Introduction: Concept of Project Analysis 43

substitution method. The process of

solution involves two steps:
(i) Express one of the variables in terms
of the variables in the constrained
equation for one of the variables (X or
Y).
(ii) Substitute the solution to the
objective functions to be maximized and
solve for the other variable.
Given the constraint in equation (2),
the values of X and Y could be expressed
in terms of one another as follows:
X=30-Y
or Y=30-X
We can now substitute the value of X (or
Y) in equation (1) and find the
maximization solution.
By substituting the value of X, the profit
function equation
(1) could be expressed as:
Π = 100 (30-Y)-2(30-Y)2 -(30-Y)Y+180Y-4Y
= 3,000- 1OOY-2(900-60+Y2)-30-Y2+180Y-4Y2
= 3,000-100Y-1,800+120Y-2Y2-30Y+Y2+180Y-4Y
= 1,200+170Y-5Y2
Note: The substitution method
converts a constrained problem into
an unconstrained one. Equation (3)
could now be maximized by obtaining
 Project Analysis and Evaluation: Principles & Techniques
its derivative and setting it equal
to zero and solving for Y.
Thus: ∂ Π/ ∂Y = 170-IOY

By setting equation (4) to zero, we have:

170-IOY=O
Y = 17
By substituting 17 for Y in the constrained
equation (2), we get:
x + 17 = 30
x= 13
Thus, the optimum solution of the profit maximization
problem is X = 13 and Y = 17. These values of X and Y
satisfy the constraint. In simple words, we get the
optimization solution that the firm maximizes its profit by
producing 13 units of X and 17 units of Y. The answer will
be the same if we substitute 30 —X for Y in equation (1)
and solve the equation for X.
We will now compute the maximized profit under
constraint, which would be done by substituting the values
of X and Y for the profit function in equation (1). By
substitution, we have 11 = 100 (13) -2 (13)2 - (13) (13) +
180 (17) - 4 (17)2 = 2,697
Now, the maximum profit (2,645) under constraint is less
than the maximum profit under no constraint (2,800).
Constrained Cost Minimization
The substitution method of optimization can now be
applied to a problem of constrained cost minimization.
Suppose the cost function of a firm producing two goods,
 Introduction: Concept of Project Analysis 45
2 2
X and Y, is given as TC = 2X — XY + 3Y , and the firm
has to meet a combined order of 36 units of the two
goods. The manager's problem is to find an optimum
combination of X and Y that minimizes the cost of
production. The problem could be restated formally as:
Minimize TC = 2X2 – XY + 3Y2 ……………..(1)
Subject to X + Y = 36 .............................................(2)
By expressing X in terms of Y, we have:
X=36-Y

By substituting equation (3) for X in the objective

function
in equation (1) we get:
TC = 2 (36-Y)2(36-Y)Y+3Y2
= 2(1,296 - 72Y + Y2)- 36Y+Y2+3Y2 ………(3)
= 2,592-144Y- 2Y2- 36Y+ Y2 +3Y2
= 2,592-180Y-6Y ……………..(4)

For the objective function in equation (4) to be

minimized, its first derivative must be set at zero.
i.e., ∂ TC/ ∂Y = 180 + 12Y = 0 ………………(5)

