Chapter One

GENERAL INTRODUCTION

The Project Management Body of Knowledge is the sum of knowledge within the profession
of project management. As with other professions such as law, medicine, and accounting, the
body of knowledge rests with the practitioners and academics who apply and advance it. The
complete Project Management Body of Knowledge includes proven traditional practices that
are widely applied, as well as innovative practices that are emerging in the profession,
including published and unpublished material. As a result, the Project Management Body of
Knowledge is constantly evolving.
1.1. Meaning and definition of project
Projects are about work, actions, buildings, re–buildings, achievements, deliverables and
outcomes. Moreover, project may have also the following meaning. “ a sequence of connected
events that are conducted over a defined and limited period of time and are targeted towards
generating a unique but well – defined outcome”.

According to Project Management Institute the term project can be defined as” a temporary
endeavor undertaken to create a unique product or service. Temporary means that, every project
has a definite end. Unique means that, the project or service is different in some distinguishing
way from all similar products or services.”

1.2. Features of a project

Generally, all projects are characterized by a certain features which may be common to all.
Thus, the following are typical features of a project:

 A start and finish. The start may have been crystallized over a period of time
and the end may by a slow phase out. This shows that every project has a beginning and
certain definite end. It is not like other ordinary course of business activities which are
having an indefinite term of existence – going – concern.
 A life cycle. This means that, there will be a beginning and an end, with a
number of distinct phases in between.
 A budget. It is unthinkable to undertake any project without sufficient cash
flows. During the planning phase, adequate budget allocation is mandatory for the
smooth flow of all project related activities.
 Non – repetitive. As it was discussed in the definition part, all project activities
are essentially unique. The project activities are rare and new. In a project, once a

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 certain activity is completed it would not be repeated. Generally, projects may found to
be similar but no two projects are exactly a like.
 Use of resources. In a project undertaking, resources are quite necessary for
successful accomplishment of its activities. The resources i.e. material, human, financial
may be coordinated from various sources.
 A Single Point of Responsibility. All Projects have a well defined responsibility.
In general, the head or manager of the project ultimately takes the responsibility of the
project. Therefore, in the project, responsibility should be specifically identifiable.
 Team Roles. A project is a team work activity of different professionals. In a
project, team roles and relationships that are subject to change need to be developed,
defined and established (team building).
1.3. Program Plans
Fundamental to the success of any project is documented planning in the form of a program plan.
The program plan provides the following framework:

 Estimates conflicts between functional managers

 Eliminates conflicts between functional management and program management
 Provides a standard communications tool thought the life time of the program.
 Provides verification that the contractor understands the customer’s objectives and
requirements.
 Provides a means for early identification of problem areas and risks.
The program plan is a standard from which performance can be measured, not only by the
customer, but also by program and functional management as well. The plan serves as a cook
book for the duration of the program by answering these questions for all personnel identified
with the program.

1.4. Project Planning:

Project involving few activities, resources, constraints and inter relationship can be visualized
by the human mind and planned informally. However, when a project crosses a certain threshold
level of size and complexity, informal planning has to be substituted by formal planning, without
effective planning there may be chaos.

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1.5. Functions of Project Planning:
Planning, a vital aspect of management serves several important functions.

i. It provides a basis for organizing work on the project and allocating

responsibilities to individuals.
ii. It is a means of communication and coordination between all those involved
in the project.
iii. It forces people to look ahead.
iv. It instills a sense of agency and time consciousness.
v. It establishes the basis for monitoring and control.
1.5.1. Areas of Project Planning:
Comprehensive project planning covers the following;

a) Planning the Project work: the activities relating to the project must be spell out in detail, they
should be properly scheduled and sequenced.

b) Planning the manpower and organization: the manpower required for the project must be
estimated and the responsibility for carrying out the project work must be allocated.

c) Planning the money: the expenditure of money in a time phased manner must be budgeted.

d) Planning the information system: the information required for monitoring the project must be
performed.

1.6. Project Performance Analysis:

Effective control over a project requires systematic ‘Performance Analysis’. For small and
simple projects, the project managers would do performance analysis for the project as a whole,
or for its major components. As the project business larger and more complex, performance
analysis needs to be done for individual segments of the projects.

Methods of Analysis:

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

based on the following terms.

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 a) BCWS: (Budgeted cost for work scheduled) It represents the total of three components (i)
budgets for all work packages, scheduled to be completed (ii) budgets for the portion in
process work, scheduled for the accomplished and (iii) budgets for the overheads for the
period.
b) BCWP: (Budgeted Cost for Work Performance) this is equal to the sum of the three
components (i) Budgets for work packages actually completed (ii) budgets applicable to
the completed in process work and (iii) overhead budgets
c) ACWP: (Actual Cost of Work Performed). This represents the actual cost incurred for a
accomplishing the work performed during a particular time period.
d) BCTW: (Budgeted Cost for Total Work). This is simply the total budget for the entire
project work.
e) ACC: (Additional Cost for Completion) this represents the estimate for the additional
cost required for completing project.
Given the above terms, the project may be monitored along the following lines;
Cost Variance: = BCWP – ACWP
Schedule variance in cost term: = BCWP-BCES
Cost performance Index: = BCWP/ACWP
Scheduled performance Index: = BCWP/BCWS
Estimate cost performance Index: = BCTW/(ACWP+ACC)
1.7. The Project Cycle
A project is “a series of activities aimed at bringing about clearly specified objectives within a
defined time-period and with a defined budget”. In reality, this simple definition covers an
enormous variety of project types, in terms of size, aims, focus and methods. Nevertheless, there
are many basic similarities. The ‘project cycle’ is a way of viewing the main elements that
projects have in common, and how they relate to each other in sequence. The cycle starts with
the identification of an idea and develops that idea into a working plan that can be implemented
and evaluated. Ideas are identified in the context of an agreed strategy. It provides a structure
tonsure that stakeholders are consulted and relevant information is available, so that informed
decisions can be made at key stages in the life of a project. Project planning proceeds from
inception to an implementation. It crosses various stages are often called “Project Cycle Phases”.
It is the life cycle though which a project advances from infancy to maturity.
The project life cycle serves to define the beginning and the end of a project. For example, when
an organization identifies an opportunity to which it would like to respond, it will often authorize
a need assessment and/or a feasibility study to decide if it should undertake the project. The

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project life-cycle definition will determine whether the feasibility study is treated as the first
project phase or as a separate, standalone project.
The project life-cycle definition will also determine which transitional actions at the beginning
and the end of the project are included and which are not. In this manner, the project life-cycle
definition can be used to link the project to the ongoing operations of the performing
organization. The phase sequence defined by most project life cycles generally involves some
form of technology transfer or handoff such as requirements to design, construction to
operations, or design to manufacturing. Deliverables from the preceding phase are usually
approved before work starts on the next phase. However, a subsequent phase is sometimes begun
prior to approval of the previous phase deliverables when the risks involved are deemed
acceptable. This practice of overlapping phases is often called fast tracking.
Project life cycles generally define:
 What technical work should be done in each phase (e.g., is the work of the analysis part
of the definition phase or part of the execution phase)?
 Who should be involved in each phase (e.g., resources who need to be involved with
requirements and design)?
Project life-cycle descriptions may be very general or very detailed. Highly detailed
descriptions may have numerous forms, charts, and checklists to provide structure and
consistency. Such detailed approaches are often called project management methodologies
1.7.1. Features of project Life Cycle
Most project life-cycle descriptions share a number of common characteristics:
 Cost and staffing levels are low at the start, higher toward the end, and drop rapidly as the
project draws to a conclusion.
 The probability of successfully completing the project is lowest, and hence risk and
uncertainty are highest, at the start of the project. The probability of successful
completion generally gets progressively higher as the project continues.
 The ability of the stakeholders to influence the final characteristics of the project’s
product and the final cost of the project is highest at the start and gets progressively lower as
the project continues. A major contributor to this phenomenon is that the cost of changes and
error correction generally increases as the project continues.
N.B. Care should be taken to distinguish the project life cycle from the product life cycle For
example, a project undertaken to bring new banking`
a) World Bank Project Cycle
What Is the World Bank’s Project Cycle?
A series of activities carried out by the world Bank in collaboration with government to ensure
that the world bank support is addressing the most important development issues for the country

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and that loans are used for purposes for which they were intended activities collectively are
referred to as the world bank’s “project cycle.” The World Bank suggested some stages in the
project activities. This project cycle is divided into the following stages.
1. Project Identification
Project identification is the initial stage of a project. Identification of promising investment
opportunities requires imagination, sensitivity to environmental changes, and a realistic
assessment of what the firm can do. It contributes towards achieving specified development
objectives. A project idea may originate from multiple sources. Many of the most important
projects in developing countries emerge from political commitments of national leaders, as
response to crises, emergencies of external threats or to foreign governments policies and
assistance agency priorities. Others are new experiments emerging from previous project
failures or from expansion and replication of successful projects tested locally or proven feasible
in other developing countries or from the discovery of critical economic and social bottlenecks of
shortages excess or idle resources and forward and backward linkages with existing projects.
Identified projects can be for infrastructure, housing, education, health, and government financial
management, among others. The World Bank and governments agree on an initial project
concept and its beneficiaries, and the Bank’s project team outlines the basic elements in a
Project Concept Note. Also generated during this phase are the Project Information
Document and the Integrated Safeguards Data Sheet, which identifies environmental and
social issues that may be raised by the project. Project planning is a process of elimination of
inferior alternatives in project cycle. Once some project ideas have been put forward, the first
step is to select one or more of them as potential viable. This calls for a quick preliminary
screening by experienced professionals who could also modify some of the proposals. At this
stage, the analyst should eliminate proposals that:
 are technically unsound and risky;
 have no market for the output;
 have inadequate supply of inputs in relation to benefits;
 assume over ambitious sales and profitability, etc
A. Preliminary Screening
Project planning is process of elimination of inferior alternatives. Once some project ideas have
been put forward, the first step is to select one or more of them as potential viable. This calls fro
a quick preliminary screening by experienced professionals who could also modify some of the
proposals. At this stage the analyst should eliminate proposals that are technically unsound and
risky; have no market for the output; have inadequate supply of inputs are closely in relation to
benefits; assume over ambitious sales and profitability etc.
B. Pre-Feasibility Study

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Following the preliminary screening, promising options should be investigated in a systematic
manner to suggest which are to be eliminated. Sophisticated analysis of the technical, financial,
social and institutional aspects of the project is postponed to a later stage. However, the report
should indicate which of these aspects deserve particular attention during the subsequent step.
These reports are called pre-feasibility or pre-investment studies. To enable the relevant
authorities to decide on the merits of various project options, the studies should contain:
1. The structure and objective of the project
2. The nature and size of the demand of the output or the needs that it would satisfy.
3. Availability of materials and human inputs.
4. Basic alternative technologies available and their merits and drawbacks.
5. Approximate investment and operation costs.
6. Rough estimates of financial and economic returns.
7. Any major factor that is likely to have an impact on the project and
8. What further information on the technical, financial, economic or institutional aspects
of the project should be acquired through special studies and surveys?
2. Project Preparation (Feasibility Studies)
Pre-feasibility study indicates that the project, prima facie, promising and further work is
justified, the project enters the next stage for more and sophisticated analysis supported by
accurate information in the study all aspects, technical and non technical, should receive the
attention to serve without postponing any consideration to a later stage. Project preparation
necessitates a teamwork approach with professionals investigating different aspects of the
project, working closely. They should exchange views and check their conclusions under the
coordination of an expert working as team leader. Time spent on project preparation is not a
lost time. There is trade off between project preparation and implementation. The better a
project is prepared, the easier and faster its implementation and lowers the probability of cost
over runs. Where a project is to be financed by multilateral or bilateral aid agencies, their
specific requirements and standards of project preparation should be taken in to account.

