Project Appraisal

Swagat Kishore Mishra

Department of Economics and Finance
WILP: Project Appraisal
Lecture 9 (Revision)
Email: swagat@goa.bits-pilani.ac.in
Tel. 0832-2580207 (O) 08879506995 (M)

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Course No. ETZC414 Project Appraisal

Outline

Introduction
Investment Analysis
Capital Investments
Project Cycle
Capital Budgeting
Appraisal of Scheme
Issues in Project Appraisal
Key Words

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 In Engineering Economics:
project is an activity that involves the use of scarce
resources during a specific time period for the
purpose of generating socioeconomic return in
the form of goods and services

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Role of Government
Government develops and evaluates investment
projects to promote economic and social wellbeing.
It describes how public sector investments should
be evaluated so that they may be taken from the
idea stage to the implementation phase in a
successful manner.
These themes are addressed under three
headings: financial, economic, and distributional
analysis of a project.
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Investment Analysis
Project as an Incremental Activity
An investment opportunity usually involves
incremental net cash outflows or economic costs
in the initial investment or construction phase
followed by incremental net cash inflows, or net
economic benefits, in the operating phase.

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 An incremental net cash flow refers to the net

cash flow, or net economic benefit that occurs
with a project minus the net cash flow, or net
benefit that would have occurred in the absence
of the project.

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 In this way, it is possible to identify the additional

net cash flow, or net economic benefit that is
expected to arise as a result of an additional or
new investment through a project and to
measure the corresponding change in wealth, or
in economic well being that can be attributed to
it.

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Exogenous Parameters
Uncertainty and Contractual Arrangements
Financial, economic and distributive analyses is
not the complete picture.
Uncertainty prevents an analyst from precisely
identifying the time path of the net cash flows or
net benefits.
The anticipated benefits and costs are likely to lie
in a given range with a given probability.
The output of a project appraisal is more than
just a point-estimate of a projects net return.
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 A project evaluation should provide some

assessment of the expected variability of a
projects net return, the probability of a negative
return, the cost of risk and who is likely to bear it.
There is also a need to know and understand a
projects contractual environment. For example,
there may be alternative financing arrangements
that would help to redistribute some of the risk and
make a project more attractive.

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 Or there may be contracts that project managers

enter into with its customers/end users or its
suppliers.
These different arrangements could also create
incentives or disincentives that would encourage
a projects participants to alter their behavior and
change the overall returns.

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Capital Investments
Importance: long term effects, irreversibility and
substantial outlay
Difficulties: measurement problems, uncertainty
and temporal spread
Types of capital investment: physical, monetary
and intangible assets

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Issues in Project Appraisal

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Key Words

PROJECT APPRAISAL
INVESTMENT ANALYSIS
FISCAL MANAGEMENT CRIETERIA
PROJECT MANAGEMENT
CAPITAL BUDGETING

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Outline

Introduction: Strategy and Resource Allocation

Corporate Capital
Allocation of Corporate Capital
Portfolio Planning Matrices

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Market Growth Rate

The Boston Consulting Groups GrowthShare Matrix

20%18%16%14%12%10%8%6%4%2%0

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Stars

Question marks

?2

Dogs

Cash cows

1
8

6
10x 4x 2x 1.5x 1x

.5x .4x .3x .2x .1x

Relative Market Share

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SPACE Approach
Strategic Position and Action Evaluation Matrix
SPACE Analysis is a systematic appraisal of four key
issues that balance the external and internal factors
that should determine the general theme of the
strategy:
External
i.
ii.

Industry Attractiveness
Environmental Stability

Internal
i.
ii.

Competitive Advantage
Financial Strength

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 Financial Strength is scored 6

great to 1 poor in the SPACE
Analysis Matrix
Competitive advantage is scored 1 (minus 1) great to 6 (minus 6)
poor
Industry attractiveness is scored 6
great and 1 poor in the SPACE
analysis matrix
Environmental stability is scored
1 (minus 1) great to 6 (minus 6)
poor
This diagram shows that the firm is in a very favorable position and is able to
take an aggressive growth strategy. It is operating in an attractive and stable
industry and has major competitive advantages backed up by significant
financial strength.
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Key Words

Resource allocation framework

Resource allocation strategies
Portfolio planning tools
Strategic planning and Capital budgeting

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Outline

Generation and Screening of Project Ideas

SWOT Analysis
Monitoring the Environment
Corporate Appraisal
Porter Model on Profits Potential of Industries
Project Screening and Rating Index
Key Words

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Corporate Appraisal
i.
ii.
iii.
iv.
v.
vi.
vii.
viii.
ix.

