includes the following two dimensions that
should be considered when developing a marketing concept (see figure IX):
• A strategic dimension covering long-term marketing management
(product target-groups, marketing aims and strategies)
• An operative dimension controlling short-term use of individual
marketing tools, marketing measures and the budget
Plastic watches — — + + ++
Designer watches + ++ + ++ + —
Sports watches ?
(timers, waterproof) — + + ?
89
should be identified for each target group (see also check-list III-1 in the
appendix to chapter III):
* Market structure and potential market volume
* Consumer needs and criteria for purchasing decisions
* Competition
* Market price level
* Product requirements
* Existing core skills or new skills
92
forwarding, insurances etc.), and what are the usual payment conditions
(advance payment, supplier credit, leasing, barter or compensation
purchase etc.).
Products may have to be priced below the total costs for certain pcriods,41
not only because of possibly excessive initial production and marketing costs
(start-up period), but also because such lower prices would facilitate entry into
the market and help to achieve a high utilization of installed production
capacities in the beginning. In the case of new products, a particular market
may have to be developed through initially low prices, for example, because of
the existence of a lower-priced substitute, or a competitive market. In all these
cases where sales prices would not satisfactorily cover the cost of products sold,
such pricing policies must, however, be limited to a specific period, and any
losses accumulating during this period must be compensated for by correspond-
ing future cash surpluses.
The marketing strategy must take into account any possible reactions of
competitors selling the same or similar products. A main competitor may be in
a position to reduce sales prices, to protect its market share against a
newcomer. In such a situation current prices would not be an adequate basis
for the projection of sales revenues.
After the above characterization of price policy as a marketing instrument,
it is obvious that price policy is not limited to the relationship between the
volume and price of sales but plays a central role in the marketing mix. The
market analysis, as part of the feasibility study, should assess the present
market situation, compare it with possible future trends, and indicate which
pricing strategies would be feasible.
(c) Promotion
Promotional measures will be required by the investment project, first for
entering the market with the new product, and, secondly, to stay in the market
and reach the long-term objectives of the project. The feasibility study should
identify the promotional measures required to reach the projected sales volume
and estimate the costs of these measures. The following promotional tools can
be distinguished:
* Advertising to stimulate or create a demand has made mass production
possible for many consumer goods. Practically all advertising is
commissioned through specialized agencies, which design the advertise-
ment and select proper media;
* Public relations, although concerned, like advertising, with opinion and
image aspects, is more involved with how to reach and influence key
persons in relevant positions in, for example, public institutions and the
media;
* Personal sales or face-to-face selling has traditionally been regarded as a
very effective way of increasing the sale of most goods. Selling by phone
and mailing to potential and actual customers are variations of personal
sales. Costs of salesmen (usually a part of the remuneration is fixed and
another variable) should be in accordance with the kind of product;
41
For direct costing see discussion of unit costs of production in chap. X, sect. C.
93
* Sales promotion or merchandising is an instrument to support especially
the retailers. Display at the point of sale, start-up events for a new
product, free samples, presentation at fairs etc. are typical examples of
this marketing procedure;
* Brand policy is an important instrument of the promotional mix. An
enterprise has to decide whether to aim at developing a brand name for
a product, or at selling "no-name" products. This decision is usually
central in the case of consumer goods. Consumers, for example, expect a
brand to be of a certain quality, to be available in almost every
shopping area and principally everywhere at the same price. Establishing
a brand name is usually very cost-intensive, which could have a
significant impact on the feasibility of a project during its initial
operational phase. However, this policy could also, in the long term,
result in a very effective differentiation vis-a-vis competitors.
The detailed promotional mix will most probably be determined during
project implementation. However, a preliminary budget estimate for the pre-
production marketing should be included in the feasibility study, and to the
extent significant for financial planning.
3. Defining the marketing strategy in case of Position in the life cycle of the
a market expansion strategy subsector
Demand expansion Possibilities of influencing the market
Demand intensification cost structure in comparison with
In case of a competition strategy competitors
Aggressive price strategy Importance of the price as a
Imitation strategy purchasing criterion
Profile strategy
4. Defining the marketing mix
(operative marketing)
Defining the end-user mix
if sales agents are used
Defining the channels mix
Productionprogramme
96
labour and equipment to the technology selected. Even if full production were
to be achieved in the first year, marketing and sales might prove a bottleneck.
The determination of the production programme and design of the plant
capacity are dealt with in chapter VI, section A.
Bibliography
97
Appendix
Project/alternative:
Structure of the target market (see check-list III-2 and figure X), with description of
the interrelationships within the system, the action of the parties etc.:
98
111-3. Analysis of market characteristics
Quantitative data
Market volume
Position in the market life cycle
Saturation of the market
Growth rates (absolute values and percentage per annum)
Partial markets
Stability of demand
Qualitative data
Structure of customer needs
Purchasing motives
Purchasing process, attitudes in relation to information
Intensity and strength of competition
99
Assessment relative to own company
Worse Equal Better Notes
Promotion
Advertising
Personal sale
Sales promotion
Brand policy
Public relations
Place
Channels of distribution
Distribution density
Lead time
Stocks, transport
100
Development of international trade
Exchange of goods
Economic integration
Protectionism
Trends in the development of the balance of payments and the foreign exchange rate
Inflation
Development of the capital market
Development of the employment situation
Expected investments trends
Fluctuations in the economic development cycles
Frequency
Intensity
Development of the economic sector concerned with the project
Social development
Demographic development in the project country
In general
Development of important population groups
Migrations
Cultural, socio-psychological aspects
Attitudes towards work
Propensity to save
Leisure-time behaviour
Attitudes towards the economy
Attitudes towards automation
Attitudes towards materials utilized
Attitudes towards products offered
Politics and law
General policy trends
East-West
North-South
General risks of local or international conflicts
Position in the market for raw material supplies
Trends in the relationship between political parties in the country concerned
Trends in economic policies
Trends in social legislation and labour laws
Importance and influence of unions
Degree of freedom of enterprises to decide and act
Marketing
Market performance
Price performance
Promotion
Distribution
101
Strengths Weaknesses Conclusions
Production
Facilities
Capacities
Productivity
Availability of supplies
Finance
Capital volume and structure
Reserves
Financing potential
Working capital
Liquidity
Capital turnover
Investment intensity
Return on investment
Personnel
Employee qualifications
Human relations
Social benefits
Note: This check-list highlights some of the most important areas generally subject
to internal analysis. As it is impossible to establish an even fairly complete listing,
"tailor-made" questionnaires must be prepared through practical internal analysis for
each individual case and with the help of specialized literature.
102
Schedule 1-1. Projected sales programme
(insert in schedules X-8, X-9 and X- 10)
Project:
Date:
Source'
Code: Units:
103
Schedule 111-2. Estimate of total marketing costs
(direct/indirect costs of sales and distribution)
(insert in schedule 111-3)
Project:
Date:
Source: [ ] Direct costs
[ ] Indirect costs
104
Schedule 111-3. Projection of total marketing costs
(insert in schedules X-3, X-8, X-9 and X-10)
Project:
Date:
Source:
Code: Units:
105
IV. Raw materials and supplies
The different materials and inputs required for the operation of the plant
are identified and described in this chapter, and their availability and supply, as
well as the method of estimating the resulting operating costs, are analysed and
described. The cost estimates are summarized in schedule IV-1, and the totals
are carried forward to the total production cost table (schedule X-3) described
in chapter X.
There is a close relationship between the definition of input requirements
and other aspects of 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
analysis of supply markets. Important determinants for the selection of raw
materials and factory supplies are environmental factors such as resource
depletion and pollution concerns, as well as criteria related to project strategies,
for example, the minimization of supply risks and of the cost of material
inputs.
In order to keep the cost of feasibility studies at a reasonable level, key
aspects are to be identified and analysed in terms of requirements, availability,
costs and risks, which may be significant for the feasibility of a project. The
approach taken in this Manual is first to classify the raw materials and supplies,
then to specify the requirements, check their availability and estimate their
costs.
Agriculturalproducts
106
under cultivation and often the introduction of another crop. In the case of
sugar cane, for example, it would be necessary to increase the area under cane
cultivation within the same region, since cane cannot be transported over long
distances without involving prohibitive transport costs, loss of sucrose content
or both.
In order to estimate the supplies and availability of agricultural products,
it may be necessary to collect data on past crops and their distribution by
market segment, that is, by geographical area or end-use. Storage and transport
costs often assume major significance and should be assessed. In some cases,
machinery and methods of collection have also to be studied. For paper plants,
the felling and collection of the raw material from the forests may need detailed
analysis.
Projects based on agricultural produce to be grown in the future may call
for actual cultivation on experimental farms under varied conditions. The
produce has then to be tested in laboratories and, if necessary, in pilot plants.
The laboratory facilities for pilot plants may not be available within developing
countries. The samples, scientifically selected, may have to be sent to other
countries where such facilities exist. A project should not be based on an
entirely new crop to be grown in the area, unless pilot plant tests based on
actual produce from the area have established the validity and viability of the
raw material for the project in question.
Marine products
Mineral products
Factory supplies
Apart from basic raw materials and processed industrial materials and
components, all manufacturing projects require various auxiliary materials and
utilities, usually subsumed as factory supplies. It is not always easy to
distinguish between auxiliary materials, such as chemicals, additives, packaging
materials, paints and varnishes, and factory supplies, such as maintenance
materials, oils, grease and cleaning materials, since these terms are often used
interchangeably. However, the requirements of such auxiliary materials and
supplies should be accounted for in the feasibility study. The current
consumption of wear-and-tear parts as well as of tools should also be projected.
A detailed assessment of the utilities required (electricity, water, steam,
compressed air, fuel, effluent disposal) can only be made after analysis and
selection of location, technology and plant capacity, but a general assessment
of these is a necessary part of the input study. Input studies frequently do not
allow for, and even the overall feasibility study tends to underestimate, the
utilities required, often resulting in miscalculation of investment and produc-
tion costs. An estimate of utilities consumption is essential for identifying the
existing sources of supply and any bottlenecks and shortages that exist or are
likely to develop, so that appropriate measures can be taken to provide for
either internal or external additional supplies in good time. Such identification
is particularly important since it may materially affect the investments to be
made in the form of buildings, machinery and equipment and other
installations, if such major utilities are in short supply in the plant and need to
be provided internally.
Electricity. An analysis of the energy situation must specify the require-
ments and the sources, availability and costs of supply of electric power. The
maximum power demand, the connected load, peak-load and possible stand-by
requirements, as well as the daily and annual consumption both by shift and in
total, must therefore be estimated in a feasibility study. Industrial projects with
high-energy requirements at sites where electric energy can only be supplied by
obsolete high-polluting power plants, such as thermal power plants, may have
to be rejected for environmental reasons.
Fuel. When using large quantities of solid and liquid combustion materials,
all the relevant environmental protection technologies will have to be integrated
in the planning and calculation of a project. Consequently, the price of energy
inputs will have to be increased by the costs of disposal measures (filters,
desulphurization etc.). Given the world-wide carbon dioxide pollution and the
probably resulting increase in global temperatures (the so-called greenhouse
109
effect), the growing use of coal favoured by the exploitation of huge coal mines
is liable to reach a critical point. This problem can only be solved through
enhancing the net efficiency factor of the industrial plants concerned, achieving
less energy consumption for the same output.
Water. A general estimate should be made of water requirements (taking
into account recycling arrangements) for the production process, auxiliary
purposes (cooling, heating and boiling, rinsing, transport facilities, grading,
steam generation) and general purposes, so that these can be considered in
locational decisions, at which stage the cost can be specifically defined.
Especially in the case of production processes with substantial water require-
ments at locations with shortages in water supply, so-called closed-circuit
processes should be promoted. The quality of intake water should be tested in
order to avoid problems such as the damaging of pipes and pumps by
aggressive substances.
Packaging materials, containers, crates. All types of containers and
packaging materials serve in principle the following two purposes: physically
holding and protecting a product (semi-finished or finished) stored by the
producer, distributor or consumer; and achieving the marketing objectives
defined in the marketing concept (see chapter III), such as the functional design
of bottles and boxes in line with the objectives of product design and
promotional functions of packaging. The costs of the materials may be
considerable in relation to the production costs of the product sold; for
example, goods produced for export may need special protective packaging if
transported by ship. Goods with a highly visible product image (brand policy)
may require costly packaging to be competitive in the local or foreign market.
The feasibility study should not only identify needs for the various types of
packaging material, but also assess the timely availability of the necessary
quantities, the qualities required and available, as well as the corresponding
costs.
Other supplies. The input study should determine the broad requirements
for various fuels and identify sources of supply and unit costs. Similarly,
general requirements for other utilities such as steam, compressed air, air-
conditioning and effluent disposal should also be identified, so that they can be
analysed in the course of selection of location.
Recycled waste
110
dimensions, not only in absolute figures, but also in relation to the total
investment costs. Today the most critical sectors in this regard are the chemical
and nuclear industries.
Spare parts
Some projects will require provision of materials and inputs that are not
directly related to the production. A remote location, or some other reason,
might require the project (or the company) to provide and pay for foodstuffs,
medicine, clothing, education and training materials etc. for the employees and
perhaps also their families.
Sometimes it may be necessary for the investing company to take
responsibility for maintenance of external infrastructure. This might be the case
if the plant depends on external infrastructure and the public does not allocate
adequate resources to maintain it. Maintenance of roads might require sand,
shingle or asphalt. Maintenance of railways might require shingle, anti-
corrosive agents, paint etc. for the track and rolling-stock.
B. Specification of requirements
42
See chap. III
112
the process and illustrate how production proceeds via those sections. The
purpose is to present main activities rather than to go into details. 4 3
Flow sheets for materials and inputs as well as material and energy balance
or a diagram indicating the quantitative flows, should also be prepared. These
sheets should indicate how and when different items enter various sections of
the process. Sections outside the manufacturing process itself should also be
included, in particular supply of different inputs, transport of materials and
inputs, storage, packaging of finished goods, storage and transport of products,
and emissions from different sections should be identified.
Each section of a process flow sheet can be analysed in more detail in
separate section diagrams. Machinery, equipment and other facilities are to be
specified in such diagrams, which should include the type of machinery,
capacity, technical standards etc. Together with other project specifications
described earlier, this information would provide an adequate basis for the task
of analysing and specifying requirements of raw materials and factory supplies
A most important though often neglected aspect has to be remembered, namely
the consequences that quality demands on the final products may have for the
requirements of material inputs. These demands should be carefully identified
and analysed and treated as a guiding principle when selecting technology,
machinery and equipment, as well as the types and qualities of materials and
inputs.
User demands. Users of the produced finished goods have expectations and
demands that will have consequences not only for the choice of technology,
machinery and equipment, but also for the materials and inputs used. It is
therefore helpful to identify and describe such demands and try to analyse the
effects on input requirements.
43
For example, a flow sheet for a mining and enrichment plant can consist of the fol-
lowing sections: mining-internal transport-crushing-grinding-flotation-dewatering-disposal
of tailings. For cane-sugar manufacturing the flow sheet may show: cultivating-harvesting-
transport-crushing/milling-clarification (heating, precipitation, filtration)-boiling/evapora-
tion/crystallization-separation-washing-drying-packaging. In the case of a cement-manu-
facturing process, it may consist of: quarrying-transport-crushing-grinding-blending of raw
materials-preparation of fuel (drying or pulverization)-burning in kilns-cement-grinding-
packaging.
113
* Section of the production process, applicable to raw materials,
intermediates, components, factory supplies (auxiliary materials, utilities),
spare parts etc.
* Machine or labour hours, applicable to factory supplies, spare parts etc.
* Employees, applicable to foodstuffs, medicine and other social costs
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. In many industries, the selection of
technology, process equipment and the product mix depend largely on the
specifications of the basic materials, while in others the potential quantities
available determine the size of the project. The prices at which such materials
are available is a determinant of the commercial and financial viability of most
industrial projects. In fact, a number of projects are conceived either to exploit
available raw materials or to utilize basic materials that become available from
other production processes.
A feasibility study must show how the materials and inputs required will
be provided. General availability, data about materials, potential users and
supply sources and programmes will have to be analysed and described. The
interdependencies between project design, material and input requirements and
supply of these items should be considered. This means that machinery,
equipment, production process, capacity etc. may have to be revised if inputs
with the specified characteristics and quantities cannot be provided as required.
At the initial stage of the study the quantities of basic material inputs that
may be required should be assessed principally for the purpose of determining
availability and sources for immediate and long-term needs. A final assessment
114
of input requirements can be made only after the plant capacity as well as the
technology and equipment to be used are defined.
If a basic input is available within a country, its location and the area of
supplies, whether concentrated or dispersed, should be determined. The
alternative uses likely to be made of such materials, and the consequent impact
on availability, should be assessed for the project in question. For example,
natural gas may be available in a remote area where it is economic to use it for
the generation of electricity in the absence of other demands. However, if the
gas is piped to major consumption centres or if the area is opened up through
better communications, it would be in much greater demand for other products
such as fertilizers and petrochemicals, and it may then not be economic to use
it for power generation.
The question of transportability and transport costs should be carefully
analysed. The distance over which basic material inputs have to be transported
and the available and potential means of transport should be defined together
with possible bottlenecks.
When the basic material has to be imported, either in whole or in part, the
implications of such imports should be fully assessed. First, the sources of
imported inputs have to be determined. Certain materials such as intermediates
and commonly used products (springs, bearings etc.) are available from
external sources whose access, however, may be greatly restricted in certain
cases. Foreign-exchange restrictions may allow for imports only from particular
currency areas or restrictive clauses in technology supply agreements may bind
licensees to obtain basic inputs, particularly parts, components and other
intermediate products, from licensors. Subsidiaries and affiliates of foreign-
controlled companies tend to purchase such materials only from their parent
companies. In many cases, there may be a lack of knowledge of alternative
external sources of basic inputs, especially of intermediate and manufactured
inputs.
Secondly, the uncertainty that may relate to imported inputs should be
stated. There have been cases where projects have been set up in developing
countries based on imported raw materials from particular sources that have
then ceased to produce the material in question. Such cases primarily relate to
processed materials and manufactured parts and components.
Thirdly, the implications of domestic production of a basic material that
was being imported should be analysed. In most developing countries, such
production is accompanied by import control and user industries have to adjust
to domestic supplies of basic materials. This may involve adjustments to the
quality, specifications and price of such materials. While these changes cannot
be anticipated in any great detail, it should be recognized that when a project is
based on imported basic materials, external and internal forces can affect
availability, and they should at least be identified and the general implications
highlighted.
Input alternatives
In many projects different raw materials can be used for the same
production. When this is the case, the raw materials must be analysed to
determine which is most suitable, taking all relevant factors into consideration.
If alternative materials are easily available, the problem is one of economics of
the process and technology rather than of feedstock selection, although the feed
115
material is still a basic issue. If alternative materials are used, the discussion
should also include an assessment of the environmental impact of each
material.
Supply marketing
Cost minimization
Unit costs
Not only the availability but also the unit cost of basic materials and
factory supplies have to be analysed in detail, as this is a critical factor for
determining project economies. 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 supply. The lower the elasticity, the higher the price as related to
growing demand for a particular material. For domestic inputs the costs of
alternative means of transport should also be considered. For imported
material inputs, c.i.f. prices (including costs, insurance and freight) should
invariably be adopted together with clearing charges (including loading and
unloading), port charges, tariffs, local insurance and taxes, and costs of internal
transport to the plant. The prices of imported inputs generally fluctuate less,
except when:
* International markets are rather volatile;
119
* Monopolistic or oligopolistic conditions prevail;
* Supplies are linked contractually to a particular source, as between a
foreign subsidiary and its parent firm or between a licensee and licensor;
* There is governmental action by way of tariffs or duties or major
changes therein.
The impact of the domestic manufacture of a material that is a basic input
for an industrial project may be significant. In most cases, domestic production
costs and consequently prices of such inputs are higher than prices of imported
inputs, particularly during initial production years. This can have substantial
effects on production costs of user industries. The extent to which consequent
price adjustments in the final product would affect demand for the product
should be assessed.
Annual costs
120
example, c.i.f. prices for imported materials) used in each case. Clearing
charges (including loading and unloading), port charges of different kinds,
customs duties, local taxes, local insurance and costs of transport to the plant
site are to be identified and included in the feasibility study.
The costs of materials and supplies used or kept in stock are specified in
schedule IV-1. The schedule, which can be expanded to allow for the relevant
number of items, should present cost estimates related to a certain production
level. Cost estimates for materials and inputs can be expressed either as the cost
per unit produced or in terms of a certain production level, for example 100,000
units per year. The latter alternative can also be expressed as full capacity
utilization, which is equivalent to a certain production level. In either case, it
will be possible to carry out a sensitivity analysis of different levels of
production and of capacity utilization in the financial calculations. The report
should also identify the unit costs applied.
The following information should be presented in schedule IV-1:
* Type of material and input;
* Unit of measurement (barrels, tonnes, cubic metres etc.);
* Number of input units consumed per unit produced;
* Estimated cost per input unit;
* Estimated cost per unit produced;
* Estimated cost per unit produced divided into direct (predominantly
variable) and indirect (predominantly) fixed cost components;
* Direct cost per unit produced divided into foreign and local currency
components (although expressed in one common currency);
* Indirect cost per unit produced divided into foreign and local currency
components.
When calculating indirect costs, the amounts resulting from environmental
protection and pollution control measures should be established per unit of
production or per accounting period, whichever is appropriate. In order to
arrive at the total operating costs by product as well as the total costs per year,
the estimated costs per unit are multiplied by the total number of units to be
produced.
Schedule IV-2 is used to project the costs over the production period. The
totals per main input category are recorded in this schedule, and the grand
totals for direct and overhead costs (factory and administrative overheads) are
then inserted in schedule X-3.
122
Schedule IV-1. Estimate of costs of
raw materials and supplies
(insert in schedule IV-2)
Project.
Date:
Source:
fo reign L local............................
F =-foreign L = local
123
Schedule IV-2. Estimate of costs of
raw materials and supplies
(insert in schedule IV-3)
Project:
Date:
Source:
124
Schedule IV-3. Projection of total costs of raw materials and supplies
(insert in schedule X-3)
Project:
Date:
Source:
Code: Units:
Year
_
Variable
_ _ [Fixed
~~~~ _
Total
_ _
Variable
_ I Fixed
_ _
Total
_
Grand
total
_
125
V. Location, site and environment
127
may be significant. Information should be collected on temperature, rainfall,
flooding, dust, fumes and other factors for different locations. A check-list on
local conditions is provided at the end of this chapter.
Climatic conditions are relevant in different ways, depending on the type
of project. Agro-industrial projects may 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 markets.
Transport and construction works are usually more complicated and expensive
under extreme conditions, which may be a critical factor in projects with heavy
transport and large construction works.
A project may also be dependent on climatic conditions in an indirect way.
The construction, operation and management of the plant may be less efficient
or more expensive if an inadequately skilled labour force is reluctant to work in
areas with extreme climatic conditions. This aspect is particularly important for
personnel in key positions (top management, administrative staff, skilled
labour) and in scarce supply.
Climatic conditions can be specified in terms of air temperature, humidity,
sunshine hours, winds, precipitation, hurricane risk etc. Each of these can be
specified in greater detail, such as maximum, minimum and average temperatures
on an average day, in particular months or over a period of 10 years. There is
sometimes a tendency to overdo this description. The study should instead
concentrate on the identification and analysis of climatic factors that can be
expected to be of vital importance for the feasibility of the project in question.
Geodesic aspects are in general more relevant for the selection of suitable
sites. These include soil conditions, subsoil water levels and a number of special
site hazards, such as earthquakes and susceptibility to flooding, all of which
extend over greater areas.
Ecological requirements. Some projects may not have a negative environ-
mental impact themselves, but rather be sensitive to such effects. 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 labour may be
reluctant to work in a factory located in a polluted area with health risks.
The feasibility study should include a thorough and realistic analysis of the
environmental impact of industrial investment projects. This impact is often of
crucial importance for the socio-economic, financial and technical feasibility of
a project.4 6 The site and environmental impact analysis will cover the impact of
46
For example, some effluents may be totally unacceptable and require purification and
treatment facilities Others may be tolerable in certain conditions based on such factors as climate,
geology and distance to urban centres. The technological project layout will indicate whether a
particular environmental impact is to be expected. Some projects may use materials and inputs that
involve the risk of spontaneous ignition or explosion, or perhaps toxicological risks Other projects
may generate flue gases, fumes, waste water, waste materials, tailings, noise etc., which affect the
environment negatively. Contamination of groundwater and surface water, air and soil would have
an impact on the natural environment, on plants, trees, animals and people. Some emissions may
even affect houses and metal products, for instance as a result of acid precipitation.
128
the project and its alternatives (in terms of size, technology etc.) on the
surrounding area, including its population, flora and fauna. This analysis
should be integrative and interdisciplinary, assessing the overall impact while
taking into account the synergetic effects of interlinked systems.
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. These consequences and the beneficial or
adverse effects of such human activities on the environment are assessed and
evaluated from a technical, financial and socio-economic point of view, to the
extent that they are significant for the project implementation decision. A
project may impinge upon the human habitat directly or indirectly. An
ecological perspective regards the human habitat in terms of the complex
network of interactions with the natural, cultural and socio-economic environ-
ment.
Environmental impact assessment is part of the project planning process.
Through statute or practice it is an integral part of feasibility analysis.
Environmental benefits or costs of a project are usually externalities or side-
effects that affect the society in whole or in part. As such they are appropriately
assessed in a socio-economic context at the local level, as well as the superior
regional and national levels, if required and as determined by the geo-political
dimensions of the impact. In a comprehensive socio-economic evaluation of the
feasibility of a project, environmental effects on the quality of life are
considered along with other criteria to decide if the overall effect of the project
is positive, or to determine what modifications may be necessary to achieve a
positive evaluation. Some economically quantifiable environmental impacts are
also included along with other economic factors in the cost-benefit appraisal of
the project.
Environmental effects are measured both qualitatively and quantitatively.
As the various environmental parameters are often incommensurate, a multi-
objective evaluation, or optimization, may be required. In such an evaluation,
deviations from the desired condition are weighted either systematically or
subjectively for each factor or combination of factors to arrive at an assessment
of the overall impact. In some cases cost-benefit analysis supplements
qualitative assessments of environmental factors that are not readily quantifiable.
Techniques have been developed for deriving monetized valuations of impacts
that may or may not be directly linked to markets. While these techniques were
originally developed to assess the economic impact of environmental regulations,
they can also be used to make an economic evaluation of environmental
changes in the absence of any regulations. A further description of some of
these techniques is given below.
In countries where the analysis of environmental impacts is already
required by law, the usual procedure is for the promoters of the project to
prepare an extensive environmental impact statement 4 that must be submitted
to the authorities for examination and clearance. This statement can also be a
part of the feasibility study. However, it should be drawn up in such a way that
it can be put forward as a separate paper when the project is submitted for
47
The format and contents of environmental impact statements is not uniform and varies
depending on the regulations of a country. The concept adopted in this Manual follows to some
extent the terminology and concept established in the United States of America.
129
approval. Where such legal provisions for environmental protection do not yet
exist, an environmental impact assessment should be made in the interests of
the investor, in particular when the intention is to apply for international
financing, since many of the international development finance institutions
already require assessment of the environmental impact of industrial invest-
ment projects. Whenever possible, the basic data for such assessments should
include all the documentation currently available on the project, in particular
test results and calculations from university institutes, regional and urban data
collection units or networks, documents from central statistics institutes,
statistics issued by United Nations bodies and other organizations.
In many cases it may well be particularly difficult to obtain sufficiently
precise data on specific regional areas. If such data are required for the
appraisal of the project, however, the assessment of the necessary information
may be rather costly and time-consuming.
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. In countries where no or only vague
regulations and standards are defined, it may be advisable to anticipate a future
tightening of environmental impact control measures, especially in the case of
long-term projects. A growing consciousness and concern for environmental
problems and ecological consequences have in fact become noticeable
world-wide, and is strongly supported by international development and
financing organizations, with the establishment of environmental protection
institutions in each of the countries concerned in order to define and enforce
corresponding environmental protection standards and policies. Therefore,
trends anticipated in the industry life cycles should also be considered in
investment planning especially for industries with high potential environmental
impacts. If trends are properly considered during the project planning stage,
unexpected costs for later plant adaptations, conversions, rehabilitations or
even the shut-down of operations can be avoided or minimized. In countries
where environmental protection standards and guidelines are not yet defined,
standards published by United Nations organizations, such as the Food and
Agriculture Organization of the United Nations, the United Nations Environ-
ment Programme (UNEP), the World Health Organization and the World
Meteorological Organization, or other international, regional or national
institutions, may by used as reference for environmental impact assessment,
when performed within feasibility studies.
Environmental conflicts
Some projects may have environmental impacts that will obviously rule
out certain locations, if serious or irreparable pollution and damages are to be
avoided. Environmental conflicts might also lead to compensation claims,
substantial costs for purification and equipment, and possibly a risk that the
plant will have to be closed down. The potential risks related to the location of
projects with negative environmental impacts are usually so great that these
aspects must be seriously considered in the feasibility study, including potential
conflicts with existing and future neighbouring industries, urban settlements
and other elements, which should be identified and analysed in so far as they
may affect the investment decision.
130
Objectives of environmental impact assessment
The general objective of environmental impact assessment in project
analysis is to ensure that development projects are environmentally sound. This
implies that the effects of the project over its projected life do not unacceptably
degrade the environment, and that no residual effects are anticipated that
would contribute to long-term environmental deterioration. 48 The immediate
and long-term health and welfare of people are linked to their natural, cultural
and socio-economic environment. For this reason, and to promote the objective
of incorporating the ideas and aspirations of the affected population in the
decision process, public participation from the earliest stages and throughout
the project development cycle is desirable.
The specific objectives of environmental impact assessment are as follows:
* To promote a comprehensive, interdisciplinary investigation of environ-
mental consequences of the project and its alternatives for the affected
natural and cultural human habitat
* To develop an understanding of the scope and magnitude of incremental
environmental impacts (with and without the project) of the proposed
project for each of the alternative project designs
* To incorporate in the designs any existing regulatory requirements
* To identify measures for mitigation of adverse environmental impacts
and for possible enhancement of beneficial impacts
* To identify critical environmental problems requiring further investiga-
tion
* To assess environmental impacts qualitatively and quantitatively, as
required, for the purpose of determining the overall environmental merit
of each alternative
48
Environment is here understood as the whole, interdependent, natural (ecological) and
social (cultural, soclo-economic) system, of which an investment project would be an integrated
part.
49
See also chap VI, sect. B
131
investment projects is then usually followed by policy analysis and the
determination of a suitable investment strategy and corporate environment
policy. Finally, and if required, the environment impact statement is prepared.5 0
Sometimes only three phases of environmental impact analysis are
distinguished. At first, a preliminary environmental impact assessment is
performed using a check-list or standardized set of criteria to ensure
consideration of all relevant environmental factors, and to determine which
impacts would need to be analysed in detail during the second phase of the
assessment, and which administrative actions are to be taken. The check-lists
annexed to this chapter may serve as a guideline for the assessment of
environmental impacts.
The environmental impact assessment in the second phase consists in the
identification and evaluation of environmental impacts resulting from the
project. A site visit with all members of the assessment team is essential if the
environmental situation is complex and significant for the investment decision.
An in-depth study of the incremental impacts (with and without the project) is
then prepared, leading to a disciplinary study by each specialist using the full
scope of research tools and resources available.
The third phase of environmental impact assessment consists in the
preparation of the environmental impact statement. Although closely related to
the feasibility study and investment decision, it is not, however, a part of the
study itself. This statement, which is now often required as a condition for
project implementation, should reflect the interdisciplinary mode in which it
was prepared. The final environmental impact statement should specify any
mitigation measures that would make the recommended alternative environ-
mentally acceptable.
As a preliminary step, the impacts of production processes and factory
operations are examined individually and jointly. Ancillary activities such as
the handling of products, raw materials and factory supplies, transport,
resource utilization, waste control and disposition measures, and safety and
process failure controls are considered. Related operations involving pipelines,
transmission lines, docking and road and rail requirements are included. Each
project, in one way or another, utilizes natural resources such as land, water,
raw materials (minerals etc.) and energy. The aesthetic and social qualities of
the site and in the region may be altered or may disappear. The project may
emit solid, liquid and gaseous wastes, radiation (including light) or noise.51
Although it is convenient for the purposes of problem identification and
teamwork to classify the totality of the environment in terms of its various
components, the analysis must take into account the complex web of
component interactions. Apart from the development of analytical models that
take into account such interactions to the greatest extent practicable, it is
imperative that the team should function in an interdisciplinary mode.
Operationally, this requires that frequent coordinated multidisciplinary obser-
50
In the United States, the environmental impact statement is prepared by an environmental
authority, and the statement is based on the environmental impact assessment submitted by the
promoter of the project (enterprise).
51
For the operation of each unit a description of the inflow of raw materials and other inputs
as well as the products, by-products, wastes and other emissions may be supplemented with a
schematic process diagram. Pollution control devices and their effect on waste streams should also
be described. Intermittent processes such as start-up, shut-down, testing, cleaning operations, the
release of gases, liquids, radiation etc. are described. The temporal distribution of process
operations is examined for each phase of the project development cycle indicated above.
132
vations and analyses of environmental factors should take place. In the first
phase of the environmental impact assessment, the definition of the problem
arises from the environmental inventory and preliminary environmental impact
statement. From these data, the scope of the assessment is determined to arrive
at a consensus concerning the impacts to be investigated. Applicable
regulations and limitations are determined and preliminary public reaction is
sought to identify public concerns and local insights.
The baseline or status quo environment (environmental inventory)
represents the foundation for the analysis of project effects. It is described as it
exists during the period of analysis and as it is projected to be 10 to 15 years in
the future. The incremental effects, or changes induced by the project over
time, can then be assessed.
The primary purpose of the environmental impact statement is to serve as
a means of including consideration of environmental consequences of the
project and its alternatives in the process of project appraisal, to ensure that the
policies, goals and aspirations of the proponents, the Government and the
affected population are incorporated in the decision process. It should provide
full and fair discussion of significant impacts and inform decision makers and
the public of reasonable alternatives that would avoid or minimize adverse
impacts or enhance the quality of the human environment.5
52
See Council on Environmental Quality, 40 Code of Federal Regulations 1502 (Washington,
D.C., Government Printing Office, 1988).
"Sometimes the preliminary environmental impact statement may not be sufficiently detailed
to satisfy the environmental authorities or the project may not be approved. In such cases, a more
detailed environmental impact assessment and environmental impact statement would have to be
prepared at the feasibility study level, taking into account the technological, engineering and
locational alternatives identified for the project.
133
Figure XXVI. Phases of environmental impact assessment
Opportunity study
I
Preliminary
Pre-feasibility study environmental impact
assessment
Sceening
Review
Decision
Environmental impact
Feasibility study
assessment
T
Interim reports
Preparation of the
environmental impact
statement
study may be further linked in the sense that certain environmental factors may
be appropriately evaluated in economic terms.54
A mechanism or organism for monitoring environmental compliance
during the construction and operational phases is essential. This body should
also monitor any unforeseen environmental consequences and bring them to
the attention of the environmental review council for further evaluation.
"See the notes on environmental cost-benefit analysis later in this chapter.
134
Methodologies and tools
"Check-lists have been developed in a variety of forms depending on the depth of the study.