There are no basic economic choices to be made in project analysis. The economic dimension
of the project is reflected in its basic objectives and it is the responsibility of authorities to
make such choices. There are two key areas where the analyst has choices to be made, the
technological area and institutional area. Some economic aspects relating to employment
and income distribution may be placed under these areas if they are not included in the basic
objectives. The feasibility study should give due consideration to the strong interrelation
linkages to ensure mutual support between the technical and institutional components in
achieving the objectives of the project.
The borrower government and its implementing agency or agencies conduct feasibility studies
and prepare engineering and technical designs, to name only a few of the work products

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 required. Government contracts with consultants and other public sector companies for goods,
works, and services, as necessary, not only during this phase but also later in the project’s
implementation phase. Beneficiaries and stakeholders are consulted to obtain their feedback
and enlist their support for the project. Due to the amount of time, effort, and resources
involved, the full commitment of government to the project is vital.
World Bank staff may determine that a proposed project could have environmental or social
impacts that are included under the World Bank’s Safeguard Policies. If so, the borrower
prepares an Environmental Assessment Report that analyzes the planned project’s likely
environmental impact and describes steps to mitigate possible harm. An Environmental
Action Plan may also be prepared.
(a) Technological Choices
In the technological sphere the choices to be made through comparative consideration of
alternatives, vary from project to project. It is the function of professionals to scrutinize the
merits of each alternative. Certain technical aspects that seek alternatives considerations may be:
i) Building a new plant or facilities as against improving the capability of existing ones.
ii) Indigenous against imported technologies, labor intensive against capital intensive one
and technologies with high initial costs but low maintenance requirements against those
with low initial costs but high maintenance needs and
iii) Possibility of implementing the project in stages and the merits of one big
Plant in the center versus a number of smaller regional ones.
(b) Institutional Choices
Professionals may consider many institutional aspects where alternatives are feasible like:
i) Consider the merits of establishing a new agency to implement and operate the projects
as against using an existing one.
ii) Comparative advantages of various degrees of centralization and decentralization of
functions and decision-making.
iii) Evaluate alternative types of owner ship and control such as public, private, co-
operative, joint venture, domestic, foreign etc. and
iv) Compare alternatives in the supply of inputs (e.g. estate farming vs. out
growers) and the supply chain of out put.
A feasibility study should form the core of the proposal preparation process. Its purpose is to
provide stakeholders with the basis for deciding whether or not to proceed with the project and
for choosing the most desirable options. The feasibility study must provide answers to the
following basic questions:
 Does the project conform to the development and environmental objectives and priorities
of the specific country and/or region?

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  Is the project technically and scientifically sound, and is the methodology the best among
the available alternatives?
 Is the project administratively manageable?
 Is there adequate demand for the project’s outputs?
 Is the project financially justifiable and feasible?
 Is the project compatible with the customs and traditions of the beneficiaries?
 Is the project likely to be sustained beyond the intervention period?
3. Project Appraisal and Investment Decision
Appraisal is the comprehensive and systematic assessment of all aspects of the proposed
project. The appraisers are usually the central economic authorities responsible for drafting
the overall development strategy and entrusted with major decisions on matters relating to this
strategy. The project is reviewed to confirm that it accords with the broad development
objectives and fits into the development process of the country. The project is viewed from
different perspectives; technical, commercial, financial, economic, managerial and
organizational. It is to ensure that the project represents a high priority use of country’s
resources and in combination with other policies, contributes the maximum possible towards
achieving national development objectives.
Appraisal gives stakeholders an opportunity to review the project design in detail and resolve
any outstanding questions. Government and the World Bank review the work done during the
identification and preparation phases and confirm the expected project outcomes, intended
beneficiaries, and the system that will be used to monitor progress. Once the Bank team
confirms that all aspects of the project are consistent with World Bank operations
requirements and that government has the institutional arrangements ready for
implementation, the project is negotiated and is ready for approval. Project approval Once
all project details are negotiated and accepted by both sides, the Bank prepares the Project
Appraisal Document (for investment lending) or the Program Document (for development
policy lending), along with other financial and legal documents, for submission to the Bank’s
Board of Executive Directors for consideration and approval. The Project Information
Document is updated and publicly released when the project is approved. When funding
approval is obtained, conditions for effectiveness are met, and the legal documents are
accepted and signed, the implementation phase begins.
4. Project Implementation, Supervision and Follow Up
It is the stage to which the conclusions reached and decisions made are put into action and the
agreed resources are used to carry out the planned activities and achieve objectives. Detailed
designs and specifications should be drawn, tender documents to be prepared, bids should be
invited and evaluated, orders for inputs have to be placed, contract to be signed, workers to be
hired and put to work, materials to be moved to site, etc. It is not well-prepared and evaluated
but studiously executed projects that deliver the envisaged benefits. The project planning and

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 execution require high level of managerial skills and adequate administrative capacities, with
many developing countries have proved to be lacking. Many nations are not so expert at
implementation as they are at planning. Any plan is only as good as it achieves. Some
implementation problems are changes in the economic and political situation of the nation or
the world market while others project specific.
The execution of the project should be supervised closely and progress should be reported
regularly to ensure that the implementation is progressing without deviating from the
envisaged path. The follow up exercise or ex-post evaluation is considered as continuation of
supervision to assess whether the objectives of the project have been reached.

Success of project implementation often depends on the quality of project planning before the
project begins. The following pro eject submission checklist is designed to assess the
feasibility of projects and the readiness of project managers to undertake them. The checklist
is designed as the project managers’ reference guide in planning for effective and efficient
project implementation.
(a) Have all relevant divisions and regional offices been consulted and are they fully
familiar with the project document?
(b) Have the possible duplications or complementarities with existing or former global
environment facility or projects been examined?
(c) Have the roles and responsibilities of the implementing partners, including divisions
cooperating agencies or supporting organizations, been clearly established and agreed
upon?
(d) Do the implementing partners have administrative, technical and human capacities to
undertake the project?
(e) Do the divisions involved have the technical and human capacities to undertake the
project?
(f) Have the priorities and needs of the countries selected for the project been identified and
incorporated in the project?
(g) Do the relevant governments support or endorse the project?
(h) Has a gender-sensitivity analysis been conducted and incorporated in the project
document?
(i) Has the linkage to poverty alleviation been analyzed and incorporated in the
project document?
(j) Have all key stakeholders been identified and included in the partnership for project
management?

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 (k) Does the project incorporate activities to ensure policy, technical and financial
sustainability?
At the end of implementation, a decision should be made about whether to close or extend the
project.
5. Project Evaluation
The final phase of the project is the evaluation phase. Evaluation is a time-bound exercise that
attempts to assess the relevance, performance and success of current Or completed projects,
systematically and objectively. Evaluation determines to what extent the intervention has been
successful in terms of its impact, effectiveness, sustainability of results, and contribution to
capacity development. Evaluation, more than monitoring, asks fundamental questions on the how
and why of the overall progress and results of an intervention in order to improve performance
and generate lessons learned. When carried out after project completion, evaluation can
contribute to extracting lessons to be applied in other projects. Evaluations at the midpoint of the
project or programme also provide timely learning that can suggest mid-course adjustments.
Many usually neglect this stage. The project analyst looks carefully at the successes and
failures in the project experience to learn how better to plan for the future. In this stage, it is
important to examine the project plan and what really happened. Performance review should
be done periodically to compare actual performance with projected performance. A feedback
device, it is useful in several ways:
I. It throws light on how realistic were the assumptions underlying the project;
II. It provides a documented log of experience that is highly valuable in future decision
making;
III. It suggests corrective action to be taken in the light of actual performance;
IV. It helps in uncovering judgment biases;
V. It induces a desired caution among project sponsors.
Weakness and strengths should carefully be noted so as to serve as important lessons for future
project analysis undertaking. Evaluation is not limited only to completed projects. Ongoing
projects could also be evaluated to rectify problems when the project is in trouble. The project
management, the sponsoring agency, or other bodies may do the evaluation.
b) UNIDO Project Cycle
According to UNIDO, a project’s cycle can be divided into the following phases:
1. Pre-Investment Phase
b) Project Identification (Opportunity Study)
c) Pre-Selection (Pre-feasibility Study)
d) Preparation (Feasibility Study)
e) Appraisal (Appraisal Report)
1. Investment Phase (Implementation)
2. Operational Phase
Pre-Investment Phase

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 (a) Project Identification / Opportunity Studies
Identification of investment potentials in developing countries generates interesting data required
to develop project idea into a project proposal (opportunity study), which should consider
analyzing the following:
1) Availability of natural resources
2) Existing agricultural pattern
3) Future demand for goods, increasing population, purchasing power.
4) Imports and import substitutions
5) Environmental impact
6) Functioning of similar project in other countries.
7) Possible inter linkage with other industries.
8) Extension by backward and forward linkages
9) Industrial policies of the local government
10) General investment climate in the economy
11) Possible for diversification
12) Expansion of an existing line to have large-scale economies
13) Export potentials and
14) Availability and cost of production factors.
The general opportunity studies can be categorized as, area studies, industry studies and resource
based studies.
(b) Pre-Feasibility Studies / Pre Selection
To analyze that:
1. All possible project alternatives examined
2. The project concept justifies detailed analysis
3. A critical area necessitates in-depth investigation.
4. Project idea is either attractive for investment or non-viable.
5. The environment situation at the site is in line with national standards.
Support functional studies to cover specific areas such as;
1. Marketing
2. Raw material and factory supplies
3. Laboratory and pilot plan testing
4. Location
5. Environmental impact assessment
6. Economies of scale and
7. Equipment selection.
(c) Feasibility Study / Preparation
Feasibility study should provide all data, define and critically examine the commercial, technical,
financial, economic and environmental aspects for each alternative. The data should be based on
investigative efforts rather than on guesstimated. A window dressing approach should be
avoided. The supporting data should fulfill the minimum reliability standard.
(d) Appraisal Report / Appraisal
When a feasible study is completed the various parties involved in the project will carry out their
own appraisal of the investment project in accordance with their individual objectives and
evaluation of expected risks, costs and gains. Large investment and development finance
institutions have formalized project appraisal procedures and usually prepare an appraisal report.

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The appraisal report will prove whether these pre-production expenditures were well spent.
Project appraisal as carried out by financial institutions concentrates on the health of the
company to be financed, the returns obtained by equity holders and the protection of its creditors.
Appraisal reports as a rule deal not only with the project but also with the industries in which it
will be carried out and its implications for the economy as 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 and to review all
those factors of a project that are conditioned by its business environment, location and markets
and availability of resources.
Investment Phase:
The investment or implementation phase of a project provides wide scope for consultancy and
engineering work, first and for most in the field of project management. The investment phase
can be divided into the following stages:
 Establishing the legal, financial and organizational basis for the implementation
of the Project.
 Technology acquisition and transfer, including basic engineering
 Detailed engineering design and contracting, including tendering evaluation of
bids and negotiations.
 Acquisition of land, construction work and installation.
 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.
Operating Phase:
The problems of the operational phase need to be considered from both a short and a long-
term viewpoint. The short-term view relates to initial period after commencement of
production when a number of problems may arise concerning such matters as the application
of production, techniques, operation of equipment or inadequate labor productivity owing to a
lack of qualified staff and labor. Most of these problems have their origin in the
implementation phase. The long-term view relates to chosen strategies and the associated
production and marketing costs as well as sales revenues. These have a direct relationship
with the projections made at the pre-investment phase. If such strategies and projections prove
faculty, any remedial measures will not only be difficult but may prove highly expensive.

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 Chapter 2
PROJECT IDENTIFICATION
2.1. Generation of Project Ideas
The search for viable project ideas is the prime step towards establishing a successful venture.
Searching opportunities requires imagination, sensitivity to environmental changes, and realistic
assessment of firm’s performance. This task is partly structured, partly unstructured; partly
dependent on convergent thinking, partly dependent on divergent thinking; partly requiring
objective analysis of quantifiable factors, partly requiring subjective evaluation of qualitative
factors; partly amenable to control, & partly dependent on fortuitous circumstances.
Many of the most important projects in developing countries emerged from the political
commitments of national leaders, as response to crisis, emergencies and external threats or a
foreign governments policies assistance agency priorities, etc.
Stimulating the Flow of Ideas
Often firms adopt a somewhat casual and haphazard approach to generation of project ideas. To
stimulate the flow of ideas, the following are helpful:
SWOT Analysis: SWOT is an abbreviation for strengths, weaknesses, opportunities and threats.
SWOT analysis symbolize a conscious, deliberate, and a systematic effort by an organization to
determine opportunities that can be profitably exploited by it. Periodic SWOT analysis
facilitates the generation of ideas.
Clear Articulation of Objectives: The operational objectives of a firm may be planned to be
one or more of the following:
 Cost reduction
 Productivity improvement
 Increase in capacity utilization
 Improvement in contribution margin
 Expansion into promising fields
A clear articulation and prioritization of objectives are helpful in guidling the efforts of
employees and encourage them to think more imaginatively.
Fostering a Conducive Climate: To tap the creativity of people and to harness their
entrepreneurial urges, conducive organizational climate has to be fostered
2.2. Macro Sources of Project Idea
Monitoring the Business Environment