Searching for New Project Ideas

Study the Existing Industries
Observe the Inputs and Outputs of Various Industries
Analysis of Imports and Exports
Study of Economic and Social Trends
Observe New Technologies
Identifying Psychological Needs
Study the Government Guidelines and
Recommendations for Financial Institution

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Screening Process
i.
ii.
iii.
iv.
v.
vi.

Acceptable Risk Level

Reasonability of Costs
Compatibility with Promoter
Consistency with Government Priorities
Availability of Inputs
Adequate Market Demand

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A view of Porters model

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Key Words

PROJECT IDEA
DELPHI TECHNIQUE
SWOT ANALYSIS
ECONOMIES OF SCALE
SCREENING OF PROJECTS
MICHAEL PORTER MODEL

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Outline

Introduction
Situational analysis
Secondary information collection
Demand forecasting
Uncertainties
Market planning

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Institutional financial markets regulate

Corporate sector

Efficient and stable financial systems are essential for both emerging
markets and low-income developing economies to achieve long-term
balanced development and to absorb various types of shocks. Emerging
market financial systems, including those in Asia, generally have proven to
be more robust and less affected by the global turmoil compared to their
advanced economy counterparts. Governance issues in financial
institutions differ from those in non-financial companies, but are at least
as relevant:
Financial institutions are charged with upholding the public's trust and
protecting depositors. Balance sheets are more opaque, leading to less
transparency and greater ability to conceal problems.
Financial institutions are uniquely vulnerable to liquidity shocks which can
result in institutional, and potentially, financial instability. Sound
governance supports prudential supervision and regulation, enhancing the
role and the effectiveness of the financial institution supervisor.

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Situational Analysis
a. Situation analysis framework (SAF) is an analytical and
planning method commonly used in PRCA and
communication programme planning and implementation.
SAF is adapted from the Logical Framework Approach (LFA)
and the Objective Oriented Project Planning (OOPP).
Participatory Rural Communication Appraisal

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SAF is therefore an analytical and organizational technique that

can facilitate the whole communication strategy design process.
It is particularly useful for the following specific phases of the
communication programme:
1. Preliminary assessment of the situation, as perceived by planners and
project management, of an on-going project to provide a common framework
for identifying and understanding the project's goal, problems, objectives and
beneficiaries. This is done before the PRCA in order to have a better picture of
the current situation of the project.
2. During field PRCA, SAF, especially the problem tree, is used in a participatory
manner with the project beneficiaries to identify and carry out a cause-effect
analysis of the main problems the project is addressing in the community. This
exercise helps in the identification and selection of the priority focal problems
the communication strategy will address.

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 3. During communication strategy design, SAF provides a

framework for the organization and management of the
various elements that form the strategy such as the
communication objectives, outputs, activities and inputs.

4. During the planning of the implementation phase of the

communication programme, SAF provides the framework for
identifying and incorporating indicators for the monitoring
and evaluation of the programme

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The major components of SAF are the following:

Stakeholders (traditionally referred to as beneficiaries): These are the people the

project is trying to involve and assist through its activities. As the term implies
stakeholders are those people in the rural communities who have a specific interest in
solving the problem or improving the situation.
Development problem: Also sometimes labelled the grand-problem, this defines a
major undesired and negative situation affecting a large number of people. Projects are
normally formulated as ways of reducing specific aspects of a development problem.
Thus, a development problem can include a number of different problems and issues
being tackled by various projects.
Project goal: This is a statement of the overall aim of the project. It describes what the
project aims to achieve by addressing the development problem. The goal provides the
overall justification for the very existence of the project. It is also called the aim or
development objective.
Main problems: These are major specific problems or the undesired situation the
project is specifically addressing. Main problems are derived from the development
problem. They are the major causes of the development problem, or issues related to
it. The definition of the main problems provides the boundaries within which the
project can act..
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Project objectives: Also known as immediate objectives, these indicate what the
project aims to specifically accomplish in relation to the main problems and as a
contribution to the achievement of the project goal.
The problem tree: This important tool assists in the cause-effect analysis of a
situation. The problem tree is the starting point of SAF as all the other components
of the framework are derived from it. The rationale and how to develop a problem
tree will be discussed in greater detail in the next section and in the Toolbox.
Focal problems: Often referred to as root-problems, these are factors causing part
or most of the main problem. This handbook will concentrate only on those focal
problems that can be directly solved through a communication intervention. In
order to identify focal problems it is necessary to carry out a cause-effect analysis
of the situation, usually starting from the main problem. Focal problems are
derived through the drawing and analysis of the problem tree.
Communication objectives: These indicate what the communication intervention
aims to accomplish, specifically in relation to the focal problem and as a
contribution to the achievement of the project goal. The communication
objectives are derived from the problem tree by rewording the focal problems as
desirable states and/or as solution- oriented statements. Each communication
objective should be expressed in a SMART manner with a specific timeframe for its
achievement.

