Investment

Project Design
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 Investment
Project Design

A Guide to Financial
and Economic Analysis
with Constraints

LECH KUROWSKI
DAVID SUSSMAN

John Wiley & Sons, Inc.

Copyright 
C 2011 by Lech Kurowski and David Sussman. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.

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Library of Congress Cataloging-in-Publication Data:

Kurowski, Lech.
Investment project design : a guide to financial and economic analysis with constraints/
Lech Kurowski, David Sussman.
p. cm. – (Wiley finance series)
Includes bibliographical references and index.
ISBN 978-0-470-91389-5 (cloth)
1. Capital investments—Evaluation. 2. Investment analysis. 3. Industrial development
projects—Finance. 4. Infrastructure (Economics)—Finance. 5. Project management—
Finance. I. Sussman, David (David Louis) II. Title.
HG4028.C4K867 2011
658.15 2–dc22
2010037958

Printed in the United States of America

10 9 8 7 6 5 4 3 2 1
 To
Zosia Kurowska and Claire Sussman
for their lifetimes of support
 Contents

Acknowledgments xi

Symbols and Most Frequently Used Acronyms xiii

Introduction 1
CHAPTER 1
Investment Environment 9
Systematic Project Analysis 10
Project Environment and Strategy 11
Project Development Process 33
Planning Horizon and Project Life 43
Project Scope 44
Preinvestment Studies 46
Investment Planning Infrastructure 58
Appendix 1.1: Elements of Commercial and
Wider Domains 60
Appendix 1.2: Outline of Business Plan for a
Manufacturing Enterprise 62
Appendix 1.3: Outline of Design/Study Report 63
Appendix 1.4: Information Flow Details 67
Notes 69
References 74

CHAPTER 2
Preparing Pro-Forma Financial Statements 75
Accounting System 77
Process of Financial Analysis 81
Financial Costs and Benefits 84
Investment Costs 87
Production Cost 116
Operating Cost, Factory Cost, and Cost of Product Sold 122

vii
viii CONTENTS

Financial Statements 127

Appendix 2.1: Depreciation Methods 142
Appendix 2.2: Starting Inventory Balance 148
Notes 150

CHAPTER 3
Financial Indicators and Criteria 155
Static Indicators 155
Types of Static Indicators 156
Dynamic Indicators 169
Financial Criteria for Investment Decisions 188
Analysis of Joint Ventures 203
Project of an Ongoing Enterprise 206
Appendix 3.1: Example of Cost of Capital Calculations 219
Notes 225
References 228

CHAPTER 4
Financing the Project 231
Capital Structure 232
Cost of Capital 249
Notes 255
References 256

CHAPTER 5
The Economic Perspective 257
Private Sector 259
Public Sector 259
General Rationale for Economic Evaluation—Who
Needs It? 260
Macroeconomic View—Impact on the
National Economy 262
Price Distortions 266
Applicability and Scope 272
Economic Pricing Principles 278
Shadow Prices of Primary Resources
(National Parameters) 292
Conversion and Adjustment Factors 297
Appendix 5.1: Costs and Benefits of Revenue Projects 299
Contents ix

Appendix 5.2: Global Pricing Framework—Importable

Input Forgone 301
Notes 303
References 307

CHAPTER 6
Economic Cost/Benefit Analysis 309
Adjustments for the Wider Domain 311
Valuation at Market Prices 311
Define the Accounting Unit 317
Value-Added 343
Notes 354
References 358

CHAPTER 7
Investment Decisions under Uncertainty and Risk 359
Forecasting 359
Risk—Dealing with Uncertainty 364
Quantitative Risk Assessment 369
Qualitative Risk Assessment 380
Risk Management 380
Risk Immunization for Financiers 383
International Investors and Risk 385
Appendix 7.1: Discrete Probability Analysis—Multivariate 386
Notes 387
References 390

CHAPTER 8
Project Appraisal 391
Macro-Micro Appraisal 392
SWOT Analysis 393
Stakeholder Perspectives 396
Appraisal Report 399
Caveats for the Appraiser 406
Notes 407
References 408

CHAPTER 9
Implementation Planning and Budgeting 409
Implementation Planning 410
Project Management 412
x CONTENTS

Conducting the Implementation Project 416

Implementation Budget 437
Appendix 9.1: Sample Responsibility Matrix for a
Portion of a Project 438
Appendix 9.2: Checklist of Project Implementation Costs 438
Notes 442
References 443

