CHAPTER ONE

1. GENERAL INTRODUCTION ABOUT PROJECT

After completing this chapter, students will be able to:
 Understand the meaning and definition of project,
 Explain the features of project,
 Narrate projects and plans
1.1. Meaning and Definition of a project
A project is a task with a desired end point. For example, building a new house is a project, the end point
being when the house is built. Similarly, creating a new piece of software or an app is a project, as is
launching a new product for a business. Projects can be used to complete many different types of tasks.
Usually the term ‘project’ is applied to tasks with some degree of complexity. The word ‘project’ is not
applied to such simple activities which do not benefit from the rigor of managing as a project. Projects have
a degree of complexity. They are complex enough that just thinking through and remembering the tasks
required or writing them down as a ‘to do’ list is not a reliable enough way to ensuring you complete them.
Projects fulfil some clear predefined objective, in a planned period of time and to a planned cost. Once the
project is complete something will have changed – for example, you have a new house, a new app or a new
product.
There is no one comprehensive definition for a project. Its definition varies from author to author, from
organization to organization, and based on the nature, objective and other characteristics of the project. As a
result you may find several definitions of a project in the literature some of which are provided below.
 A project is a proposal for an investment to create, expand and/or develop certain facilities
in order to increase the production of goods/services/ during a certain period of time in a
community, region, country, market area and/or certain organization (firm, public
organization, NGO, etc.
 USA Project Management Institute, defined project as it is a one shot, time limited, goal directed,
major undertaking, requiring the commitment of varied skills and resources
 A project also described as a combination of human and non-human resources pulled together in a
temporary organization to achieve a specified purpose.
 A project, ideally, consists of an optimum set of investment-oriented actions, based on
comprehensive and coherent sector planning, by means of which a defined combination of human
and material resources is expected to cause a determined amount of economic and social
development.

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  A unique process consisting of a set of coordinated and controlled activities with start and finish
dates, undertaken to achieve an objective conforming to specific requirement including constraints
of time, cost and resources. (ISO-8402)
 A project is any scheme or part of scheme for investing resources, which can be reasonably
analyzed and evaluated as independent unit (Little and Mirrlees, 1974).
 In relation to agricultural activities, Gittinger (1982) defined project as a whole complex of
activities in an undertaking that involves uses of resources to gain benefits.
 A project is an organized effort to do something useful or attain a useful end result which is
sometimes defined as a plan, venture or enterprise (Angus and Norman, 1997).
 Project is a temporary organization to which resources are assigned to undertake a unique, novel and
transient endeavour managing the inherent uncertainty and need for integration in order to deliver
beneficial objectives of change (Turner and Müller, 2003).
From the above all definitions we can learn that
• A project is an economic/development activity
• It requires commitment of scarce resources
• It brings some benefit from its accomplishment
• The benefit should exceed its cost
• Implementation of a project needs resources or inputs.
• Every project converts the given inputs into outputs through the process of implementation
A major misunderstanding about a project is relating it to only construction or creation of such
physical facilities as buildings, roads and dams. However, project may involve intangible things
such as creation of awareness (e.g. about HIV/AIDS), eradication of diseases (e.g. polio
vaccination), combating harmful practices (e.g. genital mutilation) and capacity building (e.g.
training to enhance service delivery capabilities of public sector employees). Thus, projects may
range from physical or technical (construction of physical facilities) to mixed (involving both
physical and nonphysical things) to nonphysical (dealing purely with behavioral aspects of an
organization).
1.2. Characteristics 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:
 Objective: A project has a fixed set of objectives. Once the objectives are achieved the project
ceases to exist. Collectively, project outputs and outcomes are identified as goals. Thus, each project

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 has a specific objective that can be identified, quantified or valued. A distinction is usually made of
the output and outcomes of a project. The output of a project refers to the tangible or intangible
thing created by undertaking the project and the goods and services that this thing delivers. A key
point to note in relation to project objective is that they should be stated in a way that facilitates
measurement of achievements.
The general rule is that project objective should be SMART
Specific: well defined and clear to anyone that has a basic knowledge of the project,
Measurable: how do we know how far away completion is and when it has been achieved
Achievable: indicate what should be done to achieve the objective,
Reliable/achievable: Is the objective achievable with the available resources and timeframe, and
Time-based: it should identify a definite target date for completion and/or frequencies for specific
action steps that are important for achieving the goal on/within a specific time period.
 Life Cycle: Like organic entities, projects have life cycles. From a slow beginning they
progress to a buildup of size, then peak, begin a decline, and finally must be terminated by
some due date.
 Uniqueness though the desired end results may have been achieved elsewhere; they are at
least unique to this organization. Moreover, every project has some elements that are
unique. No two construction or R & D projects are precisely alike. Though it is clear that
construction projects are usually more routine than R & D projects, some degree of
customization is a characteristic of projects. In addition to the presence of risk, as noted
earlier, this characteristic means that projects, by their nature, cannot be completely reduced
to routine. No two projects are exactly similar even if the plants are exactly identical or are
duplicated the two projects may differ by the location, infrastructure, the sponsoring
agencies and the people who works under the two projects make each project unique.
 Resources: include human, material, financial and information. A typical project may
involve organizations such as the owner, user, contractor, supplier and financier. These
organizations may be involved in a project through their different functional units and
contribute, among others, human resources from different professions including
engineering, architecture, accounting and environment, to mention some. Projects have
limited budgets, both for personnel as well as other resources.
 Single entity: A project is a single entity and is normally entrusted to one responsibility
center, while participants in the project are many.