Simple check-lists indicate only environmental factors. Other information relating to guidelines for
measurement and to the scaling and relative weighting of effects may be included. Check-lists are
available in several handbooks (such as R. Corwin and others, Environmental Impact Assessment
(San Francisco, Freeman, Cooper, 1975), and R. N. Burchell and D. Lisokin, The Environmental
Impact Handbook (New Jersey, Rutgers University, 1975)), in addition to United States government
publications (such as Environmental Protection Agency, Review of Federal Actions Impacting the
Environment (Washington D.C., Government Printing Office, 1975)). A check-list using scaling and
weighting, known as the environmental evaluation system, has been adapted for use in Thailand. It
was developed by the Battelle Laboratory in the United States. Although designed for assessment
of water resource projects, it can be used for other types of industrial projects. It is useful in
identifying and quantifying potential environmental impacts for decision makers. Although
relatively complex, additional information is required on such matters as the temporal distribution
of impacts.
"6See J. C. Sorenson, "Some procedures and programs of environmental impact", in
Environmental Impact Analysis. Philosophy and Methods, R. B. Ditton and T. I. Goodale, eds.
(Madison, University of Wisconsin, 1972), and B. M. Lohani and N. Halim, "Recommended
methods for environmental impact assessment in developing countries: experiences derived from
case-studies in Thailand", in EnvironmentalImpact Assessment for Developing Countries, A. K. Biswas
and Qu Geping, eds. (London, Tycooly International, 1987).
135
effects etc. Matrices are generally not sufficient for decision-making as they
usually do not meet all of the criteria indicated above.
Overlays use a set of transparent sheets on each of which is indicated the
degree of impact of the project on a particular environmental parameter. The
degree of impact is shown by the intensity of the shading or cross-hatching.
These colour-coded transparencies are positioned over the base map and the
aggregate impact on various areas is shown by the intensity and colour of the
shading. The method is widely used for showing spatial distribution of impacts
and is particularly useful in route decisions concerning, for example,
transmission lines, rail lines and highways. Computerized overlays have been
developed which include not only the shading feature, but also weighting
models that indicate the relative importance of each impact. The overlay
method is most useful in screening alternative project sites.
Networks are used to analyse the cascaded series of effects resulting from
project activities.5 7 A set of possible primary, secondary, tertiary etc. impacts is
identified from similar experiences, and the likely impacts are identified for the
project under study. The network effectively displays factual information, but
does not contain information on weightings or social valuations. It is organized
in the form of a tree, where primary effects give rise to secondary effects,
secondary to tertiary etc.
When the environmental impacts of a system are relatively extensive and
complex, more sophisticated techniques may be required to assess impacts
properly and choose among alternatives. Systems analysis (usually requiring a
computer model) is a method that can deal with multiple criteria for selection
among project alternatives. In this approach the criteria must be clearly defined
and the project impacts clearly understood. The development of an analytical
model requires the interdisciplinary contributions of experts.
Various types of models can be developed. Simulation models provide a
replica of the project and its environment. Parameters are varied to gain under-
standing of the complex interactions between the project and environmental
parameters. Stochastic and temporal features can be built into the model.
Optimization models seek the best solution in consideration of project and
environmental constraints according to an objective function. Techniques such
as goal programming permit the simultaneous consideration of multiple
objectives that are weighted by "penalties" for deviations from the ideal.
Analytical tools include the instruments of objective measurement of
environmental quality. Standards for the use of these instruments must be
respected in order to obtain reliable data. Instruments should be selected
according to criteria of accuracy and precision. Accuracy refers to the degree to
which the instrument indicates the actual value of the parameter. Precision is a
measure of tolerance, or the spread of repeated measurements obtained with
the instrument. Calibration of the instruments to standards should be checked
periodically according to standard practice.
In taking measurements it is important to consider the location and time
of measurements to ensure that they are representative and not affected by
extraneous factors. Measurements should be taken by qualified individuals.
Field analysis permits the constant monitoring of sensitive sites and the
opportunity to check unexpected results, but usually is less reliable than
analysis in the controlled conditions of the laboratory.
57
R. Bisset, "Introduction to methods for environmental impact assessment", in Environ-
mental Assessment (The Hague, Martinus Nijhoff, 1983).
136
The following basic steps should be observed when performing environ-
mental impact assessment:
* Identification of impacts
Define development objectives and key constraints on project
implementation;
Identify options for achieving the basic objectives of the project;
Identify key linkages of proposed development with natural
resources, ecological, social and socio-economic systems, and
other development activities (see matrix and check-lists in the
appendix to chapter V);
Determine requirements for environmental impact assessment (legal
requirements, including procedures for project approval) and
environmental impact statements;
Determine the scope of environmental impact assessment (terms of
reference);
Assemble baseline data for natural and social (socio-economic and
cultural) systems, potentially conflicting development policies or
projects, and key resource implications;
Analyse the proposed investment project to identify resource
demands and outputs and their environmental impacts;
* Environmental impactforecast
Prepare a projection of the magnitude and severity of the probable
future effects of the proposed investment project (see also chapter
VI, section B);
* Evaluation
Assess the significance, distribution and permanence of predicted
effects from the point of view of the affected population,
economic impacts (competition for scarce natural resources,
infrastructure, pollution control etc.) and ecological consequences;
Establish real resource costs and benefits associated with the
environmental impacts of the project, and incorporate these costs
and benefits into the overall economic evaluation, to the extent
that they would be significant for the investment decision;
* Communications
Determine how to present the results of environmental impact
assessment, indicating trade-offs, key decision factors, sources of
data, levels of confidence, conclusion and recommendations with
regard to requirements and possible risks;
Describe possible measures for reducing and controlling negative
environmental impacts, and justify any measures necessary or
recommendable, whether during the feasibility study, project
implementation or operational phases.
138
As parallel activities, the primacy of cost-benefit analysis versus environ-
mental impact assessment depends upon the context in which the project is
being reviewed. For the environmental review and decision process environ-
mental impact assessment is the primary evaluation instrument. In the case of
socio-economic evaluation, the reverse is true. Some of the environmental
impacts that are economically quantifiable would be included in the cost-
benefit analysis, and a comprehensive, interdisciplinary presentation of all
environmental impacts would be included in the accompanying environmental
impact assessment.6 0 At the level of commercial analysis, the environmental
consequences of a project are externalities in the sense that they represent
neither direct costs for the project nor are they sources of revenue.
Economically quantifiable environmental impacts can be included at the
level of economic efficiency. These quantitative values are in this sense
internalized, although the beneficial or adverse impacts affect the local,
regional or national population rather than the project. In case environmental
factors affect specific groups, such as the workforce of the project under study,
distributional effects can also be considered. In some cases it may be useful to
include subjective quantitative valuations of economically non-quantifiable
effects as project merits or demerits, although their inclusion should in no way
detract from the value of the comprehensive environmental impact assessment.
The environmental consequences of the project may be in the form of
environmental improvement or degradation. If an environmental factor to be
affected by the project is regulated, financial costs will accrue to the project for
compliance measures. Treatment of environmental impacts within the regulated
limit is a matter of judgement. If such impacts are assumed to be
environmentally non-deleterious, there would be no corresponding social cost.
Any residual effects beyond the regulated limit would be considered a social
cost. 6 1
Although the project per se is evaluated only in financial terms, an
environmental externality should be evaluated in economic terms as it has an
impact upon a segment of the population external to the project.62
In the cost-benefit context the basic principle to apply in assessing the
socio-economic impact of the project is to consider the net benefits and costs of
the incremental environmental effects of the project, on the basis of the
difference in environmental conditions and mitigation measures with and
without the implementation of the project.
The alternative circumstances regarding the project impact upon the
environment and the assessment of benefits and costs of the environmental
60
The parallel relationship of cost-benefit analysis and environmental impact assessment is
described in the United States Environmental Protection Act of 1983 as follows: "In theory (the
improvement of economic efficiency) is achieved by selecting ... options that maximize net social
benefits. Unfortunately, determining which ... options are best in terms of economic efficiency often
is made difficult by uncertainties in data, by inadequacies in analytical techniques, and by the
presence of benefits and costs that can be quantified but not monetized or that can only be
qualitatively assessed. Thus, even if the criterion of economic efficiency were the sole guide to ...
decision-making, the analytical results ... may not always point to a specific ... option as being
superior."
60On the principle of incremental analysis (with and without the project), it would be useful to
supplement the analysis with valuation of the actual incremental effect as if the regulation were not
in effect
62
In the case of regulation, control or mitigation of the adverse effects of environmental
conditions of the workplace, where the affected population is the workforce, the impacts may or
may not be wholly internal to the project. However, the same principles apply for financial or
economic evaluation as for an environmental externality.
139
impact require different approaches to valuation based upon the principle of
incremental analysis. Various scenarios and the corresponding financial and
economic consequences are outlined below.
In the second case outlined above, where the project is under study and
environmental regulation exists, although the cost of compliance is considered
a sunk cost, it would be a valuable adjunct to the analysis to isolate that part of
the investment attributable to compliance as a measure of the social investment
in the maintenance of environmental quality.
The cost saving (or cost impact) method estimates the changes in
household expenditures and in production costs for other industrial activities
affected by the environmental change attributable to the project under study.
The damage function method develops a dose-response function to assess
physical changes in receptor organisms or materials, which is then converted to
monetary units by assessing the value of the changes. For example, if a crop
yield is altered by a change in environmental quality, the change in the
economic value of the crop is a monetary measure of the environmental
change. In the case of risks to human life and health, valuation models have
been developed using risk-compensation data for occupations with varying
140
levels of risk.6 3 An alternative is the human-capital approach, in which the
financial costs associated with the health impact, principally medical costs and
the present value of lost earnings, are determined.
The contingent valuation method uses surveys to determine the value that
the affected population places on environmental changes. Subjects have
described to them proposed environmental changes and are asked for the
maximum amount they are willing to pay for an improvement or the maximum
amount they would accept as compensation or to prevent the change in the case
of environmental degradation. The data are then statistically analysed and
aggregated across households to arrive at a valuation of the environmental
change.
The contingent ranking method also uses surveys, but subjects are offered
alternatives in terms of environmental change versus payment or compensation
combinations which they then rank in order of preference. From this data a
model is developed which estimates the change in income that would just offset
the utility of the environmental change.
Environmentalparameters
141
and flora. Changes to a physical or chemical attribute of the ecological
environment are usually reflected as impacts upon ecological factors, such as
population size, growth rates, intra- and inter-species interactions and life
cycles, as well as social factors (cultural, economical, aesthetic impacts).
Ecological factors include the flora and fauna separately and conjointly in
terms of ecosystems, in which the population, growth rate, intra- and inter-
species interactions, life cycle etc. of each species and its habitat is considered.
Aesthetic factors are concerned primarily with sensory impacts, primarily
visual, of land use and installations of the proposed project.
Social factors deal with the cultural and economic impacts, such as the
quality of human life in terms of health, welfare and social infrastructure. In
the case of feasibility studies, such effects include impacts within the
corporation or production plant (internal environment), as well as the external
environment.
Check-list V-3 in the appendix to this chapter contains a listing of
potential environmental factors. However, it is not exhaustive, and should be
used only as a guide.
D. Socio-economic policies
The fiscal and legal regulations and procedures applicable for alternative
locations should be defined. The various national or 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 duties, purchase 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 vary considerably for
different areas and may be a significant locational determinant in some cases. It
would also be useful to list any building and other standards and regulations to
which the project would need to conform.
E. Infrastructural conditions
Infrastructuredependence
Factory supplies
Water. The water supply, apart from such projects as a brewery for which
it is also a raw material, should be identified. The water required for a project
can be ascertained from the plant capacity and technology. First, the
availability of water and the costs entailed should be determined, including: the
quantities that could be obtained, if any, from public utilities, together with the
conditions of supply and price; and the separate facilities, and their estimated
cost, that would have to be provided by the project from surface (for example a
river) or sub-surface sources. Secondly, the quality of the water at different
locations should be assessed for different purposes, such as drinking, cooling or
steam generation.
Electricity. The inadequate supply of electricity or its high unit cost in a
particular area can constitute a major constraint for a project or for a
particular technological process such as electrical smelting. Where the location
of a resource-based project cannot be changed, the project has to provide its
own power source. Power requirements can be defined in relation to plant
144
capacity, and the supply and cost at various locations should be studied. To
determine the impact of energy factors, however, it may be necessary to collect
and compare considerably detailed data for alternative locations. In the case of
electric energy, such data would need to cover: the amount available; whether
high- or low-tension current is required; stability of supply; point of tie-in for a
particular area; and the price at different consumption levels.
Fuel. For coal, coke, fuel oil or gas, such data should cover, for each item,
the quantities normally available, quality, calorific value and chemical
composition (to determine pollutants), source, distance to different locations,
transport facilities and costs at alternative locations.
Human resources
Infrastructuralservices
145
Certain effluents that are noxious, unpleasant or even dangerous require
special treatment. The location study should determine the extent of effluent
discharge and the possible manner of disposal at alternative locations. For this
purpose, it may be necessary to take into account any rules on emission
treatment that may prescribe the specific steps and levels of treatment and the
disposal. In such cases, the cost of the treatment, of pumping and piping
facilities, and of establishing and maintaining effluent dumps have to be
considered. Climatic and environmental data may need to be collected to
determine the impact on a community resulting from waste disposal. This
would be particularly applicable in the case of pollutants discharged into the
atmosphere or into rivers and the sea.
The locational requirements and conditions that are significant for the
selection of both location and site should be judged against the defined
corporate strategies and the financial and economic impacts the final choice
might have on the project. In a feasibility study a good starting-point for the
final selection of a suitable location is the location of raw materials and factory
supplies, or-if the project is market-oriented-the location of the principal
consumption centres in relation to the plant.
If transport costs of materials from the sources to alternative locations
have a significant impact on the choice of location, the possibilities for
substitution of materials and inputs should also be assessed. Infrastructure
should then be considered in terms of availability and cost. A combination of
these aspects enables a determination of production and marketing costs at
alternative locations. Added to these costs should be an allowance for socio-
economic and environmental factors. The best choice of location would be one
where the costs of products sold (production and marketing costs) are a
minimum. However, other environmental (ecological and socio-economic)
factors, including the climate and social welfare facilities, such as education,
medical services and recreation facilities, will probably also influence the
selection of a feasible location and site. Various such locational factors,
however, can be assessed in qualitative terms only. In projects where total costs
of products sold do not vary much for alternative locations, the qualitative
socio-economic environmental considerations could have an overriding effect
on locational recommendations.
Assessment of location
G. Site selection
The feasibility study should analyse 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. Differences in existing social
infrastructure facilities are sometimes as important as transport costs for
148
material inputs and product distribution. The analysis should result in a
selection of a specific site and conclusions regarding the feasibility and viability.
Once the location (or alternative locations if this is an objective of the
study) is decided upon, a specific project site and, if available, site alternatives
should be defined in the feasibility study. This will require an evaluation of the
characteristics of each site. The structure of site analysis is basically the same as
for location analysis, and the key requirements, identified for the project, may
give guidance also for site selection. For sites available within the selected area,
the following requirements and conditions are to be assessed:
* Ecological conditions on site (soil, site hazards, climate etc.)
* Environmental impact (restrictions, standards, guidelines)
* Socio-economic conditions (restrictions, incentives, requirements)
* Local infrastructure at site location (existing industrial infrastructure,
economic and social infrastructure, availability of critical project inputs
such as labour and factory supplies)
* Strategic aspects (corporate strategies regarding possible future exten-
sion, supply and marketing policies)
* Cost of land
* Site preparation and development, requirements and costs
The importance of these characteristics varies depending on the nature of
the project, the type of civil construction contemplated, the weight of the
heavier equipment items, the type of effluent and the number of workers.
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 or sites with urban settlements in the
immediate neighbourhood. The availability and supply of materials, utilities,
means of transport and communication obviously varies within a region. The
site selection study should therefore review all the relevant aspects in the
context of the proposed project. Full information may not be readily available,
and it may be necessary to investigate further.
Site requirements
A project may depend on particular site conditions, which should be
identified and described in the feasibility study. Heavy machinery and
foundation works, transports and technical installations may require specific
ground conditions. A survey should be made of soil conditions, including
bearing qualities and subsoil water level at alternative sites. Special attention
should be paid to construction in seismic zones. Some sites may require
substantial work on site preparation and development, or it may be exposed to
site hazards such as strong winds, fumes and flue gases from neighbouring
industries or to risks of floods. The required land area should be specified on
the basis of buildings, technical installations and facilities included in the
project.
Topography, altitude and climate may be of importance for a project, as
well as access to water, electric power, roads and railways or water transport.
149
This analysis is related to materials and inputs as well as technical
infrastructure discussed below. The distance to urban centres and the social and
economic infrastructure may be important for the availability of labour. The
study should also cover existing rights of way (regarding, for example, access
roads and water supply) and indicate potential problems.
Cost of land
Constructionrequirements
Local conditions-infrastructure
The availability and cost of electricity is common for most sites within a
given location. If an independent power facility has to be set up as part of the
project, the cost tends to be similar at various sites within an overall location.
Similarly, cost of electrical substations and electrical equipment, such as
transformers, tend to be the same at different sites. However, the cost of
extending power transmission lines to the factory site varies substantially from
site to site and has to be estimated.
Transport is very important when comparing the suitability of different
sites. Since the volume of inputs and outputs will be known after the plant
capacity is determined, transport alternatives and costs could then be calculated
and compared for different sites. Preliminary estimates should be made for:
terminals for oil, gas or other materials; railway sidings from the nearest
railhead; feeder roads connecting with main highways; and water transport.
For a determined plant capacity, it would be easy to define the water
required for various purposes, such as cooling, steam generation and drinking.
Where water is a requirement for the manufacturing process, as for pulp, such
assessment is more important, and the source and cost of the water supply has
to be estimated at alternative sites. Such costs can vary considerably and may
be a significant element of site selection, particularly if large quantities of water
are required.
150
Effluent and waste disposal
Human resources
Recruitment of managerial staff and labour may be a critical factor for the
viability of a project. Skilled labour and management staff are often in scarce
supply, and recruitment of labour with less skill and experience than required
might jeopardize the whole project. The study must therefore pay careful
attention to the question of labour availability, conditions related to recruit-
ment and facilities for training.
It may be necessary to develop a social infrastructure next to the envisaged
site-housing, primary schools, medical and social centres-to attract the
required staff and labour force. Such social investment may be imperative for
major projects, such as steel plants and heavy engineering industries, involving
a large labour complement, but would prove an unduly heavy financial burden
in most other cases, at least during the initial stages.
The selection of plant location and site does not have to be undertaken in
two stages. Generally, alternative sites are considered in conjunction with wider
locational considerations so that much of the information required is collected
simultaneously. It is useful if the location conclusions of the site study are
tabulated so that the relevant information can be incorporated into the next
stage of project formulation.
It is often necessary to limit the choice of plant site and location in line
with the provisions made by the project sponsors, whether public, institutional
or private, which reduces the task of the feasibility study. If, however, the study
has to indicate the various alternatives without any such guiding principles or
constraints, the foregoing factors should be considered.
H. Cost estimates
Schedule V-l is used for the estimates of investment costs at the site.
Examples of costs are acquisition of land, taxes, legal expenses, rights of way,
site preparation and development. Different cost items are to be identified,
quantified (if relevant), estimated and divided into components of foreign and
local currency origin. It should be carefully stated whether factory-external
facilities, possibly judged as necessary (such as disposal and treatment of
effluents, generation of electricity, water supply system, storage, housing and
schools) are included in the cost estimates. Schedule V-2 may be used for
investment costs related to environmental protection.
151
Schedules V-3 and V-4 are used for the presentation of annual costs related
to the site and environmental protection costs, respectively. This may comprise
annual payments for rent, real estate tax, rights of way, annual charges for
easements and other cost items. As in the case of investment costs, annual
payments are to be specified, quantified (if relevant), estimated and divided into
foreign and local currency origin.
Bibliography
152
United Nations. Industrial location and regional development; an annotated biblio-
graphy. (ID/43)
Sales no.: 70.II.B.15.
U.S.A. Environmental Protection Agency (EPA). 40 Code of Federal Regulations.
Ch. 1 6.202. Washington, D.C., Government Printing Office, 1988.
_____ Guidelines for performing regulatory impact analysis. Washington, D.C.,
Government Printing Office, 1983.
_____ Manual: review of federal actions impacting the environment. Washington,
D.C., Government Printing Office, 1975.
Viscuse, W. K. Alternative approaches to valuing the health impacts of accidents:
liability law and prospective evaluations. Law and contemporary problems (Durham,
North Carolina) 47:4, 1983.
153
Appendix
Land Atmosphere
Topography Air quality
Soil composition Flow
Slope stability Climatic variations
Subsidence Visibility
Seismicity (faults, earthquake Particulates
potential, volcanic action)
Current and future use
Buffer zones, protected areas
(archaelogical sites, unique
physical features etc.)
Interdependent systems (bodies
of water, mineral and energy
resources, fauna, flora)
Flora Fauna
Trees Terrestrial
Shrubs Zooplankton
Grass Benthic organisms
Crops Fish and shellfish
Phytoplankton Insects
Aquatic plants Rare species
Rare species Endangered species
Endangered species Migratory species
154
V-2. Domains of the social environment subject to and generating environmental
impacts
155
V-4. Matrix for the identification of environmental impacts
Operational phase
Post-operational phase
[41
—
Resources subject to impact
[3]
•D
Key
[ 1 ] This form may be used first to determine whether there is any impact, and if so, whether
design solutions exist Then the type of impact may be defined on another sheet using a
system of notation such as
[2] (A) = aesthetical, (D) = destructive to ecosystems, (H) = affecting health and wealth, etc
[3] Insert environmental domains possibly affected {see checklists V 1 and V-2)
[4] Insert environmental parameters possibly affected (see checklists V-1 and V-2)
Note This matrix would have to be adapted to the needs and specific circumstances of each individual project
Schedule V- 1. Estimate of investment costs:
land and site preparation
(insert in schedule X- 1)
Project:
Date:
Source: [ ] Construction phase
[ ] Operational phase
Units:
Cost
Unit
N Q U Item description cost Foreign Local Total Year,
a Of investment.
157
Schedule V-2. Estimate of investment costs:
environmentalprotection measures
(insert in schedule X- 1)
Project:
Date: [ ] Construction phase
Source: [ ] Operational phase
[ ] Post-operational phase
Units:
Cost
Unit
N Q U Item description cost Foreign Local Total Year
8 Of investment.
158
Schedule V-3. Estimate of operating costs related to the site
(insert in schedule VI-4 or VII)
Project:
Date:
Source: [ ] Direct costs
[ ] Indirect costs
159
Schedule V-4. Estimate of operating costs related to
environmentalprotection measures
(insert in schedules VI-4 or VII)
[ ] Operational phase
Project: [ ] Post-operational phase
Date:
Source: [ ] Direct costs
[ ] Indirect costs
160
VI. Engineering and technology
The scope of an investment project is first of all defined by the project or
corporate objectives and strategies determined by the potential investors, taking
into account the overall business environment, and secondly by the marketing
concept as well as the available project inputs (resources). It is the task of
engineering to design the functional and physical layout for the industrial plant
necessary to produce the defined products (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
actiyities required to deliver both inputs and outputs and to provide the
necessary ancillary infrastructure investments. This comprehensive approach
should help to determine which technical solution would best serve the
intentions of the investors or any third party participating in the project.
An integral part of engineering at the feasibility stage is the selection of an
appropriate technology, as well as planning of the acquisition and absorption
of this technology and of the corresponding know-how. While the choice of
technology defines the production processes to be utilized, the effective
management of technology transfer requires that the technology and know-how
are acquired on suitable terms and conditions, and that the necessary skills are
available or developed. The required machinery and equipment must be
determined in relation to the technology and processes to be utilized, the local
conditions, the state of the art and human capabilities. Skill development needs
to be planned through training programmes at various levels.
The analysis must include all technical, managerial and administrative, as
well as external, sociocultural and economic aspects of the required maintenance
system. It should also outline the specific requirements of each individual
technology, if selected, and specify the need for technical documentation and
maintenance procedures. In particular the analysis must include a thorough
survey of spare parts and the format of the necessary lists of spare parts.
As discussed in previous chapters, environmental protection devices (such
as filters, desulphurization plants, units for the removal of nitrogen oxides, and
closed-circuit clarification plants) are an essential part of any company
operation, in particular when they form part of the production process. The
breakdown of such plant components can, in the worst possible case, lead to a
temporary shut-down of the entire plant.
Environmental protection installations often consist of technologically
highly complex components. They originate for the most part in countries with
a high level of technological development, and are generally not produced in
series. For this reason, due care and attention must be given to the problems
specific to these installations (spare parts, timely ordering of replacement parts
for maintenance work, qualified personnel etc.).
After the determination of an outline of the marketing strategies and the
first outline of the production programme and capacity, a preliminary project
161
layout has to be prepared defining the physical features of the plant such as
infrastructure, factory and other buildings and civil works and their inter-
relationship with utilities, material flows, machinery installation and other
aspects of plant construction and operations. It is then necessary to identify the
alternative technologies that can be utilized and the implications of such
alternatives in terms of costs, foreign participation, use of local raw materials,
environmental impact and other factors. These and related aspects need to be
highlighted in the feasibility study. Project engineering, therefore, covers a wide
range of interrelated activities that have to be carefully planned and assessed
and effectively coordinated in terms of their timing and application.
The initial task and scope of engineering is to define the whole range of
project activities and requirements, including production levels to be achieved
under the technical, ecological, social and economic constraints defined in line
with this Manual. This necessitates identifying the principal products or product
range, including by-products, determining the volume of production, and
relating production capacity to the flow of materials and performance of
services at the selected site.
162
were to be achieved in the first year, marketing and sales might prove to be a
bottleneck.
Depending on the nature of the industry and local factor situations, a
production and sales target of 40-50 per cent of overall capacity for the first
year should not be considered unreasonably low. It is usually only towards the
third or fourth year that full production levels can be achieved and operating
ratios effectively determined and adequately planned for. Even in certain
process industries where rated plant capacity is capable of being achieved
shortly after the commencement of production, during the initial years
production may be programmed at well below such capacity in order to adjust
to gradual growth of demand for a particular product. Growth of skills in
operations can also be a limiting factor in a number of industries, particularly
the engineering goods industry, and production has to be tailored to the
development of such skills and productivity. Full production capacity may be
achieved in such cases only after some years, and it may be unrealistic to plan
on any basis other than fairly gradual growth of production and output.
In the case of assembly-type industries, production programming should
determine the extent of production integration, which may initially be relatively
low and increase only gradually. Production programming can take various
forms, and the most suitable production pattern should be determined in
relation to projected sales and growth of production, particularly for the initial
years of the projection in question.
The determinants of a production programme during the initial production
years vary considerably from project to project. This can be illustrated by the
different approach that would have to be adopted by the following types of
industries: single-product, continuous process manufacture as in cement
production; multiple-product, continuous process production as in an oil
refinery; batch-job order production such as in an engineering workshop; and
assembly and mass manufacture as in 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.
Input requirements
163
Detailed estimates in this regard should be prepared for the stages of initial
production and full production, together with one or more intermediate stages
if these can be clearly identified. It is also necessary to provide for wastage,
damage or rejection elements in preparing the material consumption estimates
and for reserve labour needs, as outlined in chapters IV and VIII, which deal
with material and human resource requirements. In cases where such a minute
procedure cannot be applied to calculate the material and labour costs at
different production stages until full capacity is reached, as material and direct
labour costs are variable, apportioned material and direct labour costs can
easily be calculated for the initial stage on the basis of the cost level at full
capacity production. This procedure is applied in schedule X-4/1 (annual
production cost estimate) and schedule X-3.
An example of a sales programme is provided in schedule III-1. It should
serve as planning base for determining the production programme and
scheduling the cash flow table. For this purpose the different envisaged
capacity utilization rates should be inserted as the first line of schedule X-3. In
this way it will be easily possible to programme the development of variable
production costs as production and sales increase.
Technology
164
(b) Nominal maximum capacity. The nominal capacity is the technically
feasible capacity, which frequently corresponds to the installed capacity as
guaranteed by the supplier of the plant. A higher capacity-nominal maximum
capacity-may be achieved, but this would entail overtime, excessive consump-
tion of factory supplies, utilities, spare parts and wear-and-tear parts, as well as
disproportionate production cost increases.
Once the marketing concept and the corresponding sales volume are
defined, other components have to be assessed to determine the feasible normal
plant capacity. This capacity should in fact represent the optimum level of
production as may be determined by the relative interaction of various
components of the feasibility study, such as technology, availability of
resources, investment and production costs. Though one of these components
will be critical for determining the feasible normal plant capacity in respect of a
particular project, all the implications of all these aspects should be taken into
consideration. The following two factors dominate the capacity determination:
the minimum economic size; and the availability of production technology and
equipment as related to various production levels.
Economies of scale
Industrial experience indicates that a certain time elapses before the staff
and labour involved in the manufacturing process have acquired a reasonable
level of skill. The learning curve describes this learning process, which is also
determined by various factors, such as sociocultural background, physical
strength, nutrition, adaptation and adaptability to an industrial environment.
166
B. Technology choice
The selection of appropriate technology and know-how is a critical
element in any feasibility study. Such selection 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 conditions. Appropriate tech-
nology choice is directly related to the conditions of application in particular
situations. What may be appropriate in industrialized economies with high
labour costs may not necessarily be the optimum for low-wage developing
countries, with severe constraints on infrastructure and availability of inputs.
On the other hand, 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.
Competitive production capability in the intended markets is one of the most
crucial factors for technology choice, and the related plant capacity can be a
major determinant of such capability.
Technology choice must be directly related to market, resource and
environmental conditions and the corporate strategies recommended for a
particular project. The industry, the form of foreign participation, national
objectives and policies, industrial growth strategy, availability of local resources
and skills, and several other factors can impinge directly on technology choice,
plant capacity and production costs. It is also necessary to take into account
new technological developments and applications and their impact on plant
capacity. These may either have general application, as in the case of
numerically controlled equipment, or may relate to specific stages of
production, with considerable impact on plant capacities in several fields. There
may, however, be skill and other constraints on their usage in certain
situations, and these are also to be taken into account.
In the light of the world-wide ecological impacts of agricultural and
industrial development, technology choice is no longer possible without an
assessment of the potential ecological impacts of a project on the natural
environment. Consideration of environmental aspects in modern project
engineering and technology assessment is not limited to the minimization of
pollution, but should also include preservation of natural resources and saving
of non-renewable resources. In this respect technology choice is again governed
by the principal strategic objectives of the investment project, and at the same
time has an interdependent relationship with items covered in previous chapters
on marketing, materials and location.
Ideally, an industrial project should not have any negative impacts on the
natural and social environment. Since this objective can be achieved eco-
nomically only in exceptional cases, all efforts should be made to employ
production processes with the lowest possible emissions, and to minimize the
burden on the environment. Low-emission production can be achieved by
considering different techno-economic alternatives during the individual planning
stages, such as the use of low-residue raw materials, planning of closed
circuits, planning of recycling systems (within the works or outside) and end-of-
the-pipe environmental engineering (filters, systems for the removal of sulphur
dioxides and nitrogen oxides etc.).
First of all it is important to identify those processes which result in the
lowest possible consumption of raw materials. Closed circuits would allow the
reutilization of raw and auxiliary materials within the production process by
means of a variety of different technologies (such as water recirculation in the
paper industry). By applying the appropriate industrial processes, it is possible
to recover from waste water or from the exhaust air residual materials that
would otherwise place a major burden on the environment. The recovered
substances can be reused in the production process. In this case two objectives
are achieved, namely the reduction of environment pollution and savings due to
the reutilization of raw materials. Recycling of raw materials represents in some
cases a considerable advantage in economic and technical terms.
If none of the above-mentioned possibilities can be realized for tech-
nological or economic reasons, it is possible to avoid harmful impacts on the
environment by incorporating environmental protection technologies at the end
of the production process (filter systems, clarification plants, effluent treatment
plants etc.).
Problem definition
The preparation of a plant layout and design is essential for every project.
This needs to be undertaken in two stages of project planning. The first and
initial stage should be the preparation of a preliminary project plan and layout,
on the basis of the production activities and the technological alternatives
envisaged. The second stage of project layout and design can only be drawn up
when the details relating to technology, plant capacity and machinery
specifications are finalized.
The preliminary project layout should provide the overall framework of
the project, which can serve as a broad basis for plant engineering, order-of-
magnitude projections of civil works, machinery requirements and other
investment elements. It should define the physical features of the plant such as
infrastructure and site development, factory and other buildings, transport
facilities (roads, railway sidings etc.) and utility linkages, including electric
power substations, water connections, sewage lines and gas and telephone links,
both within and outside the plant, together with other construction needs,
including possible extensions of production facilities, storage and buildings. A
layout chart at this stage should show the interrelationship between buildings
and civil works and the equipment to be installed, and provide material-flow
diagrams indicating the flow of materials as well as intermediate and final
products.
65
See A. L. Porter, A Guidebook for Technology Assessment and Impact Analysis (New York,
Elsevier, 1980)
169
The preliminary project layout should include several charts and drawings,
which need not be according to scale, but which would define the various
physical features of the plant and their relationship with one another. The types
and details of charts and drawings to be prepared would vary with the nature
and complexity of the project. Nevertheless, for most projects, functional charts
and layout drawings at this stage should include the following:
* General functional layout, defining the principal physical, or locational,
features and flow relationships of machinery and equipment, civil works
and constructions, and various ancillary and service facilities
* Basic characteristics of the technology
* Material-flow diagrams, indicating the flow of materials and utilities
* Transport layout, indicating roads, railways and other transport
facilities up to their point of connection with public networks
* Utility lines for electric power, water, gas, telephone, sewage and
emissions, both internal and external, up to the point connecting with
public networks
* Areas for extension and expansion
Physical layout drawings should be based on survey maps and data on
geological and hydrological features and on soil conditions at the selected
location. Where layout drawings are prepared according to scale, this can range
between 1:1000 to 1:200, but should be large enough to show the essential
physical features of the plant, which could then be further elaborated at the
stage of preparation of the detailed plant design.
At the stage of a feasibility study, the nature of the technology market and
the available technological alternatives have to be taken into account. The
selection of appropriate technology is undoubtedly one of the key elements of
such a study. This needs to be related to the economic plant capacity and the
minimum economic production, as well as several other factors that may vary
depending on corporate strategy and local conditions. The feasibility study
should identify both alternative technologies and alternative sources of
technology. The evaluation would then aim at selecting the technology and the
source from which it may be secured. The study should also discuss the
contractual terms and conditions which may be of special significance in
relation to the acquisition of a particular technology. The terms and conditions
may vary considerably for process industries, engineering-goods production
and the manufacture of durable consumer goods, machinery and equipment.
Requirements for the development of skills and of research and design
capabilities in the particular field need to be defined.
Assessment of availability
170
alternative production technologies may be difficult to find. There must,
however, be adequate knowledge and awareness regarding such alternatives
and their potential suppliers, including industrial property rights applicable in
each case. Technological information regarding alternative technologies and
sources constitutes an important element of the feasibility study. In developing
countries information on advanced and other technologies is frequently either
not up-to-date or scattered among many sources. The setting-up of data banks
for industrial and technological information has therefore become imperative
for the promotion of industrial development. In this connection, the UNIDO
Industrial and Technological Information Bank (INTIB) 66 became operational
in 1980, its main objective being to ensure a quicker, easier and greater flow of
information to people who need to select technologies. It is also necessary for
the feasibility study to assess technological developments in the particular field
and the likely impact of new and emerging technologies on competitive
capability.
