Oromia State University

School of Post Graduate Studies

Department of Leadership and Change
Management

CHAPTER FIVE:
Project Preparation and Analysis

Tesfaye Eba, PhD

Ch 1 -1
 Market analysis
 indicates the demand potential of the output of
the project:
• Demographic statistics

• Income levels of the people

 Market analysis should address the following

questions:
 Is the product for domestic or export consumption?
 Is the market large-enough to absorb the new product without

affecting the price?

 What share of the total market will the proposed product have?

 What marketing strategies and distribution channels are required?

2
Technical analysis
That the project has been clearly spelled out with the
correct technical design details (such as size,
location, timing, and technology)

Technical analysis gives an indication of the capacity

of operations within the project
It also includes the quality of machinery and equipment's

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Technical Analysis –Cont.
What kinds of technology will we need?

Is the required technology available “in house”? Or

can it be acquired?
If the technology is available, does it have the
capacity to handle the solution?

Is the proposed technology or solution practical?

Do we currently possess the necessary technology?
Do we posses the necessary technical expertise?

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Technical analysis
Broad purpose of technical analysis:
a) To ensure that the project is technically feasible in the
sense that all the inputs required to set-up the project
are available
&

b) To facilitate the most optimal formulation of the project

in terms of technology, size, location, & so on
 Choice of technology
 Ex: Cement can be made either by the dry process or the wet
process
 Soda can be made by the chemical method

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 Institutional analysis
 An Institutional Appraisal assesses the soundness of
institutional arrangements for implementing the Project.
 It covers:
 ORGANISATIONAL arrangements,
adequacy of PERSONNEL & examines the their
HIERARCHICAL line of authority,
FINANCIAL MANAGEMENT processes, including fund
flows, capacities of the people involved.

Institutional appraisal normally would highlight capacity gaps

and identify Training requirements.

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 Institutional analysis
Is focused on the following questions:

Are authority and responsibility properly

linked?
Does the project have sufficient authority?
 is the project manageable? Team building,
motivation of employees and managers etc

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Institutional & Social Analysis-Cont’d
Social Analysis
Social analysis is undertaken to examine the aspects of national
objectives like employment opportunities and income distribution.
To examine social implications:
 Poverty, income distribution, quality of life
 Gender
 Health
 Ethnic considerations
there must also be a sense of empowerment and security.

 A good strategy to deal with social issues for projects is:

to ensure that beneficiaries and disadvantaged groups have
inclusion in the project activities;
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 Social analysis
Examine the social implication of the project:
income distribution to the low income
group
adverse effects of a project on particular

groups
The impact of the project on improving the

quality of life.

Social Analysis will actually improve the design of

the project and will ensure that equality in the
opportunities and benefits are taken by many people.
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 Social Cost-Benefit Analysis (SCBA)
Social Cost-Benefit Analysis (SCBA) is the social
appraisal of projects.

is used for determining the attractiveness of a

proposed investment in terms of the welfare of
society as a whole.

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 Rationale (Importance) of Social Cost Benefit Analysis
Market Failure
 A private firm would only look at profitability instead of
providing social benefits but the government has to look
at other factors.
Savings & Investment
A project that induces more savings is investment in an
economy and not the other way round.
Distribution & Redistribution of Income:
The project should not lead to accumulating income in the
hands of a few but it should distribute the income equitably.
Employment and Standard of Living
The project should lead to increase in employment and
standard of living.

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Example: The possible Social costs and social benefits
for ‘ construction of a bridge on a river’ project
Social costs Social benefits
Social costs could be: employment to workers
 Increased pollution during during construction,
construction, less cost in travel and
 migration of labor from transportation,
farming, saving of time of people, and
 shortage and price increase of employment in toll tax
raw materials, collection, if any.
 unemployment to people
engaged in ferries/boat
makers,
 loss of farms and houses of
some families, if any.
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 Pre-feasibility Study
 Preliminary filtration.

 This involves the study of the project idea at a more

elaborate level than that carried out at the
opportunity study.
This stage is recommended to be followed:
When a detailed feasibility study is both costly and

time consuming.
 Pre-feasibility Study
on the basis of results from pre-feasibility study,
the investor should be able to decide:
whether the project can be straightaway accepted
or rejected,
the project requires a detailed analysis (i.e. a
feasibility study)
Contents of pre-feasibility & Feasibility Studies
UNIDO'S outline of pre-feasibility study only for industrial
projects:
Executive Summary
Project Background and Basic Idea
Market Analysis and Marketing Concept
Raw Materials and Supplies
Location, Site and Environment
Engineering and Technology
Organization and Overhead Costs
Human Resources
Implementation Planning and Budgeting
Financial Analysis and Investment Appraisal

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Pre-feasibility Study Vs. Feasibility study
The analysis involved in a feasibility study in much
more rigorous and requires specialized skills of a
higher order,
even though the basic framework is similar to the outline
presented above.