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 Fundamentally a promising investment idea enables a firm or an entrepreneur to take
advantage of opportunities in the environment by drawing on its competitive strengths. Thus,
the firm must systematically monitor the business environment and assess its competitive
abilities. The important aspects in monitoring the key sectors of the environment are as
follows:
o Economic Sector
 State of the economy
 Overall rate of growth
 Growth rate of primary, secondary, and tertiary sectors
 Cyclical fluctuations
 Linkage with the world economy
 Trade surplus /deficits
 Balance of Payment situation
o Governmental Sector
 Industrial Policy
 Government programmes and projects
 Tax framework
 Subsidies, incentives, and concessions
 Import and export policies
 Financing norms
 Lending conditions of financial institutions and commercial
banks
o Technological Sector
 Emergence of new technologies
 Access to technical know – how, foreign as well as indigenous
 Receptiveness on the part of industry
o Socio – demographic Sector
 Population trends
 Age shifts in population
 Income distribution
 Educational profile
 Employment of women
 Attitudes toward consumption and investment
o Competition Sector
 Number of firms in the industry and the market share of the top few
 Degree of homogeneity and differentiation among products
 Comparison with substitutes in terms of quality, price, appeal, and functional
performance.
 Marketing policies and practices
o Supplier Sector
 Availability and cost of raw materials and sub – assemblies
 Availability and cost of energy
 Availability and cost of money

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2.3: Micro Sources of Project Idea
Corporate Appraisal
A realistic appraisal of corporate strengths and weaknesses is desirable for identifying
investment opportunities which can be profitability exploited.
The broad areas of corporate appraisal and the important aspects to be considered under them are
as follows:
o Marketing and Distribution
 Market image
 Product line
 Market share
 Distribution network
 Customer loyalty
 Marketing and distribution costs
o Production and Operations
 Condition and Capacity of Plant Capacity
 Availability of raw materials, Sub – assemblies, and power
 Degree of vertical integration
 Locational advantage
 Cost Structure
o Research and Development
 Research capabilities of the firm
 Track record of new product developments
 Laboratories and testing facilities
 Coordination between research and operations
o Corporate Resources and Personnel
 Corporate image
 Clout with governmental and regulatory
agencies
 Dynamism of top management
 Competence and commitment of employees
 State of industrial relations
o Finance and Accounting
 Financial leverage and borrowing capacity
 Cost of capital
 Tax situation
 Relations with shareholders and creditors
 Accounting and control system
 Cash flows and liquidity

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 Chapter Three
Project Evaluation and Analysis
3.1. Market and Demand Analysis
In most circumstances, the first step in project analysis is to estimate the potential size of the
market for the product proposed to be manufactured (or service planned to be offered) and get an
idea about the market share that is likely to be captured. The task demands an in – depth study
and analysis of various factors such as: existing pattern of consumption and growth, consumption
of the market, nature of competition, income levels of the society, availability of substitutes,
system of distribution channels, etc.

The objectives of market and demand analysis in preparing a project are to:

 Identify potential consumers or buyers.

 Gathering secondary and/or primary data/ information
 Market survey
 Market classification/characterization of the market demand forecasting
 Uncertainties in demand fore casting
 Market planning
3.1.1. Situational Analysis and Specification of Objectives

The primary purpose of situational analysis is to generate enough data about the market without
formal study, which normally demands time and cost. Most often, of course, a formal study of
the market and demand is warranted. To conduct such a study, it is necessary to spell out its
objective clearly and comprehensively. Often this means that, the intuitive and informal goals
that guide situational analysis need to be expanded and articulated with greater clarity.

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To get an idea about the proposed product or services and its market share, the project
formulators, therefore, need informally, to talk to consumers or customers, competitors,
distributors preferences, purchasing power, organizations, or other similar or different producers
or services providers. It may be also advantageous to look at experiences of the organizations in
dealing with customers and their strategies.

3.1.2. Collection of Secondary Information

To conduct market demand, study information may be collected from secondary and / or primary
sources. Secondary sources are information gathered in some other places or context and are
already available. Information for market and demand analysis may be obtained from central
statistics office, sample survey reports, planning reports, academic studies, etc. These sources
may provide starting point for market and demand analysis. However, their reliability,
relevance, and accuracy for intended purpose should be carefully examined. Moreover, it
provides leads and clues for gathering primary information required for further analysis.

3.1.3. Conduct Market Survey

A comprehensive basis for market and demand analysis may be difficult to obtain from
secondary information. As such, primary information through a market survey tailored to the
specific needs of the project under preparation is necessary. There are two types of survey for
this purpose. These are a census survey and a sample survey.

In a census survey, the whole population is included (covered). Generally they are employed for
investment goods and intermediate goods if they are principally used by small number of users
or consumers. These types of surveys often tend to be costly and infeasible.

In a sample survey, a sample of population may be drawn. This method is found to be cheaper
and easier.

The information sought in a market survey may relate to one or more of the following:

 Total demand and rate of growth of demand,

 Demand in different segments of the market,

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  Income and price elasticity of demand,
 Motives of seeking the product or service,
 Unsatisfied needs or demand,
 Purchasing power of customers,
 Satisfaction with the existing product or service,
 Distribution patterns and preferences,
 Attitude towards the product or service,
 Socio – economic conditions of the consumers,
These information need to be collected and analyzed in the context of the proposed project.

3.1.4. Characterization of Market Survey

Based on the information collected through a sample survey or secondary sources it may be
necessary to classify the market for the product or service in the following manner:

 The past and present effective demand,

 Break down of demand
 Consumers or customers,
 Distribution and sales promotion,
 Supply and competition
 Price
 Government policy
o Effective Demand in the Past and Present
To get the past and present effective demand, it is necessary to estimate apparent consumption
(i.e production plus imports less exports and change in stock). In competitive market effective
demand and apparent consumption are generally equal. In most developing countries, where
competitive markets do not exist for a variety of products due to exchange restrictions and
controls on production and distribution, the figure of apparent consumption may have to be
adjusted for market imperfections. Moreover, to obtain clear insight into the nature of aggregate
market demand it may be necessary to break down demand for different segments of the market.
Segmental information is helpful to formulate market strategies that are appropriate to different
market segments.

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o Breakdown of Demand
To get an indepth insight to the nature of demand, the aggregate (total) market demand may be
broken down into demand for different segments of the market. Market segments may be
defined by (i) Nature of product, (ii) Consumer group, and (iii) Geographical division.
Segmental information is helpful because the nature of demand tends to vary from one segment
to another. The demand from consumers in high income brackets may not be sensitive to price
variations and different marketing strategies may be appropriate for different market segments.

o Consumers or Customers
Customers may be classified based on demographic (age, sex), economic (income), sociological
(profession, residence, social background), attitude (preferences, intentions, habits, attitudes, and
responses). This is not an exhaustive classification and the formulators may be able to find
meaningful groupings or categories based on targeting processes.

o Price
Along with statistics relating to physical quantities. It may be helpful to distinguish the following
types of prices:

(i) Manufacturer’s price quoted as FOB (free on board price or CIF (cost, insurance, and freight)
price, (ii) Landed price for imported goods, (iii)Average whole sale price, and (IV) Average
retail price.

o Methods of Distribution and Sales Promotion

The existing methods of distribution and sales promotion has been analyzed. This is essential to
identify patterns of consumption and problems encountered in making the proposed
product/service.

o Supply and Competition

It is necessary to know the existing sources of supply and whether they are foreign or domestic.
For domestic sources of supply, information along the following lines may be gathered:
Location, present production capacity, planned expansion, capacity utilization level, bottlenecks
in production, and cost structure.

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Competition from substitutes and near – substitutes should be specified because almost any
product may be replaced by some other product as a result of relative changes in price, quality,
availability, promotional effort, and so on.

o Government Policy
Government policy may influence the market and the demand for a product/service.
Governmental plans, policies, and legislations, which have an influence on the market and
demand of the product under examination should be disclosed. These are reflected in:
production targets in national plans, import and export trade controls, import duties, export
incentives, excise duties, sales tax, industrial licensing preferential purchases, credit controls,
financial regulations, and subsidies /Penalties of various kinds.

3.1.5. Demand Forecasting

After the completion of information gathering about various aspects of the market and demand
from primary and secondary sources, it may be possible to estimate future demand. There are
several forecasting methods which are made available to the market analyst. These methods may
be classified in three broad categories as shown below:

Methods of Demand Forecasting

I. Qualitative Methods: - These methods depend on essentially on the judgment of experts to

translate qualitative information in to quantitative estimates. The important qualitative methods
are:

 Jury of executive method

 Delphi method
II. Time Series Projection Methods: - These methods generate forecasts on the basis of an
analysis of the historical time series. The important series projection methods are:

 Trend projection method

 Exponential Smoothing method
 Moving average method

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III. Casual Methods. These method is more analytical than the preceding methods, casual
methods seek to develop forecasts on the basis of cause – effect relationships specified in an
explicit, quantitative manner. The important casual methods are:

 Chain ratio method

 Consumption level method
 End use method
 Leading indictor method
 Econometric method

o Jury of Executive Option Method

Popular in practice, involves soliciting the opinions of a group of managers on expected future
sales and combining into sales estimate. It is a speedy method for developing a demand
forecast. This method of demand forecasting will have certain advantages and disadvantages.

The advantages of this method are: (i) It is an expeditious method for developing a demand
forecast. (ii) It permits a variety of factors like economic climate, competitive environment,
consumer preferences, technological developments, and soon to be included in the subjective
estimates provided by the experts. (iii) It has immense appeal to managers who tend to prefer
their judgment to mechanistic forecasting procures.

The disadvantages of this method are: (i) The biases underlying subjective estimates can not be
easily avoided. (ii) The reliability of this technique is questionable.

o Delphi Method
This method involves eliciting the opinions of group of experts, who don’t interact face – to –
face, usually with help of a mail survey, into a forecast through an interactive process. In this
method, a questionnaire is sent to a group of experts and responses received are summarized
without disclosing the identify of the experts. These will sent back to experts to probe extreme
views expressed in the first found. The method seems appealing but the value of expert opinion
is questionable.

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Delphi method appeals to many organizations for the following reasons: (i) It is intelligible to
users. (ii) It seems to be more accurate and less expensive than the traditional face – to – face
group meetings.

o Trend Projection
This method involve extrapolating the past trend onto the future. The most commonly employed
relationship is the linear relationship. A straight line describes the linear trend, explained by the
following equations:

Ty = a + bx

Where:

 ‘Ty’ denotes the underlying trend of variable Y.

 ‘X’ denotes the points of time (each number consecutively)
 ‘a’ is the intercept term
 ‘b' denotes the change in Ty per unit of time.
o Exponential smoothing Method
In exponential smoothing, forecasts are modified in the light of observed errors. If the forecast
value for year t, Ft, is less than the actual value for year t, St, the forecast for the year t + 1, Ft +
1, is set higher than Ft. If Ft > St, Ft + 1 is set lower than Ft. In general Ft + 1 = Ft + α et

Where: Ft + 1 = Forecast for year t + 1

α = Smoothing Parameter (which lies between 0 and 1)

et = Error in the forecast for year t = St – Ft

o Moving Average Method

This method smoothes out fluctuations when the data set show irregular variations. It is
produced by averaging the values of a consecutive set of data: three, four, five … periods. The
moving average is ‘centered’ against the mid – point of the averaging period.

o Chain Ratio Method

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Under this method, the potential sales of a product may be estimated by applying a series of
factors to a measure of aggregate demand. The chain ratio method uses a simple analytical
approach to demand estimation. However, its reliability is critically dependent on the ratios and
rates of usage used in the process of determining the sales potential. While some of these ratios
and rates of usage may be based on objective proportions, others will have to be subjectively
defined.

o Consumption Level Method

The consumption – level method considers the level of consumption, using standard and defined
coefficients, and can be usefully adopted for consumer products. Thus, the demand for cars can
be estimated by determining the ratio of cars per 1000 inhabitants, or the coefficients of car
ownership among identified income levels, industrial units and Government. Once the total
requirements are known, the actual car population is subtracted from the total to arrive at the new
demand. Replacements requirements can be added to this forecast.

Consumer income is a major determinant of consumption levels, influencing the household

budget allocations which consumers are willing to make for a given product. With certain
exceptions, product consumption levels have a high degree of positive correlations with the
income levels of consumers.

End – Use Method

The end – use method is particularly suitable for assessing intermediate products.