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  Team work: Any project calls for team work-. The team members may be from different
discipline, organization, and even country
 Change: A project sees many changes throughout its life. While some of these changes may
not have any major impact, there can be changes which will change the entire course of the
project.
 Risk and Uncertainty: Every project has a risk associated with it. The degree of risk and
uncertainty will depend on how a project has passed through the various stages of its life
cycle.
1.3. Classification of a project
Project may be broadly classified as:
 Industrial/Commercial projects: For example, establishment of factories, industries, service
rendering enterprises, etc.
 Agricultural projects For example, establishment of farming, breading, forestry,
horticulture, fishery, etc.
 Infrastructure projects For example, establishment of roads, airport, schools, health stations,
hospitals, universities, etc.
Alternative classification of projects: Basically, three types of project can be identified depending
upon how new resources committed to them relate to existing economic activities:
 New Investment: Designed to establish a new productive process independent of previous
lines of production. They often include a new organization, financially independent of
existing organization.
 Expansion Projects: Repeating or extending an existing economic activity with the same
output, technology and organization.
 Updating projects: Replacing or changing some elements in an existing activity without a
major change of output. It involves some change in technology but within the context of an
existing though possibly reformulated organization.
1.4. Project Parameters/Success Factors
During a project's life, the management team focuses on three basic parameters: quality, cost, and
time. Traditionally, it is said that a successfully managed project is the one that is completed at the
specified level of quality, on or before the deadline, and within the budget.

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Time: projects are constrained by a specified period of time during which they must be completed. They are
not supposed to continue indefinitely. Thus, the first constraint that governs project management involves
this basic requirement: The project should come in on or before its established schedule.
Budget: A second key constraint for all projects is a limited budget. Projects must meet budgeted
allowances in order to use resources as efficiently as possible. Companies do not write blank checks and
hope for the best. Thus, the second limit on a project raises the question: was the project completed within
budget guidelines?
Performance: all projects are developed in order to adhere to some initially determined technical
specifications. We know before we begin what the project is supposed to do or how the final product is
supposed to operate. Measuring performance, then, means determining whether the finished product
operates according to specifications. The project’s clients naturally expect that the project being developed
on their behalf will work as expected. Applying this third criterion is often referred to as conducting a
quality check.
This so-called triple constraint was once the standard by which project performance was routinely assessed.
Today, a fourth criterion has been added to these three (see in figure 1.1)
Client (or customer) satisfaction: The principle of client acceptance argues that projects are developed
with customers or clients in mind, and their purpose is to satisfy customers’ needs. If client acceptance is a
key variable, then we must also ask whether the completed project is acceptable to the customer for whom it
was intended. Among others, is newly added parameter that partially indicates success in implementation as
well as possibilities for future replication (or sustainability). In general, each of the parameters is specified
in detail during the planning phase of the project and a basis for controlling the project during the
implementation phase.
1.5. Plan, projects and programs
1.5.1. Projects and planning
Planning in general is a conscious effort to direct human energy for the purpose of securing a
rationally desirable end. Planning is a means to an end. It is a guide to achieving certain objectives
in an optimum manner by means of orderly sequencing of activities. In other words, planning is a
form of decision making in using scarce resources in selective and economical ways to achieve a
pre-determined objectives and goals.
Planning is necessary because:
• It helps to make necessary arrangements in advance of possible challenge
• It helps an organization to think ahead an anticipate future events
• it gives clear picture of future events to measure and control actual activities