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Objectives of market and demand analysis for a product/service:

Who are buyers?

Total current demand?
Distribution of demand temporally and geographically?
Break-up of demand?
Customers willingness to pay?
Potential customers and quality of product?
Price and warranty?
Prospects of immediate sales?

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Market Planning

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Key Words

Situational analysis
Secondary information collection
Demand forecasting
Uncertainties
Market planning

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Outline

Introduction to Technical Analysis

Significance: Case Study from Road Construction
Choice of Technology
Material Inputs & Utilities, Machineries &
Equipment, Alternatives for Concrete Project
Making

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General Project Analysis

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Projects Technical Analysis

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Social and Distributional Impacts (SDI)

http://www.dft.gov.uk/webtag/documents/pr
oject-manager/unit2.13.php#013

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Key Words

Technical analysis
Social and distributional impacts
Choice of technology
Material inputs
Utilities

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Outline

Introduction: Demand for Money

Time value of money
Future value of a single amount
Present value of a single amount
Future value of an annuity
Present value of an annuity
Discounting

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Demand for money:

To settle transactions, since money is the medium of
exchange.
As a precautionary store of liquidity, in the event of
unexpected need.
To reduce the riskiness of a portfolio of assets by
including some money in the portfolio, since the
value of money is very stable compared with that of
stocks, bonds, or real estate.
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Key Words

Demand for money

Time value of money
Discounting
Simple interest
Compound interest
Annuity

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Outline

Introduction
Financial Estimates
Cost of the Project: Project cost estimate
Means of Finance
Cost of Production
Working capital requirement
Financing for working capital

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Financial Estimates
For financial aspects one must consider:
i. Cost of project
ii. Means of financing
iii. Estimates of sales and production
iv. Cost of production
v. Working capital requirement and its financing
vi. Profits projections
vii. Break-even point
viii. Projected cash flow statements and balance sheets
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Project Cost Estimate

The Project Cost Estimate Table shows the total cost of a
project and incorporates all elements in a manner that is both
explicit and meaningful.
It provides an understanding of the costs of the principal
components as at the date of appraisal.
Equally it provides information for project cost control during
implementation by the borrower, the EA and the Bank.

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PROJECT COST ESTIMATE TABLE

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Key Words

Financial Estimates
Cost of the Project: Project cost estimate
Means of Finance
Cost of Production
Working capital requirement
Financing for working capital

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Outline
COST OF CAPITAL
CAPITAL STRUCTURE OF FIRM
COST OF DEBT
COST OF EQUITY
WEIGHTED AVERAGE COST AND MARGINAL COST

FINANCIAL STRUCTURE
The term financial structure is different from the capital structure.
Financial structure shows the pattern total financing.
It measures the extent to which total funds are available to finance
the total assets of the business.

Financial Structure = Total liabilities

Or
Financial Structure = Capital Structure + Current liabilities

Finance Vs Capital

There are two major theories explaining the

relationship between
capital structure,
cost of capital and
value of the firm.

Working Capital
Working capital is the capital which is needed to meet the day-to-day
transaction of the business concern.
It may cross working capital and net working capital. Normally working
capital consists of various compositions of current assets such as inventories,
bills, receivable, debtors, cash, and bank balance and prepaid expenses.

Capitalization
Capitalization refers to the process of determining the
quantum of funds that a firm needs to run its business.

Capitalization is only the par value of share capital and

debenture and it does not include reserve and surplus.
According to Guthman and Dougall, capitalization is the
sum of the par value of stocks and bonds outstanding.
Capitalization is the balance sheet value of stocks and
bonds outstands.
Bonneville and Dewey

According to Arhur. S. Dewing, capitalization is the sum

total of the par value of all shares.

THANK
YOU
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