It is usually based on additional, and more reliable,

data especially gathered through research, surveys
Feasibility study
Objective:
Provide commercial, technical, financial and
economic information needed for investment
decision-making

Characteristics:
Clear project concepts and criteria
Comprehensive project design
Reliable information, often primary data
Quantified prediction of performance
Detailed analysis with high confidence level
Environment
The environment is the surroundings or conditions
in which a person, animal, or plant lives or operates.
The environment is not only the physical condition
but also social condition.

Human-
activity

Land use
Landscape

Human life, Wild

life & plant Soil
Air

Traffic
Noise

Water Topography

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What is an environmental impact?
Economic Impacts
development · Degrading soils
activities · Polluting bodies of · Threatening
·[Agriculture, water, biodiversity
· Polluting air, · Driving species
transportation
· altering landscapes into extinction
projects, Industry,
·Economic and
commercial,
mining, fishery, social costs on
society
etc]
· Adverse impacts
on human health

An environmental impact is a phenomenon of changing the

environment of human life or wild life.
• There is both negative and positive environmental impact.

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Reversible Impact and Irreversible Impact

v

Reversible

Irreversible

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Meanings of Environmental Impact Analysis
EIA: the process of identifying, predicting, evaluating, and
mitigating the biophysical, social, and other relevant effects
of development proposals prior to major decisions being
taken and commitments made.
According to ISO 14001:2004), the main areas of
consideration for the analysis should be:
Emissions to air
Releases to water
Releases to land
Use of energy
Energy emitted, for example: heat, radiation, vibration
Noise (that can be heard off site)
Waste in all forms, and by-products
Physical attributes of the organization, for example: size, shape,
colors, appearance, etc.
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Overview and meanings of Environmental Analysis-Cont’d
Objectives of EIA
Regardless of geographic location & type of project being
evaluated, an environmental impact assessment has
four general objectives:
To ensure that environmental considerations are explicitly
addressed and incorporated into the development decision-
making process.
To anticipate and avoid, minimize or offset (compensate) the
adverse significant biophysical, social and other relevant
effects of development proposals.
To protect the productivity and capacity of natural systems
and the ecological processes which maintain their functions.
To promote development that is sustainable and optimize
resource use and management opportunities.
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 EIA Process four EIA stages & concepts
Stages Features
Initiating the EIA study

Screening Determines whether the proposed project requires an EIA & if so,
at what level of assessment?
Scoping Identifies the key issues/components & impacts that should be
further investigated; defines the boundaries/scope and time limit of
the study
2. Impact study 1.

environmental inventory of Assess the baseline conditions

the baseline condition
Impact evaluation Identifies and predicts likely environmental & social impacts and
evaluates their significance
Mitigation Recommends the actions to reduce & avoid the potential adverse
environmental consequences of the project
Reporting Presents the result of EIA in the form of a report to the decision
making body & other interested parties.
3. Decision-making &authorization phase Examines the completeness of the information gathered in an EIA
(through Review of EIA report) and its adequacy for the purpose of decision-making; Go/no-go
4. Environmental management Plan and follow- Deals with monitoring and costing of activities of the project during
up phase its implementation
 Environmental impact Statement (EIS)
The EIA report (or a “Statement”)is a critical document,
which assembles the information to be submitted to the
decision-making body responsible for project approval.

is prepared for ensuring that it meets the requirements

and guidelines established for this purpose by a
country or international agency.

the EIA report is a public document, which describes

the findings on the impact of the proposal to all
stakeholders (including the individuals and communities
who are directly affected) prior to the final decision on a
project.

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 Environmental impact Statement (EIS)-Cont’d
Unlike other technical reports and studies, an EIA report
is subject to public review and comment.
It should both communicate effectively with non-experts
and meet appropriate technical standards.

The report:
 should be reasonably concise,
It should be objective, factual and internally consistent.
Use of plain language,
minimizing technical terminology, avoiding jargon and
summarizing data in good quality maps, charts, diagrams
and other visual aids.