Solving equation (5) for Y will give

12Y= 180

Y =15
 Project Analysis and Evaluation: Principles & Techniques
By substituting the value of Y in the
constrained equation
(2), we get:
X + 15=36
x = 36- 15
x = 21.
Thus, the optimum solution that X = 21 and Y = 15
minimizes the cost of meeting the order. The
minimum cost of producing 21 units of X and 15
units of Y could be obtained by substituting these
values in the cost function of equation (1) Minimum
cost = 2 (21)2 - (21) (15) = 43 (14)2 = 88-315 + 675
= 1242
Given that the cost function of a firm is:
TC = 3X2 -XY + 2Y2
and the form has to meet a combined order of 50 units
of two goods X and Y The problem is to find an
optimum Combination of X and Y that minimises the
cost of production.
 Introduction: Concept of Project Analysis 47
The problem could be restated formally as:
Minimize
TC=3X2 -XY+2Y2 . . . .
Subject to X + Y = 50 .
By expressing X in terms of Y will give:
X=50-Y................................................... (3)
By substituting Equation (3) from X in the objective
function in Equation (1) will give:
TC = 3 (50 -Y)2 (50 -Y) + 2y2
= 3 (2500 -100Y + Y) – 50Y+Y2+ 2y2
= 7500-350Y+6Y2 (4)

for the objective function eq. (4) to be minimized, its first

derivative must be set to Zero
i.e ∂ TC/ ∂Y = -350+ 12Y (5)

Solving Equation (5) for y in Equation (3), we get:

12Y = 350
Y = 29.17

By substituting the value of Y in the Constraint Equation

(2) we have:
x + 29.17 = 50
X = 50 - 29.17

x = 20.83

Thus, we have the optimum solution that X = 20.83 and

29.17 minimizes the cost of meeting the order. The
minimum cost of producing 20.83 units of X and 29. 17
 48 Project Analysis and Evaluation: Principles & Techniques
units of Y could be obtained by substituting these values
into the cost function in Equation (1)
Minimum Cost = 3(20.83)2 – (20.83)(29.17) +
2(29.17)2 + 2(29.17)2
= 1301.67-607.61+1701.78
= 3003.45 - 607.61
= 2395.84

Constrained Optimization by the

Lagrangian Multiplier Method
The other method of solving constrained
optimization problems is the Lagrangian
multiplier method. This method is used to
solve the optimization problems of a
complex nature and those which cannot be
solved by the substitution method.
Let us now illustrate the Lagrangian
multiplier method in respect of
(i) a constrained profit
maximization problem (ii) a
constrained cost minimization
problem.

Constrained Profit Maximization

Example 1

Given the profit function as:

P = 100X – 2X2 – XY + 180Y-4Y2

(1)
Subject to the constraint: X + Y = 30 (2)
 Introduction: Concept of Project Analysis 49
The basic approach of the Lagrangian
multiplier method is to form a Lagrangian
function and the constraint equation and then
solve it by the partial derivative method.
There is a simple technique of formulating
the Lagrangian function.

(1) Set the constraint equation (2) as

equal to zero
i.e., X+Y-30 = 0
(2) Multiply the resulting equation by
é (the Greek letter lambda)
i.e., λ( X+Y = 30)

3) Add the resulting equation to the

objective function.
Thus, the Lagrangian function is
formed as
Ln= 100X- 2X2 - XY + 180Y - 4Y2 + λ(X-
Y-30) ............ (3)
Equation (3) is the unconstrained
Lagrangian function with
three unknowns, X, Y and λ. The
values of X, Y and ë that maximize Ln
also maximize π. The Greek letter ë
is the Lagrangian multiplier. It
gives the measure of a small change
in the constraint on the objective
function.
What we need to do to maximize the Ln
function in equation(3) is to obtain
the partial derivative of In with
regard to X, Y and ë and set each of
them equal to zero. This will give us
50 Project Analysis and Evaluation: Principles & Techniques
the first order condition of profit
maximization.
i.e.,
∂Ln/∂X=100-4X-Y+λ=0...............
(4)
∂Ln/∂Y= -X + 180 -8Y + λ = 0 ……………..
(5)
∂Ln/∂ π = X+Y-30= 0....... .. (6)

By solving the simultaneous equation,

we get the values for
X, Y and λ that maximize the
objective function in equation(3). In
order to solve these equations for X,
Y and ë, we need
to reduce the three simultaneous
equations i.e., equations 4, 5, and 6
to two equations.
To do this, let us rearrange the
terms in equation (5) and subtract
from equation (4)
100-4X-Y+2=0
180-X-8Y +2=0
-80-3X+7Y= 0……………………........ (7)

Now, we have two simultaneous

equations, we then multiply
 Introduction: Concept of Project Analysis 51

Equation (6) by 3 and add it to equation

(7)
i.e.3X+ 3Y - 90 = 0
-3X+7Y - 80 = 0
IOY- 170 = 0
Y = 170/10
Y = 17.