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 • it helps to identify operational problems of past performance and future corrections
Plan requires projects: a sound plan require a great deal of knowledge about existing and potential
project. Since a plan lay down growth rate target, for Gross Domestic Product (GDP), investment,
employment etc., a realistic assumption must be established with regard to such growth. This pre-
suppose a knowledge of the rate at which good projects can be planned. Thus, good and realistic
plan cannot be formulated in the absence of a great deal of project planning and without proper
economic appraisal of projects.
Project requires plan: since projects commit scarce res, project selection is meaningful only when it
is placed within the broader development-planning framework. The best economic appraisal of
projects cannot be made without referring framework and plans and policies. To choose the right
project one must have an estimate of demand for the product. But the estimation of demand could be
more realistic if the plan is also realistic.
1.5.2. Project and Program
Some people use the terms “Program” and “project” as synonymous. But there is a difference. A
program is usually larger in scope, is activity-oriented, and is not necessarily time bound. For
example, health program, educational program, agricultural or industrial development program
may consist of one or more fertilizer projects, and so on. The project objective must aim at meeting
the program objectives. While program objectives may be broader, and project objectives are more
specific and focused.
It is necessary to distinguish between projects and programs because there is sometimes a tendency
to use them interchangeably.
 A project refers to an investment activity where resources are used to create capital assets,
which produce benefits over time and has a beginning and an end with specific objectives, a
program is an ongoing development effort or plan involving a number of projects.
 Programs may or may not necessarily be time bounded. Yet programs cannot live forever,
they have limited life cycle, which however, may or may not be explicitly stated. So in
effect in terms of time delimitation, there is only relative difference between programs and
projects. But projects are time limited and have a definite life cycle.
 A development plan or a program is therefore a wider concept than a project. It may include
one or several projects at various times whose specific objectives are linked to the
achievement of higher level of common objectives.

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  Projects in such context are the concrete manifestations of the development plans and
programs in a specific place and time. One can think of projects as subunits and bricks of
programs, which constitute a component of or the entire national plan.
 A project is a scheduled undertaking for the purpose of creating a product or service.
Program management, on the other hand, is the act of creating and managing multiple
projects, most of the projects are usually related to one another.
 Project management is usually short-lived with specific time constraints while program
management is an ongoing process in order to achieve the goals and objectives. The job of
a project manager usually involves working on finite projects or objectives. The program
manager works more often with strategy.
In general: Program in general is a group of related projects that are managed in a coordinated way
to achieve certain objective. A project normally originates from a plan which can be a national plan
or corporate plan. A program is thus, larger in scope, not necessarily time bounded and, its
objectives are broader
For Example,
The national goal/plan: Poverty Eradication
Strategy: Increase productivity (in all sectors)
1. Development program: Increase agricultural productivity
This may result in a number of projects like,
Construction of dams (irrigation infrastructure)
Upgrading the skill of agricultural practices
Construction of training centers
The national goal/plan: Poverty Eradication
Strategy: Increase productivity (in all sectors)
2. Development program: Improve the health of the community
Health program may have a number of projects like,
Construction of hospitals
Training of health officers
Expansion of health centers.
1.6. Project Management

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Project management has been practiced for hundreds, actually thousands, of years. Long before
computers and sophisticated scheduling techniques became available, the ancestors of today’s
professional project managers had to determine resource requirements, arrange for material and
equipment, and strive to meet a schedule imposed by, in many cases, a powerful leadership entity.
They knew that any construction type of undertaking or project endeavor, large or small, required a
goal, a set of objectives, a plan, coordination with many functional groups, the management of
resources, and the ability to manage change. Additionally, it became very clear that every project
requires strong and adaptive leadership.
Project managers, by nature of the position, will work with and manage teams and a variety of
stakeholders, some of whom can be expected to be a real a challenge to work with. Considering
this factor, project managers must continue to develop the skills necessary to balance the
expectations and demands of each stakeholder while managing project deliverables. Today’s
project managers see themselves as managing part of a business as well as managing a project.
Applying project management is certainly a factor in achieving organizational objectives, but it is
important to understand the definition and nature of a project.
Project management is the application of knowledge skills, tools, and techniques to project
activities to meet project objectives. Effective project management is accomplished through the
integration of five major project management processes: initiation, planning, execution, monitoring
and controlling, and closing. As projects are authorized by a project sponsor, a project manager is
assigned and becomes accountable for the success of the project through effective leadership and
the application of project management techniques. The project manager will ensure coordination
between functional organizations and must have the ability to apply the appropriate amount of
managerial and cross-organizational support and guidance to achieve success as the project is
executed.
Project management, as a discipline or profession, also subscribes to a code of ethics and
professional conduct specifically focused on integrity, respect, fairness, and honesty. This includes
business ethics as well as project management ethics because we now believe that we are managing
our business by projects and that the project managers are actually managing part of a business
Project management can be defined as the process of achieving project objectives through the
traditional organizational structure and over the specialties of the individuals concerned. Project
management is applicable for any ad hoc (unique, one-time, one-of-a-kind) undertaking concerned