Technology forecast
171
Description of the socio-economic impact
Although the socio-economic impact of a project in general and of a
selected technology in particular are rather a subject of economic cost-benefit
analysis, certain socio-economic aspects cannot be ignored in the feasibility
study. Public policies with regard to the acquisition of foreign technologies,
technology absorption and development have to be identified, and the socio-
economic infrastructure, including the structure of the labour force, may have a
significant impact on the feasibility of the technology to be selected for the
project.
67
See also chap. V, sect C
172
that technological trends and the possibility of using more developed
techniques should be studied. For example, in the production of various types
of fertilizer, technological choice should be based on the latest developments
rather than on older, though proven, processes that are soon likely to be
obsolete.
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 certain cases, the raw
materials could determine the technology to be used. The quality of limestone,
for example, is a determinant factor as to whether the wet or dry process is
used for a cement plant. The availability of surplus bagasse would determine
the type of technology used for the production of paper or newsprint.
Furthermore, the non-availability or restricted availability of certain raw
materials could be a technological constraint. A technological process based on
indigenous raw materials and inputs may be preferable to one for which the
principal inputs have to be imported indefinitely, particularly if serious foreign
exchange regulations affect the inflow of such materials. Apart from the wider
policy implications, supplies of materials and inputs are much better assured if
indigenous, and may be less subject to external influences. In fact, progressive
integration may be the only practicable means of undertaking production in a
developing country for a large number of products.
A specific technology has to be viewed in the context of the total product
mix that it generates, and if an alternative technology results in a wider product
mix, starting from the same basic production materials and inputs, the value of
the total mix, including saleable by-products, should be taken into account.
The extent to which a particular technology or production technique can be
effectively absorbed by a country could influence the choice of technology. It is
often suggested that certain technologies are too sophisticated for particular
developing countries because of their inadequate technological absorptive
capacity. Such an argument may be exaggerated, and has been used to impose
obsolete techniques for projects in developing countries. There may, however,
be cases where a particular technology, for example involving complex data
processing, cannot be effectively absorbed in a country because of the difficulty
in training the technical personnel required for the software work within a
reasonable period.
The degree of capital-intensity considered appropriate could define the
technology parameters. In countries with a shortage of labour, or where labour
is very expensive as in Western Europe, capital-intensive techniques may be
appropriate and economically justified. In countries with excess labour, labour-
saving techniques may prove unnecessarily expensive. This situation may apply
to the overall technology as well as to the degree of mechanization of projects
or particular production operations such as material-handling. The choices
from the viewpoint of both labour and capital should be given in the feasibility
study so that the most appropriate technique can be selected.
Alternative technologies should also be evaluated with regard to their
environmental impacts. Depending on the type of industry and local
environment, critical elements such as economic use of raw materials, low-
emission technologies (state of the art) and low-waste-production processes
must be considered for the selection of suitable technologies. The evaluation
should not be based on the optimization of only one variable target, but should
aim at an optimal combination of human, techno-economic and strategic
requirements.
173
When new industries or industrial plants are introduced in developing
countries, care must be taken to avoid "environmental dumping", which means
that polluting industries are transferred to countries where pollution restric-
tions are either non-existent or less stringent. Another form of environmental
dumping is the introduction of obsolete technologies, equipment or production
plants with higher pollution factors. Acquisition of previously discarded and
disassembled production plants should therefore be checked carefully.
Full account should be taken of investment and operating costs when
judging the appropriateness of more capital-intensive techniques. In developing
countries the tendency is often to prefer a capital-intensive technique because it
is used in industrialized countries. The additional capital cost involved in such
technologies should be viewed against the labour costs of less capital-intensive
techniques. Both the preference for labour- or capital-intensive technologies
and the choice of technology can only be judged on techno-economic grounds,
and should be subject to a careful cost-benefit analysis in the feasibility study.
Industrialproperty rights
Licensing
Purchaseof technology
176
rapid change, or in situations where the technology supplier can provide access
to external markets that may otherwise be difficult to penetrate. At the same
time, where foreign participation in a joint venture is primarily limited to the
capitalization of technology, caution must be exercised, and capitalization of
such costs should be assessed in terms of the overall returns that would accrue
to the technology supplier over the lifetime of the enterprise as against
technology payments in the form of fees and royalties.
Disaggregation
The technology package should be disaggregated into various component
parts, such as the technology proper, related engineering services, phasing of
domestic integration, supply of intermediate products and even the supply of
equipment by the licensors, because prospective licensees from developing
countries are often in a weak bargaining position, and technology suppliers
tend to load the technology package with features that are not essential to the
technology. A distinction should be made between essential technological
features and others that should be evaluated separately. The feasibility study
should indicate the level of such disaggregation or "unpackaging" of
technology for the project in question.
Cost of technology
The costs of the selection and acquisition of technology and the related
technical services should be estimated in the feasibility study. This may present
difficulties, as negotiations on technology acquisition and technical services
between the prospective licensee and licensor come after the preparation of the
study, and, in a number of developing countries, may depend on the degree of
regulatory control of licensing arrangements by governmental bodies. An
assessment of this question in the feasibility study could, however, provide
guidelines on technology negotiations for the project sponsors, and set the
framework within which such negotiations could be conducted.
An assessment has to be made of the proper remuneration for technology
and services. For this purpose, technology payments made in other cases for
the same industry may be referred to if the information can be obtained. An
assessment could also be made of various payment alternatives such as a lump
sum, a running royalty rate or a combination of the two. A royalty payment
may be more appropriate when the technology necessitates a relationship with
the technology licensor over a period of time. This rate tends to range from
fractional percentages up to 3 to 5 per cent of actual sales, depending on the
nature of the industry and plant capacity. For most technical services,
assessment of appropriate costs would be easier, as the cost of comparable
services can generally be obtained, except when they are highly complex or
proprietory in nature. Schedule VI-1 may be utilized for this purpose. Lump-
sum payments for patents and trade marks, for special rights and concessions
and for unpatented know-how can be capitalized (under incorporated fixed
assets in schedule VI-3/2) and amortized according to the regulations in force
in a country. Royalty payments, however, are generally not capitalized and are
included in production costs.
While the preliminary layout would define the principal physical features
of the plant and their relationship with one another, a detailed final plant
layout needs to be prepared prior to project implementation. This can only be
done when the technology and production processes are determined and the list
of capital equipment and material inputs is finalized. A close relationship exists
179
between technological processes, equipment requirements and the plant layout
and design, and the latter must necessarily be based on and closely linked with
the former. In some projects, this may not result in significant differences from
the initial preliminary layout, and the detailed plant layout would only be more
detailed in coverage. In other projects, however, there may be considerable
variations from the preliminary layout. These may relate not only to the type
and configuration of equipment to be used in particular processes, but also to
the implications of the use of particular technologies in terms of safety
requirements, emission control, waste disposal etc. This would be particularly
applicable to chemical and other process industries, where the nature of the
technology utilized would constitute a major determinant of the detailed plant
layout. In any event, a detailed plant layout needs to be prepared for all
projects prior to the stage of implementation.
Basic engineering
It will be necessary, at this stage, to prepare the plant design together with
the engineering work that it may entail. 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. In case the scope of detailed
engineering work is significant, the volume of work, the time required and costs
must be projected. Basic engineering essentially comprises the detailed
configuration of construction facilities, equipment and production processes,
and of material flows and linkages between different stages of production. The
nature of plant design and engineering would vary from project to project. In
major projects such as petrochemical and fertilizer production or smelting of
ore, considerable basic and detailed engineering work is necessary. This is often
incorporated as part of the process technology and know-how to be acquired.
In other projects, however, plant design and engineering would need to be
undertaken by the project authorities as a key element of project planning. The
plant design in all projects would define the functional relationships between
various processes and stages of production, including flows of material at
different production stages.
The plant layout and basic engineering should comprise charts and
drawings, including several features added to those prepared for the preliminary
layout. These should be as detailed as required to comply with the financial
evaluation of the project or project alternative, and should include:
* Functional layout related to site conditions and indicating the position
of principal structures and buildings, major equipment, roads, railways
and other transport facilities, various utility and service facilities, and
areas for future expansion. The layout should be done on a scale of
between 1:1000 and 1:2000, and be based on a survey of geological, soil
and other data;
* Location of main production units, including loading areas, electrical
outlets and instrumentation, and of auxiliary production units, repair,
storage and research and development facilities etc.;
180
* Material-flow diagrams, showing the flow of materials, utilities and
emissions, as well as intermediate and final products, through various
sections of the plant, and quantity-flow diagrams, indicating quantities
entering or leaving the production process;
* Production line diagrams, defining various stages of production and
indicating location, space requirements, dimensions of principal capital
equipment, of foundations and of mounting devices, electric power and
utilities etc.;
* Final physical layout for transport, utility lines, consumption, linkages
and communications facilities.
Level of automation
Categories of equipment
Production equipment
The list of plant machinery and equipment should include all movable and
immovable machines and equipment for production, processing and control
and related facilities that form an integral unit with the machines and that serve
no other purpose. Such equipment can be variously classified for different types
of projects, one classification being to divide the items into the following
subgroups: plant (process) machinery; mechanical equipment; electrical equip-
ment; instrumentation and controls; process conveying and transport equip-
ment; and other plant machinery and equipment. The erection and installation
of machinery may necessitate special foundations, supporting structures, walls,
beams and ceilings. The equipment groups and machines for various functional
processes or production centres should be subdivided to the level of individual
machines and facilities, and the machinery list should be complete so as to
cover the requirements for each stage of production from the receiving of raw
materials to the dispatch of the final products. The rated performance required
for various pieces of process equipment should be defined, and for each project
component a list of equipment should be tabulated in accordance with
schedule VI-2 given in the appendix to chapter VI.
However complete the list and evaluation of machinery and equipment
may be at the stage of a feasibility study, it may have to undergo substantial
modification if the parameters of a project are modified in the course of
investment decisions, including changes in the technological process adopted.
Such modifications would, however, have to be elaborated during the post-
feasibility study stages.
A list should be prepared of required spare parts and tools with their
estimated prices, including the parts to be obtained with original equipment
and parts and tools required for operational wear and tear. Spare part needs
would depend on the nature of the industry, availability of spare parts, the
capacity to manufacture such items in the country concerned and import
facilities. Generally, it is sufficient to stock a three- to six-month supply, under
certain conditions, although the stock could be higher. In any case, the stock
requirements have to be carefully evaluated, as they may have an impact on
plant inventories and the working capital required.
184
Erection and installation
The detailed list of machinery and equipment will later form the basis for
the preparation of tender or bid documents for equipment supply. These should
specify the details of the equipment required, together with conditions of
supply.
The feasibility study should provide plans and estimates for the civil works
related to the project. This should cover site preparation and development,
factory and other buildings, civil engineering works relating to utilities,
transport, emissions and effluent discharge, internal roads, fencing and
security, and other facilities and requirements of the plant.
Civil engineering works are fairly project-specific and have to be related to
a particular plant site and the facilities that may be required. While plans and
estimates for the principal buildings required for a specific type of plant follow
a fairly uniform pattern, there may be major variations in estimates because of
site conditions and for other civil engineering works because of local
conditions.
Buildings
Plans and estimates for buildings and structures should include: the main
factory or plant building; buildings for ancillary production facilities such as
foundries and forges, or for preparation or initial processing of raw materials;
ancillary buildings for maintenance and repair, testing and research and
development; storage and warehouses for stocks of raw material or finished
products; non-factory buildings, including administrative buildings; staff
welfare facilities such as cafeterias, medical facilities and recreation areas;
residential buildings, if any, for supervisory and shift personnel; and other
buildings required for plant personnel. These requirements can vary consider-
ably from project to project, depending on site conditions, proximity of urban
facilities and the nature of production activities. A project at a fairly remote
site may require considerable expenditure on buildings for personnel, since such
buildings may not be available. In large resource-based projects, entire
townships may have to be developed, since no alternative facilities may be
available, and project estimates must take such costs into account from the
earliest stage.
185
Ancillary construction needs
The plans and estimates for civil engineering works should be detailed for
cost estimates and implementation scheduling. The nature of each construction
should be defined, including modular construction where appropriate, the
quality of construction materials and the quantities and cost of materials
required. Detailed civil engineering drawings are usually not required before
the start of project implementation.
The estimates for buildings and other constructions should be based on
unit costs such as building costs per square metre in the plant surroundings.
While the final costs will depend on the bids and quotations that are received,
the plans and estimates at the project engineering stage should be complete for
all the necessary constructions and accurate to the extent required for
projecting the overall project investment costs.
68
The organization of plant maintenance Is discussed in chap VII, sect B
186
for general-purpose maintenance and with respect to maintenance of specific,
complex equipment and facilities.
Replacement requirements need to be determined for wear-and-tear parts,
tools, jigs and fixtures in engineering-goods industries, and for spare parts,
components and materials for plant, buildings and other facilities in all
projects. An efficient balance has to be maintained between replacement
requirements and stocks of parts, components and materials. Such a balance
constitutes a critical feature of financial planning of inventories during the
project implementation stage.
Inventory requirements for maintenance and replacement items will vary
with each project and depend on the nature of the project, the extent of
utilization of particular parts or materials, and the speed with which such items
can be replaced. In several fields, fairly standard stock levels are prescribed for
various maintenance and replacement items. These may, however, need to be
adjusted in situations where such items have to be imported and there are
foreign exchange constraints. Estimates should be prepared in this regard and
incorporated in the factory cost estimates in schedule VI-4.
Capitalcost estimates
69
The technology, type of project (turnkey greenfield site, industrial site with existing
infrastructure etc ), battery limits, plant capacity and plant location must be comparable, to permit
the use of such indicators for complete plants Published ratios are, however, fairly reliable for the
estimating costs of equipment and services forming part of the main plant items (pipings, electrical
equipment, civil engineering design etc )
187
On the basis of the estimates for technology, machinery and equipment
and civil engineering works, the feasibility study should provide an overall
estimate of the capital costs of the project. Such an estimate will undergo
modification in accordance with the bids and offers received from suppliers and
contractors, but will nevertheless provide a fairly realistic estimate of capital
costs. These costs should be reflected in schedules VI-1 (technology costs), VI-2
(equipment) and VI-3 (civil engineering works). Schedule VI-4 summarizes the
overhead costs.
The accuracy of cost estimates in relation to project development has
already been described in part one of this Manual. The preliminary estimate is
based on the process flow sheet after the scope of the project has been
determined by those concerned with the preparation of an opportunity or pre-
feasibility study. A physical contingency allowance is commonly added, but it
would be preferable to have the probable cost range quoted.
The budget estimate required at the feasibility study level must be founded
on a properly developed flow sheet and a full assessment of the site. It will be
based on a fairly detailed equipment list, and costs of special or main plant
items may be obtained through preliminary tendering. A typical degree of
accuracy would be + 10 per cent. Careful consideration must be given to this
estimate, and in particular to the contingencies allowed.
Estimating methods
\CJ S,
188
historical data because of inflation. Some typical exponential factors are as
follows:
Plant item Exponentialfactor
Tanks (spherical) 0.7
Electric motors 0.8
Columns, towers 0.7 (constant diameter)
1.0 (constant height)
Heat exchangers 0.65 = 0.95
Piping 0.7 = 0.9
Instruments and control 0.0
Factorialestimating
This technique consists in determining the costs of main plant items and
then adding up factors for subsidiary items in order to build up an estimate of
total costs. For example, if the cost of a large tank is estimated at $20,000, the
costs of erection on site, piping, instrumentation and electrical equipment may
be calculated at 32 per cent, or $6,400 dollars. The corresponding factors vary
depending on the type of subsidiary items. Erection costs may be between 1 and
24 per cent, depending on construction work required on site; piping costs may
be between 2 and 20 per cent, depending on the type of equipment and
technological process.
Estimating starts with the design of a process flow sheet. From this a list of
equipment, civil works etc. is derived with basic technical data. Quotations for
main items would be required for feasibility studies, while in the case of pre-
feasibility studies the method of factorial estimating may be applied, provided
that suitable and updated historical data are available.
Bibliography
190
Pratten, C. F. Economies of scale in manufacturing industry London, Cambridge
University Press, 1971.
Schorner Georg, Umweltvertraglichkeitspriifung in der Verwaltungspraxis. Berichte und
Dokumente der Akademie fur Umwelt und Energie. Laxenburg, Austria, Akademie
fur Umwelt und Energie, 1988. Workshop Report, Heft 23.
Singh, Rana K. D. N. Long-term needs of developing countries in technology licensing.
Cleveland, Ohio, Les Nouvelles Licensing Executives Society, December 1982.
Singh, Rana K. D. N. and W. Bogner, eds. Technology management and acquisition.
Washington, D.C., International Law Institute, 1984. 3 v.
Stumpf, H. Der Know-how Vertrag. 3. ed. Heidelberg, Verlag fur Recht und Wirtschaft,
1977.
Symposium: Ost-West-Symposium Umwelttechnologie, eine grenztiberschreitende Her-
ausforderung. Vienna, Europaverlag, 1987.
United Nations. Guidelines for the acquisition of foreign technology in developing
countries with special reference to technology licence agreements. 1973. (ID/98)
Sales no.: 73.II.B.I.
Economic Commission for Europe. Airborne sulphur pollution, effects and
control. 1984.
Report. Seminar on environmental impact assessment, Warsaw. Geneva, 1987.
United Nations Centre for Science and Technology for Development. Impact of new
and emerging areas of science and technology on the development of developing
countries. Substantive theme paper for Intergovernmental Committee on Science and
Technology. 1987. (A/CN. 11/80)
United Nations Conference on Trade and Development. Legislation and regulations on
technology transfer. Geneva, August 1980.
United Nations Industrial Development Organization. National approaches to the
acquisition of technology. 1987. Development and transfer of technology series, No. 1.
(ID/187)
Walsh, L., R. Wurster and R. J. Kimber. Quality management handbook. New York,
Marcel Dekker, 1986.
World Bank. Environment and development: implementing the World Bank's new
policies. Washington, D.C., 1988.
Manual of industrial hazard assessment techniques. Washington, D.C., 1985.
_ The environmental guidelines. Washington, D.C., 1984.
191
Appendix
Technology choice
* Describe the technology to the extent significant for the project, and state the
reasons for selection in relation to:
The basic project objectives and strategy
Socio-economic impacts
Ecological impacts (environment impact assessment)
Technology development (technology forecast)
Input requirements and constraints
Availability and possible alternatives
* Describe and justify the preliminary project plan and layout selected and prepare
diagrams and data as required for technology assessment and evaluation
* Assess the technology and identify and consider alternatives and critical elements
relating, for example, to:
Market and input requirements
Production programme and plant capacity
Economies of scale and minimum economic capacity
Infrastructure required and available
Technology absorption capacity
Hazards and ecological (environmental) impacts
Availability, industrial property rights etc.
* Evaluate the technologies assessed and justify the choice
192
Participation of the licence-holder, foreign equity participation
Costs of technology
Technology transfer
* Describe technology, know-how and related services to be performed by the
licensor, in particular:
Duration and renewal of agreement
Non-restricted use of unpatented know-how after expiry of agreement
Full and complete transfer of know-how available with licensor
Warranty on technology
Access to improvements during period of agreement
Industrial property rights-usage rights on all patents and proprietary know-
how and choice as to use of brand names
Supply of imported components and intermediate products by licensor-
exercise of option by licensee and determination of suitable pricing
formula
Training, both in-plant and in the plant of the licensor
Territorial sales rights-avoidance of undue restrictions
* Other licensing terms:
Payments: lump-sum or royalty or combination
Other provisions relating to governing law; settlement of disputes; confiden-
tiality; quality control; sublicensing; reporting; assignability, force majeure
etc.
* Define adequate measures to be undertaken for technology absorption
* Identify and recommend a programme for continuing technology assessment,
monitoring and forecasting in the relevant field of production
193
VI-2. Subdivision of cost estimates
Site
Land purchase, including all costs of purchase
Soil survey
Survey of special hazards, such as earthquakes, flooding and abnormal meteorological
conditions
Civil works-buildings
Main plant buildings
Plant structural steelwork
Chimneys and stacks
Buildings for service plants
Stores, storage buildings, warehousing
Laboratories, workshops, offices
Medical and first aid centres, fire station
Canteen, change rooms, lavatories
Site security, fencing, gate houses
Traffic lights, outdoor lights
Garages, car parks, cycle sheds
Customs and excise offices, weighbridge
Drainage, sewage system
Pipe and cable ducts
Land reinstatement, landscaping etc.
Railway tracks
Residential buildings
Process plant
Process plant machinery and equipment
194
Special erection costs for plant items
Special materials, such as catalysts, if they entail investment costs
Inspections and tests
Safety and fire protection equipment
Ventilation, air conditioning (to remove toxic gases, vapours etc.)
Effluent treatment plant
Instrumentation and control
Pipework and valves
Insulation and painting
Costs of process development and prototype testing
Stand-by plant
Engineering costs
Process and plant design, basic engineering
Detailed engineering if not covered under civil works or machinery and equipment
Inspections costs, consultants and specialists, including travel
Cost of models, prototype design
Temporaryfacilities requiredforconstruction
Site engineer: office etc.
Temporary supply of power, water etc.
Temporary access, storage facilities, site security (fencing etc.)
Construction workshops
Camp, canteen
195
Other direct costs of project implementation
Preparation and issue of bid documents for construction of civil works and other
facilities in accordance with a phased programme
Evaluation of bids, negotiations and purchasing
Inspection, commissioning (including travel)
Supervision of construction and start-up
Direct labour, contract labour, including overtime work
Transport costs, unloading and handling charges
Pre-production expenditures
Process or patent fees, agent fees
Legal and insurance fees
Consultant fees
Research and development expenditures
Central administration expenditures
Pre-production marketing costs
Training expenditures
Miscellaneous taxes and duties
Commissioning and start-up expenditures
Working capital
196
Schedule VI- 1. Estimate of technology costs
(insert in schedules VI-4, X-3 and X-1 or X-2)
(a) Technology selected (description, specifications, suppliers ...)
(b) Costs:
Lump-sum payments
Total
1
2
3
1
2
3
197
Schedule Vl-2/1. Estimate of investment costs:
plant machinery and equipment
(insert in schedule VI-2/2)
Project:
Date:
Source: [ ] Construction phase
[ ] Operational phase
Cost
Unit
N Q U Item description b cost Foreign Local Total Yeard
Plant machineryc
Pre-mixing unit
Heat exchanger
Distilling column
Rectification unit
etc.
Plant equipment
198
Schedule VI-2/2. Summary sheet of investment costs:
machinery and equipment
(insert in schedule X- 1)
Project:
Date:
Source: [ ] Construction phase
[ ] Operational phase
Cost
N Main plant item or
plant unit (cost centre) Foreign Local Total Year
N = number |
Note: For the purpose of economic cost-benefit analysis, local (foreign) cost elements contained
in imported (national) equipment should be identified.
199
Schedule VI-3/1. Estimate of investment costs:
civil engineering works
(insert in schedule VI-3/2)
Project:
Date:
Source: [ ] Construction phase
[ ] Operational phase
Cost
Unit
N Q U Item descriptionc cost Foreign Local Total Year e
Structuresd
a Covering construction works, structures, buildings etc., but not site preparation
see schedule V-1).
Insert name or description of plant or main plant item.
c Structures, stores, factory buildings, office buildings, office equipment etc.
d Insert detailed list of individual items.
eOf investment.
200
Schedule VI-3/2. Summary sheet of investment costs:
civil engineering works
(insert in schedule X- 1)
Project:
Date:
Source: [ ] Construction phase
[ ] Operational phase
Cost
N Main plant item or
plant unit (cost centre) Foreign Local Total Year
N = number |
Note: For the purpose of economic cost-benefit analysis, local (foreign) cost elements contained
in imported (national) equipment should be identified.
201
Schedule VI-4/1. Estimate of factory costs
(insert in schedule VI-4/2)
Project:
Date:
Source: [ ] Direct costs
[ ] Indirect costs
202
Schedule VI-4/2. Projection of factory costs
(insert in schedule X-3)
Project:
Date:
Source:
Code: Units:
203
VII. Organization and overhead costs
This present chapter deals with the development and design of the
organization needed to manage and control the entire operation of the factory,
and with the related overhead costs. The preceding chapters have explored and
described the problems of product marketing, providing the necessary material
inputs, locating the plant at the optimal site and preparing the engineering
design. Project engineering and organizational planning are closely related, and
should therefore be undertaken jointly in a series of feedback operations.
The aim of this chapter is to describe the process of organizational
planning and the structure of overhead costs, which can be decisive for the
financial feasibility of the project. A division of the company into organiza-
tional units in line with the marketing, supply, production and administrative
functions is necessary not only from the operational point of view, but also
during the planning phase, to allow the assessment and projection of overhead
costs. Furthermore, it is essential for the feasibility of a project that a proper
organizational structure should be determined in accordance with the corporate
strategies and policies.
The recommended organization will depend on the social environment as
well as on techno-economic necessities. The organizational set-up depends to a
large extent on the size and type of the industrial enterprise and the strategies,
policies and values of those in a position of power in the organization. It
should also be borne in mind that organizations are not static but develop with
the project (pre-investment and investment phases, start-up and operation).
While other chapters specifically deal with direct costs, this chapter will
deal with indirect or overhead costs. Past experience shows that many
feasibility studies neglect or underestimate these costs, which in some projects
may have a significant impact on their profitability. Considerations regarding
the project organization will help the analyst to identify and quantify these
costs. The design and establishment of cost centres in line with the
organizational structure will facilitate this task.
Organizationalfunctions
General Manager
Quality
Maintenance
205
Organizationalstructure
B. Organizational design
206
* The functions that are necessary to achieve the goals are identified;
* The necessary functions are grouped or related;
* The organizational framework or structure is designed;
* All key jobs are analysed, designed and described;
* A recruiting and training programme is prepared.
General management
Depending on the type and size of an enterprise, the general manager with
his office is responsible for the entrepreneurial functions. These are manage-
ment functions that are fundamental for the existence of an enterprise and may
not be delegated. Often, especially in the case of medium-sized industrial
plants, the general manager is also in charge of general administrative
functions, such as personnel and finance. In cases where technical and
technological aspects are essential for the enterprise, the production manager
could be in charge of the enterprise.
The feasibility study should determine the staffing requirements for the
office of the general manager in order to allow estimates of personnel and other
overhead costs related to this office. Cultural and social aspects should be
considered, and the study team should not try to blindly copy organizational
patterns that have proven successful in other countries.
207
Accounting and financial control
Service cost centres are those areas of activity that render the supplementary
services necessary to the smooth running of the plant, such as:
* Social services, including housing, health services, cafeterias, transport
and company food stores
* Plant management, production workshops
* Off-site transport: all transport activities that are not related to
connected production processes
* Purchasing of raw materials, spare parts and other supplies
* Stores for purchased raw materials, spare parts, packing materials,
supplies and equipment
* Repair and maintenance of machinery and equipment, buildings,
vehicles etc.
* Power supply and distribution for production and general use
* Steam generation and distribution
* Water supply (when the company has its own supply)
* Laboratories, process control
* Effluent disposal
Changes may be made according to the organizational structure of the
factory under study.
208
Administrative and financial cost centres comprise all activities related to
managerial planning, control and performance evaluation. Practice varies with
respect to the number of centres in which these activities are grouped. Larger
factories maintain specialized centres for planning, budgeting, costing, statistics,
personnel training, accounting and finance. Smaller factories have fewer such
centres. Hence, all expenses related to administration and finance should be
accumulated in one centre under the designation of administration and finance.
Marketing organization
The marketing department is the organizational unit carrying out the
marketing functions described in chapter III. Usually it has an independent line
function, but the individual structure of the unit varies according to type of
customer, the nature of the product, its geographical distribution and the sales
and distribution pattern. Establishing a marketing organization for a new
project (or product) requires the prior careful determination of both the
marketing objectives and the means required and available.
Sales and distribution of a product in a country where the infrastructure
and the means of communication are limited may also require a more costly
marketing organization, and seriously restrict the competitiveness of the
company in some cases. There are many examples of production plants based
on economies of scale that could not compete with the local traditional
suppliers, owing to a large and costly sales and distribution system.
Organizationof supplies
The supply system includes the provision of inputs of materials and
services, shipping of the goods, storage and inventory control. A number of
placements within the organization are possible. Some companies may have a
central purchasing department and stores attached to the production units. The
purchasing department may be an independent line function or it may be
placed under the supervision of the production unit. If a company is divided
into production plants that are geographically separated, it may be practical to
attach a small decentralized purchasing unit to each of these production plants.
In some large companies the entire supply system is entrusted to a
purchasing or supplies department. Its purpose is to purchase goods and
services from selected suppliers according to approved specifications and bills
of quantity, and to place them at the disposal of the production plant according
to a supply schedule derived from the production programme. In some cases it
may be necessary to include in the duties of the purchasing department the
transport of goods from suppliers.
It is the responsibility of the purchasing department to contribute to the
overall profit generation of the company by obtaining the best possible prices,
while avoiding the storage of larger quantities of input materials than are
required for reasonably safeguarding the production requirements. In devel-
oping countries procurement can be critical because of various infrastructural
and other socio-economic constraints. Supply stocks must therefore often be
considerably higher than in industrialized economies.
Purchasing will normally cover the provision of both goods and services
from domestic and overseas suppliers. Typical tasks will therefore include:
* Selection and evaluation of suppliers
209
* Requesting bids or arranging international competitive bidding
* Ordering and dispatch
* Shipping and clearing, quality control of incoming goods
* Warehousing
* Invoice control and payments of suppliers
Organizationof storage
The flow of materials, from the moment of purchasing through the entire
manufacturing process until the point of selling or delivery of the products,
needs to be organized in order to secure the undisturbed operation of the
factory. Stock control must aim at keeping stocks of materials and products
low to avoid unnecessarily high net working capital requirements, while
maintaining the minimum stock required for safe and uninterrupted operation.
Often the control of the entire material and product flow, including
storage, remains within the production department. In this case the production
programme as well as products in stock would be planned jointly with the
marketing department, and supplies would be ordered through the purchasing
department. The stock of spare parts is usually controlled by the maintenance
unit.
Organizationof production
Organizationof maintenance
Organization of personnel
The personnel unit deals with all subjects related to human resources, such
as recruitment and training of personnel and updating and developing skills
and knowledge. If management of the company staff and workforce is
relatively simple, there may be no need for a separate personnel unit. In that
case personnel matters may be placed as a staff function or could be
incorporated in the administrative department. However, if human resource
211
management is of significant importance for the feasibility of a project, a
special personnel department would be required.
The sociocultural environment of the project usually has a great impact on
the organization and overhead costs of the personnel department. For example,
labour laws directly applicable to the hiring and laying-off of personnel, local
cultural habits or customs may have a decisive impact on recruitment,
employment and development of the human resources required in the project.
In some countries religious rules or customs may restrict women from working
with men, or require special prayer facilities at the factory. In other projects
potential conflict between different ethnic or social groups may require special
measures and entail significant costs.
Human resource development may be an important task of a personnel
department. Training may have to be organized to increase skills of staff and
workers, to secure or increase the quality of products etc. Other important
subjects could be training related to health protection, the introduction and
maintenance of safety measures, and the operation of machinery and plants in
accordance with environmental protection measures.
The feasibility study should determine the costs relating to this organiza-
tional unit, and special attention should be given to costs arising during the
start-up phase of the project.
C. Overhead costs
Factory overheads
Factory overheads are costs that accrue in conjunction with the transfor-
mation, fabrication or extraction of raw materials. Typical cost items, with
chapter references, are listed below.
* Wages and salaries (including benefits Chapter VIII
and social security contributions) of
manpower and employees not directly
involved in production
* Factory supplies, e.g. Chapter IV
Utilities (water, power, gas, steam)
Effluent disposal
Office supplies
* Maintenance Chapter VII
These cost items should be estimated by the service cost centres where they
accrue.
212
Administrative overheads
Marketing overheads
Depreciationcosts
213
Depreciation costs should be calculated on the basis of the original value
of fixed investments, according to the methods applicable (straight line,
declining balance or accelerated depreciation method etc.) and rates adopted by
management and approved by the tax authorities. The same applies for non-
tangible assets, such as capitalized pre-production expenditures.
Financialcosts
Bibliography
214
Appendix
CHECK-LISTS AND SCHEDULES
Productioncost centres
Production cost centres usually comprise the main production (or plant) units or
production lines, for which costs must be determined.
Plant maintenance
Storage costs (personnel, materials and services etc.)
Internal transport services
External transport costs
Insurance
Administrative and service personnel
Salaries, wages
Social overhead costs (health etc.)
Communications and travel
Office supplies
Rents
Leasing fees (unless covered under financial costs)
Recurring land charges
Property taxes
7Use schedules for indirect costs: marketing costs (schedule III-2); factory costs (schedule VI-4);
and estimate of overhead costs (schedule VII-l).
215
Royalties, licence fees
Environmental protection costs
Costs for preventive measures
Costs for curative measures
Duties, taxes etc. payable as emission charges
Depreciation charges (costs)
Costs of financing
216
Schedule VII-1. Estimate of overhead (indirect) costs
(insert in schedule VII-2)
Project:
Date:
Source:
217
Schedule Vll-2. Projection of overhead (indirect) costs
(insert in schedule X-3)
Project:
Date:
Source:
Code: Units:
Grand
Year Variable Fixed Total Variable Fixed Total total
218
VIII. Human resources
This chapter deals with human resource planning. Once the production
programme, plant capacity, technological processes to be employed and plant
organization have been determined, the human resource requirements at
various levels and during different stages of the project must be defined, as well
as their availability and costs. The successful implementation and operation of
an industrial project needs different categories of human resources-manage-
ment, staff and workers-with sufficient skills and experience. The feasibility
study should identify and describe such requirements and assess the availability
of human resources as well as training needs. The study should pay particular
attention to the definition and assessment of those skills and experiences which
may be critical for the success of the project.
On the basis of the qualitative and quantitative human resource
requirements of the project, the availability of personnel and training needs, the
cost estimates for wages, salaries, other personnel-related expenses and training
are prepared for the financial analysis of the project. In case an economic
evaluation is intended, the costs of unskilled labour should be shown
separately.
220
shows that the level of skilled labour available in developing countries will in
many cases not be in line with the exigencies of the production process and of
the machinery and equipment to be installed in the plant under study. The
specification of requirements for professionals and skilled and unskilled
workers, as well as estimates of the necessary number of workers, are therefore
a precondition for the preparation of the manning table, recruitment planning
and the design of a training plan.
A definition of the kinds of professional staff, skilled labour and unskilled
workers needed should be provided in order to specify the minimum training
and professional experience required in order to qualify for the different posts
identified. This is even more necessary because of the substantial differences in
the available public training programmes for skilled workers in developing
countries.
Labour norms
Occupationalsafety
The project analyst should also identify and consider necessary plant
components regarding arrangements for health care and social security for the
human resources to be employed. The cost of such components will have to be
estimated and included in the cost tables of the study. ILO has published a
number of documents on the subjects of occupational safety, health and
working conditions in developing countries and in different employment
situations.