By substituting 17 for Y in the constraint

in equation (2) we get the value for X as:
X+ 17=30 x-30-17 x=13
Now that the values of X and Y are known,
the value of I could be obtained by
substituting the values of X and Y in
equation (4) or equation (5). Using
equation (5), we have:
- 13+180-8(17)+
= 167-136+ λ =0
= 31+ λ =0
λ = -31
Using equation (4) will also give the same
answer.
The value of é has an important economic
interpretation. It gives the measure of the
change in the total profit when the
output constraint is changed by 1 unit. For
example, if the output is increased by 1
unit, i.e., from 30 to 31 units, profit
will increase by about 31 and if output is
decreased by 1 unit, i.e., from 30 to 29
 52 Project Analysis and Evaluation: Principles & Techniques
units, the profit will decrease by about
31.
Example 2
Given the Profit Function as:
π = 150X -3X2 - XY + 200Y - 5Y2 .........
(1) subject to the Constraint X+Y=
40.......................(2) Set the
Constraint equation (2) equal to Zero,
i.e.
X+Y-40 = 0..........
Then multiply eq. (3) by X
λ (X+Y-40)

Then Add the outcome of eq. 4 to the objective function.

Then form the Lagrangian function as:
lull = 150X-3X-XY+ 200Y-5Y2 + λ (X+Y- 40) .. (5)
Equation (5) is regarded as the unconstrained Lagrangian
function with three unknowns X, Y and λ .
X is a measure that gives the amount of a small change in
the constraint on the objective function.
The next step to obtain the partial derivative of L with
respect to X, Y and λ and set them equal to zero.
Therefore:
FOC:
∂L π/∂X = -X+200-10Y+ λ=0
∂L π/∂X = -X+200-10Y + λ = 0
∂L π/∂X = X+Y-40=0
 Introduction: Concept of Project Analysis 53
We then solve the simultaneous equations to arrive at value
for X, Y and X. that will max the objective function in eq.
(5) To do this, we reduce the three equations above i.e.
equations 6, 7 and 8 to two equations.
Therefore, we rearrange the terms of equation 7 and
subtract it from eq. 6 this will give:
150 6X-Y+ λ =
200-X-10Y+ λ = 0
-50-5X+9Y=0 …………………(9)
We now have two simultaneous equations 9 and 8 We now
apply the method of solving simultaneous equation
i.e. we multiply equation 8 by 5 and add it to equation 9.
Therefore,
5X+5Y-200=0
-5X+9Y-50=0
14Y - 250=0
Y = 17.86
By substituting 17.86 for Y in the Constraint equation 3 to we
get the value for X as:
x + 17.86 = 40
x = 22.14
We can now get the value for X by substituting the values of X
and Y in either equation 6 or 7. Using equation 7 will give:
- 22.14 + 200-10 (17.86) +λ = 0
λ = .74
The important economic interpretation of X is that it measures
the change in total profit as a result of change in the output
Constraint.
54 Project Analysis and Evaluation: Principles & Techniques
In this case, if output is increased 1 unit i.e from 40 to 41 units,
profit will decrease by about 0.74 and if output decrease by 1unit
i.e from 40 to 39 units, the profit will increase by about 0.74.