It involves the following:

o All possible uses of a product are identified, including, for example, input to other
industries, direct consumption demand, imports and exports;
o The input – output coefficient of the product and the industries using the product are
obtained or estimated. It is then possible to derive the demand for a product, that is, for
consumption plus its exports and net imports, from the projected output levels of the
consuming industries.
End – use method utilizes consumption coefficients, and is therefore, also called the
consumption coefficient method, involves the following steps:

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 i) Identify the possible uses of the product.
ii) Define the consumption coefficient of the product for various uses.
iii) Project the output levels for the consuming industries.
iv) Derive the demand for the product.
This method may be illustrated as follows:

Illustrative Example:
Assume in a certain town annual petrol consumption per vehicle is as given below:
Annual Petrol consumption
Per vehicle
Vehicle (thousand liters)
- Private cars 2.20
- Taxis 6.50
- Commercial /vehicles using petrol 9.60
- Motor cycles 0.10

To determine the forecast consumption level, when identified, the coefficient appropriate for a
consumption level goal is multiplied by the size of the activity.

Forecasts of demand for petrol based on the above consumption coefficient are given as follows:
Projected Demand for Petrol

Vehicle Consumption Cars in year X Projected Demand for

Coefficient petrol in year x (thousand lit.)
Private cars ……… 2.20 300 660
Taxis…………….. 6.50 150 975
Commercial vehicles..9.60 200 1920
Motor cycles……..... 0.10 250 25
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.
Hence, extreme care must be exercised in the determination of past, and especially in projection
of future, coefficients.

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Leading Indicator Method

Leading indicators are variables which change a head of other variables, the lagging variables.
Thus, observed changes in leading indicators may be used to predict the changes in lagging
variables. For instance, the change in the level of urbanization ( a leading indicator) may be used
to predict the change in the demand for air conditioners ( a lagging variables).

There are two basic steps which are involved are: (i) At first, identify the appropriate leading
indicator (s). (ii) Second, establish the relationship between the leading indicator (s) and the
variable to the forecast.

An important advantage of this method is that, it does not require a forecast of an explanatory
variable, but it is not always possible to determine the leading indicator, and the lead time may
not be stable. The extent that the relationship itself may also change over time.

Econometric Method

An econometric model is all about a mathematical representation of economic relationship (s)

derived from economic theory. The primary objective of econometric analysis is to forecast the
future behavior of the economic variables incorporated in the model.

Practically, two types of econometric models are employed; the single equation model and the
simultaneous equation model. The single equation model assumes that one variable, the
dependent variable (also referred to as the explained variable). The following is an example of
the single equation model is given below:

Dt = a0 + a1P1 +a2Nt

Where Dt = demand for a certain product in year t

Pt = Price for the product in year t

Nt = income in year t

Simultaneous equation model depicts economic relationships in terms of two or more equations.

GNPt = Gt + It + Ct

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 It = a0 + a1 GNPt

Ct = b0 + b1GNP1

Where GNpt = gross national product for year t

Gt = governmental purchases for year t

It = gross investment for year t

Ct = consumption for year t

An econometric model involves the following four broad steps:

Specification: This refers to the expression of an economic relationship in a mathematical

form.

Estimation: This involves the determination of the parameter values and other statistics by a
suitable method such as the least squares method.

Verification: This step is concerned with accepting or rejecting the specification as a reasonable
approximation to the truth on the basis of the results of estimation.

Prediction: This involves projection of the values of explained variable (s)

The econometric method, as a mechanism for demand forecasting offers certain advantages: (i)
The process of econometric analysis sharpen the understanding of complex cause – effect
relationships. (ii) The econometric model provides a basis for testing assumptions and for ending
how sensitive the results are to changes in assumptions.

Econometric method are not free from certain drawbacks, among these: (i) It is expensive and
data demanding. (ii) To forecast the behavior of the dependent variable, one needs the projected
values of the independent variable (s).

3.1.6. Market Planning

An appropriate marketing plan should be formulated to reach the proposed product/service to a

desired level of customers. The prime purpose of the marketing plan is meeting the customer

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needs better than their competitors. The marketing plan should focus on customer needs, nature
of product or service offering, channel function and coverage. In planning the market the
detailed information that has been collected and analyzed should be targeted on the following:

 Customer, consider core needs and ancillary needs.

 Distribution, indicate role of distributors, whole salers and retailers
 Promotion which includes advertising, branding, own sale efforts.
 Princing, indicate final price to customers, trade margins, duties on the intended price.
 Services, state warranties, after – sale service, training, installation, etc
 Market segmentation, breakdown markets into meaningful groupings or segments giving
emphasis on distinguished characteristics, size of segment, accessibility, and degree of
competition.
3.2. Technical Analysis

Technical aspect of the project provides the basis for all other forms of project design and
analysis because a technically unfeasible project must be either revised or abandoned, regardless
of its performance in other areas.

Analysis of technical and engineering aspect is done continually when a project is being
examined and formulated. Other types of analysis are closely interwoven with technical
analysis. Technical feasibility must be conducted on the basis of the project’s ability to meet its
objectives using a technology and standards, which are appropriate to the circumstances of the
country in which the project will be located.

Project formulators or promoters must bear in mind the key word ‘appropriate’ in formulating a
project. The project should have to be designed analyzed interms of its appropriateness and
relevance with regard to the project’s objective. In line with this perspective, the project
objective is the key to technical analysis.

The broad purpose of technical analysis is (a) to ensure that the project is technically feasible in
the sense that the inputs required to set up the project are available, and (b) to facilitate the most
optimal formulation of the project interms of technology, size, location, and so on. The

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following are basic issues pertaining to technical analysis using common sense and economic
logic.

 Manufacturing process /technology

 Technical arrangements
 Materials and Inputs
 Plan capacity
 Location and site
 Structures and civil works
 Environmental aspects
3.2.1. Manufacturing Process Technology

In manufacturing a product or service often two or more alternative technologies are available.
For instance, cement can be made either by the dry process or the wet process. Similarly, a soap
can be manufactured by the semi – boiled process or the fully – boiled process.

o Technology Choice
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 to
investment strategy chosen and to socio – economic and ecological considerations. Appropriate
technology choice is directly related to the conditions of application in particular situations.
What may be appropriate in industrialized economies with high labor costs may not necessarily
be the optimum for low – age 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 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. Generally, technology
choice must be directly related to market, resource and environmental conditions and the
corporate strategies recommended for a particular project.

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It is also necessary to take into account new technological developments and applications and
their impact to plant capacity. The choice of technology is influenced by a variety of
considerations:

 Plant capacity
 Principal inputs
 Investment outlay and production cost
 Use by other units
 Production mix
 Latest developments
 Ease of absorption
Plant Capacity. Often, there is a close relationship between plant capacity and production
technology. Perhaps, only a certain production technology may be viable so as to meet a given
capacity requirement.

Principal Inputs: The chosen technology, in some cases, may be influenced by the raw
materials available – for instance, the quality of limestone determines whether the wet or dry
process should be used for a cement plant.

Investment Outlay and Production Cost. The effect of alternative technologies on investment
outlay and production cost over a period of time should be carefully assessed.

Use by Other Units: The technology adopted must be proven by successful use by other units.

Product Mix: The chosen technology must be judged in terms of the total product – mix
generated by it, including saleable by – products.

Latest Developments: The technology adopted must be based on the latest developments in
order to ensure that the likelihood of technological obsolescence in the near future, at least, is
minimized.

Ease of Absorption: The ease with which a particular technology can be absorbed can influence
the choice of technology.

o Appropriateness of Technology

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Appropriateness of technology refers to the methods of production which are suitable to local
economic, social, and cultural conditions. Nowadays, advocates of appropriate technology urge
that the technology should be evaluated in terms of the following points:

 Whether the technology utilizes local raw materials?

 Whether the technology utilizes local manpower?
 Whether the goods and services produced cater to the basic needs?
 Whether the technology protects ecological balance?
 Whether the technology is harmonious with social and cultural conditions?

3.2.2. Technical Arrangements

To obtain the technical know–how needed for the proposed manufacturing process, suitable
arrangements must be made. When collaboration is sought, among other things, the following
aspects of the arrangement must be worked out in detail:

 The nature of support to be provided by the collaborators during the designing of the
project, selections and procurement of equipment, installation and erection of the plant,
operation and maintenance of the plant, and training of the project personnel.
 Process and performance guarantees interms of plant capacity, product quality and
consumption of raw materials and utilities.
 The price of technology in terms of one – time licensing fee and periodic royalty fee.
 The continuing benefit of research and development work being done by the collaborator.
 The period of the collaboration agreement.
 The assistance to be provided and the restrictions to be imposed by collaborator with
respect to exports.
 The level of equity participation and the manner of sharing management control,
especially if the technical collaboration is backed by financial collaboration.
 Assignment of the agreement by either side in case of change of ownership.
 Termination of the agreement or other remedies when either party fails to meet its
obligation.

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  Approach to be adopted in unexpected situations.
3.2.3. Material Inputs and Utilities

An important aspect of technical analysis is concerned with defining the materials and utilities
required, specifying their properties in is some detail, and setting up their supply programme.

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.

Material inputs and utilities may be classified into four broad categories: (i) Raw materials, (ii)
Processed industrial materials and components, (iii) Auxiliary materials and factory supplies, and
(iv) Utilities.

o Raw Materials
Raw materials (processed and/or semi – processed) may be classified into four types; (i)
Agricultural products, (ii) Mineral products, (iii) Livestock and forest products, and (iv) Marine
products.

3.2.4. Plant Capacity

The term production capacity can be defined as the volume or number of units that can be
produced during a given period. Plant capacity may be seen from two perspectives: Feasibility
normal capacity (FNC) and nominal maximum capacity (NMC). FNC refers to capacity
achievable under normal working conditions, taking into account not only the 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 to be
combined, but also the management system applied. Hence, the feasible normal capacity is the
number of units produced during one year under the above conditions.

Nominal Maximum Capacity (NMC) 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 disproportionate production cost increases.

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3.2.5. Location and Site

The choice of location and site necessitates an assessment of demand, size, and input
requirement. Although most often the terms ‘location’ and ‘site‘ are used synonymously, they
should be distinguished. Location refers to a relatively broad area like a city, an industrial zone,
or a costal area; site refers to a specific piece of land where the project would be set up.

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.

Choice of Location

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 centers in relation to the plant.

Generally, the choice of location is influenced by a variety of considerations: proximity to raw

materials and markets, availability of infrastructure, labor situation, governmental policies, and
other factors.

Proximity to Raw Materials and Markets

Proximity to the sources of raw materials and nearness to the market for the final products are an
important considerations for location. In light of a basic location model, optional location is one
where the total cost (raw material transportation cost plus production cost plus distribution cost
for the final product) is minimized. Practically, it means that:

i) a resource – based project like a cement plant or a steel mill should be located close to the
source of the basic material (for example, limestone in the case of a cement plant and iron ore in
the case of a steel plant; (ii) a project based on imported material may be located near a port; and
(iii) a project manufacturing a perishable product should be close to the centre of consumption.

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A great many industrial products, however, are not affected by any one particular factor.
Petroleum products and petrochemicals, for example, can be located at source, near
consumption centers or even at some intermediate point. A wide range of consumer goods and
other industries can be located at various distances from materials and markets without unduly
distorting project economics.

Availability of Infrastructure

In a feasibility study, availability of power, transportation, water, and communications should be

carefully assessed before a location decision is made.

Inadequate supply of power 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. The
project has to provide its own power source, where the location of resource – based project can
not be changed. Power requirements can be defined in relation to plant capacity, and the supply
and cost at various locations should be studied. In assessing power supply, the following should
be looked into: the amount of power available, the stability of the power supply, the structure of
the power tariff, and the investment required by the project for a tie – up in the network of the
power supplying agency.

Transportation facilities (by rail, road, air, or water) may be available for the inflow of various
inputs and for the marketing of outputs. The availability, reliability, and cost of transportation
for various alternative locations should be assessed.

Water requirement for the project can be assessed based on the given plant capacity and
technology. Once the required quantity is estimated, the amount to be drawn from the public
utility system and the amount to be provided by the project from surface or sub – surface sources
may be determined. Moreover, the following factors may be examined i.e. its relative costs,
relative dependability, and relative qualities.

In addition to power, transport, and water, the project should have good communication
facilities, including telex telephone, and internet should also be ascertained for alternative
locations.

Labor Situation

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In project where there is labor–intensive, the labor situation in a particular location becomes
important. The key considerations in evaluating the labor situation are:

 Availability of labor, skilled, semi – skilled and unskilled

 Existing labor rates
 Labor productivity
 State of industrial relations
 Labor legislation
 Other major factors
Governmental Policies

Policies and regulations of a government have a considerable influence on location. In most of

the cases of public sector projects, location is directly decided by the government.