About the Authors 445

Index 447
 Acknowledgments

he foundation for our approach to project design and appraisal consists

T of ideas and concepts developed from our own work over the course of
the past 25 years, and interactions with fellow consultants and others with
whom we have collaborated, who graciously shared their knowledge and
experiences through informal discussions and communications and formal
presentations, and who have added immeasurably to the scope and depth
of our effort. Their knowledge and experience in their respective areas of
expertise has fused with that of the authors, so it is possible to identify only
approximately the areas of contribution of each of the following individuals,
to whom we are deeply indebted (listed in alphabetical order):
Jadranko Bendekovic, the economic viewpoint, particularly the value-
added approach; Janusz Lukasik, forecasting and the basic idea for the
expansion project case study; Andrzej Mlotkowski, project planning, im-
plementation, and contracting; Joseph Moongananiyil who coordinated the
work of the staff of the Enterprise Development Institute in Ahmedabad, In-
dia, with whom the authors communicated on a wide variety of topics; Klaus
Pertz, financial analysis; Reino Routamo, concepts of futuristic forecasting
and the basic idea for the yarns case study; Maria Elena Scaffo, market
analysis and finance; Aleksander Sulejewicz, who contributed widely to the
chapter on economic analysis; Robert Youker, who greatly influenced the
presentation on project implementation and management; and Allan Young,
project finance, financial planning, and risk. Jerzy Kurowski is responsible
for much of the preparation of graphical materials. Michael Lisk, produc-
tion editor at Wiley, was instrumental in integrating, organizing, and adding
to the coherence of the manuscript.
Although this edition owes much of its usefulness to contributions of
the aforementioned individuals, the authors are solely responsible for any
errors and omissions.

xi
 Symbols and Most Frequently
Used Acronyms

he symbols described below are consistent with international usage. They

T are, however, used in different contexts and consequently might have
slightly different meanings in the main text. The exact meaning is indicated
by the subscript—for example, i(disc) and i(infl) indicate the discount rate and
the inflation rate, respectively, whereas “i” alone is used to mean interest
rate.

Financial Symbols
BEP breakeven point
COPS cost of products sold
COT coefficient of turnover (working capital)
df discount factor, expressed as percentage
EBITDA earnings before interest, taxes, depreciation and amortization
F fixed cost (total)
f fixed cost of production, subscript denotes related resource
FC factory costs
FV future value
i rate (interest, profit expectations, inflation), expressed as
percentage
I investment
IN inventory
IRR internal rate of return
j used as subscript; depending on context, describes year
number, product number, input number, and so on
MIRR modified internal rate of return (expressed as percentage)
n number of periods, products, and so on
NCF net cash flow
NPV net present value
P production
p market price (product, input, etc.)
PC production costs
PV present value

xiii
xiv SYMBOLS AND MOST FREQUENTLY USED ACRONYMS

Q, q quantity, unit quantity (e.g., consumption of resource per unit

of production)
R project revenues (sales)
ResV residual value
RoI, RoE return on investment, return on equity
T tax rate (corporate, income) (expressed as percentage)
V value
v unit variable cost
WACC weighted average cost of capital (expressed as percentage)
WCap working capital
WiP work-in-progress
wj weight of factor j

Economic Symbols
ADJ adjustment value (difference between adjusted value and
original value)
AF adjustment factor (expressed as percentage)
AU accounting unit
AV j values adjusted for distortions of factor j
Cc market cost of capital
CF conversion factor (expressed as percentage)
CIF cost, insurance, and freight
CRI consumption rate of interest
EDR economic discount rate
EIRR economic internal rate of return (expressed as percentage)
FE foreign exchange
FOB free on board
FX foreign exchange
GDP (GNP) gross domestic (national) product
I investment (or capital consumption when indicated)
M imports
MI material inputs
MPS marginal propensity to save
MV market value
NFIA net factor income from abroad
NNI net national income
OER official exchange rate
RP repatriated payments
SCF standard conversion factor (in some methodologies, equal to
OER/SER)
Symbols and Most Frequently Used Acronyms xv

SER shadow exchange rate

SP j shadow price (for factor j)
SWR shadow wage rate
VA value added
VDR value with distortions removed
VEF value at efficiency priced
W wages and salaries
WTP willingness to pay
X exports