Constrained Cost Minimization

Example 1
Suppose a carpet manufacturing and exporting firm has to
supply an order for 500 pieces of woollen then carpets of two
varieties, X and Y, to a British buyer. The joint cost function
for the two varieties of carpets is given as:
C = 100X2+ 150Y2 . . . ……… . . . …………………(1)
The quantities of X and Y are not specified in the order. So,
the firm is free to supply X and Y in any combination. The
firm's problem is to find the combination of X and Y that
minimizes the cost of production subject to the constraint +
Y = 50. The problem could be restated formally as:
Minimize C = 100X2+150Y2
Subject to X+Y= 500
In order to solve the cost minimization problem by the
Lagrangian multiplier method, the problem has to be
converted into Lagrangian function. The procedure is to set
the constraint in equation (2) equal to zero, multiply by and
add the result to the objective function. The cost
minimization problem converted into the Lagrangian
function is given as:
Minimize Lc = 100X2 + 150Y2
Subject to 500 -X- Y=0
The objective here is to minimize equation (3) subject to X +
Y = 500. The FOC of the solution requires that the derivative
of Lc, with respect to X, Y and λ, is set equal to zero.
i.e.,
 Introduction: Concept of Project Analysis 55
∂Lc/∂X = 200- λ =0 ………………….(4)

∂Lc/∂Y = 300Y – λ =0 …………………..(5)

∂Lc/∂ λ = 500 – X - Y =0

By subtracting equation (5) from equation (4) we have:

200X- λ – (300Y – λ) = 0
200X = 300Y
X = 300Y/ 200
X = 1.5Y
By substituting 1.5Y for X in equation (6) we have;
500 -1.5Y-Y=O
2.5Y = 500
Y = 500/2.5
Y = 200
By substituting the value of Y with 200 in the constraint
equation (2) we have: x + 200 = 500 x = 300
Thus, the solution to the cost minimization problem is that X = 300
and Y = 200. This minimizes the cost of producing 500 pieces of
woollen carpets. The minimum cost could be worked out as
follows.

C = 100X2 + 150Y2
= 100 (300)2 + 150 (200)2
=15,000,000
56 Project Analysis and Evaluation: Principles & Techniques
Thus, the minimum cost of supplying 50 pieces of woollen carpets
works out to N15m. Any other combination of X and Y varieties
of carpets will make the cost exceed N15m.

Example 2
Minimize
C = 150X2 + 200Y2 ……………… (1)
Subject to: X+Y= 600……… (2)
Laugrangian function is given as:
Lt = 150X2 + 200Y2 λ (600-X-Y) .....(3)
Subject to:
600 – X -Y= 0 .......................................(4)
FOC:
∂Lt/∂ λ = 400Y - λ = 0
∂Lt/∂ Y = 400Y - λ = 0
∂Lt/∂ λ = 60 – X – Y = 0
By subtracting equation 6 from eq.5, we get 300x — X — (400Y - l)
=0
300X = 400Y x
X = 1.33Y
By substituting 1.33Y for X in equation 7, to get:
600-1.33Y-Y=O
600 = 2.33Y
Y =257.51
We can now replace in equation 2, with 257.51 to get:
X + 257.51 = 600
X = 342.49
The cost minimization problem now becomes