In the case of private sector projects, location is influenced by certain governmental restrictions
and inducements. Most often the government may forbid the setting up of industrial projects in
certain areas which suffer from urban congestion. Particularly, the government may offer
inducements for establishing industries in back ward areas. These inducements consist of
subsidies, concessional finance, sales tax loans, power subsidy, income tax benefits, lower
promoter contribution, and so on.

Other Factors

Before making final location selection decision, several other factors have to be assessed as well.
These are:

 Climatic conditions
 General living conditions
 Proximity to ancillary units
 Ease in coping with pollution / controlling pollution
Climatic Conditions: The climatic conditions like temperature, humidity, wind, sunshine,
rainfall, snowfall, dust, flooding, and earthquakes have an important influence on location
decision.

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General Living Conditions: the general living conditions, such as the cost of living , housing
situation, safety, and facilities for education, health care, transportation and recreation need to be
assessed carefully.

Proximity to Ancillary Units: Most of the firms depend on ancillary units for components and
parts. Coordination becomes easy, transportation costs are lower, and inventory requirements
become considerably lower, if the ancillary units are located in a near by area.

Ease in Coping with Environmental Pollution: A project may eventually cause environmental
pollution in various ways: it may throw gaseous emissions; it may produce liquid and solid
discharges; it may cause noise, heat, and vibrations. The locaitonal study should analyze the cost
of alleviating environmental pollution to tolerable levels at alternative locations.

Site Selection

After the completion of final locational selection, 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 impacts (restrictions, standards, guidelines)
 Socio – economic conditions (restrictions, incentive, 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 extension, supply and
marketing policies)
 Cost of land
 Site preparations and development, requirements and costs

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The cost of land tends to differ from one site to another in the same broad location. Sites close to
a city cost more whereas sites away from the city cost less.

The cost of site preparation and development depends on the physical features of the site, the
need to demolish and relocate existing structures, and the work involved in obtaining utility
connections to the site. 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 nearby 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. Moreover,
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.

Construction Requirements

The choice of location and site may sometimes strongly affected by the construction and
installation works during the future project implementation. Among the relevant aspects of it,
such as the existence of local contractors, availability of building materials, means of transport
for heavy machinery and equipment to be bought to the site, a developed social infrastructure
and a climate where construction workers accept to live for certain years probably three to five
years are important. Existing facilities of different kinds may for instance reduce the
construction cost and consequently the investment costs as well as financing required. Hence,
the feasibility study should therefore identify and describe requirements and demands during the
construction and installation phase.

Structures and Civil Works

Structures and civil works may be divided into three groups: (i) Site preparation and
development, (ii) Buildings and structures, and (iii) Outdoor works.

Site Preparation and Development

Site preparation and development includes the following: (i) grading and leveling of the site; (ii)
demolition and removal of existing structures; (iii) relocation of existing pipelines, cables, roads,
power lines, etc; (iv) reclamation of swamps and draining and removal of standing water; (v)
connections for the following utilities from the site to the public network: electric power (high

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tension and low tension), water, for drinking and other purposes, communications (telephone,
telex, internet, etc.) roads, railway sidings; and (vi) other related works.

Buildings and Structures

Buildings and Structures may have divisions, such as (i) factory or process buildings; (ii)
ancillary buildings required for stores, warehouses, laboratories, utility supply centers,
maintenance services, and others; (iii) administrative buildings; (iv) staff welfare buildings,
cafeteria, and medical service buildings; and (v) residential buildings.

Outdoor Works

Outdoor works include (i) supply and distribution of utilities (water, electric power,
communication, Steam, and gas); (ii) handling and treatment of emission, wastages, and
effluents; (iii) transportation and traffic signals; (iv) outdoor lighting; (v) landscaping; and (vi)
enclosure and supervision (boundary wall, fencing, barriers, gates, doors, security posts, etc.)

3.2.6. Environmental Aspects

The feasibility study should include, a thorough and realistic analysis of the environmental
aspects of the projects. Underestimation of the environment has resulted in negative
consequences such as poor human health, social disruption, reduced productivity and ultimately,
the undermining of development. When considering environmental aspects a number of issues
may be taken into considerations, these may include the following:

 A clear understanding of the meaning of sustainability

 Assessment of the potential environmental impact of the project.
 Formulation of mitigation measure and a plan of action.
Environmental Sustainability

The world commission on Environment and Development (WGED) defined sustainable

development as “development that meets the needs of the present without compromising the

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ability of future generations to meet their own needs”. This definition emphasizes the idea of
maintaining the economic value of environmental capital stock. Hence, the project formulators
must seek to:

 Maintain if possible increase the value of man made capital.

 Avoid damage to critical natural capital at all costs.
 Limit exploitation of renewable natural capital to sustainable level.
 Internalize the cost of depleting non – renewable resources through some form of
compensation measures.

Environmental Impact Assessment

Environmental impact assessment is part of the project planning process. Practically 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 wholly or partially. In a broader socio –
economic evaluation of the feasibility of a project, environmental effects on the quality of life are
considered along with other factors to determine if the overall effect of the project is positive, or
to determine what modifications may be necessary to achieve a positive evaluation.

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.
Whereas, in countries, where no or only vague regulations and standards are defined, it may be
advisable to anticipate a future serious environmental control measures, especially in the case of
long – term projects.

Generally, externalities or side effects may bound to create environmental conflicts that might
ultimately lead to compensation claims, substantial costs for purification and equipment, and
possibly to the extent of the closure of the plant.

The general objective of environmental impact assessment in project analysis is to ensure

whether the development projects are environmentally sound. This implies that the effects of the
project over its estimated life do not unacceptably degrade the environment, and that no residual
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effects are anticipated that would contribute to long – term environmental deterioration. It is
well known that the immediate and long – term health and welfare of people are linked to their
natural, cultural and socio – economic environment. Because of this reason, and to promote the
objective of incorporating the ideas and aspirations of the affected population in the decision
process, right from the earliest stages and through out the project development cycle, public
participation is desirable.

The specific objectives of environmental impact assessment are as follows:

 To promote a comprehensive, interdisciplinary investigation of environmental

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 investigation.
 To assess environmental impacts qualitatively and quantitatively, as required, for the
purpose of determining the overall environmental merit of each alternative.
Stages of Environmental Assessment

The environmental impacts of each of the project cycle will usually differ one to the other. As
first, a preliminary environmental impact assessment is made by 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 analyzed in detail during the second stage.

In the second stage, the environmental impact assessment consists in the identification and
evaluation of environmental impacts resulting from the project. Some times a site visit with all
members of the assessment team is essential if the environmental situation is complex and
significant for the investment decision.

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The third stage of environmental impact assessment involves the preparation of the
environmental impact statement. The final environmental impact statement should specify any
mitigation measures that can possibly make the recommended alternative environmentally
acceptable.

3.3. Financial Estimates

3.3.1. Cost of Project

The cost of the project represents the total of all items of outlay associated with a project that can
be financed by long - term funds. Generally, the total outlays will include the following:

 Land and site development

 Buildings and civil works
 Plant and machinery
 Technical know – how and engineering fees
 Expenses on foreign technicians and training
 Miscellaneous fixed Assets
 Preliminary and capital issue expenses
 Pre – operative expenses
 Provision for contingencies
 Margin money for working capital
 Initial cash losses
Land and Site Development

Major costs for land and site development include the following items:

 Basic cost of land including conveyance and other related charges.

 Premium payable on lease hold and conveyance charges.
 Cost of leveling and development.
 Cost of levelling approach reads and internal roads.
 Cost of gates.
 Cost of tube wells.

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Practically, cost of land tend to vary from one location to another. In rural location the cost of
land is relatively lower. Whereas, in urban and semi – urban locations the cost becomes higher.
Site development expenditure also vary considerably depending on the location and topography
of the land.

Buildings and Civil Works

The cost of the buildings and civil works depends on the types of structures required. Mainly,
buildings and civil works cover the following:

 Buildings for the main plant and equipment.

 Buildings for auxiliary services such as steam supply, work shops, laboratory, water
supply, power house, etc.
 Non – factory buildings like lounge, guest houses, time office, etc.
 Silos, tanks, wells, chests, basins, cisterns hopers, bins and other structures which are
necessary for installation of the plant and equipment
 Garages
 Sewers, drainage, etc.
 Other related engineering works.
Plant and Machinery

In a project undertakings, the cost of plant and machinery constitute the major component of the
project cost, consists of the following:

 Cost of imported machinery: It is the total of (i) FOB (free on board) value, (ii) shipping,
freight, and insurance cost, (iii) import duty, and (iv) clearing, loading, unloading, and
transportation charges.
 Cost of indigenous machinery: it consists of (i) for (free on board), (ii) sales tax, and
other taxes, if any, and (iii) transportation charges to the site.
 Cost of stores and spares.
 Foundation and installation charges.
The cost of the plant and machinery is based on the recent available quotation adjusted for
possible escalation.

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3.3.4. Cost of Production
Generally, it is essential to make realistic forecasts of production or manufacturing costs for a
project in order to determine it’s the future viability.

Given the estimated production, the cost of production may be worked out. The principal
components of cost of production are:

 Material cost
 Utilities cost
 Labor cost
 Factory overhead cost

Materials

Materials, predominantly variable costs, such as raw materials, factory supplies and spare parts.
Materials are the most important component of cost and generally the material cost comprises the
cost of materials, chemicals, components, and consumable stores required for production. It is a
function of quantities in which these materials are required and the prices that can be paid for
them

The following points should be considered, while estimating the material cost:

i) The requirements of various material inputs per unit of output may be established on
the basis of one or more of the following : (a) theoretical consumption norms, (b)
experience of the industry, (c) performance guarantees, and (d) specification of
machinery suppliers.
ii) The total requirement of various materials inputs can be obtained by multiplying the
requirements per unit of output with the anticipated output during the year.
iii) The prices of materials inputs are defined in CIF (cost, insurance, and freight) terms.
iv) The present costs of various material inputs is considered. In other words, the factor
of inflation is ignored. It may be recalled that the factor of inflation is ignored in
estimating the sales revenues too.

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 v) If seasonal fluctuation in prices are regular, the same must be considered in
estimating the cost of material inputs.
Utilities

Utilities consist of power, water, and fuel. The requirements of power, water, and fuel may be
determined on the basis of the norms specified by the collaborators, consultants, etc. or the
consumption standards in the industry, whichever is higher.

Labour

Cost of labour is the cost of all the manpower employed in the factory. Normally, the labour cost
is the function of the number of employees and the rate of remuneration. The requirement of
workers depends on the number of operators/helpers required for operating various machines and
manning various services. Based on the existing general norms in the given industry, the number
of supervisory personnel and administrative staff may be calculated.

While estimating remuneration rates, he prevailing rates in the industry- area should considered.
The remuneration should include, besides basic salary, dearness allowance, house rent
allowance, conveyance allowance, medical reimbursement, leave travel concession, provident
fund contribution, gratuity contribution, and bonus payment. Moreover, account should be
maintained for vacations, overtime work, night work, work on holidays, etc.

Factory Over Heads

In general, factory over heads are fixed costs. Collectively, factory overheads referred to as the
expenses on repairs and maintenance, rent, taxes, insurance on factory assets, and so on. Repairs
and maintenance expenses depends on the state of the machinery – this expense bound to be
lower in the initial year and higher in the later years. Rent, taxes, insurance, etc. may be
calculated at the prevailing rates.

3.3.3. Working Capital Requirement

In computing the working capital requirements, the minimum coverage of days for current assets
and liabilities should be determined first. Annual factory costs, operating costs, and costs of

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products sold should then be computed, since the values of some components of the current
assets are expressed in these terms.

In estimating the working capital requirement and planning for its financing, the following points
should be considered;

1. The working capital requirement consists of the following: (i) raw materials and
components (indigenous as well as imported), (ii) stocks of goods – in – process (work –
in – process), (iii) stocks of finished goods, (iv) debtors, (v) operating expenses and (vi)
consumable stores.
2. The principal sources of working capital fiancé are: (i) working capital advances
provided by commercial banks, (ii) trade credit, (iii) accruals and provisions, and (iv)
long term sources of financing.
3. There are limits to obtaining working capital advances from commercial banks. They are
into two forms: (i) the aggregate permissible bank fiancé is specified as per the norms of
lending, followed by lending bank, (ii) against each current asset a certain amount of
margin money has to be provided by the firm.
4. The margin requirement varies with the type of current asset. Since there is no fixed
formula for determining the margin amount, the ranges for various current assets are as
follows:
Current Assets Margin
Raw materials………………………………………….. 10 – 25 percent
Work – in- process ……………………………………. 20 – 40 percent
Finished goods ………………………………………… 30 – 50 percent
3.4. Social Cost Benefit Analysis (SCBA)

To reflect the real value of a project to society, we must consider the impact of the project on
society. Thus, when we evaluate a project from the view point of the society (or economy) as a
whole, it is called Social Cost Benefit Analysis (SCBA)/ Economic Analysis.