C. Project-related requirements
Identification of requirements
Timing of requirements
Pre-productionphase
When estimating labour requirements, a distinction should be made
between the pre-production and the operational phases. During the pre-
production phase, it may be assumed that labour requirements occur mainly in
conjunction with preparatory measures needed to start the operational phase.
Thus, the managerial staff, supervisors, and some foremen and specialized
machine operators have to be recruited in advance, not only to be trained, but
also to attend to the construction of buildings and the installation of equipment
that they will later be operating. Estimates should be made by category of staff
and workers, as well as by function, applying standard pro-forma man-month
costs to arrive at the labour costs that need to be capitalized. The persons
required at this phase should be kept to a minimum to maintain pre-production
costs as low as possible.
Foreign expertise may also be required for such functions as detailed
engineering or supervision of construction or equipment erection. The number
of persons required, together with costs and periods of service, could in each
case be indicated. It should be specified when foreign expertise is provided at
this stage on a lump-sum basis. When such expertise is provided at the plant
site or within the country of the project, the man-months and periods of service
should be specified in each case. This is to ensure that suitable training
programmes can be set up for domestic personnel easily enough to keep both
the number of foreign personnel and the time they are required to a minimum.
Operationalphase
Requirements during the operating phase may vary over time. Capacity
utilization is usually improved gradually and additional shifts may be
introduced, bringing about increased production and possibly additional
requirements in certain personnel categories.
When estimating labour requirements for the operational phase, the
functions and skill levels needed should be determined by departments
(schedule VIII-1) and aggregated for the project (schedule VIII-2). A distinction
should be made between variable and fixed wage and salary costs, as well as
between the local and foreign labour components. The number of shifts should
be considered. When calculating the total wage and salary costs, it should be
noted that the hourly wage rate and monthly salaries do not constitute the only
personnel costs, but that provision should also be made for the following:
* Annual, sick and training leave, which reduce the number of effective
working days
* Social security, fringe benefits and welfare costs, annual deposits to
pension funds etc., which increase the human resource costs
223
* Installation grants, subsistence payments and similar cash costs, which
occur with recruitment and employment of manpower
* Costs of training
* Payroll taxes
In the case of both wage and salary estimates, it is suggested that these
extra labour costs should be covered by surcharges; these should be computed
separately for wage- and salary-earners. An example is provided in the
appendix to this chapter.
When estimating labour requirements, the qualifications and skills
required should be described by categories of labour and staff in order to
provide a framework for recruitment and for arranging suitable training
programmes. When estimating these requirements, the technology selected,
labour availability and changing levels of productivity should be considered.
Manning tables
The feasibility study should analyse and assess the general availability of
human resources required and describe briefly the background situation,
focusing on employment, progress of economic development and of indus-
trialization, urbanization etc. Particular attention should be paid to the
availability (supply and demand) of management staff, supervisors and relevant
categories of skilled labour. The existence of educational and training
institutions and plans for the establishment of new institutions may increase the
availability of staff and labour for the project, whereas competing investment
plans would increase the demand for human resources.
The feasibility study should not only provide a national outlook, but also
briefly describe and assess the employment situation in the region, given its
relevance for the project. The assessment of human resources available should
cover sectoral employment conditions in the region, unemployment, technical
and social infrastructure and migration trends. General economic development,
infrastructure development and plans regarding industrial projects should be
analysed with regard to possible future changes of the employment situation
and availability of personnel.
The following factors should be given due consideration when the
availability and employment of human resources are analysed:
* The general availability of relevant human resource categories in the
country and the project region
* The supply and demand situation in the project region
* Recruitment policy and methods
* Training policy and programme
Assessments and estimates should as far as possible be explained and
justified. For example, a certain technology, safety hazards, sophisticated
machinery and equipment, international market orientation and other factors
may justify special skills and experience.
It is not sufficient to show only general statistical figures regarding human
resource availability. The study should indicate the current supply and demand
situation in the region as well as possible shortages in relevant categories.
Strong demand from existing industries and expected demand from projects
under construction might make it more difficult for the project in question to
recruit human resources with the professional background and skills required.
The study should also indicate common employment conditions prevailing in
the region, and describe significant differences between different parts of the
region (such as free schools and housing and special allowances granted in
remote areas).
Recruitment planning
The study should analyse the ability of the project to attract the human
resources required. The competitiveness will depend both on the wages and
225
salaries offered and on social security and fringe benefits. A developed and
diversified infrastructure in the project region is usually of importance in a
situation where certain categories are scarce and difficult to recruit.
Recruitment policy and methods should therefore be assessed in the
feasibility study. The methods and means of retaining key personnel for long
periods, probable terms of employment and possible fringe benefits to
employees and their families should be identified. The policy regarding key
personnel is obviously of particular interest.
Difficulties in the recruitment of key personnel (such as managers,
supervisors and skilled labour) can be dealt with in different ways:
* Recruitment is combined with intensive training of key personnel in
order to meet quality requirements;
* Foreign expertise is recruited.
The use of foreign experts is often subject to debate. It is sometimes
regarded as an expensive solution and not in conformity with the general
objective of giving priority to domestic human resources. It may on the other
hand be the only way in the short term to provide the project with skilled key
personnel.
Foreign experts
F. Cost estimates
The manning tables prepared for each department can be used for
estimating labour costs. A distinction should be made between variable and
fixed costs. There is a tendency to consider non-production labour costs as
fixed and production labour costs as variable. This is generally too great a
simplification, as most labour costs are semi-fixed or fixed in the short term.73
The feasibility study should present the estimated labour costs for each
department and function. Underlying assumptions (such as average wages and
salaries for different categories) are to be presented. The costs are to be divided
into foreign and local currency components. When estimating the total wage
and salary costs, provision should be made for the following personnel
overhead costs:
* Social security, fringe benefits and welfare costs
* Installation grants, subsistence payments and similar cash costs that
occur in connection with recruitment and employment
* Annual deposits to pension funds
* Direct and indirect costs of training
* Payroll taxes
The total labour costs are to be aggregated and transferred to schedule X-3.
73
The feasibility study should provide information not only about the extent of these costs at a
certain production level, but also how they vary with production and over time. An identification
of fixed and variable cost components as well as foreign and local currency components should be
made.
228
Bibliography
229
Appendix
Human resource planning will have to take into account the needs of the project,
that is, the previously determined production (chapter VI) and marketing (chapter III)
requirements that form the basis of an organizational concept (chapter VII), as well as
the availability of human resources and training needs (chapter VIII) assessed in
connection with the choice of location (chapter V). The main steps involved in the
assessment of data and preparation of manning tables, including personnel costs, are
reflected in the following check-list.
230
Describe in detail the selected alternative
* Show structure (organization)
* Prepare detailed manning table
Cost estimate
Estimate annual cost of local and foreign staff
Use schedules VIII-l and VIII-2 and insert totals in schedule X-10
The following worksheet provides a typical example of the computation of
surcharges on wages and salaries. All figures given in this example depend on the
working programme (working days per week, number of shifts etc.) and on the labour
laws and benefits granted to staff and labour. The figures should be checked carefully
before being introduced into the projections of production and marketing costs.
Note: If shift work or regular overtime work is necessary for plant operation (as in a
steelworks), the allowances should be added to the surcharges.
231
Schedule VIII-1. Manning table
Function b 1 2 _ 3 _ 4
Sc F L F L F L F L F L
Total labour
S = shift
F = foreign personnel (recruited from abroad)
L = local personnel (recruited nationally)
232
Schedule Vll-2. Estimate of personnel costs
(insert in schedules VI-4 and VII-1, depending on type of personnel)
Project:
Date:
Source:
Directcosts by category Annual costs per person Total costs per year
Code F/L V/F U b Costs C U per Costs per No. of Variable share
per U year person persons Total of total d
":':,: '"":
".':'"'
:'"::': :' : '-'" '!
''
...-: ,-. "'
Surcharge (%)
Surcharge (costs)
a Indicate whether number of persons varies with capacity utilization (V)or remain fixed (F).
b Indicate whether costs are given by hour (H), day (D), week (W), month (M) or year (Y).
c Indicate foreign (local) cost components, if applicable.
d Indicate personnel costs, varying proportionally with capacity utilization (production volume).
233
IX. Implementation planning and budgeting
The project implementation phase embraces the period from the decision
to invest to the start of commercial production. It is very important carefully to
plan and analyse this critical phase of the project cycle, because deviations from
the original plans and budgets could easily jeopardize the entire project. A
primary objective is therefore to determine the technical and financial
implications of the various stages of project implementation, with a view to
securing sufficient finance to float the project until and beyond the start of
production. The choice of financing as well as the financial implications of
investment and production delays should receive particular attention.
A series of simultaneous and interrelated activities taking place during the
implementation phase have to be identified, including the financial implications
they might have for the project. When preparing the implementation plan for
the feasibility study it should also be borne in mind that, at a later stage, this
plan will be the basis for monitoring and controlling the actual project
implementation. The implementation schedule must present the costs of project
implementation as well as the schedule for the complete cash outflows (for all
initial investments), in order to allow the determination of the corresponding
inflows of funds, as required for financing the investments.
This chapter deals with the objectives of implementation planning and
budgeting and describes the characteristics of the main implementation work
tasks as well as the major constraints that normally have a particular impact on
project implementation. Planning techniques commonly applied in implementa-
tion planning are briefly introduced, including the use of computers for
planning large investment projects. A check-list and a schedule for the
preparation of the implementation budget are provided in the appendix to this
chapter.
To implement a project means to execute all the on- and off-site work
tasks necessary to bring a project from the feasibility study stage to its
operational stage. While the preparation of the preliminary implementation
plan is a part of the feasibility study, the execution of the implementation plan
is usually entrusted to a project implementation team.
A realistic schedule should be drawn up for the various stages of the
project implementation phase. This is an essential part of the feasibility study,
as the implementation of every project must be related to a time schedule. Such
a schedule must initially define the various implementation stages in terms of
the resources and duration of activities required for each stage. The
implementation plan should then establish a time schedule that combines the
234
various stages into a consistent pattern of activities that dovetail into each
other. This comprehensive schedule should cover the entire investment phase,
including the period between the investment decision and the initial production
stage, of which the actual construction period is only one, although the most
important, part. Project implementation planning is considered here mainly in
order to draw the attention of the project planner to the financial implications
of project scheduling and to the possibilities of the early detection of
implementation delays and their financial consequences.
Varying periods of time are required for various stages of implementation
in different projects. These depend on the circumstances prevailing in a country
and the specific nature and requirements of a particular project. A considerable
amount of time may elapse between the moment when the investment decision
is taken and the actual start of construction. This period comprises the
following main activities: appointment of the implementation team, company
formation, financial planning, organizational build-up, technology acquisition
and transfer, basic engineering, pre-qualification of contractors, consultants
and suppliers, preparation of tender documents, tendering, opening of bids,
evaluation of bids, negotiations and award of contracts, detailed engineering,
acquisition of land, construction works, installation of equipment, purchase of
materials and supplies, pre-production marketing, training and plant com-
missioning, start-up and initial production. Both local and foreign parties may
be involved, and many problems will have to be referred to the local
authorities.
In some cases the implementation period may be so long that the cost data
given in the feasibility study become outdated and need to be reviewed. If a
construction period of two, three or more years follows, the cost data used for
the investment decision may be several years old by the time of the start-up.
Thus it is imperative that all cost data are dated and documented to allow for a
continuous cost monitoring by way of both projections and gathering actual
data. By comparing the actual data accruing during the construction stage with
the data provided in the feasibility study, it will be possible to detect the
implications any cost overruns may have on the liquidity, financing require-
ments and overall profitability of the project.
Implementation planning and budgeting includes the following major
tasks:
* Determination of the type of work tasks, on- and off-site, that are
necessary to implement the project
* Determination of the logical sequence of events in the work tasks
* Preparation of a time-phased implementation schedule, positioning all
the work tasks correctly in time and allowing for adequate time to
complete each individual task
* Determination of the resources needed to complete the individual tasks
and the extraction of the corresponding costs
* Preparation of an implementation budget and cash flow that will ensure
the availability of adequate funds throughout the implementation phase
* Documentation of all implementation data allowing the implementation
plan and budget, as well as the forecasts made in the feasibility study, to
be updated
235
B. Stages of project implementation
The main stages of project implementation planning, which are dealt with
in further detail for the case of a new industrial investment project, do not
always lend themselves to a stage-by-stage analysis with one stage invariably
leading to the other. A great deal of overlapping and simultaneous planning of
various activities is inevitable. Training activities, for example, may start very
early when key personnel from the company participate in out-of-the country
training for a long period, while the training of maintenance technicians and
operators is undertaken later during construction and start-up. It is particularly
important to link socio-economic conditions of a country, or indeed a region of
a country, to many activities of the implementation period in order to evaluate
their consequences for the scheduling of the individual activities. An effective
port organization may be important to a specific project, but if the highway
that connects the port with the company premises is badly maintained because
the staff of the responsible authority is inexperienced and underpaid, the
project could be critically affected.
Governmental approvals
237
The import of intermediate goods, including processed materials, parts and
components, may also require the sanction of governmental agencies at the
production stage. In all these cases, adequate time should be provided to obtain
the necessary approvals and to avoid creating bottlenecks. It is difficult to
specify a fixed time-frame, as conditions differ from country to country, but in
those countries in which approvals have to be obtained, from 1 to 6 months is
necessary in most cases.
Financialplanning
After the decision to invest has been taken and once the total investment
costs and their scheduling are known, detailed arrangements for project
financing need to be initiated in line with the financial requirements of project
implementation. A sound debt-equity ratio should be aimed at, taking into
account supplier credits, institutional loan financing and investor funds. There
must be a good understanding at the feasibility stage of all the implementation
costs. Only with such a comprehensive assessment will it be possible to
determine the financial requirements and the accruing financial costs that also
constitute a part of the initial investment costs.
The implementation plan and schedule prepared for the feasibility study
will normally form the basis for the future work of a project management team.
When implementing a project, the investor should first set up a project
management team. It is usually advisable to appoint a key person who would
build up a company-internal management team, or select outside project
management consultants. The team should have the necessary authority vis-a-
vis contractors and consultants to ensure the efficient and timely implementa-
tion of the project. It would also be an asset if the team members have an
intimate knowledge of local conditions. The team should not only remain
active during the implementation period, but should ideally form the nucleus of
the managerial, technical and operational staff that is to be put in charge of
operating the plant.
Organizationalbuild-up
238
Technology aquisition and transfer
The acquisition of technology is a key element of the implementation
phase. The selected technology has many legal, economic, financial and
technical aspects, and negotiations with technology suppliers may take
considerable time in certain cases, particularly if minority or significant
participation is sought from the licensors. Legal problems such as patent rights,
exploitation limitations, or restrictions on the transfer of technology and trade
names may sometimes have to be solved. If the contractual obligations of the
technology suppliers include training, this should be included in the training
plan (see chapter VIII). The feasibility study should contain a projection of the
time schedule and the costs related to the acquisition and transfer of the
technology chosen for the project. Moreover, the time allocated for the detailed
engineering design will depend on the kind and complexity of the technology
(see also chapter VI).
Modelforms of contract
Acquisition of land
75
"UNIDO model form of turnkey lump-sum contract for the construction of a fertilizer plant
including guidelines and technical annexures" (UNIDO/PC.25/Rev 2); "UNIDO model form of
semi-turnkey contract for the construction of a fertilizer plant including guidelines and technical
annexures" (UNIDO/PC 74/Rev. 1), "UNIDO model form of cost-reimbursable contract for the
construction of a fertilizer plant including guidelines and technical annexures" (UNIDO/PC.26/
Rev.2); "Guidelines containing illustrative articles of a licensing and engineering services agreement
for the construction of a fertilizer plant including technical annexures" (UNIDO/PC 141/Rev.l).
The four model forms of contract drafted follow a uniform list of 46 main articles and 29 technical
annexures. The essential differences between these model forms of contract relate to the scope of
work of the contractor, the method of payment and the type of site.
241
safety hazards are not properly dealt with in the feasibility study, additional
work on or off the site may be necessary, probably resulting in extension of the
construction work and additional costs.
The time and cost projections for construction and installation work on
site are basically part of the engineering work described in chapter VI. At the
stage of the feasibility study the realistic planning of construction works and
installation of equipment is of crucial importance. Any delays during the actual
construction phase will have an immediate impact on the costs and income
projections made in the feasibility study. For scheduling of the construction
and installation work it is important to understand that such work can begin
only when the final plant layout has been prepared, land has been acquired at
the selected site, and all necessary approvals have been obtained from local
authorities.
Site preparation can generally be planned without major problems, but
care must be taken to perform the necessary tests and technical investigations
to ensure that the projected civil works are adequate. Site preparation must
also cover requirements during construction, with an assessment of locally
available offices, living quarters, means of transport, the size and layout of
camp facilities etc.
The sequence of civil works and construction activities needs to be
carefully defined in relation to infrastructure requirements and availability and
the arrival and erection schedule of different types of plant equipment. The
material flow on site must be considered carefully to ensure that the location of
open-air stores and warehouses do not hamper other activities on the site.
Arrangements for erection and installation of equipment need to be
undertaken in good time, both when erection work is subcontracted and when
it is carried out by the project authorities. Aggressive follow-up and expediting
of equipment deliveries is important, and the provision of technical assistance
to local suppliers and contractors may be considered in order to interpret or
explain complicated technical specifications or work procedures.
242
operating in the countries of foreign suppliers. In agro-industries some input
materials (for example, sugar cane for a sugar factory) must be grown before
they are delivered, which makes the scheduling of the availability of such
materials especially important.
Pre-productionmarketing
The preparation of the sales market must start early enough to ensure that
the output can be sold as scheduled. Otherwise, a stock of unsold products may
accumulate, and the major assumptions concerning the commercial profitability
of the product may no longer be valid. Market preparation ranges from
advertising and training of salesmen and dealers to the organization of the
distribution network and the provision of special sales facilities (such as deep-
freezing equipment, showrooms, workshops).
Plant commissioning
One of the most critical stages during the implementation period is the
commissioning of the plant. This stage normally comprises the following
activities:
* Pre-operational checks
* Trial runs
* Performance test
* Acceptance and take-over
The commissioning stage-which is often rather long-can be most
effectively used as a valuable training period, particularly for the maintenance
technicians. That requires, however, appropriate training of the technicians
before commissioning starts.
Commissioning activities require the supply of inputs, materials and
labour to the site. A supply programme must therefore be included in the
implementation plan.
C. Implementation scheduling
243
engineering must necessarily precede construction and installation; company
formation must have been completed before the assignment of staff is
considered. Other tasks may need more analysis before they can be positioned
correctly.
In the second step the planner will analyse how specific tasks are to be
undertaken. This analysis will normally reveal that some tasks can be further
subdivided into subtasks. Detailed engineering, for example, is the result of the
coordinated effort of several groups of architects and engineers. Again the
subtasks must be properly timed to show the interdependence between various
tasks. The analyst will then proceed to an analysis of the work content of each
subtask, which will make it possible to determine how much time it takes to
complete the individual subtasks.
The analyst can then establish the implementation schedule showing the
proposed start and duration of project implementation and the correct
positioning and duration of all activities and tasks. The description of each task
should include:
* The work to be done
* The resources needed
* The time it takes to complete the task
* The responsibility for the task
* Information inputs required for the task
* Results to be produced
* Interrelationship with other activities
Suppliers of plant equipment will be able to provide information
concerning installation and commissioning. Shipping or forwarding companies
can provide valuable information on transport times, the handling of
documents and customs clearance procedures.
244
D. Projecting the implementation budget
The objective of implementation budgeting is to determine the cost of
resources required to implement an investment project, once the project has
been approved and the investment decision is made. The feasibility study
should determine the cost of resources in accordance with the timing of the
various stages of project implementation described above. The estimated
implementation costs are capitalized pre-production costs forming part of the
total initial investment costs.
The cost estimates are based on the implementation activities and tasks
determined for the project. For various cost items standard costs can be found
in publicly available reference material. For example, associations of architects
and engineers in many countries have established unit costs per man-day and
rules for calculating fees for architectural and engineering services (calculated
on the basis of the type and scope of the project and the work). Other cost
items such as housing, transport, legal fees and duties may require local
surveys. Price and cost estimates should include contingencies for probable
price increases, projected for the most likely starting date of project
implementation. In case the actual starting date is delayed, it will be necessary
to update all cost and income projections and recompute the schedules required
for project financial analysis (see chapter X).
Bibliography
Choudhury, S. Project scheduling and monitoring in practice. New Delhi, South Asian
Publishing, 1983.
Cleland, D. I. and W. R. King. Project management handbook, 2. ed. New York,
Reinhold, 1988.
Coombs, W. E. and W. J. Palmer. The handbook of construction accounting and
financial management. 3. ed. New York, McGraw-Hill, 1984.
Harrison, F. L. Advanced project management. 2. ed. London, Gower, 1985.
Hed, Sven R. Project control manual. Windsor, Hed, 1984.
Marsh, P. V. D. Contracting for engineering and construction projects. London, Gower,
1971.
Stuckenbruck, L. C. The implementation of project management: the professional's
handbook. Reading, Massachusetts, Addison-Wesley, 1981.
United Nations. Contract planning and organization. (ID/1 17)
Sales no.: 74.II.B.4.
The initiation and implementation of industrial projects in developing
countries: a systematic approach. (ID/146)
Sales no.: 75.II.B.2.
245
Appendix
CHECK-LISTS AND SCHEDULES
246
Supervision and coordinationof construction work, installation, testing, trial runs,
start-up and commissioning
Salaries and wages of site staff
Costs of local and foreign experts and consultants
Rents (living quarters, offices etc.)
Erection, operation and camp maintenance
Raw and auxiliary materials, factory supplies for test runs, performance testing and
initial production
Cost of interim warehousing off site
Cost of spare parts and maintenance
Insurance paid during project implementation
Arrangementsfor pre-productionmarketing
Salaries and wages for sales and marketing staff
Advertising
Training of salesmen and dealers
Travel expenses
Communications
Cost of establishing distribution network including special equipment
Printing expenses for public relations materials etc.
Preliminary expenses and costs involved in capital issues (unless included already in cost
groups listed above)
Registration and incorporation fees
Printing and incidentals expenses
Public relations expenses
Underwriting commissions
Brokerage
Legal fees
Insurance
Interest during construction (on term loans, current bank accounts etc.)
Other pre-production expenses
247
Schedule IX- 1. Project implementation charts
e If applicable.
248
Schedule IX-2. Estimate of investment costs:
project implementation
(insert in schedule X- 1)
Project:
Date:
Source:
Currency'
1
Project implementation (insert main task from IX-1)
Cost
Unit
N Q U Item description cost Foreign Local Total Year"
Note: For the purpose of economic cost-benefit analysis, local (foreign) cost elements contained
in imported (national) equipment should be identified.
249
X. Financial analysis and investment appraisal
Given the conditions for investment appraisal, project preparation should
be geared towards the requirements of financial and economic analysis. In this
chapter, after an introduction to the scope and objectives of financial analysis,
the principal aspects of the analysis and the concept of investment appraisal are
explained. Basically, financial analysis should accompany the design of the
project from the very beginning, which is only possible when the financial
analyst is integrated into the feasibility studies team at an early stage. From a
financial and economic point of view, investment can be defined as a long-term
commitment of economic resources made with the objective of producing and
obtaining net gains (exceeding the total initial investment) in the future. The
main aspect of this commitment is the transformation of financial resources
(that is, the investor's own and borrowed funds) into productive assets,
represented by fixed investment and net working capital. While the interest in
future net gains is common for each party investing in a project, the expected
gains or benefits may differ considerably between them, and may also be valued
differently.
Important aspects of financial analysis, such as basic criteria for
investment decisions, pricing of project inputs and outputs, the planning
horizon and project life, as well as risks and uncertainty, will be discussed, and
then detailed consideration will be given to cost analysis, basic accounting
principles, methods of investment appraisal (discounting and conventional
methods), financing, financial efficiency and ratios, and financial analysis and
project evaluation in conditions of uncertainty.
The chapter concludes with a brief characterization of the objectives and
commonly accepted methods of economic evaluation. Examples of the various
schedules required for financial analysis are given in the appendix to the
chapter. The example presented in annex I to this Manual contains the
background information and data needed for the computation of all schedules
shown in chapter X.
250
future.77 The main aspect of this commitment is the transformation of
liquidity-the investor's own and borrowed funds78-into productive assets,
represented by fixed investment and net working capital, as well as the
generation of liquidity again during the use of these assets.
The above definition comprises all types of investment, including industrial
investments. With this characterization in mind, it becomes evident that
financial analysis and final project appraisal involves the assessment, analysis
and evaluation of the required project inputs, the outputs to be produced and
the future net benefits, expressed in financial terms. The methods applied for
this purpose are as follows: analysis of the reliability of projected data; analysis
of the structure and significance of costs and income projections in order to
identify the critical variables that could have a significant impact on the
feasibility of an investment; determination and evaluation of the annual and
accumulated financial net benefits, expressed as profitability, efficiency or yield
of the investment; and consideration of the time factor with regard to prices,
cost of capital, and decisions taken in conditions of uncertainty (norm 1
business risks and specific project risks).
The above-mentioned transformation of liquid financial resources (funds)
into productive assets (fixed assets and net working capital) corresponds to the
financing of an investment. Project financing includes the design of a proper
financial structure, considering the conditions under which funds would be
available, and the optimization of project financing from the point of view of
the enterprise and the investors.
As noted earlier, the conditions for the appraisal of an investment are that
a technically feasible solution is also financially feasible, can be implemented
within the socio-economic and ecological environment identified for the
investment project (socio-economic and ecological feasibility), and is likely to
continue to be feasible for the minimum time determined by decision makers as
the planning horizon for their decisions. The scope and objectives of financial
analysis are therefore to determine, analyse and interpret all the financial
consequences of an investment that may be relevant to and significant for the
investment and financing decisions.
Furthermore, financial analysis and evaluation7 9 should ensure that for the
objectives determined by the decision makers, and within the given confidence
levels of a feasibility study, the following conditions are fulfilled:
251
* The most attractive of the possible project alternatives is determined
under the prevailing conditions of uncertainty;
* The critical variables and possible strategies for managing or controlling
risks are identified;
* The flow of financial resources required during the investment, start-up
and operational phases is determined, and the financial resources
available at the lowest cost are identified for the time required and used
in the most effective way.
These objectives are interrelated. Their conversion into project reality
requires sound judgement, useful concepts, techniques for analysing situations
and principles for the guidance of action. Financial analysis uses a family of
highly developed concepts and techniques for decision-making, planning and
monitoring, which have to be mastered by drawing on related subjects and
techniques such as financial and management accounting, economics, quantita-
tive methods, law and taxation. As the financial analyst must work with all
specialists engaged in the preparation of the feasibility study, he or she must
have a broad appreciation of their functions and working methods. These
matters are dealt with in the following sections, which present an accepted
conceptual framework from a practical point of view.
252
by investors. However, financial analysis should not limit itself to answering
questions raised by investors, but should also indicate and highlight any other
critical impacts that would have to be considered when appraising a project.
The orientation of financial analysis towards the needs of decision makers and
their investment and financing criteria, as well as the principal conceptual
aspects, are discussed below.
253
income tax. It may therefore be interesting for the shareholder to leave the
profit in the firm and reinvest at a profitability rate above 5 per cent.8 4 The
computation of discounted net cash returns on equity and of the profitability of
invested equity capital is described later in the section on investment appraisal
methods.
Public interest
254
* Will the project make efficient use of economic resources, and are there
better alternative uses of the main inputs required for the project?
* Are projections of total investment costs and production and marketing
costs within the acceptable confidence level?
* Are the total investment costs within the financial limits determined by
the availability of capital?
* Does the structure of cash outflows and inflows and of the corresponding
net cash returns meet with the minimum requirements and expectations
of the investors and financiers?
* Will the supply of local money and foreign exchange be sufficient to
meet outstanding financial obligations at any time during the life of the
project?
* How sensitive are the accumulated discounted returns and the annual
returns to the planning horizon, to errors in data assessment and project
design, to inflation and relative price changes and to changes in the
business environment (mainly those involving competitors, consumers,
markets, supplies and public policies)?
* Have critical variables been identified? What risks are associated with
these variables, and what strategies exist to manage or control those
risks?
* What are the financial consequences of the risks; in other words, do
they entail additions to investment costs, to the funds required, to
production and marketing costs, and to finance costs, or lower than
expected production, sales volumes and sales prices?
* How likely is the projected scenario or business environment required as
a minimum condition for the investment to be appraised by investors,
by financing institutions etc.
The methods applied for financial analysis and investment appraisal are
described in detail in the following sections, starting with cost analysis, then
dealing with discounting and conventional methods, project financing, ratio
analysis and financial evaluation in conditions of uncertainty.
Accounting systems
255
the costs accounted for over the reporting period, and the corresponding
income shown in the net income statement. In addition, a cost accounting
system is needed in order to determine production and marketing costs, which
is necessary not only for the preparation of the net income statement, but also
for efficient financial planning, product pricing and cost control.
For liquidity planning the cash flow statement is used. It should be pointed
out that depreciation allowances are not classified among the cash outflows.
The inclusion of depreciation charges (costs) would result in the double-
counting of fixed project costs, since they are already accounted for as fixed
capital investments. This is why depreciation charges are regarded as a cost
item, but not as a cash item. The financial costs (interest paid) are included
among the cash outflows. However, for the computation of the discounted cash
flow (IRR and NPV), the financial costs must be excluded, because they
constitute-like the dividends paid on equity-a yield generated by the
investment and are reflected in the discount rate.
Cost accounting is intended to provide a measurement of budgeted
material costs, wages and salaries, and other expenses involved in producing
and marketing the goods and services generated by the project. These
contemplated costs are examined in an effort to establish the relationship
between them and the level of business activity of the project, for which an
indication of the variable and fixed costs is required. With this information a
profit plan that defines the cost-volume-profit relationships may be constructed.
Measuring profits involves separating costs applicable to units sold from the
cost applicable to the units remaining in inventories. Finally, to establish
rational sales prices requires a knowledge of both the costs and their
relationship to the sales volume (see also chapter III). The contemplated costs
budgeted for normal capacity permit the analyst to price goods and services for
the recovery of costs and a normal profit.
Standard costs representing a predetermined cost may be calculated in
advance of operations for later comparison with actual costs. During plant
operation costs may be recorded on a chronological or other predetermined
basis under any applied system, such as job-order costing or process costing.
After completion of the operations, the actual costs incurred are recorded
chronologically. Both, chronological and pre-determined costs may be utilized
in a cost accounting system.
The classification of costs is necessary in order to facilitate cost planning
(budgeting) and to permit the determination of cost items that could be critical
for the feasibility of a project. The classification described below in the section
on the analysis of cost estimates has already been used in the schedules given in
the appendices to chapters III to IX.
The inputs and outputs of a project appear in physical form, and prices are
used to express them in value terms in order to obtain a common denominator.
Ideally, for the purpose of the feasibility study prices should reflect the real
economic values of project inputs and outputs for the entire planning horizon
of the decision makers. Prices may be defined in various ways, depending on
whether they are:
* Market (explicit) or shadow (imputed) prices
256
* Absolute or relative prices
* Current or constant prices
88
Depending on whether tonnes or calorific values are used as a reference, relative prices may
be different.
89
In the case of hyperinflation, it is also necessary to re-evaluate the fixed and current assets
on a yearly basis, or even for shorter periods, and to convert unemployed liquidity into short-term
investments (such as bonds).
257
relative prices, and of deciding whether to use current or constant prices. The
use of constant prices may still require some adjustments to account for the
expected change in relative prices. If the analysis is made using current prices,
the analyst will have to anticipate the future inflation rate. In this case, possible
inflation rates should be projected by item-for the main cost and revenue
items-in order to consider any significant changes in relative prices of locally
produced and of imported goods and services.
It is evident that the economic life of a project can never be longer than its
technical life or its legal life; in other words, it must be less than or equal to the
shorter of the latter. For project planning purposes only the economic life is
relevant.
Considering that the accumulated net cash flows of an investment project
are a function of the time period covered in the feasibility study, the planning
horizon may have a considerable impact on the results of the financial analysis.
Since the values obtained for the discounted cash flows and the various
profitability and efficiency ratios vary sometimes considerably with the length
of the planning period, the determination of the planning horizon of a
feasibility study is often a very critical task. The relationship between the
planning horizon and project life should therefore be considered when
appraising an investment project.
258
Risk and uncertainty
Investment projects are by definition related to the future, which a project
analyst cannot forecast with certainty. Thus financial analysis and evaluation
have to be carried out under conditions of risk and uncertainty. The difference
between risk and uncertainty is related to the decision maker's knowledge of
the probable occurrence of certain events. Risk is present when the probabilities
associated with various outcomes may be estimated on the basis of historical
data. Uncertainty exists when the probabilities of outcomes have to be assigned
subjectively, since there are no historical data. The aspects and methods of
financial analysis under uncertainty are discussed later in this chapter in the
section on break-even analysis, sensitivity analysis and probability analysis.
Initial investment costs are defined as the sum of fixed assets (fixed
investment costs plus pre-production expenditures) and net working capital,
with fixed assets constituting the resources required for constructing and
equipping an investment project, and net working capital corresponding to the
90
The terminology introduced with the first edition in 1978 is based on the most important
publications in the fields of project appraisal, analysis of capital projects, accounting and financing,
and has been widely accepted
259
resources needed to operate the project totally or partially. At the pre-
investment stage, two mistakes are frequently made. Most commonly, working
capital is included either not at all or in insufficient amounts, thus causing
serious liquidity problems for the nascent project. Furthermore, total invest-
ment costs are sometimes confused with total assets, which correspond to fixed
assets plus pre-production expenditures plus current assets. The amount of
total investment costs is, in fact, smaller than total assets, since it is composed
of fixed assets and net working capital, the latter being the difference between
current assets and current liabilities (see below).
Pre-productionexpenditures
260
Other pre-production expenditures.9' Included among other pre-production
expenditures are the following:
* Salaries, fringe benefit and social security contributions of personnel
engaged during the pre-production period;
* Travel expenses;
* Preparatory installations, 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.
Trial runs, start-up and commissioning expenditures. This item includes fees
payable for supervision of start-up operations, wages, 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-in period up to the stage
when satisfactory levels are achieved also have to be capitalized. Pre-
production expenditures can be tabulated according to schedule X-2.
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. Pre-production expenditures that are not attributable are
capitalized as a total and also amortized over a certain number of years.
For the phasing of pre-production expenditures on an annual basis see
schedule X-2.
Plant and equipment replacement costs. Such costs include all pre-
production expenditures as described above and related to investments needed
for the replacement of fixed assets. Again, the estimates include the supply,
transport, installation and commissioning of equipment, together with any
costs associated with down time, production losses as well as allowances for
physical contingencies.
"Investment in current assets, such as stocks of spare parts, raw materials and factory
supplies, as required for the start-up of plant operation, is dealt with below in the section on net
working capital.
261
and land reclamation. It is often reasonable for a feasibility study to assume
that these costs can be offset against the salvage value of the corresponding
asset.
Fixed assets
As indicated above, fixed assets comprise fixed investment costs and pre-
production expenditures.