X= 342.49
 Introduction: Concept of Project Analysis 57
Y = 257.51
This will minimize the cost of producing 600 pieces
of the required good. From this known
information, it is now possible to work out
the minimum cost.
i.e.
c = 150X2 + 200Y2
= 150 (342.49)2 + 200 (257.51)2
= 17,594, 910.02 + 1326 2280.2
= N30, 857,190.22
This is the minimum amount that could be spent to produce 600
pieces of carpet. It X and Y are combined in another
combination different from the above, the cost of producing in
any other combination will exceed this amounts.
Importance of Sound Project Analysis
One obvious single obstacle in the way of rapid economic
development of many developing countries is the paucity of
well-prepared and analyzed projects. Schatz (1965) once said
that what bedevilled the emergence and growth of industries in
Nigeria was not the shortage of capital, as conventional wisdom
would make one believe, but the lack ofviable projects. Many
projects, both in the private and public sectors of the economy,
have turned out to be "white elephants" simply because they
have not been properly analyzed and appraised.
From the national point of view, most governments now
engage in formulating economic development plans as a
framework for accelerating growth and development. The
operational level of such plans and the degree of success
ofplan targets require the preparation and execution of sound
projects.
From the point of view of the states in the federation, there
is an important element which makes sound project
58 Project Analysis and Evaluation: Principles & Techniques
analysis imperative. One of the directives sent to all
economic planning units by the Federal Ministry of
Economic Development on the 1970-1974 National
Reconstruction and
Development Plan stated;
It is worth mentioning that the clarity and comprehensiveness
with which a project is presented will affect its chances of
finding a place in the National Plan.
It follows then that a state that does not wish to be left out in
the race for economic development must pay attention to
sound project analysis. Sound project analysis is also important
from another point of view. Most international
finance and development agencies and domestic
development banks require it as the basis for negotiation
for loan or development assistance. The World Bank, for
instance, wants;
to ensure that the Bank funds are invested in sound
productive projects with the purpose of contributing both
to the borrowing country's capacity to repay and to the
development of its economy.

There is no objective a priori means of ensuring the

realization of this objective other than by ensuring that
loan projects are well prepared, analyzed and
appraised.
Some of the reasons given for the need for sound project
analysis, from the point of view of the nation, are also relevant
from the point ofview of the business firm or private
entrepreneur. A business firm is affected by scarce resources
and it would want to ensure that its funds are put to the most
effective uses by preparing and analyzing projects. For both
 Introduction: Concept of Project Analysis 59
private and public projects, project analysis may serve as point
of reference during the execution and operating stages.
Finally, a decision about whether or not to invest in a
production facility may be taken by an expert or a
committee of experts. Project analysis provides an aid in the
decision making process. It is a model — an abstraction
from, and an idealization of reality — embracing all the
important variables and their relationship. It ensures
objectivity by every participant in the decision-making
process. Therefore, sound project analysis leads to the
realization of rational decisions•
Obstacles to Good Project Development in Nigeria
The following are identified as some of the obstacles to good
project development in Nigeria.
(i) Lack of Pre-investment Studies: Many projects are
commenced without adequate pre-investment studies.
Where such studies are available, they may be lacking in
sufficient detail. Some studies are merely financial
projections without detailed analysis of the market and
other technical aspects of the projects.
(ii) Wrong Location of Project: Optimum location is an
important consideration in project studies. However, this
is often ignored especially in government projects.
Political considerations are often allowed to override all
economic dictates with the result that projects become
distressed even from the early stages of their
implementation. Important factors in optimum location
of projects are considered in chapter three.
(iii) Over-ambitious Projects: Some of the projects taken on by
the government are sometimes technically overambitious for
the level of development of the country. The result is that
60 Project Analysis and Evaluation: Principles & Techniques
the general proposals and targets embodied in the project
become generally unattainable because constraints such
as inadequate executive capacity, raw materials, working
capital, and so on set in early in the project's life to
stultify' the efforts of the project's sponsors.
(iv) Manpower Constraints: One of the major problems
bedevilling industrialization in developing countries is
the lack of executive capacity. This was recognized and
clearly alluded to in one of Nigeria's Development Plans,
where it was categorically stated that only 60% of the
targeted proposals would be realized for lack of
executive capacity. Many projects, both in the public and
private sectors, have floundered on the mire of lack of
executive capacity virtually at all stages of project cycle
from preinvestment analysis to the implementation. This
has meant unnecessary delays both in starting off and in
implementation of projects. There has been a general
dependence on foreign consultancy services with
the resultant additional costs.
(v) Financial Constraints: This may take different forms
such as shortage of funds, to finance both fixed and
working capital, lack of credit facilities and shortage
of specialized finance institutions.
(vi) Raw Materials Problems: The manufacturing sector
of the economy is highly import-dependent for baalc
raw materials and spare parts. rlhe average capacity
utilization has been hovering a little over 33% for a
long time as a result of the constraint imposed on raw
materials import by the scarcity of foreign exchange.
Uncompetitive prices of final products, traceable to
high costs of production, are the ultimate reflection of
the prohibitive costs of raw materials.
 Introduction: Concept of Project Analysis 61
(vii) Inadequate Infrastructure: Lack of infrastructural
facilities plague the development efforts of both private
and public enterprises. Intermittent supply of electricity,
lack of good portable water both for industrial purposes
and the industrial work force, lack of access roads and
transportation facilities for produce evacuation, poor
telecommunication facilities, and inadequate housing for
workers, characterize the industrial landscape. Many
states of the federation do not deem it worthwhile to
create industrial areas where the necessary infrastructure
could be provided to enhance the siting of industries.
(viii) Lack of Political Stability: Peace is a precondition for
investment and growth of the economy. In an
atmosphere that is overcast by wars and rumours of war,
it would be difficult to maintain a consistent policy on
development, which would attract investors and sustain
investment.
(ix) Institutional Impediments: In the southern areas of
the federation in particular, the land tenure system
makes optimal location of projects very difficult,
especially
private sector projects. Several problems of multiple
ownership of land are still encountered in spite of the Land
Use Decree. In addition, there are cases of religious
interference in the siting of projects. In some local areas, the
natives believe that if a certain local industry is mechanized,
the raw materials would disappear from their area. Similarly,
certain animals are held to be sacred or unholy; and it would
be kicking against the belief of the people to site projects
involving these animals in such areas. Such projects could
be sabotaged.
62 Project Analysis and Evaluation: Principles & Techniques
Potential Sources of Project Ideas
The market economy is dynamic, giving rise at different points
in time, to different economic states which are characterized by
different configurations of economic activities and resource
allocation together with different distribution of the rewards for
such activities. New entrepreneurs emerge in new and old
activities or they modernize in order to maintain or increase
their market share. The planning of entry into the market by
new entrepreneurs, and of the diversification by the old,
requires some ideas about new projects.
The following hints by Bryce (1960) and United Nations
(1958) provide a useful guide to some sources from where
ideas about new projects can be obtained.
(i) The Development Plans: Some of the past development plans
contain an appraisal of development in the private sector of the
economy and a list of projects which the private sector can
undertake. The constraints and bottlenecks in the economy are
also usually highlighted A careful study of these might spark
off ideas about possible projects.