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with a specific end objective. (Project management 8 th edition) Project managers perform the
following major functions/roles:
1. Identify and communicate the benefits of project management.
2. Set objectives clearly using SMART criteria.
3. Establish guidelines and criteria for selection of a project manager. Emphasize soft skills as
well as managerial skills.
4. Resolve conflicts and problems,
5. Establish expectations with executives at project start-up.
6. Communicate project sponsor support and executive support to the team. Understand line
manager priorities. Create a positive working relationship.
7. Prepare and communicate acceptance criteria. Communicate the scope statement.
8. Obtain sponsor and executive support, establish clear objectives, and develop a
communications plan.
9. Reward and recognize project teams and develop team-building activities.
10. Control technical quality, budget, and schedule of the project
11. Develop a risk management plan and a process for managing issues.
12. Establish a project management office, require documentation of lessons learned, and
ensure that management support is visible.
Typical Project Problems
1. Scope may not be clearly defined when commitment is made to a client.
2. There may not be enough resources allocated (people, money, materials, time, space, etc).
3. Conflict of interest between or among stakeholders (ops vs. engineers, sales vs. technical support,
line vs. staff).
4. Commitment to unrealistic dates – the PM may be too optimistic about the completion date of the
project.
5. There may be unclear roles and responsibilities. 6. Things may go wrong for some natural reasons.
CHAPTER TWO PROJECT CYCLE
After completing this chapter, students will be able to:
 Understand the meaning and definition of project cycle.
 Explain the World Bank Project Cycle
 Differentiate World Bank Project Cycle and UNIDO Project Cycle.
Project cycle

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 There tends to be a natural sequence in the way projects are planned and carried out. Before any project is
actually realized it goes through various planning phases Therefore, the different stages through which
project planning proceeds from inception to implementation are often called “the project cycle”. The stages
or phases through which the project passes are necessary for its completion and they constitute a specific
sequence that is cyclical in nature identified as project life cycle.
A project life cycle are important because they demonstrate the logic that governs a project. They
also help us develop our plans for carrying out the project. They help us decide, for example, when
we should devote resources to the project, how we should evaluate its progress, and so forth. A
project cycle is a sequence of events, which a project follows. These events, stages or phases can
be divided into several equally valid ways, depending on the executing agency or parties involved.
Some of these stages may overlap.
Every program, project, or product has certain phases of development known as life-cycle phases. A clear
understanding of these phases permits managers and executives to better control resources to achieve goals.
During the past few years, there has been at least partial agreement about the life-cycle phases of a product.
They include:
 Research and development
 Market introduction
 Growth
 Maturity
 Deterioration
 Death
Today, there is no agreement among industries, or even companies within the same industry, about the
lifecycle phases of a project. This is understandable because of the complex nature and diversity of projects.
The theoretical definitions of the life-cycle phases of a system can be applied to a project. These phases
include:
 Conceptual
 Planning
 Testing
 Implementation
 Closure
The first phase, the conceptual phase, includes the preliminary evaluation of an idea. Most important in this
phase is a preliminary analysis of risk and the resulting impact on the time, cost, and performance

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 requirements, together with the potential impact on company resources. The conceptual phase also includes
a “first cut” at the feasibility of the effort.
The second phase is the planning phase. It is mainly a refinement of the elements in the conceptual phase
and requires a firm identification of the resources required and the establishment of realistic time, cost, and
performance parameter.
The third phase testing is predominantly a testing and final standardization effort so that operations can
begin. Almost all documentation must be completed in this phase.
The fourth phase is the implementation phase, which integrates the project’s product or services into the
existing organization. If the project was developed for establishment of a marketable product, then this
phase could include the product life-cycle phases of market introduction, growth, maturity, and a portion of
deterioration.
The final phase is closure and includes the reallocation of resources. Consider a company that sells products
to consumers. As one product begins the deterioration and death phases of its life cycle (i.e., the divestment
phase of a system), new products or projects must be established.
2.1. World Bank Project Cycle (The Baum Cycle)
Project with the characteristics already outlined above typically run through at least several
separable stages of activity which can be thought of as constituting a definite sequence that some
author’s /institutions/ have called a project cycle. The first basic model of a project cycle is that of
Baum (1970), which has been adopted by the World Bank and initially recognized four main
stages, namely.
1. Identification
2. Preparation
3. Appraisal and Selection
4. Implementation
At a later stage (in 1978) the author has added an additional stage called “Evaluation” which usually closes
the cycle as it gives rise to the identification of new projects.
1. Identification
Project identification consists in finding project ideas that could contribute towards achieving
specified development objectives. But, where do projects come from? There is no simple answer.
Some may be "resource based" - stem from the opportunity to make profitable use of available
resources; "market based" - arise from an identified demand in home or overseas markets; and
"need based" - to make available to all people in an area where minimal amounts of certain basic
material requirements and services exist. Once some project ideas have been put forward, the first