Fixed investments should include the following main cost items, which
may be broken down further, if required:
* Land purchase, site preparation and improvements
* 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
The estimates include supply, packing and transport, duties and installa-
tion charges. Depending on the type and accuracy of the pre-investment study,
provisions should also be made for physical contingency allowances, providing
a safety factor to cover miscellaneous (unforeseen or forgotten) minor cost
items. To arrive at the total fixed investment costs, the final amounts derived
from schedules V-1 and V-2, and schedules VI-1, VI-2 and VI-3, should be
inserted in schedules X-l and X-2,9 2 respectively, and added up. Total annual
fixed investment costs are projected for each year of the construction period
until the planned production level is reached. Any investment required during
the operational phase to maintain the operation of the plant should be inserted
in schedule X-1.
92
These schedules are given in the appendix to this chapter.
93
In the literature quite often the term working capital is used as a synonym for net working
capital. This term should not, however, be mixed up with the net increase or net changes of
working capital, which result from changes in current assets and liabilities.
262
(cash inflow for the project). Since the working capital is computed net of
creditors, that is, net of short-term finance, it is quite logical that working
capital should be financed from equity or long-term debt (short-term seasonal
peaks occurring within a production year may, however, be financed by short-
term or medium-term capital).
In the analysis of investment costs it should be carefully checked whether
the initial working capital requirements as well as the changes during plant
operation are properly considered in the cost estimates. Only thus can it be
ensured that there is no unexpected shortage of finance during start-up of
operations, and that working capital outlays are included for the appraisal of
the investment project.
The above classification makes no mention of time, and since time is vital
in the formulation of procurement policies, working capital should furthermore
be classified as either permanent or temporary. Permanent working capital is
that amount of funds required to produce the goods and services necessary to
satisfy demand at its lowest point. The funds representing permanent working
capital never leave the business process. Temporary or variable working capital
is not always gainfully employed. For example, project businesses that are
seasonal or cyclical in nature require relatively more temporary working
capital. Therefore, capital that is temporarily invested in current assets should
be obtained from sources that will allow its return when not in use.
The net concept is used in determining the amount and nature of assets
that may be used to pay current liabilities. The amount that is left after these
debts are paid may be used to meet future operational needs. If the analyst
abstained from classifying permanent and temporary working capital, then net
working capital is used as the average long-term level of working capital and
has to be covered by medium or long-term financing or equity (schedules X-4
and X-7).
The amount of working capital invested should be optimal, that is, neither
too large nor too small, to avoid penalties for the project. Working capital
should be carefully estimated and adequately controlled and monitored.
In the case of accounts receivable the value of annual gross sales should be
calculated as costs of the product sold (that is, production costs plus marketing
and distribution costs) minus depreciation and interest, with the understanding
that the latter are to be covered by the sales revenues and not by the working
capital.
263
Inventories
Cash-in-handand cash-in-bank
94
For the purpose of feasibility studies and in the case of a similar distribution of receipts and
payments during each year, the approximate minimum cash/overdraft to be included in the
computation of the net working capital may be computed on the basis of annual costs of labour,
factory and administrative overheads, as well as direct marketing costs (or operating costs less the
costs of raw materials, factory supplies and indirect marketing).
264
Accounts payable (creditors)
Accounts payable will depend on credit terms provided by suppliers.
Hence raw materials, factory supplies and services are usually purchased on
credit with a certain period elapsing before payment is effected. Accrued taxes
are also paid after a certain period has elapsed (unless tax advances have to be
paid), and may be another source of finance similar to accounts payable. The
same holds true for wages payable. Such credited payments reduce the amount
of net working capital required.
It is very important to understand that creditors related to investment are
to be excluded from the computation of working capital requirements, because
by definition investments are long-term commitments and must therefore be
financed by long-term resources (equity or debt).
Production costs
95
See sect. G below.
266
Figure XXVIII. Structure of the balance sheet
Assets Liabilities
Pre-production
expenditures
Equity
and reserves
Fixed
assets Fixed Permanent
capital
investment
Long-term
liabilities
critical comparisons with similar projects, are proper means of improving the
reliability and accuracy of cost projections and predictions of the financial
feasibility of an investment.
Production costs should be calculated as total annual costs and preferably
also as cost per unit produced (unit costs). Often pre-investment studies deal
only with overall production costs, which should then be broken down at least
into the main cost items (raw materials, factory supplies, personnel, overheads
etc.). The computation of unit costs, which is relatively simple for single-
product factories, may become rather complicated for certain technologies and
the manufacture of a variety of products. For the analysis and justification of
an envisaged production programme and for the break-even analysis, it is
necessary to determine the main cost items directly related to each individual
product. Production costs must be determined for the different levels of
capacity utilization, and for an operational period corresponding to the
planning horizon of the investors and financing institutions interested in the
project.
Frequently overlooked in feasibility studies is the fact that fixed costs may
be constant within only a limited range of production increases or decreases.
96
In the first edition of this Manual sales and distribution costs were treated as a part of total
production costs. With the revision and extension of chapter III, the term marketing costs has been
introduced, covering direct and indirect costs of all marketing activities (including sales and
distribution costs). Since marketing costs are, strictly speaking, costs relating to the marketing of
products and not to the manufacturing process, it has been decided to differentiate between these
two types of costs.
267
elements required for the calculation of total production costs therefore have to
be projected and scheduled in line with the production programme and for the
full planning period. It is, however, not necessary to prepare a schedule for
each cost item separately. Once production costs at full output level have been
defined and their breakdown into variable and fixed costs is established,97 it is
possible to adjust the variable costs in proportion to the percentage of capacity
utilization, assuming that fixed costs remain approximately unchanged. All of
the cost items entering into production costs have been described in the
preceding chapters. These cost elements should now be assembled in order to
arrive at production costs. For this purpose schedule X-3 should be used. The
definition of production costs as given earlier and as applied throughout this
Manual divides production costs into four major categories: factory costs;
administrative overhead costs; depreciation costs; and costs of financing. The
sum of factory and administrative overhead costs is defined as operating costs.
Factory costs. Factory costs include the following cost items:
* Materials, predominantly variable costs, such as raw materials, factory
supplies and spare parts
* Labour (production personnel) (fixed or variable costs, depending on
type of labour and cost elements)
* Factory overheads (in general, fixed costs)
To arrive at factory costs (schedule VI-4), the final amounts derived from
schedules IV-1, V-3, V-4, VI-1 (if applicable), VII-1 and VIII-2 should be
inserted in schedule VI-4 and schedule X-3.
Administrative overheads. The composition of administrative overhead
costs as well as procedures for their computation were described in chapter VII.
All that is needed at this stage is to transfer the final amounts from schedules
VII-1 and VIII-2 to schedule X-3.
Depreciationcosts. Depreciation costs are charges made in the annual net
income statement (profit-loss account) for the productive use of fixed assets.
While depreciation costs have to be considered in accounting for the
computation of the balance sheet and net income projections, they present
investment expenditure (cash outflow during the investment phase) instead of
production expenditure (cash outflow during production). Depreciation charges
must therefore be added back if net cash flows are calculated from the net
profit after corporate tax, as obtained from the net income statements.
Depreciation costs do have an impact on net cash flows, because the higher the
97
Variable costs change roughly in proportion to the variations in the level of production.
Typical variable costs include materials, production labour and utilities. Variable costs can be
divided further into: proportional costs, which change proportionally with the volume of
production (for example, raw materials); degressive costs, which change at a lower rate than the
volume of production (for example, maintenance and repair); progressive costs, which change at a
higher rate than the volume of production (for example, overtime); and regressive costs, which
decrease with an increase in the volume of production (for example, maintenance costs of
unutilized machines).
Fixed costs remain unchanged regardless of changes in the level of activity, and include
mainly overhead and depreciation charges, the latter only if the calculation is time-based Fixed
costs include long-term contractual services, rents, and administrative salaries.
This differentiation is a considerable simplification, and is only valid for a specific range of
capacity utilization. It should be kept in mind when break-even analysis is discussed later in this
chapter-the assumed cost curve may actually have a different shape.
268
depreciation charges, the lower the taxable income, and the lower the cash
outflow corresponding to the tax payable on income.
Financialcosts. Financial costs (interests) are sometimes considered as part
of the administrative overheads, particularly if they relate to an existing
establishment or one that is being expanded and for which the financing scheme is
already known. For the purposes of financial analysis and investment appraisal,
however, it is necessary to determine financial costs separately. Most feasibility
studies show a declining amount of external finance and, correspondingly,
decreasing financial costs. The computation of financial costs is described later
in this chapter.9 8 Financial costs are computed in schedule X-7 and inserted
into schedule X-3.
Figure XXIX shows the interaction of the various cost elements in a
feasibility study and indicates the chapters of the Manual in which they are
covered. This should help the reader to obtain a better understanding of the
cost structure and its impact on the profitability (return on investment and
equity, respectively) of a project.
For the purpose of cash flow analysis it is sufficient to calculate the annual
costs. At the feasibility stage, however, an attempt should also be made to
calculate unit costs to facilitate the comparison with sales prices per unit. For
single-product projects, unit costs are calculated simply by dividing production
costs by the number of units produced (therefore unit costs usually vary with
capacity utilization). In the case of a multi-product project it is recommended
to apply direct costing and compute both the direct costs and the margin
generated per unit produced and sold. The overall margins serve to cover the
indirect costs or overheads, that is, those costs which have not been directly
related to a certain product. A common accounting method for computing unit
overhead costs is to allocate overhead costs to direct material and direct labour
unit costs by means of different percentage surcharges. For new investment
projects the determination of these surcharges may be difficult, and for projects
in developing countries in particular, comparative data may be difficult to
obtain or may not be available at all. Cost accounting surcharges vary from
factory to factory and country to country, and are computed with the help of a
specially designed cost-centre accounting scheme. For an ongoing project,
surcharges are based on historical data. In the absence of such data it might
perhaps be thought that for new, large-scale projects an ex-ante cost-centre
accounting scheme should be built up to compute ex-ante surcharges. There
are, however, too many imponderables for this procedure to be generally
practicable.
98
See sect. F below.
269
to Figure XXIX. Origin of cost items for profitability calculation (return on equity)
~J
o
Factory
Direct material Direct labour Overhead labour and administrative Depreciation Net working capital
overhead!
Raw materials Salaries and wages Management Auxiliary materials Buildings Current assets
Factory supplies Benefits and Functional staff and supplies Machinery and less current liabilities
social security Factory supervision Utilities plant equipment
contributions Indirect labour Communications Tools
Repair, maintenance Office equipment
Rents Vehicles
Insurances and taxes
(chapter IV) (chapter VIII) (chapter VIII) (chapters IV and VII) (chapter VII) (chapter X)
+ Fixed investment6
= Production costs
. Pre-production
f iviai I\G Liny CUalS a 1 Sales revenues expenditures
_ Sales forecasting _\ r- Total costs
Total costs of <„!,,>„»„.. mi = Total investment costs
products sold (chapter III)
1 Gross earnings
_ Borrowings (chapterX)
income tax" Return on equity
a
Calculate income (corporate) tax as applicable.
= Et|uit
Fixed investments: chapter X, on the basis Net earnings - (chapter X) V capital (chapter X)
cost of production materials and production labour. Since indirect costs
(factory administrative overheads such as management and supervision,
communications, depreciation and financial charges) cannot be easily allocated
directly to a particular unit of output, they must first be apportioned to cost
centres, and thereafter to the unit cost price by way of surcharges obtained
from the cost accounting department. Direct costing is an accounting method
that avoids the problem of determining surcharge rates. The direct variable and
direct fixed costs are deducted from the revenues generated by a certain
product (or product group), and the remaining surplus or margin together with
the margins generated by other products is then available to cover the indirect
costs. The surplus then remaining is called the operationalmargin (excluding or
including costs of finance). This method may be extended for the computation
of margins on different production or enterprise levels, such as a production
line (first level), then a plant unit composed of more than one production line
(second level), then the complete factory (third level), and finally the entire
enterprise, which may operate more than one factory. Direct costs are often
mixed up with variable costs and indirect costs with fixed costs, probably
because most of the indirect costs are invariable or fixed. However, as
described above, both direct and indirect costs may be variable or fixed. The
distinction between direct and indirect costs is made to indicate the relationship
between a cost item and a cost centre or profit centre, while the variability (or
non-variability) describes the relationship between a cost item and the volume
of production.
The solution adopted in this Manual is to deduct from the anticipated unit
sales price the variable unit costs and then multiply the remaining margin by
the units produced.9 The annual margin must then be sufficient to cover all
fixed costs arising in the period, and should also generate a sufficient surplus,
as required by the investors.
Marketing costs
Marketing costs comprise the costs for all marketing activities as described
in chapter III (see also schedule III-2), and may be divided into direct
marketing costs for each product or product group, such as packaging and
storage (if not included in the production costs), sales costs (salespersons,
commissions, discounts, returned products, royalties, product advertisements
etc.), transport, interim storage (if required) and distribution costs, indirect
marketing costs, such as overhead costs of the marketing department
(personnel, materials and communications, market research, public relations
and promotional activities not directly related to a product or product group
etc.). The analysis of these costs involves their assignment to various costing
groups such as territories, certain classes of customers (wholesalers, retailers,
governmental institutions etc.), and products or product groups.
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 incurred (while production costs are frozen
in inventory until the units are sold). For depreciable investments as required
99
It is also possible to deduct the total annual variable costs from the total sales income to
compute the annual margin, in this case the variable margin. The computation of the variable
margin is necessary when a break-even analysis is required.
271
for marketing and distribution (for example, delivery trucks), depreciation
charges are to be included in the computation of total marketing costs. The
analysis of marketing costs together with direct costing can be a very useful
instrument for evaluating a marketing mix and for determining an optimal
production programme and product mix.
Although the cash flow analysis has been adopted as the principal
instrument of investment appraisal, it is necessary for the analyst and for those
finally deciding whether to invest and finance a project to have an
understanding of basic accounting principles and statements. The accounting
statements are also important for the analysis of the structure of project
financing and for the computation of the capital costs of a company. In the
case of rehabilitation, modernization and expansion projects, the accounting
records of the existing company are usually the best source of information and
the basis for starting the financial analysis.
There are basically two categories of accounting statements: the net
income statement or profit and loss account which is linked to the balance
sheet; and the cash flow table for financial planning. In many countries the
balance sheet and net income statement must be published in the case of certain
types of corporations.
The net income statement (schedule X-10) is used to compute the net
income (net earnings) or deficit of the project arising each year. The projections
are required for the entire duration of the planning period chosen for the
project. The net income statement differs from the cash flow statement inasmuch
as it shows costs and incomes (and not expenditures and revenues) 100 by
period, following the accrual concept, according to which income from
operations is associated with the costs that were needed to achieve this income
during the period under consideration. To keep computations simple, in
feasibility studies it is usually assumed that inventories of raw materials, work-
in-progress and final products are the same at the beginning and end of each
accounting period (usually the calendar year).
The net income statement is linked with the projected balance sheet in so far
as the annual profit (or loss) shown in the net income statement (schedule X-10)
increases (or reduces) the wealth of a company as represented on the balance
sheet. Annual profits, if retained, increase the reserves (schedule X-ll), while
losses are accumulated under the assets. 10° As dividends are usually not paid in
the same year, the annual balance contains also a line for dividends payable
(schedule X-ll ).
'°°The cash flow concept is described in the section on accounting terminology in part one of
this Manual.
'`In United States accounting, accumulated losses are not shown on the asset side, but are
deducted from accumulated profits, making the account negative if the losses exceed the profits.
272
For the purpose of a feasibility study the net income statement should
show at least how the net earnings are divided between different classes of
equity shareholders, the different suppliers of loan capital and the tax
authorities. For the break-even analysis the variable costs, the variable margin,
fixed costs (including depreciation and financial charges) and the operational
margin should be shown (schedule X-10). No explanatory notes on the concept
of net income statements are provided here, since this has been sufficiently
covered in the literature.
Balance sheet
'02In the United States, the term "liabilities" does not include equity and reserves.
'03The discussion of the rate of turnover presented at this point in the first edition has been
transferred to the later section on financial and efficiency ratios.
'0 4Changes in inventories of raw materials, work-in-progress and finished products have been
taken into account when calculating the working capital (see schedule X-4 for the growth of current
assets).
273
Source and application offunds (cash flow table for financialplanning)
It is not sufficient to determine the total amount of financial means
required and to identify sources of available finance. The timing of the inflow
of funds (paid-in equity, loan disbursements, sales revenues, short-term loans,
bank overdrafts or creditors) must be synchronized with the various expenditures
(cash outflow) for investments as well as the plant operation. If this timing of
financial flows is not properly done, the project may experience periods with
accumulated financial surpluses not employed but costing interest, or face
sudden shortages of funds and liquidity problems. The latter case may have a
serious financial impact, for example, forcing the project to borrow short-term
finance at usually higher costs, or there may be delays in project implementa-
tion if a financial bottleneck cannot be covered during the construction phase.
During the operational phase liquidity problems would lead to reduced supplies
and under-utilization of the installed production capacities.
The net income statement and the balance sheet, designed to show the
wealth of a firm, are not directly suitable for financial planning, that is, the
assurance of the liquidity of the firm. It is therefore necessary to prepare a cash
flow schedule showing the sources and application of funds, in particular, the
overall cash inflows and outflows. During the project implementation and
operational phases detailed financial planning is required at least on a monthly
basis. For the purpose of the feasibility study, however, an annual cash flow
schedule is generally sufficient.
Just as financial planning for the investment phase should ensure that
capital is available to finance investment expenditures, and that financial
inflows and expenditures (cash outflows) are synchronized, financial planning
for the operational phase must ensure that cash inflows, or sales revenues, from
operations will be adequate to cover all production expenses and all financial
commitments, such as debt service (both interest and principal), taxes and
payment of projected dividends. This aspect is particularly significant in the
early years of operation, when output is usually considerably below the
installed capacity, while the burden of debt service is often the highest. This is
the case, for example, with supplier credits, which usually have to be repaid
over a period from 5 to 8 years in equal instalments.
In schedule X-8, an example of integrated cash flow (comprising
operational (real) and financial cash flows) is given, covering the periods of
construction, start-up and operation at full capacity. The preparation of a
separate cash flow schedule showing also the foreign exchange requirements
and foreign cash inflows is recommended. Data for the financial planning
schedule are obtained from schedules X-l, X-2 and X-4 (fixed investment,
current assets and current liabilities), X-7 (sources of finance and corresponding
debt service) and X-10 (sales revenues). The cash flow tables are closely linked
to the projected balance sheet, since the cumulative cash balance obtained in
the cash flow schedule for financial planning-which should never be
negative-corresponds to the figure in the balance sheet. The cash outflow for
tax payments is obtained from the net income statements, assuming that the tax
is paid at the end of the same year, in other words, that no tax credits are
granted.
Since capital is frequently scarce, it is the general tendency of inexperienced
promoters to keep the projected financial requirements as low as possible. A
project analyst should resist the temptation to please the sponsors of the study
by such unreasonably low figures. Bad financial planning in the pre-investment
274
study will hamper the progress of the project either while obtaining clearance
by financial institutions or at an even more crucial stage of project
implementation.
In order to shed more light on the financial structure of investment
proposals and to facilitate the final choice of financing, alternative modes of
financing must be considered and provided for in every pre-investment study.
For each financing alternative the cash flow tables, net income and balance
sheet projections have to be computed, as well as those ratios and indicators of
the efficiency of investment projects which vary with the structure and costs of
finance.
The following two approaches are generally taken in projecting cash needs:
* A cash flow forecast based on the income statement, in which the
statement is adjusted for non-cash items. The resulting figure refers to
funds provided by operations. Considering cash flows not recognized in
the income statement leads to the final funds position of the project;
* A cash receipts and disbursement statement, or the cash budget,
reflecting the initial cash balance, the receipts for the period, the
expected disbursements and the ending cash balance. This statement is
typically divided into subperiods, possibly in terms of weekly or
monthly time intervals.
275
usually to know the profitability of the equity capital, that is, the net profit
after tax over the paid-in equity (or share) capital. When preparing a feasibility
study, however, it is generally not known how the project will be finally
financed. Apart from the impact of loan financing on income tax computations
(cost of finance is deductible from the operational margin),'0 6 the profitability
rate for equity capital depends entirely on the overall profitability of total
capital invested and the interest paid on the debt balance (leverage effect). It is
therefore necessary first to determine the financial feasibility of the investment
project as a whole, and only then assess the individual feasibility for each
participating source of finance (equity holders including joint venture partners,
commercial banks and development finance institutions).'0 7
Cash-flow concept
Financialinflows Financialoutflows
Paid-in equity capital Dividends paid
Buying back of shares
'06 See schedule X-10.
t0 7Profitability ratios for capital invested are computed from the figures contained in the
balance sheet and net income statement of the project. Since the net profit is usually not identical
with the profit distributed (dividends paid), two different values can be computed for the
profitability of equity capital. As compared with the cash-flow concept, there is also a difference
between the net cash return on equity capital and the profitability computed for the same source of
funds. The differences are explained in detail below in the analysis of cash-flow discounting
methods.
"08See sect B. above.
276
Financialinflows Financialoutflows
Subsidies, grants Repayments (if required)
Long- and medium-term loans Interests paid on loans and other costs
of finance
Amortization (repayment) of loans
Short-term loans, bank overdraft Interest paid on short-term loans and
overdraft, repayments on short-term
loans and overdraft
Increase in accounts payable Decrease in accounts payable
Operational cash flows are shown in schedules X-9 (discounted cash flow):
This Manual does not undertake to justify and explain the methods and
basic assumptions of cash-flow discounting and compounding, because the
subject is extensively dealt with in the literature. The basic assumption
underlying the discounted cash-flow concept is that money has a time value in
so far as a given 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
indicating 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 an agreed interest I, the total
sum to be paid after one year would be (F + I), where
F+I= F(l + r)
and r is defined as the interest rate (in percentage per year) divided by 100 (if
the interest rate is, for example, 12.0 per cent, then r equals 0.12).
'09It should be noted that depreciation charges (costs) and interest payments are not classified
among the operational cash outflows, because inclusion of depreciation of assets would provoke a
double-counting of the costs to the project, since they are already accounted for as investment costs
when capitalized in the balance. However, for accounting purposes (including taxation) assets are
to be depreciated over the project lifetime. This is why the depreciation of assets is a cost item in
the net income statement only, and must be deducted from the annual total costs of products sold
(production and marketing costs) when determining the annual cash outflows. Interest and any
other cost of finance are also included for the computation of the yield or return on the total
capital investment, because they are part of this total yield. However, interest on loans (but not net
profits distributed) is a cost item in the net income statement.
277
Supposing that CFn is the nominal value of a future cash flow in the year n,
and CFp the value at the present time (present value) of this expected inflow or
outflow, then (assuming that r is constant):
CFp = CF,/(1 + r)n
or CFp = CF(1 + r)- n
There are two main discounting methods used in practice for the appraisal
of investment projects, as far as the evaluation of financial feasibility is
concerned: the net-present-value method (often referred to as NPV method),
and the internal-rate-of-return (IRR) method, sometimes also referred to as the
discounted-cash-flow method.
where NCF, is the annual net cash flow of a project in the years n = 1, 2, ..,
j, and an is the discount factor in the corresponding years, relating to the
discount rate applied through the equation
a, = (1 + r)-
Discount factors (an) may be obtained from present value tables.
The discount rate or cut-off rate should be equal either to the actual rate
of interest on long-term loans in the capital market or to the interest rate (cost
of capital) paid by the borrower.110 The discount rate should basically reflect
the opportunity cost of capital, which corresponds to the possible returns an
investor (financier) would obtain on the same amount of capital if invested
elsewhere, assuming that the financial risks are similar for both investment
alternatives. In other words, the discount rate should be the minimum rate of
return, below which an entrepreneur would consider that it does not pay for
him to invest.
""The market rate for long-term loans is usually valid for borrowers with the best credit
rating. In case additional risks, exceeding the normal investment risks, are expected, financing
institutions as well as private investors would increase the costs of finance for the project by adding
a safety margin to the base rate to cover the various country risks etc
278
If the computed NPV is positive, the profitability of the investment is
above the cut-off discount rate. If it is zero, the profitability is equal to the
cut-off rate. A project with a positive NPV can thus be considered acceptable,
provided a sufficient margin of error above zero NPV to account for
uncertainty has been included. If the NPV is negative, the profitability is below
the cut-off rate (usually the opportunity cost of capital for this type of project),
and the project should be dropped.
An important decision criterion of the investor is often not only the
profitability of his investment, but also the answer to the question: how long
does it take to get the money back including a certain minimum interest rate?
He may decide, for instance, to invest only if the investment is repaid in five
years at an interest rate of 15 per cent per year, which would mean that the
NPV must not be negative for a discounting rate of 15 per cent and a planning
horizon of five years. The net cash return on equity would have to be used for
discounting.
Using the data of the example, the NPV of the total investment outlay
(schedule X-9/1) and the NPV of the equity capital (schedule X-9/2) can be
determined. The relevant schedules are given at the end of this chapter.
Schedules X-9/1 and X-9/2 show that the working capital and the salvage
value of fixed assets will be recovered by the end of the project life. For the
computation of the discounted return on equity capital invested, any
outstanding debt balances would have to be deducted from these salvage values
in order to obtain the real end-of-life net worth for the shareholders.
The NPV and the IRR for the total investment (schedule X-9/1) shows the
yield of the project as a whole. In case there is no loan (outside) financing, the
NPV and IRR are the same as in schedule X-9/2.1" However, if part of the
investment is financed from loan capital (outside financing), the NPV and IRR
are different because of the tax effect of the debt service (interest is a cost item,
and therefore the taxable profit is lower in the case of interest payments). The
cash flow corresponding to payment of the income (corporate) tax is taken
from the net income statement (schedule X-10).
Net-present-value ratio
If one of several project alternatives has to be chosen, the project with the
largest NPV should be selected. This needs some refinement, since the NPV is
only an indicator of the positive net cash flows or of the net benefits of a
project. In cases where there are two or more alternatives, it is advisable to
know how much investment will be required to generate these positive NPVs.
The ratio of the NPV and the present value of the investment (PVI) required is
called the net-present-value ratio (NPVR),1' 2 and yields a discounted rate of
return. This should be used for comparing alternative projects. The formula is
as follows:
NPV
NPVR= NP
PVI
'"It should be borne in mind that if a project is financed without loan capital, the production
costs will not contain any financial costs.
"'Insome textbooks this is called the profitability index.
279
If the construction period does not exceed one year, the value of investment
will not have to be discounted. A comparison of the two alternative ways of
financing the project in the example yields the NPVRs shown in table 1.
NPVa at
Schedule 12 per cent PVI NPVR
The internal rate of return is the discount rate at which the present value
of cash inflows is equal to the present value of cash outflows. In other words, it
is the discount rate for which the present value of the net receipts from the
project is equal to the present value of the investment, and the NPV is zero.
Mathematically, it means that in the NPV equation discussed earlier, the value
for r has to be found for which-at defined values for CF,- the NPV equals
zero. The solution is found by an iterative process, using either discounting
tables or a suitable computer programme.
The procedure used to calculate the IRR is the same as the one used to
calculate the NPV. The same kind of table can be used, and, instead of
discounting cash flows at a predetermined cut-off rate, several discount rates
may have to be tried until the rate is found at which the NPV is zero. This rate
is the IRR, and it represents the exact profitability of the project.114
The calculation procedure begins with the preparation of a cash flow table.
An estimated discount rate is then used to discount the net cash flow to the
"'An investor may be willing to invest if the NPV on his paid-in equity is above zero for a
shorter period-his planning horizon adopted for the investment decision-than the project
lifetime. In this case the net cash return on equity is estimated for this shorter period and
discounted using the cut-off rate of the investor. If the value of the plant at the end of the planning
horizon (assuming, for example, that the investor could sell his equity share at that time) is taken
into account in the decision, then the net value, that is, the total value net of all obligations towards
others, is taken as a net cash inflow occurring at the end of the discounting period
"4The IRR is known also as marginal efficiency of capital, interest rate of return, discounted
cash flow, or financial rate of return (as opposed to the economic rate of return used in economic
analysis).
280
present value. If the NPV is positive, a higher discount rate is applied. If the
NPV is negative at this higher rate, the IRR must be between these two rates.
However, if the higher discount rate still gives a positive NPV, the discount rate
must be increased until the NPV becomes negative.
If the positive and negative NPVs are close to zero, a good approximation
of the IRR value can be obtained, using the following linear interpolation
formula:
PV (i2 -i,)
ir -- il
PV + NV
where ir is the IRR, PV is the positive NPV (at the lower discount rate i,),
and NV is the negative NPV (at the higher discount rate i2).
The absolute values of both PV and NV are used in the above formula. It
should be noted that i, and i2 should not differ by more than one or two
percentage points (absolute). The above formula will not yield realistic results if
the difference is too large, since the discount rate and the NPV are not related
linearly.
For the total capital invested the NPV equals $3,801,000 at a 12 per cent
discount rate (for the example shown in schedule X-9/1). In order to find the
IRR, several discount rates greater than 12 per cent are tried until the NPV is
approximately zero. The NPVs at discount rates of 18 per cent and 20 per cent
are shown in table 2.115
"SThe IRR is sensitive to the length of the cash flow array (planning horizon). For example, if
the cash flow is discounted for 16 years only, the IRR would be approximately 18 per cent, and less
if a shorter planning horizon is chosen.
281
Table 2 shows that, discounted at 18 per cent, the net cash flow is still
positive, but it becomes negative at 20 per cent. Consequently, the IRR
must lie between 18 and 20 per cent. For practical purposes this would be
sufficiently close to be able to calculate the exact IRR using the formula or
a graphical interpolation.
The IRR may be interpreted as the annual net cash return (gain or yield
in financial terms) produced on capital outstanding per period, or understood,
in other words, as the highest net-of-tax annuity rate (annual debt service rate)
at which the project could raise funds, provided the annual net cash flows are
rather constant. 16
When analysing the equations for the computation of the NPV of a
series of annual cash flows CFn, it can easily be shown that the same NPV
may be obtained for different cash flow arrays, and similarly, for investment
projects with completely different cash flow structures, the same IRR may
be computed (see table 3). In addition, the value computed for the NPV
depends also on the lengths of the cash flow array (that is, the planning
horizon adopted as a criterion for the investment decision). The IRR or
NPV should therefore never be used as the only decision criterion, and the
financial evaluation of investment projects should always include a critical
analysis of the structure and timing of discounted cash flows.
Rate
Discounted annual net cash flow of discount
or IRR
Invested capital 1 2 3 4 5 6 7 8 NPV (per cent)
Project A
(950) 150 170 190 210 230 250 270 375 895 -
(950) 130 129 125 120 114 108 102 122 - 15
(950) 134 136 135 134 130 127 152 152 120 12
(190) a 34 34 34 33 32 - - - (17) 12b
Project B
(780) 166 180 190 200 200 200 200 - 556 -
(780) 144 136 125 115 99 86 75 - - 15
(780) 148 144 135 127 113 101 91 - 79 12
a
(156) 37 36 34 32 28 - - - 9 12b
"6When the assets of a project sufficiently cover all liabilities at the end of the discounting
period, the IRR would only then correspond to the highest net-of-tax interest rate, provided that
the firm has the option to repay Its obligations at will.
282
The investment proposal may be accepted if the IRR is greater than the
cut-off rate (the cost of capital plus any margin for risk), which is the lowest
acceptable interest rate for the invested capital." 7
If several projects or alternatives are being compared, it is not necessarily
the project with the highest IRR which should be selected, provided the IRR is
greater than the cut-off rate for at least two of the projects or alternatives. In
this case, known as the ranking problem and the problem of mutually exclusive
investment projects, the two discussed discounting methods may lead to
contradictory results.17
The rankingproblem
It has been shown above that different cash flow arrays can produce an
identical IRR, and it is also possible that a project with a lower IRR (still above
the cut-off rate, however) should be given preference to a project with a higher
IRR but showing an undesirable cash flow structure. Furthermore, projects
may be ranked differently if the NPV method is applied. Figure XXX below
illustrates the problem.
The IRR of project B (IRRB) is higher than for project A (IRRA), and for
any rate of discount between i2 and the IRR, the NPV is higher for project B
than for project A. If the cut-off rate is below i2, then both projects would be
still acceptable from the profitability point of view. In this case, however,
project A would be given priority if the NPV dominates project selection. The
rate of discount for which the NPVs of both projects are identical is called the
crossover rate (i2). Under the rather theoretical conditions of completely
identical project risks, identical project life and a comparable amount of
investment, the project earning the higher yield would normally be ranked first.
Since these assumptions would rarely apply in real life, the investors' evaluation
of the different project risks and of possible risk minimization strategies would
finally determine the investment decision.
For the reasons explained above the IRR method should also be applied
with care in the case of two or more mutually exclusive projects. Projects are
mutually exclusive if the acceptance of one project means the rejection of the
other. This situation is typical, for example, if only one site is available to the
"7The IRR should be applied with care in cases where major negative net cash flows occur
repeatedly during the later life of the project. Although this occurs very seldom (occasionally in the
oil and mining industry, for example), the NPV may go positive and negative more than once when
applying different rates of discount. In this case, there would be more than one solution for the
IRR (a polynomial equation has as many solutions as there are changes in the sign of the cash flows
series, although most likely not all solutions would be real), and the IRR method may produce
meaningless results. To overcome this deficiency, the adjustment of the cash flows in accordance
with the yield method and the following procedure has been recommended. The point is determined
from which the future cash flows-discounted at the yield rate-are negative. These cash flows are
then discounted at the normal cost of capital to bring them back in time to the point at which they
are largely absorbed by the preceding positive cash flows. A revised yield calculation is then
performed on the cash flows modified in this way. This method is explained and justified in detail
in A. J. Merrett and A. Sykes, The Finance and Analysis of Capital Projects (London, Longman,
1974).
283
Figure XXX. NPV method and ranking problem
Net
present
value
Since both projects have the same IRR of 15 per cent, an investor would be
indifferent to the choice of either if the IRR method alone is applied. However,
project A would produce a higher NPV at 12 per cent, and is also better if the
NPVR is taken as an efficiency measure (0.126 for A and 0.101 for B). Project
A should therefore be recommended for implementation, provided the projects
are similar with regard to other investment criteria (risk, markets, total funds
available etc.). On the other hand, an investor sharing, for example, 20 per cent
of the initial investment and-as a simplification-25 per cent of the annual net
cash flows would prefer project B, if the aim is to recover the investment at
12 per cent within five years.
The discounted net cash return on equity (NPV and IRR on equity) is
computed by deducting from the net cash flows of the entire project the
financial cash flows related to loans (outside financing), that is, the debt service
(interest and amortization of the loan) as well as the repayment of any debt
balance outstanding at the end of the planning period (see schedule X-9/2).
The concept of cash flow discounting can also be applied to determine the
NPV of an investment from the point of view of the shareholders. Two
positions may be distinguished:
* The cash returns on equity as represented by annual payments of
dividends are discounted at the opportunity cost of capital of the
shareholders. The NPV for shareholders is obtained by deducting the
total of discounted paid-in equity from the accumulated discounted
dividend payments. If this NPV is positive for the planning period of
shareholders, the investment would be able to pay the required returns.
The IRR for this cash flow shows the profitability of equity capital, as
represented by dividends paid.
* The cash surpluses generated annually, that is, after debt service and
corporate tax, but before payment of dividends, is discounted. The
discounted net cash flow from the point of view of the shareholders is
obtained by deducting the total discounted equity payments from the
accumulated discounted cash surpluses (that is, the accumulated
discounted return on equity capital). The computation of this discounted
return on equityl8 is demonstrated in schedule X-9/2.