3.4.1. Scope of SCBA

SCBA can be applied to both Public & private investments –

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  Public Investment: SCBA is important especially for the developing countries where
government plays a significant role in the economic development.
 Private Investment: Here, SCBA is also important as the private investments are to be
approved by various governmental & quasi-governmental agencies.
3.4.2. Objectives of SCBA

Cost benefit analysis (CBA) is concerned with the examination of a project from the view point
of maximization of net social benefit while cost benefit analysis originated to evaluate public
investment; it is also used in project appraisal. Earlier, project appraisal covered only private
costs and benefits at present social costs and benefits are also reckoned. Cost benefit appraisal a
project proposes to describe and quantify the social advantages and disadvantages of a policy in
terms of a common monetary unit. The unit should reflect society’s strength of performance for
each outcome. The economist uses as a measure of their preference, the consumer’s willingness
to pay (WTP) for a good. There fore, the main focus of Social Cost Benefit Analysis is to
determine:

1. Economic benefits of the project in terms of shadow prices;

2. The impact of the project on the level of saving and investment in the society;
3. The impact of the project on the distribution of income in the society;
4. The contribution of the project towards the fulfillment of certain merit wants (self-
sufficiency, employment etc).
3.4.3. Significances of SCBA

CBA is unable to reflect social values. Hence SCBA has been emerged with some
interesting significances. These significances also make the SCBA different from
the CBA with respect to:

•Market Imperfections

• Externalities

• Taxes & Subsidies

• Concern for Savings

• Concern for Redistribution

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 • Merit Wants

1. Market Imperfections: Market prices, the basis for CBA, do not reflect the Social values
under imperfect market competition. Private costs and profits reflect social costs and benefits
only under perfect competition. Market prices which form the basis for computing the monetary
costs and benefits from the point of view of the project sponsor, reflect social values only under
conditions of perfect competition, which are rarely, if ever, realized by developing countries,
when imperfection exist, market price do not reflect social values. The common market
imperfections found in developing countries are:

a. Rationing: Rationing of a commodity means control over its price and distribution. The
price paid by a consumer under rationing is often significantly less than the price that
would prevail in a competitive market.
b. Foreign exchange regulation: the official rate of foreign exchange in most of the
developing countries, which exercise close relation over foreign exchange, is typically
less than the rate would prevail in the absence of foreign regulation
2. Externalities: A project may have beneficial or harmful external effects that are considered in
SCBA, not in CBA. For example, it may create certain infrastructure facilities like roads, which
benefit the neighboring areas. Such benefits are concerned in SCBA, though they are ignored in
assessing the monetary benefits to the project sponsors because they do not receive any monetary
compensation from those who enjoy their external benefit created by the project. Like wise, a
project may have a harmful external effect like environmental pollution.

3. Taxes and subsidies: From the social point of view, taxes & subsidies are nothing but transfer
payments. But in CBA, taxes & subsidies are treated as monetary costs and benefits respectively
and hence considered relevant.

4. Concern for Savings: In SCBA, the division between benefits & consumption is relevant
herein higher valuation is placed on savings. But in CBA such division is irrelevant.

5. Concern for Redistribution: In SCBA, the distribution of benefits is very much concerning
issue where commercial private firm does not bother about it.
6. Merit Wants: Merit wants are important from the social point of view and therefore, SCBA
considers these wants, while merit wants are not relevant from the private point of view.

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3.4.4. Approaches to SCBA

There are two principal approaches for Social Cost Benefit Analysis.

A.UNIDO Approach, and

B. L-M Approach.
a) UNIDO Approach: This approach is mainly based on the publication of UNIDO
(United Nation Industrial Development Organization) named Guide to Practical
Project Appraisal in 1978. The UNIDO approach of Social Cost Benefit Analysis
involves five stages:

1. Calculation of financial profitability of the project measured at market prices.

2. Obtaining the net benefit of the project at shadow (efficiency) prices.
(Objective of SCBA-1)
3. Adjustment for the impact of the project on Savings & Investment. (Objective
of SCBA-2)
4. Adjustment for the impact of the project on Income Distribution. (Objective
of SCBA-3)
5. Adjustment for the impact of the project on Merit and Demerit Goods whose
Social values differ from their economic values. (Objective of SCBA-4)

Stage-1: Calculation of financial profitability of the project

 A good technical and financial analysis must be done before a meaningful economic
(social) evaluation can be made so as to determine financial profitability.
 Financial profitability is indicated by the Net Present Value (NPV) of the project, which
is measured by taking into account inputs (costs) and outputs (benefits) at market price.
n
CFt
Vt    I0
 Net Present value of a Project is calculated as: t 1 (1  k ) t Here,
Vt = Value of outputs at market price at time t

Ct = Value of inputs at market price at time t

K = Discount Rate

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 T = Lifetime of the project

I0 = Initial cost at the start of the project.

 The project is viewed as financially feasible if NPV > 0.

Stage-2: Obtaining the net benefit of the project at economic (shadow) prices

 The Commercial Profitability analysis (calculated in stage - 1) would be sufficient only

if the Project is operated in perfect market. Because, only in prefect market, market prices
can reflect the social value. If the market is imperfect (most of the cases in reality), net
benefit of the Project is determined by assigning shadow prices to inputs and outputs
 Shadow Prices reflect the real value of a resource (input or output) to society.
 Shadow Prices are also referred as economic prices, accounting prices, and
economic/accounting efficiency prices etc.
 Shadow Prices can be defined as the value of the contribution to the country’s basic
socio-economic objectives made by any marginal change in the availability of
commodities (output) or factor of production (input).
General Principles of Shadow Pricing
a) Numeraire:
 A unit of account in which the values of inputs and outputs are to be expressed.
 Numeraire is determined at-
• Domestic currency (BDT) rather than border price.

• Present value rather than future value. Because,” a bird in the hand is worth two in the bush.”

• Constant price rather than current price.

b) Tradability:
 Tradability refers to whether a good or service is tradable or non- tradable; if tradable
whether it is fully traded or non-traded.
 A good/service is tradable in the absence of or within limited trade barriers.
 A tradable good/service that is non actually traded is called non traded good/service.
A tradable good/service is actually traded when-
 The import (export) supply is perfectly elastic over the relevant range of volume.

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  All additional demand (production) must be made (consumed) by import
(export) due to the full capacity in the domestic industry (fulfillment of demand
by domestic consumer).
 The import (CIF) price is less or the export (FOB) price is more than the domestic cost of
production.
A good/service is non-tradable; if

 Its import (CIF) price is greater than its domestic cost of production and/or
 Its export (FOB) price is less than its domestic cost of production.
Sources of shadow prices: The UNIDO approach suggests three sources of shadow pricing,
depending on the impact of the project on national economy. A project, as it uses and produces
resources, may for any given input to output (i) increase or decrease the total consumption in the
economy. (ii) Decrease or increase production in the economy. (iii) Decrease imports or increase
imports or (iv) increase exports or decrease exports.
c) Taxes: When shadow price are being calculated taxes usually pose difficulties. The
general guidelines in the UNIDO approach with respect to taxes are as follows: (i) when
a project results in diversion of non-traded inputs which are in fixed supply from other
producers or addition to non-traded consumer goods, taxes should be included (ii) when a
project augments domestic production by other producers, taxes should be excluded (iii)
for fully traded goods, taxes should be ignored
d) Consumer willingness to Pay: If the impact of the project is on consumption in the
economy, the basis of shadow pricing is consumer willingness to pay. The measurement
of consumer willingness to pay may be explained with the help of chart. In the graph
shown in the exhibit, below DD1 represents the demand schedules, SS, the supply
schedule, E the equilibrium point, OQ the quantity bought and OP the price per unit.
Looking at the demand schedule, we find that the consumer who buys the first unit is
willing to pay OD for that unit and the consumer who buys the last unit is willing to pay
OP for the unit. The consumer willingness to pay by consumers who buy the product is
measured by the area ODEQ. The Price paid by them, however, is only OPEQ. The
difference between ODEQ and OPEQ, namely DEP, is referred to as the consumer
surplus.

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 Price

P E

0 Q Quantity

Stage 3: Adjustment for the impact of the project on savings and investment

Most of the developing countries face scarcity of capital. Hence, the governments of these
countries are concerned about the impact of project on savings and its value thereof. Stage three
of the UNIDO approach, concerned with this, seeks to answer the following questions: Given the
income distribution impact of the project, what would be its effects on savings?

Impact on savings:

The savings impact of a project is equal to:

Yi MPSi

Where, Yi = change in income group i as a result of the project.

MPSi = Marginal propensity to save of group i

Example 5.10.4: As a result of a project the income gained/lost by four groups is Group 1 = Br.
100,000, Group 2 = Br.600, 000, Group 3 = Br.(200,000 )and Group 4 = Br. (400,000). The
marginal propensity to save these four groups is as follows:

MPS1 = 0.05, MPS2 = 0.10, MPS3 = 0.20 and MPS4 = 0.40

The impact on savings of the project is: 100,000X0.05 + 600,000 X 0.10 – 200,000 X0.20 –
400,000 X 0.40 = Br. 145,000

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Stage 4. Measurement of the impact of Distribution:

Stage four of the UNIDO method is concerned with measuring the value of a project in terms of
its contribution to savings and income redistribution. To facilitate such assessments, we must
first measure the income gained or lost by individual groups within the society.

Groups: For income distribution analysis, the society may be divided into various groups. The
UNIDO approach seeks to identify income gains and losses by the followings.

 Project
 Other private business
 Government
 Workers
 Consumers
 External sector There can, however be other equally valid grouping.
Measure gains of loss:

The gain or loss to an individual group within the society as result of the project is equal to the
difference between the shadow price and the market price of each input or output in the case of
physical resources or the difference between the price paid and the value received in the case of
financial transactions.

Stage 5. Adjustment for Merit and Demerit Goods:

In some cases, the analysis has to be extended beyond stage four to reflect the difference
between the economic value and social value of resources. This difference exists in the case of
merit goods and demerit goods.

Merit goods:

A merit good is one for which the social value exceeds the economic value. For example,
country may place a higher social value than economic value on production of oil because it
reduces dependence of foreign supplies. The concept of merit goods can be extended to include a
socially desirable outcome like creation of employment. In the absence of the project, the

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government perhaps would be willing to pay unemployment compensation to provide mere
make-work jobs.

Demerit good:

The social value of the good is less than it economic value. Foe example, a country may regard
alcoholic products as having a social value less than the economic value.

3.4.5. Little – Mirrlees Approach:

L.M.D. Little and James A. Mirrlees have developed an approach to SCBA which
is famously known as L-M approach. The core of this approach is that the social cost of using a
resource in developing countries differs widely from the price paid for it.
Hence, it requires Shadow Prices to denote the real value of a resource to
society. (Mentioned earlier)

Features of L-M Approach

 L-M Numeraire is present uncommitted social income.

 L-M methods opts for savings as the yardstick of their entire approach. Present savings is
more valuable to them than present consumption since the savings can be converted into
investment for future.
 L-M approach rejects the ‘consumption’ numeraire of UNIDO approach since the
authors (L & M) feel that the consumption of all level is valuable.
 This approach measures the cost and benefits in terms of international or border prices.
1. Similarity between UNIDO and Little – Mirrlees Approach

There is considerable similarity Between the UNIDO approach and the L.M approach both the
approaches call for:

1. Calculating accounting shadow prices particularly for foreign exchange savings and
unskilled labor.

2. Considering the factor of equity.

2. Difference between UNIDO and Little – Mirrlees Approach

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Despite considerable similarities there are certain differences between the two approaches.

1. The UNIDO approach measures costs and benefits in terms of domestic Birr whereas; the
L.M approach measures costs and benefits in terms of international prices, also referred
to as boarder prices.
2. The UNIDO approach measure costs and benefits in terms of consumption whereas the
L.M approach measures costs and benefits in terms of uncommitted social income.
3. The stage-by-stage analysis recommended by the UNIDO approach focuses on
efficiency, savings, and redistribution considerations in different stages. The L.M
approach, however, tends to view these considerations tighter.
UNIT 5
PROJECT FINANCE
5.1. Why Use Project Finance
Before we talk about finance, what do you know about project financing? Characteristics of
project financing? Types of project financing? Limitations of project financing? So, try to
provide your own answer by writing.

i. As an addition to its existing business rather than stand alone basis. Such project finance is
easy as it is by means of internal accruals and/or corporate loans.

ii. The lenders need high degree of confidence with reference to timely completion of the project
and without cost overrun; technically capable, sales projections achievable and projected cash
flows are adequate and realistic. The projections should be adequate to service the debt
obligations and be robust enough to cover any temporary problems that may arise.

iii. The lenders need to ensure that the project risks are allocated to appropriate parties other than
the Project Company, or where this is not possible, mitigated in other ways.

iv. Lenders may also need to continue to monitor and control the activities of the Project
Company to ensure that the basis on which they assessed the risks is not undermined.