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 step is to select one or more of them as potentially promising. This calls for a quick preliminary
screening by experienced professionals who could also modify some of the project proposals.
Preliminary screening is conducted to reduce to a manageable number the project alternatives to
which more work and time will be devoted. As a result of preliminary screening exercise, some of
the project alternatives will be rejected and those that are promising will be advanced to the next
stage.
2. Preparation
Once projects have been identified, there begins a process of progressively more detailed preparation and
analysis of project plans. At this stage the project is being seriously considered as a definite investment
action.
Project preparation sometimes called project formulation covers the establishment of technical,
financial, economic, social and institutional aspects of the project. Following preliminary
screening, promising project options should be investigated in a systematic manner. The analysis of
the projects technical, commercial, social, environmental, financial, economic and institutional
aspects should be detailed and comprehensive enough to decide on the future of the project with
confidence.
3. Appraisal and Selection
It is the comprehensive and systematic assessment of all aspects of a proposed project. During
appraisal, it should be verified that the proposed project, in combination with other policies,
contributes towards achieving certain development objectives.
After a project has been prepared, it is generally appropriate for a critical review or an independent appraisal
to be conducted. This provides an opportunity to re-examine every aspect of the project plan to assess
whether the proposal is appropriate and sound before large sums are committed. It is done both in the field
and at the desk level. Appraisals should cover at least seven aspects of a project, each of which must have
been given special consideration during the project preparation phase:
a) Technical – here the appraisals concentrate in verifying whether what is proposed will work in the
way suggested or not.
b) Financial – the appraisals try to see if the requirements for money needed by the project have been
calculated property, their sources are all identified, and reasonable plans for their repayment are made where
necessary.
c) Commercial – the way the necessary inputs for the project are conceived to be supplied is examined
and the arrangements for the disposal of the products are verified.

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 d) Incentive – the appraisals see to it whether things are arranged in such a way that all those whose
participation is required will find it in their interest to take part in the project, at least to the extent envisaged
in the plan.
e) Economic – the appraisal here tries to see whether what is proposed is good from the viewpoint of
the national economic development interest when all project effects (positive and negative) are taken into
account and check if all are correctly valued.
f) Managerial – this aspect of the appraisal examines if the capacity exists for operating the project and
see if those responsible ones can operate it satisfactorily. Moreover, it tries to see if the responsible are given
sufficient power and scope to do what is required.
g) Organizational – the appraisal examines the project if it is organized internally and externally into
units, contract policy institution, etc so as to allow the proposals to be carried out properly and to allow for
change as the project develops.
These issues are the subjects of specialized appraisal report. And on the basis of this report, financial
decisions are made – whether to go ahead with the project or not. In practice, there can be quite a sequence
of project selection decisions. Following appraisal, some projects may be discarded.
4. Implementation
The objective of any effort in project planning and analysis clearly is to have a project that can be
implemented to the benefit of the society. Thus, implementation is perhaps the most important part of the
project cycle. The major priority during this stage is to ensure that the project is carried out in the way and
within the period that was planned.
In this stage, funds are actually disbursed to get the project started and keep running. A major priority during
this stage is to ensure that the project is carried out in the way and within the period that was planned.
Problems frequently occur when the economic and financial environment at implementation differs from the
situation expected during appraisal.
It is during implementation that many of the real problems of projects are first identified. Because of this,
the feedback effect on the discovery and design of new projects and the deficiencies in the capabilities of the
project actor can be revealed.
Therefore, to allow the management to become aware of the difficulties that might arise, recording,
monitoring and progress reporting are important activities during the implementation stage. There are some
aspects of implementation that are of particular relevance to project planning and analysis.
i. The first is that the better and more realistic a project plan is, the more likely it is that the plan can be
carried out and the expected benefit realized. This emphasizes once again the need for careful attention to
each aspect of project planning and analysis.

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 ii. The second is that project implementation must be flexible. Circumstances will change and project
managers must be able to respond intelligently to these changes.
5. Evaluation
Once a project has been carried out, it is often useful to look back over what took place, to compare actual
progress with the plans, and to judge whether the decisions and actions taken were responsible and useful.
Evaluation can help not only in the management of the project but also help in the planning of future
projects. As a result of undertaking evaluation, major achievements and problems are identified,
recommendations for remedial action made and lessons of experience drawn (experience with one project
can give rise to new ideas for extension of the existing project as well as formulation of new project). And,
finally, evaluation should be undertaken when a project is terminated or is well into routine operation.
Different people may do evaluation.
 Project manager will be continuously evaluating its experience as implementation proceeds.