"8 The discounted return on equity corresponds to the "present value for a project with
outside financing", as described in schedule X-14 in the first edition of this Manual.
285
Conventional methods
Payback period
The payback, also called pay-off period, is defined as the period required
to recover the original investment outlay through the accumulated net cash
flows earned by the project. It is important to note that the cash flows of a
project are used to calculate the payback. It would be entirely wrong to
compute the payback on the basis of the accumulated net profit after tax. Even
when accumulated interest and depreciation are added back, there is the danger
that investments for replacement, as usually necessary for continuing the
operation of the plant, will not be included in the calculations.
The payback method 119 is mainly criticized for its concentration on the
initial phase of the production period, without taking into account, for the
investment decision, the performance of the plant after the payback period.
This critical argument would be justified if an investment decision is entirely
based on the payback method. However, if applied for assessing risk and
liquidity, and if used in combination with profitability measures as discussed in
this Manual, the payback can be a very practical and useful instrument.
Risk. The payback is useful if a new project would have to expect rapid
technological change in the industrial sector, in particular when the tech-
nological life cycle is much shorter than the technical life cycle of the project or
its main components. Another typical situation would be that the entry barriers
(see chapter III) are relatively low in a highly competitive market. In such
business environments the investors may choose a project strategy to recover
the investment outlay, including a certain minimum interest within a period
related to the phase of the life cycle of the industrial sector as well as to the
expected technology and product life. The decision makers would then be able
to determine the payback points first for the recovery of all investment outlays
(conventional payback), and secondly for the recovery of all investment outlays
including a minimum profitability (the NPV at the required discounting rate
would be equal to zero for a payback period of n years, thus breaking even at
this point, and then earning additional interest in the following years).
The experienced financial analyst can use this information to determine the
sensitivity to cost and sales price variations in each of these periods. After
allowing for debt service, the net cash generation capacity (self-financing
capacity) may be computed for the payback period-indicating the capacity of
the project to finance the new investments probably needed to cope with the
development of the industrial sector (innovation and modernization invest-
ments, rationalization etc.).
Approximate measure of profitability. A short payback period corresponds
on average to a high annual net cash flow. The reciprocal of the payback
"'While the payback is usually interpreted as a break-even point at which accumulated net
cash flows become positive, the method is sometimes adapted, in so far as those assets which could
be converted into cash easily, such as working capital, are added to the accumulated net cash flows,
thus shortening the payback period. This method is not recommended, because it would mean
assuming that the plant would cease operations at the moment the initial investment outlay is paid
back, no longer being able to earn the necessary return (interest) on capital.
286
period can therefore be used as an appropriate measure of the profitability of
an investment.1 20 A long payback period would also imply that the ratio
between the annual net cash flows and the initial investment is relatively poor.
If at the same time the output-capital ratio (expressing the value of the annual
output produced by investing one unit of capital) is also low, the project is
likely to be unattractive to investors and financiers.
The simple rate of return method relies on the operational accounts. 2 ' It is
defined as the ratio of the annual net profit on capital. This ratio is often
computed only for one year, generally a year of full production. However, it
may also be calculated for various degrees of capacity utilization (sensitivity
analysis) or for different years during the start-up phase. For investment
appraisal two rates of return-on total capital employed (total investment) and
on equity capital-are usually of interest.
The (annual) rate of return on total capital invested R, is
NP + I
R, (per cent) = - x 100
K
and the (annual) rate of return on equity capital paid RE is
NP
RE, (per cent) = - x 100
where NP is the net profit (after depreciation, interest charges and taxes),
I the interest, K the total investment costs (fixed assets and working
capital, 122 and Q the equity capital.
287
explained before a final judgement is made. Using the figures of the example
presented in annex A, the rates of return shown in table 4 could also be
considered for year 6, the first year of full capacity, and for year 8, after the
expiry of tax holidays:
The simple rate of return method has a few serious disadvantages. For
example, which year is the normal (representative) year to be taken as a basis
for computing the rate of return? Since the simple rate of return uses annual
data, it is difficult and often impossible to choose the most representative year
of the project. In addition to the varying levels of production, especially during
the initial years, and the payment of interest, which can also differ annually,
there are certain other factors that cause changes in the level of net profit in
particular years (tax holidays, for instance).
In years in which a tax concession is to be applied, the net profit will
obviously be quite different from that in years when the profit is subject to
normal taxation. This shortcoming of the simple rate of return-which is a
consequence of its static character-can to some extent be alleviated by calculating
the profitability of the project for each year as shown in schedule X-10. The
difficulty of choosing the "normal" year is revealed by the varying annual rates
of return shown in table 5.123
Even after this calculation, however, the main shortcoming of the simple
rate of return remains: it does not take into account the time value of the equity
payments and of the annual returns on equity. Furthermore, the annual return
on equity is lower than the net cash flow remaining after debt service. Thus,
unless the annual depreciation is reinvested without delay, the rate-of-return
method always underestimates the financial gains (yield) of an investment as
expressed by means of the IRR. Income obtained in an early period is
'2 The computation of an average rate of return (accumulated net profits divided by the
number of years) would solve the problem of selecting a representative year. However, the problem
of the time value of money would still remain unsolved. The rate of return method is often used
when alternative technologies are compared by determining the total annual production costs
assuming full capacity utili/ation. The margin between sales prices and costs of products sold
(production costs plus marketing costs) is then related to the respective investment costs and the
alternative with the higher rate of return is given priority, ignoring all other factors relevant for
investment appraisal, as discussed in this Manual.
288
Table 5. Annual rate of return on equity capital
Year of project
Construction Start-up andfull capacity
1 2 3 4 5 6 7 8 9
Net profit after tax - - (434) 712 1 682 2 381 1 241 1 292 1 308
Equity capital - - 3 500 3 500 3 500 3 500 3 500 3 500 3 500
Rate of return (per cent) - - - 20.3 48.1 68.0 35.5 36.9 37.4
Net worth - - 3 500 3 066 3 778 4 830 6 581 7 192 7 869
Return on net worth
(per cent) - - - 23.2 44.5 49 3 18.9 18.0 16.6
F. Project financing
289
most cases before a feasibility study is undertaken. This is especially true if a
project opportunity or pre-feasibility study has previously been performed, as
such studies would indicate the order of magnitude of the required capital
outlay. A feasibility study should only be made if financing prospects to the
extent indicated by such studies can be defined fairly clearly.
As discussed earlier, resource constraints may define the parameters of a
project well before an investment decision is made, and at various stages of
project formulation. A large steel plant may not be practicable in a small
country with extensive iron ore deposits but with very limited financial
resources. Such resource constraints may limit the consideration of certain
projects or restrict project capacity to the minimum economic levels. Financial
constraints could exist at all levels of project sponsorship and occur whether a
particular project is under consideration by an individual entrepreneur, a major
industrial group (domestic or foreign), or a governmental or semi-governmental
agency.
Apart from some instances where resource constraints constitute a major
limiting factor in the consideration of project possibilities and project size, it is
only when the basic techno-economic parameters of a project are defined that
the detailed requirements of financing can be adequately assessed. Thus, in a
feasibility study, the capital outlay of a project can be appropriately determined
only after plant capacity and location have been decided, together with
estimates of the costs of a developed site, buildings and civil works, technology
and equipment.
Defining the financial requirements of a project at the operational stage in
terms of working capital is equally necessary, although too often neglected.
This can only be determined once estimates are made of production costs, on
the one hand, and sales and income, on the other. These estimates should cover
a period of time and be reflected in a cash flow analysis. Unless both estimates
are available and unless the available resources are sufficient to meet the fund
requirements, both in terms of initial capital investment and working capital
needs over a period of time, it would not be prudent to proceed to the financing
decision and project implementation. There are innumerable instances of
projects that ran into serious financing problems because of inadequate
estimates of fund requirements at the initial investment or operational stages,
because investment, production costs and marketing costs were underestimated,
or sales and income were overestimated.
Sources offinance
Equity
A generally applied financing pattern for an industrial project is to cover
the initial capital investment by equity and long-term loans to varying extents,
and to meet working capital requirements by additional short- and medium-
term loans from national banking sources. However, as explained before, the
minimum net working capital requirements should be financed from long-term
capital. Within this framework various permutations are possible and need to
be assessed.
In certain projects, equity capital covers not only the initial capital
investment but also net working capital requirements, for the most part. This
generally occurs in situations where institutional capital is scarce and available
only at high cost. Since earnings from capital through term deposits are also
290
high in such situations, a project would need to be very attractive financially
before it could mobilize adequate investible resources. In other cases, where
relatively inexpensive long- or medium-term credit is available, there is a
growing tendency to finance projects through such loans.
In all cases, a balance needs to be struck between long-term debt and
equity. The higher the proportion of equity the less the debt service obligations
and the higher the gross profit before taxation. The higher the proportion of
loan finance, the higher the interest payable on liabilities. In every project,
therefore, the implications of alternative patterns and forms of financing must
be carefully assessed; a financing pattern should be determined that is
consistent with both availability of resources and overall economic returns.
Equity can be raised by issuing two types of shares: ordinary shares
(common shares in United States terminology); and preference shares.
Preference shares usually carry a dividend at least partly independent from
profit, without, or with only limited, voting rights. Preference shares can be
convertible to common shares, they can be cumulative or non-cumulative in
terms of dividends, or they can be redeemable or non-redeemable, with the
redemption period varying between 5 and 15 years. Dividends on ordinary
shares with full voting rights, however, depend on the profitable operation of
the company. There is currently a trend towards more than one class of
common shares, involving greater voting rights combined with lower dividends
and receipts and fewer privileges, or vice versa.
Loan financing
Since it is relatively easy for a sound project to obtain loans, the process of
project financing may well start by identifying the extent to which loan capital
can be secured, together with the interest rate applicable. Such loan capital
would need to be separately defined in the following forms: short- and medium-
term borrowings from commercial banks for working capital purposes, or
supplier credits of various forms; and long-term borrowings preferably from
national or international development finance institutions.
Short-term loans. Short-term loans from commercial banks and local
financial institutions are available against hypothecation, or pledging, of
inventories. The limits to which inventories are financed by commercial banks
are fixed by the banks, and depend on banking practices in the country, the
nature of the project and inventories, and the credit rating of the enterprise and
its management. The limits usually vary between 50 and 80 per cent, leaving a
margin of from 20 to 50 per cent of inventories to be financed from other
sources, preferably venture capital.
Bank borrowing for working capital can be arranged on a temporary basis.
If at any time the cash flow statement suggests that sufficient liquid funds are
available, such commercial bank borrowings should be substantially reduced or
entirely eliminated, without however jeopardizing the overall liquidity of the
project. In some cases, such a cash-flow surplus may be needed for further
capacity expansion, so that the enterprise may need to rely on long-term bank
credits for some time. Working capital needs should even be partly met out of
long-term funds (equity capital and long-term loans), since the largest portion
of working capital is permanently tied in inventories (raw materials, work-in-
progress, finished goods and spare parts).
291
In the example case presented in annex A to this Manual, 20 per cent of the
total liabilities are financed from equity funds. As shown in schedule X-7/2, the
loan capital is repaid during five years starting in the second year of operation.
The change in the ratio of net worth to debt is possible because the project
generates a sufficient cash surplus (over interest payments) to repay the debt.
Other short-term funds are trade credits (creditors or accounts payable), bills of
exchange, deferred tax payments and wages payable.
Long-term loans. Loan financing is usually subject to certain regulations,
such as restrictions on the convertibility of shares and declaration of dividends.
Apart from these regulations, certain ratios in the capital structure of the
company need to be maintained. Investment may also be financed partly by
issues of bonds and debentures. The market for bonds and debentures tends to
be fairly limited as far as new projects are concerned, but such securities are
often issued to finance the expansion of existing enterprises.
An important source of finance is also available at government-to-
government level for many developing countries. This can take the form of
general bilateral credit or tied credit, which may be related to the purchase of
machinery and equipment from a particular country or even from a particular
source.
In addition to share capital and loan finance, an important financial
category at the operational stage is the internal cash generated by the project
itself. This can take the form of accumulated reserves (retained profits and
depreciation).
Supplier credits. Imported machinery and spares can often be financed on
deferred credit terms. Machinery suppliers in industrialized countries are
generally willing to sell machinery on deferred-payment terms with payments
spread over 6 to 10 years, and sometimes even longer. Deferred payment terms
are available against bank guarantees; this enables such machinery suppliers to
obtain refinancing facilities from financial institutions in their own countries.
Example
Cost of the project and means offinance. In table 7, part A, the total initial
investment outlay (schedule X-6/1) amounts to NCU 8.72 million (including
interest accrued during construction). Financing of the total initial investment
outlay is shown in part B.
Leasing
292
Table 7. Example of investment outlay and structure of finance
Funds
Item (thousand nationalcurrency units)
A. Investment outlay
Fixed-investment costs
Land 80
Buildings 2 900
Equipment 4 000
Other 730
Total initial fixed investment 7 710
Working capital (including bank borrowing) 400
a
Pre-production capital expenditures 610
Total initial investment costs 8 720
B. Structure of investment
Source
Equity capital 3 500
Supplier credit 2 600
Commercial credit (including NCU 200 for start-up year) 3 000
Total long-term capital 9 100
Surplus (long-term capital) during construction phase 380
Start-up year
Short-term finance (bank overdraft) 400
Cash deficit (start-up year) (10)
Financing of net increase in assets (start-up year) (600)
Finance available 170
' 5If the lessor is responsible for maintenance and insurance, as is usually the case with an
operating leasing contract, the leasing payments include these costs. In the case of financial leasing,
maintenance and insurance are usually the responsibility of the lessee, and the corresponding costs
must be included in the production cost estimates.
293
than the technical and economic life of an asset, it is necessary to include the
residual value (cash inflow) of the leased asset when comparing leasing with
loan financing. The inflow for the lessee would usually not be the book value
but either the book value or the market value (minus the lessor's cost of selling
the used items), whichever is lower.126
If the investor has a choice between loan and leasing financing,' 27 he would
compare the discounted cash flow for both cash flow arrays to determine which
alternative would bring the higher yield (IRR, NPV), bearing in mind, however,
the liquidity aspect and risks involved. If tax regulations have different effects
on leasing financing, these tax impacts need to be included in the cash flow
discounting.
Funds to finance leases may be obtained from independent leasing
companies (service or financing leasing companies, lease brokers), banks,
insurance companies, pension funds and industrial development agencies.
Leasing financing of investment projects in developing countries has been
introduced by international financing institutions such as the International
Finance Corporation, and may become an interesting financing alternative,
especially in cases where leasing has certain advantages over loan financing.
Cost of capital
'26If the market value is greater than the book value, usually the margin is split between the
lessor and the lessee, at a rate determined in the contract. The lessee may also have the option to
purchase the equipment from the lessor at the market price or book value.
'27Apart from the above described situations, when the financing policy of a firm requires
leasing financing, or when the investor cannot raise the necessary funds on the capital market, or
when the firm has exceptionally high marginal capital costs, there is little justification for a
company to undertake lease commitments on plant and machinery or any assets.
'2 8Similarly, most public sources of finance stem from individual savings (individual income
which is not or cannot be consumed).
294
Impact of financing cost on financing policies
The cost of equity capital for the project or firm is basically determined by
the minimum accumulated return,' 29 expressed as the NPV of the future income
of the shareholders, and the minimum annual rate of return, expressed as the
rate of return on equity capital. The acceptable minimum rates depend on the
opportunity cost of capital, the expected business risks, and the valuation of
any gains or benefits obtained in addition to the payment of dividends. The
purpose of the concept of equity is to give the management of the firm more
flexibility with regard to the best use of the annual net profits in the interest of
the shareholders or owners and the firm.
The debt service (interest and amortization) is fixed and legally binding for
the firm, and has to be paid even when the generation of cash is insufficient in
certain years, whereas payment of dividends is in general linked to a sufficiently
high profit and cash generation. The determination of the right (optimal)
capital mix is therefore essential when a financing strategy is designed for an
investment project.13 0
Different financing institutions impose different financing conditions. A
government guarantee is even sometimes required for multilateral financing. It
is important that the enterprise is not obliged to start with loan amortization
before the start-up of operations. Very often financial costs are capitalized
during the implementation period, and debt service starts when sufficient cash
is generated through the operation of the new production facilities.
It may be possible to combine relatively short-term supplier credits (for
instance, a three-year grace period and a four-year amortization period) with
longer-term financing from multilateral banks. In this case, supplier credits
could be disbursed last and amortized first, while leaving multilateral financing
for early disbursement and late amortization. Thus, generally suitable loan
terms can be obtained.
In new as well as expansion projects, the kind of debt service will also have
to be decided on. The following two systems are possible: periodical debt
service with equal amortization instalments (constant principal) plus gradually
decreasing interest; and periodical debt service with constant payments
(annuities), in which case the sum of the declining amortization and increasing
interest payments is constant over the amortization period of the loan. The first
system requires less total financing cost but a fairly substantial initial debt
service during the start-up of the project. The second system, although it has a
higher total financing cost, is preferable for the new enterprise because the
initial debt-service burden is smaller than under the first system.
The various forms and sources of financing have different implications in
terms of impact on different projects and may even affect project formulation.
Supplier credits and other forms of medium-term credit, though initially
advantageous in terms of coverage of resource gaps at the initial stage,
constitute a heavy debt burden during early years of production; their incidence
on production costs should be determined and accounted for in the cash flow
analysis. National and international institutions that provide loan finance
require that projects should be formulated in considerable detail, so that their
29
' For an investor, the return net of all taxes will of course be taken into account when
deciding whether to finance or co-finance an investment project.
'30A rule applied by consultants suggests that the total equity capital should be able to cover
possible losses over a five-year period (assuming the worst case).
295
full implications are adequately highlighted. In some cases, they insist that the
feasibility study should be prepared by recognized independent consultants or
that management responsibilities for certain major projects be assumed by
experienced and acceptable parties.
Financinginstitutions
297
relatively small share of the total equity required. The situation varies widely,
but in some countries, the initial portion of equity to be raised by sponsors of
industrial projects can be as low as 10-25 per cent of the total finance needed.
The various aspects discussed above need to be fully assessed before
evolving a financing package suitable for a project under consideration.
Invariably, the package is determined by identifying the most economic pattern
in terms of cost of finance, assessing the feasibility of obtaining capital on such
a basis, and ensuring that the pattern is consistent with both public policies and
regulations, and the projected cash flows of the proposed enterprise. The various
sources of finance can then be tabulated in schedule X-7/1. Schedule X-7/2
shows the flow of financial resources and schedule X-8/2 the utilization of
these funds during construction, start-up and full capacity operation.
The figures appearing in the balance sheet, the net income statement and
the cash flow tables convey a considerable amount of information in terms of
their absolute values. In financial analysis it is usual to refer to several well-
known ratios that facilitate the analysis and specially the comparison of
projects and alternatives.' 32
The ratios discussed below are those most frequently used. Other ratios
may be applied as well. Whichever choice is made by the project evaluator, the
ratios should not be applied automatically. The computation of such ratios
alone would little serve the purpose of project appraisal, if not accompanied by
an interpretation of their meaning. Analysts and decision makers should also
bear in mind that ratios may not automatically be regarded as good or bad, but
have to be evaluated in the light of the characteristics of the corresponding
industry, the type and scope of the project and the country of investment.
Financialratios
298
times the net woith or one fifth or 20 per cent of the total liabilities. In a
number of projects of large or medium size, an ideal debt-equity ratio of 50:50
tends to be adopted, but this is by no means a standard pattern. A feasibility
study should define the appropriate financing arrangement, taking the
availability of resources and the nature and requirements of funds fully into
account. Equity-debt ratios of 33:67 or 25:75 or even higher are practised in
many countries. A generalization, however, cannot be made, since each project
should be assessed on its own merits.
The debt-equity is also a measure of investor leverage. The smaller
the equity capital, the higher the income per unit share. From the profitability
point of view, equity owners therefore favour high debt-equity ratios, since
such ratios give leverage to equity capital and allow equity owners to control
projects even with a small amount of capital. However, since the financial risk
is growing with an increasing debt balance, it is also in the interest of the
shareholders to establish a sound balance between risk and loan capital.
Investment banks ask for a sound debt-equity ratio, since the largest
portion of equity capital is always tied in land, buildings and equipment, which
can be liquidated only with difficulty or only at a loss in case of bankruptcy of
the project. Banks therefore frequently refuse to finance a project with loans
greater than the amount the promoter is prepared to invest, thus limiting the
loan to 50 per cent of the required investment outlay.
Currentratio or current-assets-to-current-liabilities
ratio
' 33The annual cash generation may be obtained from the cash flow schedule for financial
planning (schedule X-8), or may be derived from the figures contained in the balance sheet and net
income statement (net profit after tax plus interest and depreciation plus net increase of liabilities
(equity or debt), minus new investments.
299
(interest plus repayment of principal). Ratios of 1.5-3.0 range between
acceptable and satisfactory. This ratio often increases considerably if the long-
term debt service gradually decreases and no new borrowing is projected.
Debtors-creditorsratio
Efficiency ratios
Output-capitalratio
300
Net present value ratio
When the present value of the accumulated net benefits of a project (that is
the annual output of the project net of annual operating expenditures and
income taxes, discounted and accumulated over the planning horizon) is related
to the present value of the total capital invested, the NPVR, which has already
been described in this chapter, is obtained.
The relation between total initial investment and the number of workers
and staff employed is used when comparing alternative technologies. However,
when the problem is to choose between alternatives with different labour
intensities, it may be advisable to compute the ratio between investment and
total costs of personnel. Similarly, the efficiency of personnel employed may be
computed by determining the value of output produced by one unit of
personnel costs. These ratios, including the capital-output ratio, complement
the cash flow and financial analysis in so far as additional information may be
obtained with regard to possible risks, suitable investment strategies and
positioning of a project in a competitive environment. 3 4
Turnover of inventories
301
and organization, as well as the implementation of the project). To minimize
uncertainty with regard to the reliability of project data and design, the
financial analyst should check whether the feasibility study covers all aspects
relevant to the investment and financing decisions. Then the study must
indicate all sources of data, and any assumptions made should be explained
and justified. 136 Only when the feasibility study fulfils these basic requirements
should the analysis of the business risks begin. The most common reasons for
uncertainty, however, are inflation, changes in technology, false estimates of
the rated capacity, and the length of the construction and running-in periods.
The problem of uncertainty is aggravated by the phasing of a project over time.
Investments also underlie many developments and changes in the political,
social, commercial and business environment, as well as changes in technology,
productivity and prices.
To cope with the risks involved in any significant investment, management
has basically the following two options with regard to a policy on risks: to seek
insurance against various risks identified for an investment project; to identify
the possibilities for active risk control or risk management. The main
instrument of the insurance strategy is to invest (finance) only when the
expected returns are higher than the cost of capital plus the risk margin. This
concept, however, can be successful only when the investor has an investment
portfolio, in other words, when his risks are spread over a number of carefully
selected investments. Practically, only large business groups and financing
institutions have this possibility, while most of the owners of firms do not
dispose of enough funds to invest in different projects.
The insurance strategy, which is based on an assessment of the probability
of risks,'3 7 is a basic strategy for financing institutions. However, in a very
dynamic business environment this concept cannot be satisfactory, and the debt
burden accumulated by many developing countries may, to a large extent, be
the result of focusing on the projected investment yields (expressed as the
internal rate of return). The feasibility study should therefore identify possible
strategies for risk control and design the project following the strategic
orientation, as described in part one and elaborated further in chapter III of
this Manual.
When deciding about the desirability of a project, all the elements of
uncertainty have to be taken into account by evaluating, on the one hand, any
foreseeable risks that could have significant impacts on its feasibility, and, on
the other, the possible means of risk control. The allowance to be provided for
such risks may have a decisive impact on the profitability of the project, and
may, in the case of a marginal proposal, tip the balance against project
implementation.
When the aspects of uncertainty are to be included in the financial
evaluation, three variables in particular should be examined, namely sale
revenues, costs of products sold and investment costs. A host of individual
items enter into these variables, all of which are composed of a price and a
quantity. The project planning team should identify the variables that could
'3 6For example, assumptions concerning estimates of production and investment costs, prices
or the lifetime of the project may not always be correct, or the decision makers may evaluate a
scenario differently.
'3 7For example, the country risk is evaluated on the basis of the economic and political
situation in the country, the total outstanding foreign debt in relation to the domestic product etc.
A country risk may be insured through a government guaranty, possibly from an exporting
country.
302
have a decisive influence on the profitability of a project, and that should be
subjected to risk analysis. Sensitivity analysis is a proper instrument for
identifying these critical variables and the extent to which they could affect the
financial feasibility of a project.
Sensitivity analysis
With the help of sensitivity analysis it is possible to show how the net cash
returns or the profitability of an investment alter with different values assigned
to the variables needed for the computation (unit sales price, unit costs, sales
volume etc.). Sensitivity analysis should be applied already during the project
planning stage, when decisions concerning major inputs are being taken. The
element of uncertainty could be reduced at this stage by finding the optimistic
and pessimistic alternatives, and thus determining the commercially most
realistic combination of project inputs for the business environment (or
scenario) favoured by the decision makers.
To determine the critical variables the structure of cash flows should be
analysed first. The variables having the greatest share of cash inflows and
outflows are then subject to variations of quantities or prices or both
parameters at the same time. For example, usually a few products out of a
product range generate most of the sales revenues, but this does not necessarily
mean that these products also make the greatest contribution to the return or
gross profits. The direct costing method should therefore be applied to
identifying the variable margin generated by one unit of each product having a
significant share of sales revenues. Similarly, those cost items need to be
identified which, in case of prices or quantities deviating from the forecasts,
would have a significant impact on the variable margin and the operating profit
as well.' 38
This exercise can be performed by assigning values to the critical variables
corresponding to reasonably pessimistic, normal and optimistic scenarios, and
by the computation of the discounted cash flows (IRR or NPV) and any ratios
etc. chosen as a yardstick for investment appraisal. With the help of sensitivity
analysis it is possible to identify the most important project inputs, such as raw
materials, labour and energy, and to determine any possibilities of input
substitution, as well as the critical elements of the marketing concept.'3 9
To illustrate the application of sensitivity analysis in project formulation,
the impact of changes in the unit sales price, variable production and fixed
production costs (including depreciation) on the break-even point is dealt with
below.
Break-even analysis
'3 Cost structure analysis, direct costing, and the computation of variable and operational
margins is described above in sect. C of this chapter.
'39When analysing the critical variables, it is important not only to estimate confidence levels,
but also to determine the possible reasons for deviations from the projections. This analysis should
include the determination of critical factors possibly affecting the defined critical variables, such as
possible transport and supply problems for critical materials, possible price fluctuations for critical
products and supplies caused by highly speculative, competitive or volatile markets etc.
303
corresponding production) are below this point, the firm is making a loss, and
at the point where revenues equal costs, the firm is breaking even. Break-even
analysis serves to compare the planned capacity utilization with the production
volume below which a firm would make losses. The break-even point can also
be defined in terms of physical units produced, or of the level of capacity
utilization at which sales revenues and production costs are equal. The sales
revenues at the break-even point represent the break-even sales value, and the
unit price of a product in this situation is the break-even sales price. If the
production programme includes a variety of products, for any given break-even
sales volume there would exist a variety of combinations of product prices, but
no single break-even price.
or U= Cf
(Ps- C)
304
Figure XXXI. Determination of the break-even conditions
U,
BEV BE
Variable costs
Fixed costs
In the above equation, the number of units U (or the rate of capacity
utilization) is computed for given values of p,, c, and Cf. It is also possible to
compute ps, the break-even sales price for a given production volume and
defined costs. In case of more than one product, for example, products A and
B, the break-even sales value would be computed as follows:
The break-even analysis may be carried out excluding and including costs
of finance. In the latter case, the annual costs of finance need to be included in
the fixed costs. Since the interest payable depends on the outstanding debt
balance, the total annual fixed costs are usually not constant over the start-up
and initial operating period. The break-even analysis should therefore be
carried out for each year during this phase of the project. 140
Probabilityanalysis
'4 0The same is true for the production and marketing costs, because various cost items may
change as a result of extra costs arising during initial operation.
305
First of all, the investor would have to estimate the probability of a certain
scenario materializing. For example, the possible reaction of competitors' 4'
could be to do nothing, to reduce sales prices, or to increase sales promotion
activities. Each of these alternatives would require counter-strategies and affect
sales revenues (quantities, prices) and costs. Each possible reaction of the
competitors may be expected with a certain probability, as reflected by the
following values assigned for different reactions: no reaction-0.1; price
reduction-0.4; sales promotion measures-0.3; and price reduction and
promotional measures-0.2. The simplest method is to assign to each possible
alternative one profitability or yield measure (annual rate of return, IRR,
NPV), and to multiply each measure by the corresponding probability factor,
as in table 8.
The weighted IRR, 18.6, given in table 8 in the example has a limited value
for investment appraisal, because it does not imply that the investment would
yield 18.6 on an average. However, it may be useful for ranking projects. What
analysts can deduce from the above table is that there is a 4 out of 10 chance
that the investment would yield 19 per cent or more, and a 60 per cent chance
of earning between 17.5 and 18.5 per cent as a result of the reactions of
competitors. Supposing an 18 per cent cut-off rate applied by the investors, the
project could be rejected on the assumption of a +0.5 per cent confidence level
of the IRR (that is the IRR is expected to be between 17.5 and 18.5, with the
probability of 0.6).
For the appraisal of a project, however, it is important to determine not
only the critical variables and their probable values and impacts, but also when
deviations from the forecast may happen. For example, it makes a great
difference whether a drop in sales prices occurs during start-up or during or
after the payback period. In case there are a number of critical variables,
stochastic models may be applied, where for each critical variable a confidence
level is determined, and within these limits each variable is assigned a random
value. For such a random combination of cash flows, the financial ratios etc.
are computed, sometimes repeatedly in order to obtain a data series for project
appraisal. While the introduction of stochastic models may be an interesting
complementary method, it can also give analysts and decision makers an
impression of accuracy that does not really exist. 42
14'Seethe analysis of competition in chap. III, sect. B
42
One of the problems is that various variables are not independent; e.g. nitrogen fertilizer
production costs depend to a considerable extent on energy costs, while their market prices depend
on supply and demand, and production costs as well. To identify such interrelations is a
precondition for the application of stochastic models and for the development of investment,
production and marketing strategies.
306
The value of probability analysis, however, lies in the identification and
analysis of what could affect and seriously endanger a project, if implemented,
and the determination of possible strategies to manage such situations.
With the introduction of sensitivity and probability analysis the number of
computations increases considerably, since for each variable several values need
to be computed in addition to the probability forecasts of occurrence. Access to
suitable and reliable (well-tested) computer models is therefore a condition for
the application of such methods.
I. Economic evaluation
307
investors and financiers. The enterprise performance within a business
environment is analysed, taking all expenses for project Inputs as cash outflows,
and the income from operations (sales revenues) as cash inflows. Financial
resources required to implement and utilize the investment are inflows from the
point of view of the firm (outflows for the banks, shareholders etc.), and the
costs of finance as well as repayment of liabilities are financial outflows for the
firm. All inputs and outputs are valued at market conditions. This means that
the analyst and decision makers measure the net gains or benefits generated by
the investment in financial terms, including the net benefits from the overall
investment as well as the surplus left to investors (equity or share capital),
taking into consideration the individual time preferences of the investors and
financing institutions.
'44For example, incentives in case the investment is beneficial for the economy but not
sufficiently attractive from the point of view of the investors, or prohibitive measures such as higher
taxes and duties in certain areas or for certain technologies in case the investment has negative
impacts in the form of social costs to the economy etc
308
* Project inputs and outputs are valued at shadow prices' 45 that reflect
their true value to the national economy;
* Direct effects on the economy (involving imports, exports, employment,
foreign exchange, supply and demand, ecological conditions etc.), as
well as indirect effects (affecting performances in other sectors, through
reduced under-utilization of installed capacities, new investment initia-
tives etc.), are included in the analysis where significant (these effects
may be economic benefits or costs, both tangible and intangible);
* Social time preferences' 4 6 are accounted for.
The economic evaluation of investment projects is beyond the scope of this
Manual. When an evaluation of the contribution of industrial projects to the
national economy is required, one of the methods developed for this purpose
should be used. The principal methods are described in detail in various
publications recommended in the bibliography to this chapter.
'4'Shadow prices indicate the value of goods and services assuming no market distortions.
While market prices are to be used for the financial evaluation, shadow prices reflect the value of
project inputs and outputs better than market prices, and may be considered as their necessary
correction for the economic evaluation. Shadow prices are usually determined only for major
production factor. and project inputs and outputs, as well as when market distortions are
significant.
'46Social time preferences reflect the weight that society attaches to future as opposed to
present consumption. For the economic evaluation, time preferences are expressed by the social
discount rate, which differs from the individual discount rate applied in the financial evaluation
309
Bibliography
Alfred, A. M. and J. B. Evans. Discounted cash flow, principles and some short-cut
techniques. 2. ed. London, Chapman and Hall, 1969.
Amachree, S. Investment appraisal in developing countries. Aldershot, Avebury, 1988.
Anthony, R. Essentials of accounting. 3. ed. Reading, Massachusetts, 1983.
Baum, W. C. and Stokes M. Tolbert. Investing in development: lessons of World Bank
experience. Washington, D.C., International Bank for Reconstruction and Develop-
ment, 1985.
Beams, F. Advanced accounting. 2. ed. Englewood Cliffs, New Jersey, Prentice-Hall,
1982.
Biermann, H. Jr. and Seymour Smidt. The capital budgeting decision, economic analysis
and financing of investment projects. 3. ed. New York, Macmillan, 1971.
Bussery, A. Case study. Example of import substitution: ironworks with an output of
30,000 tons per year for the production of (concrete) reinforcement bars from scrap
iron. Industrializationandproductivity (United Nations publication) No. 19, 1973.
Sales no.: 72.II.B.8.
__---- Evaluation of economic viability of production projects in developing
countries. Industrializationand productivity (United Nations publication) No. 19, 1973.
Sales no.: 72.II.B.8.
Chervel, M. Calculs economiques publics et planification: les methodes d'evaluation de
projet. Paris, Publisud, 1987.
Chervel, M. and M. Le Gall. Manuel d'6valuation economique des projets: la methode
des effets. Paris, Ministere des Relations Ext6rieures, 1984.
Clark, J. J., T. J. Hindelang and R. E. Prichard. Capital budgeting: planning and
control of capital expenditures. 2. ed. Englewood Cliffs, New Jersey, Prentice-Hall,
1984.
Derkinderen, F. G. and R. L. Crum Risk. Capital costs and project financing decisions.
Boston, Massachusetts, Nijhoff, 1981.
Fess, P. E. and C. S. Warren. The financing of foreign direct investment: a study of the
determinants of capital flows in multinational enterprises. London, Pinter, 1981.
Gittinger, J. Compounding and discounting tables for project evaluation. 3. ed.
Washington, D.C., International Bank for Reconstruction and Development, 1974.
Harvey, C. Analysis of project finance in developing countries. London, Heinemann,
1983.
Haugen, R. A. Modern investment theory. Englewood Cliffs, New Jersey, Prentice-Hall,
1986.
Hofmann, M. and K. Schedl, Hrsg. Entwicklungsmanagement: Beitrage zu einer neuen
Dimension im internationalen Management. Berlin, Duncker und Humblot, 1982.