5.2.Project Financing

Project financing may be defined as the raising of funds required to finance a capital investment
proposal which is economically separable. The assets, contracts cash flows are separated from the

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parent company and the assets acquired for the projects serve as collateral for loans. The repayments
are made from the revenue generated from the projects.

5.3. Characteristics of Project Financing

1. There is a presence of a special project entity.

2. The component of debt is very high and therefore gives raise to a highly leveraged firm.
3. Project financing is separated form the parent company’s balance sheet.
4. Debt servicing and repayments are done only from the cash flows arising from the projects.
5. Project financier’s risks are not entirely covered by the sponsor’s guarantee.
6. Third parties like suppliers, customers, government and sponsors commit to share the risk of
the project.
5.4. Conventional Financing vs. Project financing
CONVENTI ONAL FI NANCI NG PROJECT FI NANCI NG
Creditor makes an assessment of repayment Cash flows from project related assets alone are
of his loan by looking at all cash flows and considered for assessing the repaying capacity.
resources of the borrower.

End use of the borrowed funds is not The creditors ensure proper utilization of
strictly monitored by the lender. the fund.

Creditors are interested only in their money Project financiers are keen to watch the
getting repaid. performance of the enterprise and suggest
measures.

Project financiers can appoint their nominee is

the Board of directors of their clients.

5.5. Debt Financing Vs Equity Financing

Businesses need finance, either to expand an already existing business, or to start a new one.
There are three alternatives for financing a business, namely, self financing, equity financing and
debt financing. Self financing involves a huge risk and is generally taken up by small business
owners. That leaves us with the other two financing methods, that is, debt and equity financing.
Let's compare debt financing vs. equity financing on various counts, but before that it is
important to understand their meaning.

Tilahun D. Page 55
Debt financing means when a business owner, in order to raise finance, borrows money from
some other source, such as a bank. The business owner has to pay back this loan or debt within a
pre-determined time period along with the interest incurred on it. The lender has no ownership
rights in the borrower's company. Debt financing can be both, short term as well as long term.

Equity financing means when a business owner, in order to raise finance, sells a part of the
business to another party, such as venture capitalists or investors. Under equity financing, the
financier has ownership rights equivalent to the investment made by him in the business, or in
accordance with the terms and conditions set between him and the business owner. This is the
main difference between debt financing and equity financing. In equity financing, the financier
has a say in the functioning of the business as well.

Ignoring preference capital (which is of minor significance) the basic differences between
shareholders’ funds (referred to as equity) and loan funds (referred to as debt) falls on:

 Process: Procedure of raising money through debt financing is easier, than raising
money through equity financing. In equity financing, there are a number of security
laws and regulations, which have to be complied by the business. Such rules are not
applicable for debt financing.
 Ownership Rights: In debt financing, the business owner has full control and
ownership of the business. In equity financing, the investor or the venture capitalist has
ownership rights, as well as decision making power, in running the business.
 Rights over Profit: In debt financing, the lenders only have a right over the principal
loan and the interest incurred on it. They have no rights over the profits or revenues
generated by the business. Once the loan is repaid, the relationship between the lender
and the business owner also, ends in debt financing.
 Ease of doing Business: In debt financing, decisions and rights regarding running the
business, solely lie with the owner. Whereas in equity financing, the shareholders and
investors have to be updated and consulted about the business regularly. So, it is easier
to do business with debt financing, than with equity financing.
 Repayment: If the investors are backing the business, there will be no problem in
arranging finance for the business in future, as investors lend credibility to a business
and lenders will have no reservations in giving loans to such businesses. Thus, equity
Tilahun D. Page 56
 financing improves the scope of arranging financing for the business in future.
However, if the business has taken too much loan, that is, its debt to equity ratio is on a
higher side, the investors will not like to invest in such a business as it's a "high risk"
venture.
 Cost to Company: In debt financing, the loan amount is already known and fixed, so
the business owner can make a provision for it beforehand. Also, the interest incurred
on loan in debt financing can be deducted from the corporate tax . Thus, cost to
company in debt financing is easy to forecast, plan and reimburse. On the other hand, in
equity financing, if the business generates huge profits, the investor and the venture
capitalist have to be paid back money, which is much in excess of the amount they
invested.
 Future Funding: if the investors are backing the business, there will be no problem in
arranging finance for the business in future, as investors lend credibility to a business
and lenders will have no reservations in giving loans to such businesses. Thus, equity
financing improves the scope of arranging financing for the business in future.
However, if the business has taken too much loan, that is, its debt to equity ratio is on a
higher side, the investors will not like to invest in such a business as it's a "high risk"
venture.
Thus, after comparing debt financing vs. equity financing, it can be concluded that both
have their pros and cons. Ideally, a business should have a mix of debt and equity
financing with the debt amount comparatively low, so that debt management becomes
easy. However, it is up to the owner of the business to decide where his preferences lie.
A business owner who wants full authority over the business, should choose debt
financing .While an owner who is willing to share his risks and profits should opt for
equity financing.

Debt vs. Equity -- Advantages and Disadvantages

In order to expand, it is necessary for business owners to tap financial resources. Business
owners can utilize a variety of financing resources, initially broken into two categories, debt and
equity. "Debt" involves borrowing money to be repaid, plus interest. "Equity" involves raising

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money by selling interests in the company. The following paragraph discusses the advantages
and disadvantages of debt financing as compared to equity financing.

5.5.1. Advantages of Debt Compared To Equity

 Because the lender does not have a claim to equity in the business, debt does not dilute
the owner's ownership interest in the company.
 A lender is entitled only to repayment of the agreed-upon principal of the loan plus
interest, and has no direct claim on future profits of the business. If the company is
successful, the owners reap a larger portion of the rewards than they would if they had
sold stock in the company to investors in order to finance the growth.
 Except in the case of variable rate loans, principal and interest obligations are known
amounts which can be forecasted and planned for.
 Interest on the debt can be deducted on the company's tax return, lowering the actual cost
of the loan to the company.
 Raising debt capital is less complicated because the company is not required to comply
with state and federal securities laws and regulations.
 The company is not required to send periodic mailings to large number of investors, hold
periodic meetings of shareholders, and seek the vote of shareholders before taking certain
actions.

5.5.2. Disadvantages of Debt Compared To Equity

 Unlike equity, debt must at some point be repaid.

 Interest is a fixed cost which raises the company's break-even point. High interest costs
during difficult financial periods can increase the risk of insolvency. Companies that are
too highly leveraged (that have large amounts of debt as compared to equity) often find it
difficult to grow because of the high cost of servicing the debt.
 Cash flow is required for both principal and interest payments and must be budgeted for.
Most loans are not repayable in varying amounts over time based on the business cycles
of the company.

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  Debt instruments often contain restrictions on the company's activities, preventing
management from pursuing alternative financing options and non-core business
opportunities.
 The larger a company's debt-equity ratio, the more risky the company is considered by
lenders and investors. Accordingly, a business is limited as to the amount of debt it can
carry.
 The company is usually required to pledge assets of the company to the lender as
collateral, and owners of the company are in some cases required to personally guarantee
repayment of the loan.

5.6. Factors Determining Capital Structure (debt equity ratio)

The key considerations in determining the debt equity ratio or capital structure are:

i) Earning Per Share: Earning per share is simply equity earnings divided by the
number of outstanding equity shares, is regarded as an important financial number
that firms would like to improve. Hence, we need to understand how sensitive is
earnings per share (EPS) to changes in profit before interest and tax(PBIT) under
different financing alternatives.
ii) Risk; concerns the deviation of one or more results of one or more future events from
their expected value. Technically, the value of those results may be positive or
negative. However, general usage tends to focus only on potential harm that may
arise from a future event, which may accrue either from incurring a cost ("downside
risk") or by failing to attain some benefit ("upside risk).The two principal sources of
risk in a firm are:
 Business risk
 Financial risk
a) Business risk: A business risk is a circumstance or factor that may have a negative
impact on the operation or profitability of a given company. Sometimes referred to as
company risk, a business risk can be the result of internal conditions, as well as some

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 external factors that may be evident in the wider business community. Business risk
can be brought by, demand variability, price variability, variability of input prices and
proportions of fixed assets.
b) Financial risk: It represents the risk emanating from financial leverage. When a firm
employs a high proportion of debt in its capital structure, it carries a high burden of
fixed financial commitments. Equity share holders, who have a residual interest in the
income and wealth of the firm are naturally exposed to the risk arising from such
fixed commitments. Equity share holders face this risk, also referred to as financial
risk, in addition to business risk. Generally, the affairs of the firm are, or should be
managed in the way that the total risk born by equity share holders is not unduly
high. This implies that if the firm is exposed to a high degree of business risk, its
financial risk should be kept low and vice versa.
iii) Control: The rights issue options severely limits the financing ability of the firm-the
present owners may lack resources or inclination or both-the options which may merit
serious considerations are debt capital and public issue of equity capital. In evaluating
the options, among other things, the issue of control is important.
iv) Flexibility: Flexibility for practical purpose means that the firm does not fully
exhaust its debt capacity. But differently, it implies that the firm maintains reserve
borrowing power to enable it to raise debt capital to fund unforeseen needs.
v) Nature of assets: The nature of a firm’s assets has an important bearing on its capital
structure. If the assets are primarily tangible (plant, machinery and buildings) and
have a liquid resale/secondary market, debt finance is used more. For example,
electric utility companies use more debt because their assets are mainly tangible,
physical in nature. on the other hand if the assets are primarily intangible(brands and
technical know-how),debt finance is used less. for example, software companies use
very little debt, as their assets are mainly intangible.
5.7. Situations that enforce a firm to use More Debt/ Equity

Use more equity when

 The corporate tax rate applicable to the firm is negligible.

 Business risk exposure is high.

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  Dilution of control is not an important issue.
 The assets of the firm are mostly intangible.
 The firm has many valuable growth options.
Use more debt when

 The corporate tax rate applicable to the firm is high.

 Business risk exposure is low.
 Dilution of control is an issue.
 The assets of the firm are mostly tangible.
 The firm has few growth options.

5.8. Menu of Financing:

Dear Students! Before you go through the following discussions try to define and explain menu
of financing and its components parts, their advantages and disadvantages in detail.

Project finance can be classified under two categories.

(i) Shareholders fund (Equity)

(ii) Loan funds (Debt)
The various forms of financing are given in the chart

Equity
capital

Preference
capital

Sources
of Term loans
Capital
Internal
Tilahun D. Page 61 Accruals

Debentures
A) Equity/Ordinary Shares

Equity share represent ownership capital and its owners- ordinary share holders/ equity holders-
share the reward and risk associated with the ownership of corporate enterprises. They are also
called ordinary shares in contrast with preference shares. However, their liability, unlike the
liability of the owner in a proprietary firm and the partners in a partnership concern, is limited to
their capital contributions.

Some terms:

1. Authorized Capital; the amount of capital that a company can potentially issue as per
its memorandum, represents the authorized capital.

2. Issued Capital: the amount offered by the company t o the investor called the issued
capital.
3. Subscribed Capital: that part of issued capital, which has been subscribed to by the
investors, represents the subscribed capital.
4. Paid up Capital: the actual amount paid up by the investors is called paid up capital.
5. Par value, issue price, Book Value and Market Value: The par value of an equity
share is the value stated in the memorandum and written on the share scrip. The par value
of equity shares is generally Br. 10, Br. 100.

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The issue price is the price at which the equity share is issued. Generally the issue price and par
value are and the same for new companies. An existing company may some times set its issue
price higher than the par value.

The Book value of an equity share is equal to

Paid up Equity capital + Reserves and Surplus – intangible
----------------------------------------------------------------------
No. Of outstanding equity shares
Quite naturally, the book value of an equity share tends to increase as the ratio of reserves and
surplus to paid up capital increases.
Market Value: Market value of an equity share is the price at which it is traded in the market.
This price can be easily established for a company, which is listed on the stock market and
activity, traded.