 The sponsoring agency, perhaps the operating ministry, the planning agency or an external
assistance agency – may undertake evaluation.
 In large and innovative projects, the project’s administrative structure may provide a separate
evaluation unit responsible for monitoring the projects implementation and for bringing problems to
the attention of the projects’ management.
2.2. UNIDO – Project Cycle
UNIDO project life cycle (Behrens and Hawranek, 1991) consisting of pre-investment, investment
and operational phases, and although, the aforementioned models use different terminologies and
divide the project life cycle into different number of phases. The very essence of project life cycle
is that projects are first identified in the form of ideas followed by different types of studies to
determine their feasibility, execution of the feasible one/s, use of the outputs of the project to
deliver goods and services (operating and maintain project output) and assessment of whether the
projects support the organization in achieving its goals. UNIDO has established a project cycle
comprising three distinct phases):
1. The pre investment phase,
2. Investment phase and
3. Operational phase phases.
2.2.1. The pre- investment phase
A. Project Identification

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 Project identification amounts to finding projects which could contribute towards achieving specified
development objectives. In principle, especially in developing countries like Ethiopia, project identification
should be an integral part of the macro-planning exercise with sectoral information and strategies as the
main source of project ideas. In practice, however, projects are not always derived from national and
sectorial plans; they originate from multiple sources such as investment promotion agencies, private
consultants and private investors. Irrespective of their origin project ideas should, in general, aim at:
overcoming constraints to the development effort, be they material, human or institutional constraints; or,
meeting unsatisfied needs and demand for goods and services. Constraints, needs and demand should be
interpreted broadly to include, for example, foreign exchange constraints that might necessitate projects for
import substitution or export promotion.
Opportunity studies:
The identification of investment opportunities is the starting – point in a series of investment – related
activities, when potential investors (private or public) are interested in obtaining information on newly
identified viable investment opportunities.
Where does Projects Originate? The variety of projects makes it impossible to prepare an exhaustive list of
sources from where project ideas emanate; much depends on the experience, and even imagination, of those
entrusted with project creation. In general, we can distinguish two levels where project ideas are born: the
macro-level and the micro-level.
At the macro-level, project ideas emerge from:
 National, sectorial,, or regional plans and strategies supplemented by special studies, often called
opportunity studies, conducted with the explicit aim of translating national and sectorial programs
into specific projects;
 Constraints in the development process due to shortages of essential infrastructure facilities,
problems in the balance of payments, etc.;
 A government’s decision to correct social and regional inequalities or to satisfy basic needs of the
people through development projects;
 A possible external threat that necessitates projects aiming at achieving, for example, self-
sufficiency in basic materials, energy, transportation, etc.;
 Unusual events such as droughts, floods, earth-quakes, hostilities,
 A government’s decision to create locally project implementing capacity in such areas as
construction
 Multilateral or bilateral development agencies and as a result of regional or international agreements
in which a country participates.

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 At the micro-level, the variety of sources is equally broad. Project ideas emanate from:
 The identification of unsatisfied demand or needs;
 The existence of unused or underutilized natural or human resources and the perception of
opportunities for their efficient use;
 The need to remove shortages in essential materials, services or facilities that constrain the
development effort;
 The initiative of private or public enterprises in response to incentives provided by the government;
 The necessity to complement or expand investments previously undertaken; and
 The desire of local groups or organizations to enhance their economic independence and improve
their welfare.
B. Project Preparation – Feasibility Studies
A feasibility study should provide all data necessary for an investment decision. The commercial, technical,
financial, economic and environment prerequisites for an investment project should therefore be defined and
critically examined on the basis of alternative solutions already reviewed in the pre – feasibility study.
If the pre-feasibility study indicates that the project is, prima facie, promising and further work is justified,
the project enters the stage of preparation.
Project preparation takes the form of a feasibility study conducted by the agency sponsoring the project or
by consultants. At this point it would be helpful to address a question often raised, i.e. what is the difference
between a pre- feasibility and a feasibility study? The answer is simple: they differ only with respect to the
amount of work needed to decide if a project is viable. The table of contents is the same in both; it is the
details and the sophistication that vary.
How Much Preparation: At this point we can ask how far in detail should project preparation advance before
the project is ready for appraisal. This is a practical question and the answer depends upon the magnitude
and the characteristics of the project. Projects that commit relatively small amounts of investment funds do
not deserve painstaking and expensive preparation. After all, the risks taken in implementing small projects
are small; of course, what is small is a practical question. Furthermore, projects that: (i) consist of a large
number of small, dispersed components (e.g. hundreds of primary schools or village water supplies) or, (ii)
depend heavily on community participation, need not be prepared in detail before an investment decision is
made. Often, those responsible for project planning complain that too much information is asked from them
and that they have to spend unnecessarily long time in project preparation. In most cases their complaints
are not justified. They should realize that resources are scarce and mistakes expensive. Furthermore, time
spent on project preparation is not lost time. There is a trade-off between project preparation and