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 Environmental impact Statement (EIS)-Cont’d
Most of the time there is a prescribed format for the
report by the regulating authority
The report provides the information necessary for
decision makers and stakeholders to understand:
proposal and its rationale (need, objectives,
alternatives, project deliverables);
environment and people affected (critical resources,
key stakeholders);
views of those who have been consulted (responsible
agencies, people affected, experts).
likely impacts and their significance (adverse and
positive effects of each alternative); and
proposed mitigation and follow up measures (the
environmental management plan).
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 Project category

The EPA (Ethiopia) has issued in July 2000 a “Guideline Document” for Environmental
Impact Assessments.
Categorization of Programs

The guideline categorizes programs into three “schedules” according to their potential impacts:

Schedule 1 includes “sub programs which may adverse and significant environmental
impacts, and may therefore require a full EIA”, as well as “programs in environmentally
sensitive areas irrespective of their nature”;

Schedule 2 includes “sub programs whose type, scale or other relevant characteristics have
potential to cause some significant environmental impacts, but not likely to warrant an
environmental impact study”;

Schedule 3 includes “sub programs which would have no impact and do not require an
environmental impact assessment”.

Water and sanitation programs:


Categorized in schedule 1:

Construction of dams,
Programs that cause the resettlement of more than 100 families.

Categorized in schedule 2:
Rural water supply and sanitation;
Sewerage system;
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Financial Analysis & Economic analysis
Both the Economic analysis and the Financial Analysis
investigate whether or how the “benefit” ( or “revenues” in
the case of financial analysis) excesses the “cost” ( or
“expenditure” in the case of financial analysis) of the project
quantitatively.

The Difference between Economic and Financial Analyses

Financial Analysis Economic Analysis

 Will the project be  Will the project have an impact

Issues to be profitable for the project on society or the national
addressed owners? economy?
 Will the project worth investing
with a limited budget?

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 Financial analysis
The financing of a project is crucial for its sustainability.

Is adequate financing available for the project?

How will the financing arrangements affect the
distribution of costs and benefits of the project?

Specifically, if the project is planning to financially cover

its operation and maintenance by Revenue-generating,
it should be confirmed whether the total revenue
estimated could cover the total expenses for O/M

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 The Costs of a Project
 It is the total outlay of all items associated with a
project costs related to:
A. the investment of the project /capital
expenditures/and
B. costs incurred during the operation &maintenance of
the project.
A) Capital expenditures.
 the expenditures of those items needed to set up or
establish the project so that it can be operated.
 cover items related to construction of facilities (site
preparation and other civil costs), plant and equipment,
comprising not only the acquisition cost but also the cost
of transport, installation and testing; vehicles; and
working capital.
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 The Costs of a Project-Cont’d
B. Costs related to operation of a project:
 Operating expenditures are those incurred in operating
and maintaining the project.
 typically comprise raw materials, labor and other
input services, repairs and maintenance.
 It is collected at the time of material and input
analysis

 cost of production comprises three main cost

elements: = Material cost + labour cost + overhead cost.

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 Project cash flows
The cash that is likely to be generated by the project
(i.e. the revenue) and the cash that is likely to be
needed to sustain the project (i.e. the cost).

The money received /cash inflow/and money paid

out /cash outflow/by the firm at particular points in
time.

The financial analysis of a project is based on “cash

flow analysis.

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 Categories of a project cash flow
For analytical purposes, project cash flows may be
separated into two categories:
(i) Capital cash flows, & (ii) operating cash
flows

I. Capital cash flows may be disaggregated into three

groups:
i. the initial investment
ii. additional ‘middle-way’ investments such as upgrades and
increases in working capital investments/reserve/, and
iii. terminal flows.

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Initial investment
The largest capital flow
the ‘initial capital outlay’ or just ‘capital expenditure’.
The amount to ‘initiate’ or ‘start’ the project, and
Involves the cash outflows required to start a project by
purchasing or creating assets.

The installation costs of the machines purchased

are included in the initial capital outlay.

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 Working capital requirements
The cash required to purchase the current
assets needed for startup and subsequent
support.
The amount carried in cash, accounts
receivable, and inventory that is available to
meet day-to-day operating needs.
Examples of working capital include
materials inventory, spare parts, tools, and
personnel training.
Working capital is recovered at the end
of the project
 Terminal cash flows
Set of capital flows at the end of the project’s economic
life.
For example:
the terminal cash inflows :
 the sale of the project as a going concern,
 the salvage value of the asset net of tax, and

 recovery of any remaining working capital.

Terminal cash outflows could be:

 The cost of asset disposal or demolition,
 the cost of environmental rehabilitation, and

 compensation payments to employees.

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 II. Operating cash flows
Once the initial investment is made and the project is in
operation, the project is expected to generate cash
flows over its economic life.
Lifetime of a project can be expressed as:
Economic life
 The period over which an asset is expected to be usable, with
normal repairs and maintenance, for the purpose it was
acquired, rented, or leased. [Expressed usually in number of
years, process cycles, or units produced]
Physical life
 The life for which the facility is designed under given operating
conditions.