Little, I. and J. A. Mirrlees. Project appraisal and planning for developing countries.
London, Heinemann Educational Books, 1974.
Merrett, A. J. and A. Sykes. The finance and analysis of capital projects. 2. ed. London,
Longman, 1974.
Morse, W. J., J. R. Davis and A. L. Hartgraves. Management accounting. Reading,
Massachusetts, Addison-Wesley, 1984.
Ray, Anandarup. Cost-benefit analysis: issues and methodologies. Baltimore, Maryland,
Johns Hopkins, 1984.
Reutlinger, S. Techniques for project appraisal under uncertainty. World Bank Staff
Occasional Papers No. 10. Baltimore, Johns Hopkins, 1972.
309a
Roemer, M. and J. J. Stern. Cases in economic development: projects, policies and
strategies. London, Butterworths, 1981.
Seidler, L. J. and D. R. Carmichael. Accountants' handbook. New York, Wiley, 1981.
Skully, M. T. ASEAN financial co-operation: developments in banking, finance and
insurance. London, Macmillan, 1985.
Solomon, M. J. Analysis of projects for economic growth. New York, Praeger, 1970.
Statistical, Economic and Social Research and Training Centre for Islamic Countries.
Project evaluation and management. Ankara, 1983.
Tucker, S. A. The break-even system. Englewood Cliffs, New Jersey, Prentice-Hall,
1973.
United Kingdom. Foreign and Commonwealth Office, Overseas Development Ad-
ministration. A guide to project appraisal in developing countries. London, HM
Stationery Office, 1972.
._____ Civil Service College. The economies of investment analysis. Occasional Paper
No. 17. London, HM Stationery Office, 1973.
United Nations. Guidelines for project evaluation. [Prepared by P. Dasgupta, S. Marglin
and A. K. Sen]
Sales no.: 72.II.B.11.
Guide to practical project appraisal: social benefit-cost analysis in developing
countries. [Prepared by John R. Hansen]
Sales no.: 78.II.B.3.
United Nations Commission on Transnational Corporations. International standards of
accounting and reporting: report of the Intergovernmental Working Group of
Experts. Geneva, 1985.
Van der Tak and L. Squire. Economic analysis of projects. IBRD Staff Working Paper
No. 194. Washington D.C., World Bank, 1975.
Weiss, D. Economic evaluation of projects: a critical comparison of a new World Bank
methodology with the UNIDO and the revised OECD approach. Berlin, German
Development Institute, 1976.
Wiener, D. and M. Chervel. Le calcul economique de projet par la methode des effets.
Collection documents pedagogiques, No. 4. Paris, Ministere de la Cooperation, 1985.
Wiener, D. Le calcul economique de projet par les methodes des prix de r6ference.
Collection documents p6dagogiques, No. 4. Paris, Ministere de la Cooperation, 1985.
309b
SCHEDULES FOR FINANCIAL ANALYSIS 147
N
The figures shown in the schedules are based on the data given in the case stuck presented in j n n e x "\ to this Manual
Schedule X-1/2. Total fixed investment costs: foreign or local components
1
Project/alternative: sample case, annex I. Initial fixed investment.
Date: 19xx/xx/xx ' Rxed investment during plant operation.
t-»J
K)
Capacity utilization (%) 55 75 90 100 100 100 100 100 100 100 100
1 . Raw materials
Raw material A VI-4/2 1265 1725 2070 2300 2300 2300 2300 2300 2300 2300 2300
Raw material B VI -4/2 1182 1612 1935 2150 2150 2150 2150 2150 2150 2150 2150
2. Factory supplies VI-4/2 248 338 405 450 450 450 450 450 450 450 450
3. Spare parts consumed VI-4/2 250 250 250 250 250 250 250 250 250 250 250
4. Repair, maintenance, material VI-4/2 193 263 315 350 350 350 350 350 350 350 350
5. Royalties VI-4/2 30 30 30 30 30 30 30 30 30 30 30
6. Labour VII I-2 687 937 1125 1250 1250 1250 1250 1250 1250 1250 1250
Skilled labour
Unskilled labour
7. Labour overheads (taxes etc.) VIM-2
8. Factory overhead costs VI-4/2 1320 1320 1320 1320 1320 1320 1320 1320 1320 1320 1320
Salaries, wages
Social costs etc. (on salaries)
Materials and services
Rents, leasing costs (factory)
Insurance
FACTORY COSTS 5175 6475 7450 8100 8100 8100 8100 8100 8100 8100 8100
9 Administrative overhead costs VII-2 500 500 500 500 500 500 500 500 500 500 500
Salaries, wages
Social costs etc (on salaries)
Materials and services
Rents, leasing costs
Insurance
OPERATING COSTS 5675 6975 7950 8600 8600 8600 8600 8600 8600 8600 8600
10 Depreciation 780 780 780 780 780 780 840 840 840 490 110
11 Financial costs
Interests X-7/4 522 546 453 339 238 136 45
Leasing costs
TOTAL PRODUCTION COSTS 6997 8301 9183 9719 9618 9516 9485 9440 9440 9090 8710
TOTAL ANNUAL COSTS OF PRODUCTS SOLD (thousand NCU) Foreign [X] Local [ ]
Capacity utilization {%) 55 75 90 100 100 100 100 100 100 100 100
1 . Raw materials
Raw material A VI-4/2 1265 1725 2070 2300 2300 2300 2300 2300 2300 2300 2300
Raw material B VI-4/2
2. Factory supplies VI-4/2
3. Spare parts consumed VI-4/2
4. Repair, maintenance, material VI-4/2
5. Royalties VI-4/2 30 30 30 30 30 30 30 30 30 30 30
6. Labour VII I-2
Skilled labour
Unskilled labour
7. Labour overheads (taxes etc.) VII I-2
8. Factory overhead costs VI-4/2
Salaries, wages
Social costs etc. (on salaries)
Materials and services
Rents, leasing costs (factory)
Insurance
FACTORY COSTS 1295 1755 2100 2330 2330 2330 2330 2330 2330 2330 2330
9. Administrative overhead costs VII-2
Salaries, wages
Social costs etc. (on salaries)
Materials and services
Rents, leasing costs
Insurance
OPERATING COSTS 1295 1755 2100 2330 2330 2330 2330 2330 2330 2330 2330
10. Depreciation 300 300 300 300 300 300 300 300 300 50
11. Financial costs
Interests X-7/5 208 198 156 114 73 31
Leasing costs
TOTAL PRODUCTION COSTS 1803 2253 2556 2744 2703 2661 2630 2630 2630 2380 2330
12. Direct marketing costs II-3 70 70 70 70 70 70 70 70 70 70 70
Salaries etc.
Rents, leasing costs
Other direct costs
13. Marketing overhead costs HI-3 30 30 30 30 30 30 30 30 30 30 30
Salaries etc.
Rents, leasing costs
Other indirect costs
COSTS OF PRODUCT SOLD 1903 2353 2656 2844 2803 2761 2730 2730 2730 2480 2430
Share of total (%) 26.0 27.2 27.8 28.1 28.0 27.8 27.6 27.7 27.7 26.1 26.7
Variable share (%) 34.6 34.6 34.6 34.6 34.6 34.6 34.6 34.6 34.6 34.6 34.6
TOTAL ANNUAL COSTS OF PRODUCTS SOLD (thousand NCU) Variable [X] Fixed I ]
Capacity utilization (%) 55 75 90 100 100 100 100 100 100 100 100
1 Raw materials
Raw material A VI -4/2 1265 1725 2070 2300 2300 2300 2300 2300 2300 2300 2300
Raw material B VI-4/2 1182 1612 1935 2150 2150 2150 2150 2150 2150 2150 2150
i Factory supplies VI-4/2 248 338 405 450 450 450 450 450 450 450 450
3 Spare parts consumed VI-4/2
4 Repair, maintenance, material VI-4/2 193 263 315 350 350 350 350 350 350 350 350
5 Royalties VI-4/2
6 Labour VIII-2 687 937 1125 1250 1250 1250 1250
1250 1250 1250 1250
Skilled labour
Unskilled labour
7 Labour overheads (taxes etc ) VIII-2
8 Factory overhead costs VI-4/2
Salaries, wages
Social costs etc (on salaries)
Materials and services
Rents, leasing costs (factory) - - - - - - - - - - -
Insurance
FACTORY COSTS 3575 4875 5850 6500 6500 6500 6500 6500 6500 6500 6500
9. Administrative overhead costs VII-2
Salaries, wages
Social costs etc. (on salaries)
Materials and services
Rents, leasing costs
Insurance
OPERATING COSTS 3575 4875 5850 6500 6500 6500 6500 6500 6500 6500 6500
1 0. Depreciation
1 1 . Financial costs
Interests X-7/4
Leasing costs
TOTAL PRODUCTION COSTS 3575 4875 5850 6500 6500 6500 6500 6500 6500 6500 6500
Share of total (%) 50.0 57.6 62.6 65.7 66.4 67.1 67.3 67.6 67.6 70.1 73.0
Foreign share (%) 34.6 34.6 34.6 34.6 34.6 34.6 34.6 34.6 34.6 34.6 34.6
TOTAL NETWORKING CAPITAL REQUIREMENTS - 400 1355 1670 1886 2043 2043 2043
INCREASE IN NETWORKING CAPITAL - 400 955 315 216 157
Foreign share(%) - 625 342 378 399 409 409 409
a
Project/alternative sample case, annex I The coefficient of turnover (CTO) is obtained as follows
Date 19xx/xx/xx CTO = 360/MDC (min'mum days of coverage)
Schedule X—4/2. Total net working capital requirements: foreign or local components
TOTAL NET WORKING CAPITAL REQUIREMENTS (thousand NCU) Foreign [X] Local [ ]
TOTAL NETWORKING CAPITAL REQUIREMENTS - 250 464 631 753 836 836 836
INCREASE IN NETWORKING CAPITAL - 250 214 167 122 83
Share of total (%) - 62.5 34.2 37.8 39.9 40.9 40.9 40.9
1
Project/alternative: sample case, annex I. The coefficient of turnover (CTO) is obtained as follows:
U)
Date: 19xx/xx/xx CTO = 360/MDC (minimum days of coverage).
to
Schedule X-5/1. Calculation of working capital requirements
according to seasonal fluctuations
Inventory/stock:
Inventory/stock:
Month STOCK b/f IN OUT STOCK c/f Month balance b/f IN OUT balance c/f
I 775 0 180 595 I
II 595 500 190 905 MAX
III 905 0 220 685
IV 685 0 260 425 IV
V 425 250 250 425 V
VI 425 150 220 355 WIN VI
VII 355 0 0 355 WIN VII
VIII 355 600 200 755 VIII
IX 755 400 260 895 IX
X 895 0 270 625 X
XI 625 350 180 795 XI
XII 795 0 70 725 XII
TOTAL _
2250 2300 7540 TOTAL
AVERAGE - - - 628 AVERAGE
TOTAL TOTAL
AVERAGE AVERAGE
322
Schedule X-5/2. Calculation of the short-term liquidity
(Cash and bank overdraft requirements)
323
Schedule X-6/1. Total investment costs
TOTAL INVESTMENT COSTS 8720 2643 3320 5400 955 315 216 157 - 1000
Foreign share (%) 37.3 37.3 32.2 40.4 22.4 53.0 56.5 52.9 - 40,0
TOTAL INVESTMENT COSTS 3250 986 1070 2180 214 167 122 83 - 400
Share of total (%) 37.3 37.3 32.2 40.4 22.4 53.0 56.5 52.9 - 40.0
I
3;
-*,
S-
CD"
O
CD
cn
|
1
1
-£
2fj
Financial terms
0
3
3
c
o
<t
>
m
5
o
O
^
c
m <3
m
8
e.
o
8
M .2
6"
<v
ro
00
Payable in instalments
» S ™
Up to 1 2% of equity shar
m <x
m
-< S
8
8
o
CO"
o"
3.
^j
c_
en -^
5
XI
Payable in instalments
Dividend payment condition
^ ci
5!
o
z
~
"0
CO CO
8
8
S'
.
Q.
CO
~\
ho
O)
<i . a. o» *. -^
S
c
T3
.
Repayment starting (year)
Duration of loan (years)
1
0
°°1:.
—•
a
Type of amortization
3
o
Z cfi O
to
Interest rate
O "O
Other costs of finance
2 <0
g
0
8
=L oo en ro
o"
o
ro
co
(?T3 2.
a
Type of amortization
o"5
SB
Interest rate
9 '
Other costs of finance
| co | co
8
8
a.
o
§>
CD
CO
3T
<o
^-^
Disbursement starting (year
fr
§
O
CD
ro
<t P
o "p
Other costs of finance
1
T|
o
c
0
8
CD'
ro
3
3
8
C
O
3
§
.8.
r>
<a
at
n
5 a?•
2 ^
O -o
•2.
sM-
—
x 3
m
3
8
S
S- 5
3
VI
s-
Schedule X-7/2. Flow of financial resources
(excluding cash generated internally)
TOTAL LONG-TERM FINANCE 9100 3320 5580 200 (520) (1120) (1120) (1120) (1120) (600)
3. Short-term finance
Bank overdraft X-7/4400 - 400 (300) (100)
Accounts payable X-4/1338 216 54 41 27 - - -
TOTAL FINANCIAL FLOW 9838 3320 5580 81 6 (746) (1 1 59) (1 093) (1120) (1120) (600)
Foreign share (%) 34.5 32 2 40.0 7.2 67.2 43.7 46.7 46.4 46.4 0.0
3. Short-term finance
Bank overdraft X-7/5 -
Accounts payable X-4/297 54 19 14 10 - - -
TOTAL FINANCIAL FLOW 3397 1070 2230 54 (501) (506) (510) (520) (520)
Share of total (%) 34.5 32.2 40.0 7.2 67.2 43.7 46.7 46.4 46.4 0.0
1. Loan A X-7/1
Disbursement 2600 720 1880
Repayment - 520 520 520 520 520
Debt balance end of year 720 2600 2600 2080 1560 1040 520
Capitalized interest
Interest payable 29 133 208 198 156 114 73 31
Other financial costs
2. Loan B Note : Disbursement of loan has been assumed
Disbursement to take place in the middle of the year. Interest
Repayment payable on mean debt before start of repayment
Debt balance end of year is computed as follows: "
Capitalized interest (Debtj-i + Debtj)/2 x I = interest; (p.a.)
Interest payable The loan is assumed to be repaid in 10
Other financial costs half-yearly installments.
332
table for financial planning
Scrap
Production value
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
12500 12500 12500 12500 12500 12500 12500 12500 12500 12500 12500 3123
12500 12500 12500 12500 12500 12500 12500 12500 12500 12500 12500
- - - - - - - - - - -_3123
12229 13178 11583 10960 10960 11135 11325 11325 11325 11325 11325
- 1000 - - - - - - -
8600 8600 8600 8600 8600 8600 8600 8600 8600 8600 8600
400 400 400 400 400 400 400 400 400 400 400 -
1241 1292 1308 1330 1330 1505 1695 1695 1695 1695 1695
238 136 45 - - - - - - - -
1120 1120 600 - - - - - - - -
630 630 630 630 630 630 630 630 630 630 630 -
271 (678) 918 1540 1540 1365 1175 1175 1175 1175 1175 3123
2448 1770 2688 4228 5768 7133 8308 9483 10658 11833 13008 16131
601 243 1194 1194 1194 1194 1194 1194 1194 1194 1194 1486
(330) (921) (276) 346 346 171 (19) (19) (19) (19) (19) 1637
1637 1880 3074 4268 5462 6656 7850 9044 10238 11432 12626 14112
811 (110) (386) (40) 306 477 458 439 420 401 382 2019
333
Schedule X-8/2. Cash-flow table for financial planning:
334
foreign or local components
3750 3750 3750 3750 3750 3750 3750 3750 3750 3750 3750
- - - - - - - - - - - 1486
3149 3507 2556 2556 2556 2556 2556 2556 2556 2556 2556
- 400 - - - - - - - - - -
2330 2330 2330 2330 2330 2330 2330 2330 2330 2330 2330 -
100 100 100 100 100 100 100 100 100 100 100 -
73 31 - - - - - - -
520 520 - - - - - - - - -
126 126 126 126 126 126 126 126 126 126 126 -
601 243 1194 1194 1194 1194 1194 1194 1194 1194 1194 1486
1633 1876 3070 4264 5458 6652 7846 9040 10234 11428 12622 14108
335
Schedule X-9/1. Discounted
336
cash flow - total capital invested
(thousand NCU)
Scrap
Production varue
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
12500 12500 12500 12500 12500 12500 12500 12500 12500 12500 12500 3123
12500 12500 12500 12500 12500 12500 12500 12500 12500 12500 12500
- - - - - - - - - - -_3123
10241 11292 10308 10330 10330 10505 10695 10695 10695 10695 10695
- 1000 - - - - - - -
8600 8600 8600 8600 8600 8600 8600 8600 8600 8600 8600
400 400 400 400 400 400 400 400 400 400 400 -
1241 1292 1308 1330 1330 1505 1695 1695 1695 1695 1695
2259 1208 2192 2170 2170 1995 1805 1805 1805 1805 1805 3123
1518 2726 4918 7088 9258 11253 13058 14863 16668 18473 20278 23401
1144 546 885 783 699 574 463 414 369 330 294 455
(1956) (1410) (525) 258 957 1531 1994 2408 2777 3107 3401 3856
337
Schedule X-9/2. Discounted return
338
on equity capital invested
(thousand NCU)
Scrap
Production value
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
901 (48) 1548 2170 2170 1995 1805 1805 1805 1805 1805 3123
271 (678) 918 1540 1540 1365 1175 1175 1175 1175 1175 3123
630 630 630 630 630 630 630 630 630 630 630 -
901 (48) 1548 2170 2170 1995 1805 1805 1805 1805 1805 3123
838 790 2338 4508 6678 8673 10478 12283 14088 15893 17698 20821
456 (22) 625 783 699 574 463 414 369 330 294 455
(820) (842) (217) 566 1265 1839 2302 2716 3085 3415 3709 4164
339
Schedule X--10. Netincome
From Production
schedule 1993 1994 1995 1996 1997 1998
RATIOS (%)
Gross profit / sales (6.3) 7.6 15.0 19.0 19.9 20.7
Net profit after tax / sales (6.3) 7.6 15.0 19.0 9.9 10.3
Net profit / equity capital (12.4) 20.3 48.1 68.0 35.5 36.9
Net profit +interest / investment 0.9 13.0 21.6 27.0 14.7 12.9
340
statement from operations
Production
1999 2000 2001 2002 2003 2004 2005 2006 2007
341
Schedule X-11. Projected
342
balance sheet
Production
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
9978 9420 9498 10198 10898 11773 12838 13903 14968 16033 17098
5458 4780 5698 7238 8778 10143 11318 12493 13668 14843 16018
916 916 916 916 916 916 916 916 916 916 916
203 203 203 203 203 203 203 203 203 203 203
358 358 358 358 358 358 358 358 358 358 358
750 750 750 750 750 750 750 750 750 750 750
153 153 153 153 153 153 153 153 153 153 153
3078 2400 3318 4858 6398 7763 8938 10113 11288 12463 13638
4420 4640 3800 2960 2120 1630 1520 1410 1300 1190 1080
7710 7710 8710 8710 8710 8710 8710 8710 8710 8710 8710
- 1000 - - - - -
610 610 610 610 610 610 610 610 610 610 610
3900 4680 5520 6360 7200 7690 7800 7910 8020 8130 8240
9978 9420 9498 10198 10898 11773 12838 13903 14968 16033 17098
337 337 337 337 337 337 337 337 337 337 337
337 337 337 337 337 337 337 337 337 337 337
1720 600 - - - - - - - -
520 - - - - - - - - -
1200 600 - - - - - - -
3500 3500 3500 3500 3500 3500 3500 3500 3500 3500 3500
3500 3500 3500 3500 3500 3500 3500 3500 3500 3500 3500
3080 3691 4353 5031 5731 6431 7306 8371 9436 10501 11566
1241 1292 1308 1330 1330 1505 1695 1695 1695 1695 1695
630 630 630 630 630 630 630 630 630 630 630
611 662 678 700 700 875 1065 1065 1065 1065 1065
35.1 37.2 36.8 34.3 32.1 29.7 27.3 25.2 23.4 21.8 20.5
0.3 0.1 - - - - - - -
16.2 14.2 16.9 21.5 26.3 30.1 33.6 37.1 40.6 44.0 47.5
343
Annex I
CASE-STUDY
The case-study presented in this annex has been worked out to facilitate the
application of the concepts dealt with in this Manual, particularly when calculating fixed
and working capital and when preparing cash flow tables for financial planning and
evaluation. All schedules and calculations discussed in chapter X contain data taken
from this case. However, to minimize statistics, no data were put into the schedules
attached to chapters II through IX, and, for the same reason, inflationary impacts were
not considered.
The textile and garment industry is a high-employment activity that has contributed
considerably to industrial development in various developing countries. In a number of
newly industrializing countries' 48 foreign exchange earnings from textile exports have
reached a share of from 20 to 40 per cent of total earnings from exports of
manufactured goods.
The selected project strategy is to produce textile products such as shirts, blouses
and other garments for selected export markets, employing skilled local labour available
at comparatively low costs. Considerable local demand for foreign trade marks is taken
into account, with foreign (joint-venture) partner being interested in granting the use of
its trade mark on the domestic market and in undertaking the export marketing.
The basic project strategy ts characterizedby:
* Focusing on main points: high-quality products (foreign trade mark) on the
national market and selected export markets (see chapter III, figure XVIII);
* A market development strategy (see chapter III, figure XXI) using production
and marketing know-how of a foreign joint-venture partner (cooperation
strategy) to enter an expanding national market as well as to penetrate growing
markets in selected foreign countries.
The total value of annual product sales is projected at NCU 12,500,000, 30 per cent
of which will be exported. The value of outputs has been estimated at prices 10 per cent
lower than the average market prices'4 9 valid over the last five years. This assumption
344
has been made in spite of a growing market, because the potential investors expect their
competitors to change their prices with the market entry of the newcomer. In the case of
exports, a 6 per cent export charge has to be paid to the State Trading Organization
through which all exports have to be made.
Fabrics that depend mainly on synthetic raw materials are not available to the
project from domestic resources and have to be imported. At full capacity utilization the
annual costs for imported raw materials are projected at NCU 2,300,000. Fabrics made
of natural fibres (cotton) are available from domestic suppliers in sufficient quality and
quantity. The total annual consumption of domestic raw materials is projected at
NCU 2,150,000.
Raw material and factory supplies (annual costs at full capacity utilization), are
listed in the following schedule:
The initial fixed investment costs are shown in chapter X, schedule X-l, the pre-
production expenditures in schedule X-2, and the total initial investment in schedule
X-6/1.
6. Computation of depreciation
The following depreciation rates are used for the computation of the annual
depreciation charges:
* At 10 per cent per annum for all fixed investment items, except for a part of
locally supplied civil works (NCU 1,000,000) depreciated at 5 per cent per
annum;
* For plant machinery and equipment, the end-of-life (salvage) value has been
assumed at 10 per cent of the price of the new equipment.
*Excluding 6 per cent export charge of the State Trading Organization. During the first three
years the volume of production is assumed to be 55 per cent, 75 per cent and 90 per cent of the
installed production capacity.
**Excluding 6 per cent export charge of the state Trading Organization, but including royalties
payable to the foreign joint venture partner who will market the exports.
345
7. Operating costs
The following standard costs have been projected for full capacity utilization
(fourth year of operation); the detailed figures are shown in schedule X-3/1.
Accounts receivable 30 30
Raw materials 90 30
Factory supplies 30 30
Spare parts 180 180
Production in progress 9 9
Finished products 15 15
Cash-in-hand - 15
Accounts payable 15 15
9. Projectfinancing
The investors intend to finance 40 per cent of the total initial investment by equity
capital and 60 per cent by long-term loans. Of the equity capital, 20 per cent will be paid
by the foreign joint-venture partner and 80 per cent by the local investors.
For the imported goods and services a supplier credit of NCU 2.6 million will be
available, subject to the following conditions:
* Disbursement during the construction phase (two years);
* The duration of the loan is eight years, with repayment in 10 equal instalments
(principals) payable half-yearly, starting three years (36 months) after the first
disbursement (two years after the last disbursement);
* The interest rate will be 8 per cent per annum payable on the outstanding debt
balance.
346
It is estimated that short-term finance will be required during start-up, amounting
to NCU 400,000 in the first year and NCU 100,000 in the second year of plant
operation. The interest will be 12 per cent per annum.
The tax on corporate income is 50 per cent of taxable profits. The first four years
after starting production are exempt from tax (tax holidays), and losses may be carried
forward for up to three years.
The shareholders will be paid a dividend of 12 per cent per annum (before tax) on
paid-in equity capital. However, payments will be made only after covering any previous
losses carried forward and after the build-up of legal reserves.
The mean value of the annual rate of return on equity capital is 31 per cent (-12,
20, 48, 68) during the first four years of operations; for the same period the project
would be exempt from the corporate tax. After this period the annual rate of return on
equity after corporate tax is 35 per cent, increasing to 38 per cent over a five-year period
(schedule X-10). The IRR on equity (that is, the discounted net cash return) is 22.7 per
cent (schedule X-9/2). The profitability of equity capital is higher than that of the total
capital invested, which is due to the leverage effect resulting from loan costs lower than
the IRR of the overall investment.
The NPV of the annual net cash returns on equity generated during nine years from
the start of construction (that is, the seventh year of operations) and discounted at a rate
of 12 per cent, equals the paid-in equity, meaning that the equity capital can be repaid
(before income tax paid on dividends) by the project in approximately nine years
including an interest payment of 12 per cent per annum (see also schedule X-9/2).
The break-even point is defined as the equilibrium point at which the variable
margin (see also schedule X-10) equals the fixed costs. At this point the fixed-cost-
coverage ratio equals 1.00. Table 10 shows that the project would not break even in the
first year of production.
Before costs of finance but including depreciation, the ratio given in table 10 would
be 1.03 for the first production year and increase during the following years from 1.40 to
1.87. The planned capacity utilization and break-even capacities are given in table 11.
347
Table 11. Production cost factors
Year
Item 1 2 3 4 5
348
Annex II
1. Basic features of the area: area size and leading physical features, with maps
showing the main characteristics
349
10. Identification of recommendable project objectives and suitable strategies deter-
mining the type and scope of the project, including approximate capacities of new
or expanded units that could be developed
11. Estimated capital costs of selected projects (lump sum), taking into account the
following
* Land
* Technology
* Equipment
Production equipment
Auxiliary equipment
Service equipment
Spare parts, wear-and-tear parts, tools
* Civil engineering works
Site preparation and development
Buildings
Outdoor works
* Project implementation
* Pre-investment capital expenditures, including expenditures for preparatory
investigations
* Working capital requirements
12. For each project approximate quantities of essential inputs should be estimated, so
as to obtain the total input requirements. Sources of inputs should be stated and
classified (local, shipped from other areas of the country, or imported). Inputs
should be classified as follows:
* Raw materials
* Processed industrial materials and components
* Factory supplies, such as auxiliary materials and utilities;
* Labour
Furtherproject requirements
350
20. Financial evaluation, approximate pay-off period, approximate rate of return.
Assessment of possible enlargement of product-mix, increased profitability and
other advantages of diversification (if applicable)
21. A tentative analysis of overall economic benefits, and especially those related to
national economic objectives, such as balanced dispersal of economic activity,
estimated saving of foreign exchange, estimated generation of employment
opportunities, and economic diversification. Indicative figures based on reference
programming data, such as surveys and related studies, secondary data and data on
the performance of other similar industrial establishments should be sufficient for
this purpose
1. Characteristics of the resource, prospective and proven reserves, past rate of growth
and potential for future growth
2. Role of the resource in the national economy, its utilization, demand in the country
and exports
3. Industries currently based on the resources, their structure and growth, capital
employed and labour engaged, productivity and performance criteria, future plans
and growth prospects
4. Major constraints and conditions in the growth of industries based on the resource
5. Estimated growth in demand and prospects of export of items that could utilize the
resource
The items numbered from 11 to 21 from section A of this appendix follow item 6 of
the resource-based opportunity studies, since the structural requirements of the studies
are the same once the investment opportunities have been identified.
351
Annex III
Executive summary-a synoptic review of all the essential findings of each chapter
352
* Processed industrial materials
* Components
* Factory supplies
Auxiliary materials, utilities (especially power and energy requirements)
6. Project engineering:
* Determination of plant capacity
Feasible normal plant capacity
* Quantitative relationship between sales, plant capacity and material inputs
* Preliminary determination of scope of project
* Technology and equipment
Technologies and processes that can be adopted, given in relation to capacity
Technology description and forecast
Environmental impacts of technologies
Rough estimate of costs of local and foreign technology
Rough layout of proposed equipment (major components)
Production equipment
Auxiliary equipment
Service equipment
Spare parts, wear and tear parts, tools
Rough estimate of investment cost of equipment (local and foreign), classified
as above
* Civil engineering works
Rough layout of civil engineering works, arrangement of buildings, short
description of construction materials to be used
Site preparation and development
Buildings and special civil works
Outdoor works
Rough estimate of investment cost of civil engineering works (local and
foreign), classified as above
353
* Estimated annual human resource costs, classified as above, including overheads
on wages and salaries
9. Implementation scheduling:
* Proposed approximate implementation time schedule
* Estimated implementation costs
Note: Additional information may be taken from the detailed check-lists and
schedules given in each chapter of the Manual.
354
Annex IV
'5 0 The term evaluation is used by the World Bank for the ex-post evaluation of a project,
which is carried out when a project is completed. Analysis and evaluation ex-ante is then called
project appraisal.
355
Annex V
In order to facilitate their eventual merger, the structure of the check-list given
below is the same as that of a feasibility study as outlined in the Manual.
''See also the discussion of corporate or internal analysis in chap. III, sect. B.
356
3. Market analysis and marketing concept:
* Market structure and characteristics (see chapter III, check-lists III-l, 111-3, III-4
and III-6)
Describe existing market for products and by-products, and show its location
on maps
Describe its historic development
* Sales of products and by-products
Existing sales volume, domestic and export markets, historical development
Seasonal variations of sales
Estimate of market share (percentage of total market)
* Sales organization
Channels (own sales force, brokers, agents, direct to consumer)
Sales organization, staff
Marketing, advertising etc.
Competitors, capacity
Prices, discounts, commissions
Annual sales revenues
* Value of stock of semi-finished and finished products
* Analysis of marketing costs (direct and overhead costs)
* Analysis of the main competitors
* Analysis of strengths and weaknesses of the firm
* Evaluation of the marketing concept; conclusions and recommendations
357
Show situation and size on geodetic maps
Existing rights of way, easements etc.
Value of land
Annual costs of rights of way, rents, taxes, payments to neighbours etc.
* Local conditions
Describe impacts of project on population, infrastructure, ecology, landscape
etc.
Evaluate the tendency of impacts (positive or negative)
* Assessment of environmental impacts, public and corporate policies, conflicts,
costs and environmental forecast
* Production programme
Production programme of products and by-products: quality specifications,
quantities produced, time schedule of production (seasonal variations),
percentage of spoilage and waste
Emissions: specifications, quantities, time schedule means of treating emissions
and waste disposal
Cost of emissions disposal
* Plant capacity
Installed nominal maximum capacity
* Feasible nominal plant capacity of entire plant, main departments, major
equipment units
* Plant layouts and charts (show existing structure of plant on physical layouts and
on functional charts and layouts)
* Scope of enterprise (show scope of enterprise on layout drawings, and divide it
into project components and cost centres)
* Technology
List and describe technologies used, historic development
Sources of technology
Type of acquisition: licensing, purchase, joint venture
Experiences (positive or negative)
Technology forecast
Annual costs of technologies (royalties, fixed payments)
* Equipment
List and specify equipment, classify into production, auxiliary and service
equipment
Show equipment on plant layouts
Describe sources, age, type (automatic, semi-automatic etc.)
State capacity, condition (up-to-date, obsolete etc.)
Value of installed equipment
Annual depreciation and repair costs
Estimated life and replacement costs
* Civil engineering works
List and specify civil engineering works, classify into works for site preparation
and development, buildings and special civil works, outdoor works
Show situation and dimensions on maps and drawings
358
Describe construction and status (up-to-date, obsolete etc.)
Value of civil works and buildings
Annual depreciation and repair costs
Estimated life and replacement costs
8. Human resources:
* Labour
List and describe labour force
Describe skill and availability
State annual cost of labour at nominal feasible capacity, subdivide into
production labour (variable) and non-production labour (fixed)
* Staff
List and describe staff, show structure on manning tables
State annual staff cost
Total Total No of
No nominal paid-up votes
issued amount amount per share
Ordinary
Preference
Deferred
359
Bonds and mortgages
Security provisions (secured and unsecured)
Type and priority of mortgages or other liens
Redemption provisions
Convertibility
* Marketing costs (direct and indirect costs of sales and distribution)
* Production costs
Direct materials and inputs
Direct labour and staff
Factory overhead costs (labour and materials)
Depreciation
Administrative overheads
Financial overheads
Fixed and variable costs as percentage of production costs
Maintenance expenditures for recent years
Cost accounting (costing) system (inventory control, burden determination and
charge, labour and material charge, check of costing system with operating
figures)
* Accounts and statements
Copies of the last four (or more) annual reports, income statements, cash flow
tables and balance sheets
Auditors' report and certificate
* Analysis of financial statements
Prepare a summary of comparative balance sheets, cash flow tables and income
statements
Analyse background of important changes during the period under review in
assets, liabilities, income or cost items
When a parent-company-subsidiary relationship exists, a thorough investiga-
tion of inter-company relations is necessary
* Detailed analysis of balance sheets (analyse major balance sheets, identify
significant items, note variations in accounting methods)
Receivables: financing by discounting or other methods, terms, amount of
claims overdue, amount of debt written off
Inventory: method of evaluation, unsaleable or obsolete stock
Fixed assets: changes on fixed assets, depreciation rates, accelerated or
extraordinary depreciation
Investments: itemized list of investments at book value
Short-term debt: original amount, outstanding amount, interest
Notes payable
Long-term debt: list of outstanding issues (date, amount, interest rate,
maturity)
Deficiencies: amount, period, debt interest or principal in arrears, preferred
dividends in arrears
Capital: share capital (authorized, issued, subscribed, paid-up), capital account
(balance, plus net profit and deposits, minus losses, withdrawals and tax)
Owners' account: amounts outstanding from or due to partners
Surplus: earned, unearned (appreciation of assets, premium on bonds or
stocks)
Reserves: bad debts, depreciation, inventory, tax, hidden reserves
360
Contingencies: notes and receivables discounted, guarantees, endorsements,
contingent liabilities with regard to subsidiaries
Bad debt: average annual amount written off
* Tax position
Tax legislation applicable to company
Production or turnover tax
Income tax
Property tax
Others
* Insurance (coverage of fixed assets, inventories etc.)
Pending litigations by or against the company
361
Annex VI
362
judgement, since they depend on the availability of a product through increased
domestic production or imports. New domestic production can take the form of
expansion of existing enterprises or the establishment of new industrial units in the same
line of production. Existing domestic enterprises have an obvious advantage in that their
production capacity can be increased with less capital outlay than is needed for a new
unit. In countries where a formal or informal system of industrial licensing or
governmental approval operates, it is possible to project estimates of manufacturing
capacity to a reasonable degree. In other cases, however, an independent assessment of
domestic manufacture of a particular product has to be made. The availability of a
product in a particular market is also determined by government policies relating to
imports.