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 implementation. The better a project is prepared the easier and faster its implementation and the lower the
probability of cost overruns.
The need for professional project preparation does not imply that this stage should include engineering
design that precedes implementation and which provides more accurate cost estimates. However, it is
essential that the project is prepared to a level that its characteristics are clearly presented, its objectives and
beneficiaries accurately defined and its merits and shortcomings thoroughly discussed. It is only on such a
sound base that apprized judgment can be formed by the authorities responsible for investment decisions.
Obviously, when it is expected that the project will be financed entirely or partly by multilateral or bilateral
aid agencies, their specific requirements and standards of project preparation should be taken into account.
Before proceeding to the stage of project appraisal we should mention that pre-feasibility and feasibility
studies become much easier to conduct when precise and comprehensive terms of reference are prepared for
these studies. Issued to a working group of local experts or to outside consultants, the terms of reference
should make clear that the project should be researched carefully and all its aspects illuminated.
C. Appraisal and Investment Decision
After the completion of preparation, the project has been nursed by the sponsoring agency; now it changes
hands. The project proposal in the form of a feasibility study is submitted to the investment decision makers
for a broad and impartial appraisal. Appraisal is the comprehensive and systematic assessment of all aspects
of the proposed project. After appraising the project carefully, appraisers will decide whether it will be
implemented or not, with or without minor modifications.
Criteria and Questions: At the early stages of the project cycle we might say that the evaluation criteria are
mainly, but not exclusively, technical and micro-economic in character. It is at this stage, and before an
investment commitment is made, that the project should be reviewed again to confirm that it accords with
the broad development objectives, or criteria set by donors, or bankers or other parties who have a stake in
the project. The framework within which the project is appraised is broad and multi-faceted.
During appraisal, it should be verified that the project, in combination with other policies, contributes the
maximum possible benefits towards achieving certain development objectives.
To this end the following questions could be answered to the viability of a project:
 Does the project belong to a sector where the country needs additional investment?
 Does the project meet urgent needs of the sector, that is, does it reflect sound sub-sector allocations;
 Does the project represent the least-cost alternative in achieving sector and sub-sector objectives?
 Is the project of optimum size, too big or too small?
 is the timing of the project right or the proposed investment is premature;
 is the project well designed with reasonably accurate cost and benefit estimates or are there still
many loose ends; and How smoothly the appraisal will proceed depends on how well the project has

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 been prepared. Even this indicative list of questions shows that a meaningful appraisal is possible
only if the project has been carefully and professionally researched and planned.
To the appraisal of these aspects of the project we can add the review of, and a judgment about its
noneconomic dimensions, e.g. dependency for key inputs and outputs on unreliable foreign markets. The
nature and range of the non-economic aspects vary from project to project and relate to the stated objectives
of the development strategy and the conditions in the country.

2.2.2. The Investment phase

The Project in Motion
The next stage in the project is the actual implementation of the project, followed by operation.
Implementation begins immediately after the final decision on the project ends when it starts rendering the
benefits envisaged. While in earlier stages of project planning there was more thinking and less action, in
this stage the combination switches in favor of the latter: more action and less thinking is needed. It is the
time when the conclusions reached and the decisions made are put into action.
The phase is divided into the following stages:
1) Establishing the legal, financial and organizational basis for the implementation of the project.
2) Technology acquisition and transfer, including basic engineering.
3) Detailed engineering design and contracting, including tendering, evaluation of bids and negotiations.
Detailed engineering design will include site preparation final selection of technology construction
planning and time scheduling as well as flow charts and scale drawings preparation. Negotiations are
concerned with legal obligations arising from the acquisition of technology, construction of buildings,
purchase and installation of machinery, and financing
4) Acquisition of land construction work and installation. This involves site preparation construction of
buildings and other civil works, together with erection and installation of equipment
5) Pre-production marketing, including the securing of supplies and setting up of the administration of the
firm. This and secures critical supplies prepares the market for the new product
6) Recruitment and training of personnel. This stage proceeds simultaneously with the construction stage to
ensure timely commissioning and the expected growth in productivity and efficiency in plant operations.
7) Plant commissioning and start-up. It is usually a brief but technically critical span in project
implementation. It links the preceding construction phase with the operational (production) phase. The
success achieved in this stage demonstrates the effectiveness of implementation planning and execution
of the project and has a bearing on the future performance of the project.