Advantages of Equity:

1. Equity shares do not create any obligation to pay a fixed rate of dividend.
2. Equity shares can be issued without creating any charge over asset of the company.
3. It is permanent source of capital and the company has not to repay it except under
liquidation
4. Equity share holders are the real owners of the company who have the voting rights
5. In case of profits, equity shareholders are the real gainers by way of increased dividends
and appreciation in the value of shares.
Disadvantages of Equity shares:

1. If only equity share are issued, the company cannot take the advantage of trading on
equity.
2. As equity capital cannot be redeemed, there is a danger of overcapitalization.
3. Equity shareholders can put obstacles in management by manipulation and organizing
themselves.
4. During prosperous periods higher dividends have to be paid leading to increase the value
of shares in the market and speculation.

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 5. Investors who desire to invest in safe securities with a fixed income have no attraction for
such shares.
A) Preference Shares
Preference share is a unique type of long term financing in that it combines some of the features of
equity as well as debentures. As a hybrid security or of financing:

• It carries a fixed/stated rate of dividend.

• It ranks higher than equity as a claimant to the income/assets.
• It normally does not have voting rights.
• It does not have a share in residual earnings/assets.

A preference share ordinarily does not carry voting rights. It is, however, entitled to every resolution
if:

• The dividend is in arrears for 2 years in respect of cumulative preference shares.

• The preference dividend has not been paid for a period of two/more consecutive preceding years
or for an aggregate period of three/more years in the preceding six years ending with the expiry of the
immediately preceding financial year.

Preference Share are of the Following Types

a) Cumulative preference shares: These shares have a right to claim dividend for those years also
subsequent years.
b) Redeemable Preference Shares: Normally, the capital of a company is repaid only at the time of
liquidation. Neither the company can return the share capital nor can the shareholders demand
its repayment. The company, however, can issue redeemable preference shares. In this case the
company has right to return redeemable preference share capital after a certain period.
c) Irredeemable Preference Shares: Those shares, which cannot be redeemed unless the company
is liquidated, are known as irredeemable preferences shares.
d) Participating Preference Shares: the holders of that share participate in the surplus profits of the
company. They are firstly paid a fixed rate of dividend and then a reasonable rate of dividend is
paid on equity shares. If some profit remains after paying both these dividends, then preference
shareholders participate in the surplus profits.

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 e) Non – Participating Preference Shares: The shares on which only a fixed rate of dividend is paid
are known as non – participating preference shares. These shares do not carry the additional
right of sharing profits of the company.
f) Convertible Preference Shares: The holders of the shares may be given a right to convert their
holdings into equity shares after a specific period. Theses are called convertible preference
shares.
g) Non – convertible preference shares: The shares, which cannot be converted into equity shares,
are known as non – convertible preference shares.
Advantages of Preference Shares:

1. There is no legal obligation to pay preference dividend the company does not face bankruptcy or
legal action if it skips preference dividend.
2. There is no redemption liability in the case of perpetual preference shares. Even in the case of
redeemable preference shares, financial distress may not much because (i) periodic sinking fund
payments are not required. (ii) can be delayed without significant penalties.
3. Preference capital is generally regarded as part of net worth. Hence, it enhances the credit
worthiness of the firm.
4. Preference shares do not, under normal circumstances, carry voting rights. Hence, there is no
dilution of control.
5. No collateral is pledged in favor of preference shareholders. Hence, the mort gable assets of the
firm are conserved.
Shortcomings of the Preference Share Capital:

1. Compared to debt capital, it is said to be a more expensive sourer of financing because

the dividend paid to preference shareholders is not, unlike debt interest, a tax –
deductible expense.
2. Though there is no legal obligation to pay preference dividends, skipping them can
adversely affect the image of the firm in the capital market.
3. Compared to equity shareholders, preference shareholders have a priority claim on the
assets and earnings of the firm.
4. If a firm skips preference dividends for three years, it has to grant voting rights to the
preference shareholders, on matters affecting them.

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 B) Term loans:
The term loans given by financial institutions and banks have been the primary source of long
term debt for private firms and most public firms. Terms loans, also referred to as term finance,
represent a source of debt finance, which is generally repayable in less than 10 years. They are
employed to finance acquisition of fixed assets and working capital margin. Term loans differ
from short-term bank loans, which are employed to finance short-term working capital need and
tend to be self-liquidating over period of time usually less than one year.

Features of term loans:

The following features of term loans may be discussed.

Currency: financial institutions give Birr term loans as well as foreign currency term loans. The
most significant form of assistance provided by financial institutions’ Birr term loans are given
directly to industrial concerns for setting up new projects as well as for expansion, modernization
and renovation of projects. These funds are provided for incurring expenditure for land, building,
plant and machinery, technical know-how, miscellaneous fixed assets, preliminary expenses,
preoperative expenses, and margin money for working capital.

Financial institutions provide foreign currency term loans for meeting the foreign currency
expenditure towards import of plant, machinery and equipment, and payment of foreign technical
know –how fees. The periodically liability for interest and principal remains in the
currency/currencies of the loan and is translated into Birr at the prevailing rate of exchange for
making payments to the financial institutions.

Security: Term loans typically represent secured borrowings. Usually assets, which are financed
with the term loan, provide the prime security. Other assets of the firm may serve as collateral
security.

Interest Payment and Principal Payment: the interest and principal repayment on term loans
are definite obligations that are payable irrespective of the financial situation of the firm. To the
general category of borrowers, financial institutions charge an interest rate that is related to the
credit risk of the proposal, subject usually to a certain floor rate.

Tilahun D. Page 66
The principal amount of term loan is generally repayable over a period of 4 to 7years hereafter
the initial grace period of 1 to 2 years. Typically, term loans provided by financial institutions are
repayable in equal semi-annual installments or quarterly installments.

Term loan Procedure:

The procedure associated with a term loan involves the following steps;

 Submission of loan application

 Initial processing of Loan Application
 Appraisal of the Proposed Project
 Issue of the Letter of sanction
 Acceptance of the Terms and Conditions by the Borrowing Unit
 Execution of Loan Agreement
 Creation of security
 Disbursement of loans
 Monitoring
D. Debenture/ Bonds/ Notes

Promissory note, debenture / bonds, represent Creditors hip securities and debenture holders are
long term creditors of the company. As a secured instrument, it is a promise to pay interest and
repay principal at stipulated times. In contrast to equity capital, which is a variable income
(dividend/ security, the debenture / notes are fixed income (interest) security.

A fixed rate of interest is paid on debentures. The interest on debenture is a charge on the profit
and loss account of the company. These debentures are generally given a floating charge over the
assets of the company. When the debentures are secure, they are paid on priority in comparison
to all other creditors.

Types of Debentures:

 Simple, Naked or unsecured Debentures

 Secured or Mortgaged Debentures
 Bearer Debentures

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  Registered Debentures
 Redeemable Debentures
 Irredeemable debentures
 Convertible Debentures
 Zero interest debentures
 Guaranteed debentures
 Collateral Debentures
Advantages of Debentures:

1. Debentures provide long-term funds to a company

2. The rate of interest payable on debentures is usually, lower than the rate of dividend paid
on shares
3. The interest of debentures is a tax-deductible expense and hence the effective cost of
debentures is lower as compared to ownership securities where dividend is not a tax-
deductible expense.
4. Debt financing does not result into dilution control because debenture holders do not
have any voting rights
5. A company can trade on equity by mixing debentures in its capital structure and there by
increase its earning per share.
6. Many companies prefer issue of debentures because of the fixed rate of interest attached
to them irrespective of the changes in price levels.
7. Debentures provide flexibility in the capital structure of a company as the same can be
redeemed as and when the company has surplus funds and desires to do so.
Limitations of Debentures:

1. The fixed interests charges are repayment of principal amount on maturity legal
obligations of the company. These have to be paid even when there are no profits.
2. Charges on the assets of the company and other protective measures provided to investors
by the issue of debentures usually restrict a company from using this source of finance.
The company cannot raise further loans against the security of assets already mortgaged
to debenture holders.

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 3. The use of debt financing usually increases the risk perception of investors in the firm.
This enhanced financial risk increases the cost of equity capital.
4. Cost of raising finance through debentures is also high because of high stamp duty
5. A company who’s expected future earnings is not stable or who deals in products with
highly elastic demand or who does not have sufficient fixed assets to offer as security to
debenture holders cannot use this source of raising funds to its benefit.
E. Working Capital Advance:

Working capital advance by commercial banks represents the most important source for
financing current assets.

Forms of Bank of Finance:

Working capital advance is provided by commercial banks in three primary ways;(i) cash
credit / Overdrafts,(ii) loans, and (iii) purchase/discount of bills. In addition to these
direct forms, commercial banks help their customers in obtaining credit from other
sources through the letter of credit arrangement.

Miscellaneous Sources:

Apart from the above-mentioned sources of finance, there are several other ways in
which finance may be obtained. These include:

Deferred Credit: Many times the suppliers of machinery provide deferred credit facility
under which payment for the purchase of machinery is made over a period of time. The
interest rate on deferred credit and the period of payment vary rather widely. Normally,
the supplier of machinery when he offers deferred credit facility insists than the buyer
should furnish a bank guarantee.

Lease finance: A lease finance represents a contractual arrangement whereby the lessor
grants the lessee the right to use an asset in return for periodic lease rental payments.
While leasing of land, buildings and animals has been known from times immoral, the
leasing of industrial equipments is a relatively recent phenomenon.

Hire Purchase agreement: The hire purchases the asset and gives it on hire to the hirer

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 The hirer pays regular hire purchase installments over a specified period of time. These
installments cover the interest as well as principal repayment. When the hirer pays last
installment, the title of the asset is transferred from the hire to the hirer. The hire charges
interest on flat basis.

Unsecured Loans: The promoters to fill the gap between the promoter contributions
required institutions typically provide unsecured loans and the equity capital subscribed
to by the promoters. These loans are subsidiary to the institutional loans.

Deposits: deposits from the public, referred to as public deposits, represent unsecured borrowing
of one to three years duration. Many existing companies prefer to raise public deposits instead of
term loans from financial institutions because restrictive covenants do not accompany public
deposits

Chapter 6
Project Management
Introduction
Project management can be defined as the process of controlling the achievement of the
project objectives. Utilizing the existing organizational structures and resources, it seeks
to manage the project by applying a collection of tools and techniques, without adversely
disturbing the routine operation of the company.
The function of project management in defining the requirement of work, establishing the extent
of work, allocating the resources required, planning the execution of the work, monitoring the
progress of the work and adjusting deviations from the plan.
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 analyze 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.

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 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
minds 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.

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.

6.1. Projects Planning and Scheduling

The act of planning, in essence, is about the creation of a plan and that plan can be a diagram, a
table of figures, a programme of dates or a sequence of actions. From a system point of view,
management must make effective utilization of resources.

 Banchart/Gantt chart
 Network model
Gantt Chart. Henry Gantt (1861 – 1919) designed the barchat as a usual aid for planning and
controlling his ship building projects. Gantt chart has a horizontal time scale and a vertical list of
activities and a series of horizontal lines or bars with one for each activity. The following is an
illustration of a Gantt chart for construction of a house.
(1)
Activity (2) Mon Tue Wed Th Fr Sat Sun Mon Tue Wed Th Fri Sat Sun Mon
Description 1 2 3 u i 6 7 8 9 10 u 12 13 14 15
4 5 11

Lay Foundations (4)

Build Walls (3)

Install Roof (5)

Tilahun D. Page 71
 Time
now
The scheduling of each activity is represented by a horizontal line, from the activity start to
finish date. The length of the activity line is proportional to its estimated duration.

Gantt further used this bar chart to track progress by drawing a second line alongside the planned
schedule to indicate work done (4). The relative position of the progress line to the planned line
indicated percentage complete and remaining duration, while the relative position between the
progress line and the time now (5) indicated actual progress against planned progress.

Network Model: The network diagram is referred to as the project graph, shows the activities
and events of the project and their logical relationships.

Example: A simplified network diagram for a dinner project:

Send invitation (2)

Receive guests
(1)

Prepare dinner (3) (4)

Take dinner

The network diagram is constructed in terms of activities and events. An activity is a definite
task, job or functions to be performed in a project.

For example, in the above diagram, prepare dinner is an activity. An activity is represented by
an arrow. The head of the arrow marks the completion of the activity and the tail of the arrow
marks its beginning. (The length and ‘compass’ direction of the arrow has no significance.)

An event is a specific point in time indicating the beginning or end of one or more activities. It
represents a milestone and does not consume time or resources. For example, event 2 in the
previous network diagram marks the completion of the activity ‘send invitation’.

Once the activities are enumerated it is necessary to define for each activity, the activities which
precede it, the activities which follow it, and the activities which can take place concurrently.

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