Projection of exports
The possibility of extending the market to other countries should be explored for
most projects of any size, as export sales have to be taken into consideration in
determining plant capacity. It may be possible, through expansion of plant capacity, to
cater for a much larger market than the home country. Though a project may be
conceived primarily as an import-substitution measure, nevertheless it may have export
capability either immediately on commencement of production or within a reasonable
period during which productive skills can be developed in order to be able to offer a
product of international quality standard at a competitive price. For example, a
petrochemical or fertilizer plant can enter export markets much easier after commence-
ment of production than a plant producing heavy electrical equipment, which takes
some years until plant capability is adequately established and products are fully proven.
In all such cases, export capability needs to be assessed, and therefore the determination
of possible export markets is an essential feature of demand forecasts.
The evalution of export markets has a somewhat different emphasis from that of
domestic markets. For products that have been, or are currently being, exported, the
starting-point is the collection and evaluation of data relating to the quantities exported,
units, unit prices for exports, countries to which exports have been or are being made,
and any special characteristics of the products exported, such as quality specifications or
use of a particular brand name, either foreign or domestic, or use of a particular foreign
selling agency. In certain countries, particular specifications are enforced for engineering
goods and other products, and these need to be identified for particular products. Such
information can generally be obtained either from the exporter or from the importing
country, and should then be related to the products to be manufactured and to the
nature of the proposed enterprise. A further survey then has to be undertaken of the size
of the market in countries already importing the proposed product and in other
countries that are similar in terms of development, import policies, shipping costs etc.
In the case of products that developing countries are contemplating, or have just
started, manufacturing-and these would be the majority of goods and services from
developing countries-the starting-point should be an analysis of past imports into the
home country, the unit cost of such imports, the exporting countries and the
characteristics of the imported product. Such information is necessary, even from the
point of view of domestic production.'5 2 The price and quality of the product in the
'52Except for small projects designed solely for local markets, there is a close relationship and
interaction between the domestic and foreign manufacture of a product. Domestic products are
frequently in competition with imported products except in countries imposing severe import
controls. But even then, the price, quality and delivery of equivalent imported products has a
considerable impact on the price and quality of domestic products. In some countries, a direct
relationship is established in the matter of pricing, and domestically manufactured products have to
sell at a certain percentage (approximately 20-25 per cent) below equivalent imported products.
Even in the case of public sector products, an attempt is made to relate product pricing of
comparable imported products.
363
international market should first be defined, which is not difficult. When related to
export incentives and facilities provided by the home country, the pricing factors can be
identified. Secondly, the geographical divisions of possible export markets should be
defined in the context of a particular product. While there is an international market for
most products, some are less popular than others, and various obvious constraints have
to be taken into account. The market for consumer products such as cameras, colour
television sets, stereo equipment and electronic calculators is international but highly
competitive. However, if a proposed product is considered to be internationally
competitive in terms of quality and technological input, the global market should be
tackled step by step. There is no reason why such products, if produced in Latin
America, should not be able to enter markets in Asia, provided the products are
competitive in terms of technology, quality and price. In such cases, no detailed survey
of all countries is necessary, and the export market survey can start with certain
principal markets to be penetrated initially and gradually extended to other countries as
plant capacity is expanded to meet increased market demand.
For some products, economies of scale may prove a determining factor in defining
export markets. A plant contemplating an annual production of from 30,000 to 50,000
motor cars in an Asian country cannot expect to compete effectively in external markets
with other manufacturers producing more than 300,000 motor cars annually. However,
the possibility of exporting trucks is much greater, as economies of scale may allow
operation at a much lower level of production, and an export market survey could be
undertaken starting with neighbouring markets and gradually penetrating other
markets.
In the case of intermediate products and the products of process industries, their
export could be determined by transport costs, assuming that such products are
comparable in quality, which is usually the case. For capital goods, export markets have
to be gauged in terms of the possible acceptability of particular products by principal
users. The number of such users is much smaller than in the case of consumer goods,
and greater stress is normally placed on quality and reliability as related to prices,
together with such aspects as availability of spares and after-sales services. Machine
tools produced in India are currently being exported to the United States of America in
small quantities, but to set up a full-scale machine-tool assembly plant oriented solely to
such exports may not prove feasible, despite the fact that the United States market for
machine tools is very large. Projections of exports have to be related to the degree of
penetration considered practicable in any particular market.
After delineation of the geographical divisions of possible export markets on the
basis of reasonable projections as to the degree of penetration, a market survey may
need to be undertaken in selected countries. The scope of such a survey would vary
depending on the degree of export orientation contemplated for a project. Thus, export
surveys could range from projections of past imports in an external market with general
projections for the future, to a detailed demand forecast in any particular external
market using the forecasting techniques described earlier. The latter should, however, be
undertaken rarely and only when export prospects of a particular product justify such
an expensive course.
Information on imports and sources of imports into developed countries can
generally be obtained without too much difficulty. In the case of developing countries,
such information may be more difficult to obtain from published sources, and visits to
selected countries may be necessary. Most developed countries have agencies to collect
and collate economic data on possible export markets, and similar agencies may have to
be established by developing countries contemplating exports of new and non-
traditional products.
While an assessment of potential exports is essential to demand forecasts, a word of
caution is necessary on the scope of such studies and on their reliability over a period.
Because of rapid technological development, market prospects in developed and
developing countries tend to alter within a few years, and it is far more difficult
accurately to foretell such developments in foreign markets than in domestic ones.
364
Types of surveys
Whereas overall quantitative estimates are based entirely or mainly on the results of
desk research, more detailed quantitative findings and those of a qualitative nature
emerge typically from the other principal form of market research: the field survey.
Overlap between these two types of survey occurs because, in estimating total market
size, written sources will quite commonly have to be supplemented by interviewing,
while the necessity for some such field work for more detailed and qualitative answers
will be obviated if appropriate written sources are accessible.
All relevant written material from within and outside the enterprise must be
collected and analysed, in order to minimize both the various financial costs incurred in
field surveys and the possibility of straining the tolerance of respondents by undue
consumption of time at interviews. Furthermore, the results of desk research should
impart perspective and extra definition to a questionnaire. No field survey should be
undertaken before the full potential of desk research has been exhausted.
On the basis of sampling principles explained in annex VII, the field survey will fall
within one of two categories, namely consumer or industrial, which includes trade
research.
Both categories are described in annex VIII. Independent specialists in market
research are commissioned to ensure objectivity, the application of experience and
expertise, and observation of the rule that confidentiality will attach to the answers and
comments of individual respondents unless they are informed otherwise beforehand.
Owing to the large number of interviews involved in consumer research, a market
research agency or company operating within the country concerned must be engaged.
In industrial research the number of interviews is typically between 50 and 100, but
frequently less. Thus one experienced specialist in industrial surveys may be commis-
sioned, and, if necessary, he can be imported for the assignment. Sometimes in
developing countries the prospective respondents for industrial surveys, traders perhaps,
constitute the only viable source of information in the field.
Many manufacturing executives tend to regard their own industries as being
uniquely complex. The intensity of such an attitude may be correlated with the number
of years served and, to a lesser degree, with seniority of organizational position. The
attitude becomes a problem when the skills needed for useful and valid results from
market research are not understood, causing personnel to be engaged primarily for their
knowledge of the industry. That knowledge must never be more than a secondary
consideration, though the prospective client should be satisfied, before commissioning,
about the suitability of the individual or individuals who will direct and supervise the
research. Experience of the manufacturing industry concerned, or of a related one, is
advantageous, but advantage may also accrue from opposite conceptual cross-fertilization.
The brief for a field survey must be carefully prepared in terms of objectives, scope
and time scale. Typically the proposals of the research house or expert on industrial
research will not be approved without modification or addition, the desirability of which
will have become evident in discussions. As a general rule, the researcher should be
required, by his terms of reference, to interpret the results in a written report; this will
include a succinct presentation of the conclusions and, probably, his recommendations.
Total demand
Total demand, present and projected, should therefore cover both the domestic and
export markets and relate to the phasing of market penetration for a particular product.
The demand or market study should also highlight the broad requirements of such
markets in terms of product pricing, quality, technology and special characteristics such
as consumer preference for particular brands. Any marketing strategy necessary for
these markets should also be broadly defined. It is only then that the demand study can
serve an effective purpose in determining plant capacity and the strategy to be followed
in project formulation and implementation.
365
Market penetration
The trend method, a quite common technique is based on the extrapolation of past
data, and involves the determination of a trend and the identification of its parameters.
Two of the alternative trend curves for forecasting are indicated below.
The first step in measuring a trend is to take a moving average of two to three
years, in order to correct for major annual fluctuations. Where such a moving average
results in a smooth curve, a growth pattern will be discernible. It is, however, possible
that fluctuations will cover a period longer than a year (for example, the demand for
power-generating equipment when attributable to an intensified programme for
expanding capacity). Correction should be made foi such fluctuations. Figures for one
year are sometimes missing, in which case statistical interpolation may be necessary.
C. Consumption-level method
366
A major determinant of consumption levels is consumer income, influencing, inter
alia, the household budget allocations which consumers are willing to make for a given
product. With few exceptions, product consumption levels demonstrate a high degree of
positive correlation with the income levels of consumers. However, the degrees of
correlation differ between products. An example of products being negatively correlated
with income levels is the consumption of such items as cheaper varieties of cloth and
paper by the poor.
Ey= Q2- Ql X Y, + Y
YP:= YP, Q, + Q2
where Ey is the income elasticity coefficient of the product, Q, is the quantity
demanded in the base year, Q2 is the quantity demanded in the subsequent
367
observation year, Ypl is the per capita income in the base year, and YP2 is the per
capita income in the subsequent observation year.
Values of Ey above 1.0 imply elasticity; values below 1.0 imply inelastic demand.
Using the data from table 12 as an example of per capita income and per capita
demand for paper in 1975 and 1978, the income elasticity of paper in the case cited
would be:
2.20- 2.00 90.0 + 94.5
Ey 94.5 - 90 0 2.00 + 2.20 1952
The income elasticity of demand for paper is therefore elastic to income. Once
determined, the coefficient of income elasticity can be applied to any future year to
obtain the (unadjusted) per capita consumption of paper in that year. Thus, if per capita
income in 1990 is 15 per cent higher than in 1985, per capita consumption of paper in
1990 would be 30 per cent higher than in 1985. The figure for projected per capita
consumption may then be multiplied by the consumer population to arrive at the
absolute size of demand.
Priceelasticity of demand
E Q -Qo /P - P _ - Q P, + P
p Ql +Q0 P +Po Po -P,- Q, + PO
where Ep is the price elasticity coefficient, Ql is the new demand, Q0 Is the existing
demand at the present price P0 and Pi is the new price.
This coefficient can be very useful for studying sensitivities in the economics of a
project, by enabling consideration of the price levels that may prevail in future.
Variations in price clearly affect sales, and consequently production levels and the unit
costs of production. The coefficient assumes, however, that other market conditions and
behaviour remain constant. Furthermore, the coefficient is applicable only to quite small
variations in price, since it does not remain constant over a wide range of price
variations.
Cross elasticity
The demand for a product is determined not only by its own price, but also by the
price of complementary or substitute products. It is often necessary to identify the
products with price variations that may affect demand for the product under
consideration That is determined by cross elasticity.
368
The cross elasticity of product A to product B is determined by the following
formula:
Q2A + QIA / P2B- PIB
/
CAB- Q2A Q A PB + P I
B
This cross elasticity of product A to product B, CAB, is therefore the ratio of the
proportionate change in the demand of product B to the proportionate change in the
price of product B. The value of CAB is interpreted as follows:
If CAB > 0, the product is a substitute for A;
If CAB < 0, the product is complementary to A;
If CAB = 0, no cross elasticity exists between A and B.
3X 55
CaseY: - = 2.2
15x5
0 x 0.45
Case Z: - 0
200 x 0.50
Since CAB is less than zero in case X, the demand for cars is complementary to, or
correlates positively with, the price of petrol. Since CAB is greater than zero and as high
as 2.2 in case Y, safety razors are a sensitive substitute for electric shavers. As may be
expected, since CAB is zero in case Z, there is no cross elasticity between milk and cloth.
When complementarity or substitutability of products is established, demand forecasts
should be amended to provide for the impact of expected price changes in a
complementary or substitute product.
369
In order to forecast the demand for methanol, for instance, industries using
methanol would initially be identified. These would include the formaldehyde, fertilizer
and pharmaceutical industries. The planned manufacturing programmes of these three
industries would define the future requirements of methanol, after allowing for demand
from other users (who would be grouped together).
A similar approach could be adopted for some items of machinery, such as
compressors or industrial turbines. The technique can also be used for consumer
products and for mixed types of product. For example, the demand for cement can be
assessed by estimating the requirements of cement for various construction activities,
such as private and public housing, dams, public works and other types of construction.
The end-use method utilizes consumption coefficients, and is therefore also called
the consumption coefficient method. When identified, the coefficient appropriate for a
consumption goal is multiplied by the size of the activity to arrive at the forecast
consumption level. The following example demonstrates the application of the method.
Annual petrol consumption
per vehicle
Vehicle (thousand litres)
Private cars 3.20
Taxis 8.60
Commercial vehicles using petrol 11.20
Scooters, motor cycles, three-wheelers 0.12
Other uses (10 per cent of figure for private cars) 0.32
Forecasts of demand for petrol based on the above consumption coefficients are
given in table 13.
Consumption coefficients vary over time from one market to another, in size of
producing units and as a function of technological change. For petrol consumption, the
consumption coefficients differ between the types of vehicle, but each coefficient can
vary from one period to another. Therefore, extreme caution must be exercised in the
determination of past, and especially in the projection of future, coefficients.
In the case of intermediate products, coefficients can vary with the size of the
consuming unit and with technological changes. In steel-plate production, for example,
consumption of steel might be reduced by reducing the thickness of plates, while still
conforming to prescribed standards.
As a result of the divergences in consumption coefficients, a considerable amount of
skill is required in projecting the coefficients (and hence demand), even though the data
may be precise and reliable. This forecasting technique can be applied fairly effectively,
if adequate projections of change in the consuming industries are available, which is
frequently not the case. To some extent, such projections can be obtained from national
plans.
370
Regression models
Bibliography
371
Annex VII
SAMPLING PRINCIPLES
The selection of the sample is obviously very important. The basic requirement is
that the selection should be random, or, in other words, that every member of the
population should have an equal chance of being selected. This ideal is in fact seldom
achieved; most samples are biased to some extent. Finding out as much as possible
about the population before designing a sample is one way of eliminating bias. There are
many different types of sample design, but all are based on the assumption of random
selection. The simplest is unrestricted random sampling.
More valid results are usually obtained from a stratified sample, where the
population is divided into groups according to some characteristic such as income levels
or geographical regions. Random samples are then taken within each group and the
results are weighted according to the proportions of each group within the population
and combined. The size of the sample in each stratum should be determined not by the
relative size of the population stratum, but by, the amount of variation within each
stratum.
B. Results
372
The formula is:
a
5A= 0?~
where a is the standard deviation of the sample mean (x), and n is the size of the
sample.
There is a 68 per cent chance that the true mean lies within the sample mean plus or
minus one standard error, and a 95 per cent chance that the true mean lies between the
sample mean plus or minus two standard errors. The results of each sample survey of
consumers (except in motivation or psychological research) ought to be expressed in
terms of the mean and the standard error.
C. Statistical techniques
l/z(x - x)2
n
The deviations from the mean are squared and averaged, and the square root is
taken. This measure of dispersion is extremely important in sampling.
373
Normal distribution. When data are dispersed symmetrically around their mean, so
that the arithmetic mean equals the median and the mode as well, a normal distribution
is attained. This is a basic concept for all sampling. In such a distribution, 68 per cent of
all items occur within the range of the mean plus or minus one standard deviation, and
95 per cent of all items occur within the range of the mean plus or minus two standard
deviations. Thus a normal distribution is described by the arithmetic mean and the
standard deviation. The normal distribution can be represented by the "normal curve".
The value of the normal distribution is that many distributions approach it, and that the
characteristics of the normal distribution are valid for reasonably normal distributions.
374
Annex VIII
FIELD SURVEYS
The five principal functions involved in field surveys are as follows: sampling;
questionnaire design; interviewing; data processing; and interpretation and report
writing.
A market survey is an expensive and time-consuming way to forecast demand for a
particular product. It also involves extensive field work, the extent depending upon how
detailed the survey needs to be. Market surveys can either cover a broad field of inquiry
or be related to a specific product. The procedure followed in both cases is fairly similar,
though it differs widely in detail. Usually limited market surveys are undertaken as part
of a demand and market analysis, in so far as specific products are concerned, to cross-
check the results of forecasts made on the basis of one of the forecasting techniques
described earlier. Thus, if by use of the trend or end-use technique the market for
electrical motors in the higher ranges is defined over a period, the results can be cross-
checked through a survey of the principal industrial sectors that would be purchasing
such motors.
A. Consumer surveys
375
Success depends, to a large extent, upon the preliminary work and the selection of
trained interviewers who must be properly briefed and supervised. The quality of the
fieldwork and the variations in and overall nature of the results need constant attention.
Special care must be taken in interpreting the results, in which task the report writer
should at the very least participate. Additional tabulations and cross-tabulations are
nearly always necessary or desirable.
B. Industrial surveys
376
Index
377
Cash-in-hand, 264 Conventional methods, 286
Cash flow Cooperation (strategy), 25
-concept, 276 Corporate
-statements, 256 -analysis, 43, 79, 101
-table for financial planning, 274 Cost
Change -centres, 28, 121, 206, 208-9
understanding-, 22 -control, 256
Channels of distribution, 94 -estimates, 256
Choice of -estimating methods, 188-89
-location, 146 -leadership, see Strategy of
-plant site, 151 -minimization, 116
Civil engineering works, 185, 187 marginal cost of production, 84
Climate, 149 Cost of
capital, 294
Climatic conditions, 127
COMFAR, 51. equity capital, 295
See also UNIDO software land, 150
products sold, 32, 34
Commissioning site preparation and development, 150
plant-, 243 technology, 179
Company formation, 236
Cost benefit analysis
Competition -of environmental impacts, 137
analysis of-, 68 -models, 138
-policies, 65
-strategy, 86, 90 Cost items,
international-, 74 definition of production-, 267
Competitors Costs
analysis of the-, 76, 99 annual-, 120-21
Computation of cash flows, 276 -of studies, 38
depreciation-, 33, 213-14, 268
Computers, micro-, 49 direct-, 269-70
Concentration of forces, 24 end of life-, 261
Conditions for technology acquisition expenditures and-, 30
and transfer, 177 factory-, 33, 268
Construction financial-, 214, 269
-and installation, 242 fixed-, 268
-requirements, 150 impact of inflation on investment
-stage, 20 costs, 36
Consultancy services, 46 indirect-, 269-70
initial investment-, 259
Consulting firms, 47 investment costs, 174, 187
Consumer labour-, 228
-behaviour, 66, 72 marketing-, 33, 95-96, 271
-needs, 66, 72 operating-, 33, 120, 174, 346
Consumption overhead-, 204, 212, 228
centres of-, 146 pre-production-, 245
-coefficient method, 369 production-, 33, 266
-level method, 366 replacement-, 260, 261
Contingencies standard-, 256
-and inflation, 34 total initial investment-, 259
financial-, 34 typical investment-structures, 190
physical-, 34 unit-, 119
Contracts variable-, 268
model forms of-, 240-41 See also Estimating nethods
tendering, negotiations, award of Credit
contracts, 19, 239 bilateral-, 292
Contract terms and conditions, 177 tied-, 292
378
Creditors, see Accounts payable Discount rate, 278, 280
Credits Discounted
supplier-, 292 -cash flow, 277-78
Critical variables, 81, 252, 255, 303, 305 main discounting methods, 278
Cross elasticity, 368 Distribution
Cross-over rate, 283 channels of-, 75, 94
-costs, 271
Cultural environment, 221 -directly to consumers, 76
Currency -through retailers, 75
local-, 34 -through wholesalers, 75
Current liabilities, 262, 273 normal-, see Statistical techniques, 373
Customer behaviour, 66 Diversification, 86
Cut-off rate, 278-79, 283 Dividends, 276
379
Environmental Financial
-conflicts, 130 -analysis, 250-51
-costs and benefits, 140 -costs, 214, 269
-effects, 129 -evaluation under uncertainty, 301
-impact(s), 11, 127, 167, 172 -feasibility, 275
-parameters, 141 -flows, 276
Environmental impact -inflows, 276-77
-assessment, 14, 128, 172 -obligations, 255
-interaction matrices, 135 -planning, 238, 274
-social factors, 142 -ratios, 298
-statement, 129, 134, 172, 241 Financial analysis, 250-52
Environmental impact assessment, scope and objectives of-, 250
-simulation models, 136 Financing
-, the assessment process, 133 -institutions, 297
objectives of-, 131 -of studies, 38
phases and structure of-, 131 -strategy, 295
Equipment off-balance sheet-, 292
categories of-, 182 project-, 289, 346
-selection studies, 15 public policy on-, 296
imported and domestic-, 184 Flexibility
maintenance-, 186 -, assessment of location, 148
production-, 183 Flowsheet
testing and research-, 183 process-, 112
Equity, 290 Forecasting techniques
-capital, 276, 287, 290, 299 demand-, 362
Estimating Foreign
-based on full design, 189 -cash inflows, 277
-methods, 188 -exchange, 255
exponential cost-, 188 -exchange requirements, 184, 274
factorial-, 189 -experts, 226
Expansion Fuel, 109
-studies, 45 Functional objectives, 26
market expansion strategy, 87
Funds
Expenditures
easy availability of-, 40
commissioning-, 261
pre-production-, 260-61
start-up-, 261 Gantt chart, 243
See also trial runs, 261 Geodesic aspects, 128
Expert support systems, 50 Geographical area of strategy, 82-83
Experts, foreign-, 226
Export markets, 73 Hazardous technologies, 167
Exports Health care and social security, 222
level of-, 70 Human resources, 44, 145, 151, 219
projection of-, 363
assessment of supply and demand, 225
availability of-, 225
Factory -resource development, 212
-overheads, 212 -resource planning, 219
-supplies, 109, 144, 345 -, timing of requirements, 223
Feasibility studies, 15 identification of requirements, 222
Field training plan, 227
-survey, 69
-surveys, 375 Impact
Finance chemical-, 141
source of-, 290 ecological and environmental-, 167
380
physical-, 141 Investment
socio-economic-, 172 definition of-, 250-51
Implementation fixed investment costs, 262
-budgeting, 234, 245 initial investment costs, 259
-plan, 238 -appraisal, 252
-planning, 234-35 -costs, 31, 259
-scheduling, 243-44 -phase, 19
Imports -portfolio, 302
level of-, 70 -project cycle, see Project cycle
-promotion, 46
Income overall investment costs, 187. See also
-elasticity of demand, 367 Estimating methods
-tax, 277, 347 reliability of cost estimates, 188
Indicators right investment, 22
economic-, 70 yield of-, 251
Indirect Investment decisions
-costs, 269-70 basic criteria for-, 254
-effects, 309
-marketing costs, 271
Industrial Joint venture, 176
-master plan, 11 -partner, 227, 253, 276
-property rights, 174
Inflation
contingencies and-, 34-35 Laboratory and pilot plant tests, 14
future-rate, 258 Labour norms, 221
-risks, 307 Land
Information systems, 49 acquisition of-, 241
Infrastructural services, 145 cost of-, 150
-, conditions and requirements, 127 Layout
Infrastructure functional-, 180
communication facilities, 144 physical-, 181
external-, 111 preliminary-, 168
-constraints, 184 Leading indicator method, 371
-dependence, 143 Leasing, 292, 307
-, local conditions, 150 Legal process, registration and
sea transport, 144 authorization, 236
technical-, 143
Legislation and labour terms, 221
transport and communication, 143
Leverage
Input
investor-, 299
imported inputs, 115
-requirements, 111, 163 Liabilities
current-, 262, 273
Institutional infrastructure, 46
Licensing, 175
Interaction matrices, 135
non-affiliate-, 176
Interest
Life
-of parties involved, 253
economic-, 258
public-, 254
project-, 258
Internal analysis,
Life cycle
see Corporate analysis
-of a subsector, 77
Internal rate of return, 280, 282 -of the industry, 258
interpretation of-, 282
Liquidity, see Accounting systems, 255-56
INTIB (UNIDO), see Technology Livestock and forest products, 107
information
Loan
Inventories, 264 -financing, 291
Inventory requirements, 187 short-term loans, 291
381
Location -mix, 65, 91
experience and preferences, 148 -objectives, 90
fiscal and legal aspects, 143 -organization, 209
infrastructural conditions, 142 -overheads, 213
infrastructural services, 145 -plan and budget, 63
-analysis, 127 -research, 63
Long-term debt equity ratio, see Debt- -revenues, 95
equity ratio. See also Debt service -strategy, 90
coverage -system, 66, 98
-tools, 66, 91
Machinery and equipment, 181 operative dimensions of-, 65, 91
-, relation to other study outline of the-concept, 88-89
components, 181 pre-production-, 20, 243
selection of-, 181 supply-, 116
Main Marketing data
-cost items, 267 projecting marketing data, 80
-discounting methods, 278 Marketing research, 66-67
-production units, 180 objectives and scope of-, 68
Maintenance Material
and replacement requirements, 186 -flow diagram, 163, 170, 181
-skills and capability, 186 raw materials and supplies, 106
Management Means of technology acquisition, 175
general-, 207 Merchandising, see Sales promotion, 94
Manning tables, 224 Methods of investment appraisal, 275
Margin Mineral products, 107
operational-, 271, 273 Minimum
variable-, 273 -economic size, 165
Marginal -rate of return, 278
-cost of production, 84 Modernization projects, 272
-sales values, 83 Mutually exclusive projects, 283-84
Marine products, 107
Market National development impact, 308
capital goods-, 72 Negotiating power, 78
consumer goods-, 72
Net income statement, 256, 272-73, 276
-analysis, 43, 62-63, 73
-development strategy, 86 Net present value, 278
-expansion strategy, 87, 91 Net present value ratio, 279
-opportunities and risks, 81 Net working capital, See Working capital
-participants (relations), 67 Network planning, 244
-penetration, 366
-position, 87 Obligations
-prices, 256-57 financial-, 255
-requirements, 162
Occupational safety, 221
-risks, 81
-segmentation, 71-72 Operating costs, 33, 120, 174, 346
-share, 83 Operational
-structure, 98 -cash flows, 277
-studies, 14 -margin, 271, 273
Market-project relations, 68 -phase, 21, 223
Marketing, 62-63 Operative dimensions
-budget, 66, 344 -of marketing, 65, 91
-concept, 43, 64-65, 86, 88-89, 162 -of the marketing concept, 91
-costs, 95, 271 Opportunity studies, 11-12, 349. See also
-instruments, 63, 91 Pre-investment studies
-measures, 94 outline of-, 349
382
Opportunity cost Place
-of capital, 253, 278. See also Cost -of sales and channels of distribution,
Organization see Distribution channels
general management, 207 Planning
-of accounting and financial alternative techniques, 244
control, 208 cash flow table for financial-, 274
-of maintenance, 211 financial-, 238, 274
-of personnel, 211 human resource-, 219
-of production, 210 -horizon, 258
-of quality assurance, 210 -horizon of decision makers, 276
-of storage, 210 use of computers in-, 244
-of supplies, 209 Plant
plant organization and -capacity, 88, 112, 162. See also
management, 204-5 Capacity
Organizational -commissioning and start-up, 20
-build-up, 238 -layout, see Layout
-design, 206-7 Policies
-functions, 205 fiscal and legal aspects, 143
-set-up, 206, 224 government-, 70
-structure, 206 socio-economic-, 127, 142
Orientation the role of public-, 142
resource and market-, 146 Pre-feasibility studies, 13, 352
Outline of Pre-investment
-area study, 349 -phase, 9
-opportunity studies, 349 -studies, 9, 22
-pre-feasibility study, 352
-resource-based opportunity Pre-production phase, 223
studies, 351 Preliminary
-sub-sector opportunity study, 351 -environmental impact statement, 134
Overdraft, see Bank overdraft -layout, 168
Overhead costs Price
administrative-, 33, 213, 268 -and price policy, 92
factory-, 33, 212 -elasticity of demand, 368
marketing-, 34, 213 Prices
organization and-, 204-5 absolute-, 257
-of personnel, 228 constant-, 257
-of supplies, 121 current-, 257. See also Market prices
explicit-, 256
Packing relative-, 257, 307
-materials, containers, crates, 110 Pricing of inputs and outputs, 256
Participation of the licence holder, 176 Probability analysis, 305
Pay-back period, 286 Problem classification matrix, 69
interpretation of the-, 286
Processed industrial materials and
Pay-off, see Pay-back goods, 108
Performance test, 243 Procurement lead time, 184
Personal
Product
-sales, 93
Personnel -development strategy, 86
health care and social security, 222 -life cycle, 258
legislation and labour terms, 221 -market relations, 86
occupational safety, 221 -policy, 91
organization of-, 211 -pricing, 256
-overhead costs, 228 -range, 88, 162
-recruitment and training, 20 Product-target-group fields
skilled and unskilled workers, 220 determination of-, 89
383
Production Rate of return on equity
level of-, 120 capital, 287-88, 295
level of domestic-, 70 Ratio
-capacity, 164 current-, 299
-costs, 33, 266 debt-net worth-, 298
-cost centres, 208 efficiency ratios, 300
-materials, 264 financial and efficiency ratios, 298-99
-programme, 88, 96, 162 net present value-, 279
-targets, 70 output-capital-, 300
Products -analysis, 266
agricultural-, 106 turnover of inventories, 301
finished- (goods), 264 Raw material and supplies
livestock and forest-, 107 -, specification of
marine-, 107 requirements, 111, 345
mineral-, 107 -studies, 12
Profit Reaction of competitors, 306
annual-, 272 Recruitment
Profit and loss account, 272 -planning, 225
Profitability Recycled waste, 110
-of sales, 300 Regression models, 371
-of the sub-sector, 78
Rehabilitation
Project -measures, 40
-alternative, 252 -projects, 39-40, 272
-cycle, 9-10, 21 -studies, 40
-financing, 289, 346 -studies (structure of-), 43
-history, 59
Relations
-idea, 59, 344
product-market-, 86
-implementation, 234-35
-implementation team, 236 Reliability of
-management, 19 estimates, 36, 251, 302
-management and organization, 238 investment cost estimates, 188
-objectives, 25, 63, 81, 254 project design, 302
-promoter, 55 supplies, 116
-size, 143 Replacement requirements, 186-87
-strategy, 63-64 Research
-strategy (determination of), 87 desk-, 69
Projected balance sheet, see Balance sheel marketing-, 66-67
Projecting marketing data, 88 Resource allocation, 138
Promotion, 93. See also Public relations Retained profits, 273, 287
advertising, personal sale, 93 Return on equity capital, 285, 295, 347
-of industrial investment Revenue and income, 30
projects, 18, 46
Risk
-policy, 93
business-, 295
sales-, 94
inflation-, 307
Public -and uncertainty, 259
-interest, 254 -balance strategy, 24
-relations, 93 -management, 302
Purchase of technology, 175 -minimization, 1 1f
Royalties, 178
Quality Sales
-assurance, 210 marginal-, 83
-control system, 242 projection of-, 96
-programme, 160
Ranking problem, 283 -promotion, 94
384
-revenues, 96 developing a-, 25
-tax, 96 differentiation-, 85
Sampling principles, 372 market expansion-, 87, 91
marketing-, 90
Scope
niche-, 85
-of marketing research, 68
preliminary project-, 64
-of the project, 28
project-, 63, 81, 254
Seasonal fluctuation -, emphasis on main points, 85
-of operations, 265 -of cost leadership, 85
Sensitivity, 306 utility of a-, 24
-analysis, 121, 303 Structure of cash flows, 303
Shadow prices, 309 Studies
Shares economies of scale-, 14
ordinary-, 29 environmental impact assessment, 14
preference-, 291 evaluation-, 355
Simple rate of return, see Annual rate pre-investment-, 9-10
of return support-, 14, 355
Simulation models, 50 Sub-sector
Site, -life cycle, 77-78
-cost estimates, 151 -profitability, 78
-preparation, 242 Substitute products, 70, 79
-requirements, 149 Summary
-, topography, 149 executive-, 55
Site selection, 148-49 Supplier
final-, 151 competition from domestic and foreign
Social time preferences, 309 suppliers, 362
Socio-economic relations with the-, 116
-environment, 76 selecting the-, 117
-impact of technology, 172 Supplies
Socio-economic policies, 142-43 electricity, fuel, 144-45
factory-, 109, 112, 144
Source and application of funds, 274 other-, 110
Sources of finance, 274, 290 raw material and factory-, 146
Spare parts, 111, 264 reliability of-, 116
-and tools, 183 -, loading, unloading and storage, 119
Staff Supply
managerial and supervisory-, 220 -marketing, 116
Statistical analysis, 50 -markets, 117
-techniques, 373 -of materials and services, 242
-programme, 118
Status of an existing enterprise, 356
Support studies, 14, 355
Storage facilities, 119
Surcharges
Strategic cost accounting-, 269
-constraints, 68
-dimensions of marketing, 65, 89 Target
-options, 68 marketing-, 65
-orientation, 22, 127 -market structure, 68
-principles (basic-), 24 Technological
Strategies industrial and technological
alternative-, 88 information bank, 171
basic-, 83 -absorption and adaptation, 177
functional-, 26 -absorptive capacity, 173
project-, 206, 252 Technology
Strategy appropriate-, 167
basic-, 344 assessment of-, 168
385
Technology (continued) Trend
availability-, 170 arithmetic (linear)-, 366
cost of-, 179 exponential (semi-log)-, 366
local integration of-, 171 -extrapolation method, 366
purchase of-, 175 Trial runs, 261
selection of-, 172
-acquisition, 174-75
-acquisition and transfer, 174-75, 239 Uncertainty, 259 (Risk and-)
-choice, 164, 167 UNIDO software, 51
-description and forecast, 131, 164 Unit costs of production, 269
-description and project layout, 169 Utilities, 109
-disaggregation, 177
-Exchange System (TIES), 179
-forecast, 171 Variable
-licensing, 175 -costs, 268
-market and alternatives, 170 -margin, 273
-, problem definition, 169 Variables
-transfer, 174 critical-, 81, 252, 255, 303, 305
Tendering and evaluation of
bids, 19, 239-40 Waste
Tenders and bids, 185 recycled-, 110
TIES (UNIDO), see Technology Water, 110, 144
exchange system Wealth of a company, 272
Topography, 149 Work-in-progress, 264
Trade Workers
-mark, 174 skilled and unskilled-, 220
Training Working capital, 262-63, 291, 322, 346
-plan, 227
Working capital requirements
-programme, 227
calculation of net-, 265
Transport, 150
means of transportation, 118
-and communication, 143 Yield of investment, 251
386
,jL~~J I cU ; J·1LAJ
J r
~J.lj.
cs -JI c 4jL LJuJ I J-.j& JI 4S {, &2 __L
-ti _-; ~Si ~ &1
. : J-il , l.j to-,
c-..J1 j. * .l -..'. ..
,. Jj - . J.
* Fi? t J1 > j i