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 Sources of Financing: HOW ARE PROJECTS FINANCED?

Raising the capital needed to fund projects can come from

many different sources.
Two basic types—debt and equity.
Debt financing refers to how much money the company has
borrowed from financial institutions to finance its operations
and invest in asset creation.
 The cost of debt financing : the current borrowing rate.
Equity financing refers to how much money a
company has received from the owners of stock
(shareholders), plus the amount of money that the
company has kept for the purpose of reinvesting in
the company on the shareholder’s behalf (retained
earnings). 38

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 projected cash flow Statement-Cont’d
The cash flow statement measures only the cash inflow
and outflow of the business.
Net cash flow starts with the net income amount, makes
adjustments for all non-cash items, then adjusts for all
cash-based transactions.

Projected Income Statement:

Revenues
- Depreciation (D)
- All other costs
EBT
- Taxes
Project NI (PNI)
Cash flow = PNI + Non-cash expenses
= PNI + Depreciation
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 A Typical Format used for Presenting
Cash Flow Statement
Cash flow statement
Operating
+ Net income
activities
+Depreciation
Income statement
Revenues - Capital investment +
Expenses + Proceeds from sales of
Cost of goods sold depreciable assets
Depreciation - Investments in working Investing
Operating expenses capital activities
Taxable income + Working capital recovery
Income taxes
Net income

Net cash flow

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 Case I : When Projects Require only Operating and
Investing Activities
• Project Nature: Installation of a new computer control system
• Financial Data:
– Investment: $125,000
– Project life: 5 years
– Salvage value: $50,000
– Annual labor savings: $100,000
– Annual additional expenses:
• Labor: $20,000
• Material: $12,000
• Overhead: $8,000
– Depreciation Method: straight line approach
– Income tax rate: 40%

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 Solution: - Income Statement
YEAR end 0 1 2 3 4 5

Revenues $100,000 $100,000 $100,000 $100,000 $100,000

Expenses:
Labor 20,000 20,000 20,000 20,000 20,000
Material 12,000 12,000 12,000 12,000 12,000
Overhead 8,000 8,000 8,000 8,000 8,000
Depreciation 15,000 15,000 15,000 15,000 15,000
Taxable Income $45,000 $45,000 $45,000 $45,000 $45,000
Income Taxes (40%) 18,000 18,000 18,000 18,000 18,000

Net Income $27,000 $27,000 $27,000 $27,000 $27,000

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 Solution- Cash Flow Statement
YEAR end 0 1 2 3 4 5

Operating
Activities:
Net Income $27,000 $27,000 $27,000 $27,000 $27,000

Depreciation 15,000 15,000 15,000 15,000 15,000

Investment
Activities:

Initial (125,000)
Investment
Salvage 50,000

Net Cash Flow ($125,000) $42,000 $42,000 $42,000 $42,000 92,000

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 Case II: When Projects Require Working Capital
Investments
• Working capital means the amount carried in cash, accounts
receivable, and inventory that is available to meet day-to-
day operating needs.
• It is investment in working capital
• How to treat working capital investments: just like a capital
expenditure /Investment in physical assets/ except that
no depreciation is allowed.

• Assume that the working capital required is

$23,331, prepare the cash flow by using the
previous data

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 Solution
Year 0 1 2 3 4 5
Income Statement
Revenues 100,000 100,000 100,000 100,000 100,000
Expenses
Labour 20,000 20,000 20,000 20,000 20,000
Material 12,000 12,000 12,000 12,000 12,000
Overhead 8,000 8,000 8,000 8,000 8,000
Depreciation 15,000 15,000 15,000 15,000 15,000
Total Expenses 55,000 55,000 55,000 55,000 55,000
Taxable income 45,000 45,000 45,000 45,000 45,000
Income taxes (40%) 18,000 18,000 18,000 18,000 18,000
Net Income 27,000 27,000 27,000 27,000 27,000
Cash flow statement
Operating activities
Net Income 27,000 27,000 27,000 27,000 27,000
+ Depreciation 15,000 15,000 15,000 15,000 15,000
Investment Activities
Initial Investment (125,000)
Salvage 50,000
Working capital (23,331) 23,331
Net Cash flow (148,331) 42,000 42,000 42,000 42,000 115,331
Key Points _ summary
Project identification
N
Corporate Goal ·Investment opportunities
·Preliminary screening

Strategic Project preparation/feasibility

planning study/project appraisal
·Market, technical, institutional,
social, environmental & financial
it is not worth
spending resources
to thoroughly
Detailed planning
evaluate such
proposals.
Implementation
Close out
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 u !!
Yo
n k
h a
T
Tesfaye Eba, PhD

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