(ii) The International Standard Industrial Classification

(ISIC): This manual contains a check list of all

conceivable economic activities within an economy.
Project ideas could be suggested by carefully looking
through the list.
(iii) Observation of the Trends of Market Prices and Rate of
Turnover of Some Products: A product that is moving
very fast in the market while its price is also increasing
indicates that its demand is larger than its supply, and
existing producers must be making supernormal
profits. If entry is not impeded in any way, project
 Introduction: Concept of Project Analysis 63
ideas may surface from this phenomenon. The local
market women frequently draw hints about new
ventures from such observation.
(iv)AnnuaI Bulletin of Import Statistics: The annual
statistics of imports usually show the volume and the
value of various products imported into the country for
a given year. Where a study of these statistics reveals a
large volume of imports of some products, ideas about
import-substituting projects may be indicated.
(v) A Study of Available Skills: The informal sector of the
economy provides a good study of available skills that
can be properly organized into viable enterprises. The
furniture, shoe, dress, and similar industries, have
suggested project ideas that have been developed in
highly-profitable undertakings.
(vi) Investigation of Local Raw Materials: An abundance
local raw materials may give ideas about processing or
refining projects for the production of commodities both
for export and for domestic consumption.
(vii) Study of the Needs of Existing Enterprises:
Changing technology and size of existing enterprises
have necessitated the demand for certain services
which are better contracted out; for example,
janitorial services for