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 The need to pay particular attention to project implementation cannot be over emphasized. No matter how
carefully a project has been prepared and evaluated, the expected benefits are realized only when it is
properly implemented; it is not project reports but studiously executed projects that deliver the envisaged
benefits. Of course, it is easier to execute a well prepared project but sound preparation is not a substitute for
careful programming and close control during implementation. This is all the more so because most projects
face problems during implementation and some of them cannot be identified in advance; they emerge as we
proceed in the execution of the project. Some implementation problems are the result of general factors such
as changes in the economic and political situation of the country or the world market while others are project
specific.
2.2.3. Operational phase
This is the production phase that commences after commissioning and start-up. The resultant challenges of
this phase are viewed from the short-term perspective and long-term perspective. In the shot-term challenges
may arise with regard to application of production techniques operation of equipment, inadequate labour
productivity due to a lack of qualified staff and labour etc. Most of these problems have their origin in the
implementation phase.
The long-term view relate to the chosen strategies and the associated production and marketing costs as well
as sales revenues. These have a direct relationship on the projections made during the pre-investment phase.
If such strategies and projection prove faulty any remedial measure will not only prove difficult but may be
too expensive.
CHAPTER THREE
PROJECT IDENTIFICATION
INRODUCTION
Project identification is the first and, perhaps, the most crucial stage of both project cycles. It is from this idea
that the project will be based, and a poor idea or lack of ideas is likely to lead to poor or no projects. It is at
this stage that an initial screening of project ideas will take place, with some project ideas being abandoned
as impractical or of a low priority. Ideas for projects can come from a range of different sources and
organizations including ministries, individuals, local communities, nongovernment organizations, and donor
and international agencies. There will usually be more project ideas than resources to implement them, and
therefore only small portions of these are ever likely to lead to the full implementation of an actual project.
Mechanisms are therefore needed not only to identify different project ideas, but also to put these priorities
for development and eventual implementation. This section discusses these issues: who identifies project
ideas, source of project ideas, and the different roles of governments, private sector, NGOs and local
communities in this process.

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At the end of this chapter, students will be able to:
 Understand the sources of project ideas.
 Explain project ideas
 Differentiate between macro and micro sources of project ideas.
3.1. PROJECT IDENTIFICATION
Project identification is the findings of project that could contribute towards achieving specific development
objectives. Often, project ideas should, in general, aim at overcoming constraints on the national
development effort. It is the first stage in project cycle to identify an idea, which enable to launch a project.
The question at this stage is where do project idea come from?
3.2. SOURCES OF PROJECT IDEAS
How to come up with a project before grasping to project preparation? Usually we can distinguish two levels
where project ideas are generated from:
3.2.1. MACRO LEVEL
At macro level project ideas emanated from:
 National, sector or regional plans
 Constraints in the development process due to shortage of essential infrastructure facilities
 Government's decision to correct social and regional inequalities or to satisfy basic needs of the
people through development projects.
 Possible external threat that necessitates projects aiming at achieving, for example, selfsufficiency
in basic materials, energy, transportation, etc.
 Unusual events such as droughts, floods, earthquakes, etc.
 Government decision to create locally project-implementing capacity in such areas as
construction, etc.
 Multilateral or bilateral development agencies.
 Regional or international agreements in which a country participates.
3.2.2. MICRO LEVEL
At micro level project ideas emanated from:
 Existence of unused or underutilized natural and human resources and the perception of
opportunities for their efficient use
 Identification of unsatisfied demand or needs
 The need to remove shortage in essential materials, services, or facilities that constrain the
development effort.
 The initiative of private or public enterprises in response to incentives provided by the
government

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  The Necessity to complement or expand investments previously undertaken
 The desire of local groups or organizations to enhance and improve their welfare.
During identification, the analyst should eliminate project proposals that:
 Are technically unsound and risky
 Have no market for the output
 Have inadequate supply of inputs
 Are very costly in relation to benefits
 Assume over ambitious sales and profitability, etc.
As a result, some of the project alternatives will be rejected and those that are promising will be advanced to
the next stage called project preparation or feasibility (pre-feasibility and feasibility) study.
3.3. Opportunity Studies and Preliminary Screening
Preliminary screening is required to eliminate ideas that are not promising from beginning. The following six
dimensions should be considered for preliminary project idea screening:
a. Compatibility with promoter
The idea must be compatible with the interest, personality, and resources of the entrepreneur, i.e.
 It must fit the personality of the entrepreneur.
 It must be accessible to the entrepreneur.
 It must offer the entrepreneur the prospect of rapid growth and high return on investment.
b. Consistency with governmental priorities
 Is the project consistent with national goals and priorities?
 Is there any environmental effect contrary to government regulations?
 Can the foreign exchange requirements of the project be easily accommodated?
 Will there be any difficulty in obtaining the license for the project?
c. Availability of inputs
The input requirements, their availability and cost should be considered. Resources and inputs required must
be reasonably assured.
d. Adequacy of the market
The size of the present market must offer the prospect of adequate sales volume, potential for growth, and a
reasonable return on investment. To check adequacy, see for:
 Present and future demand
 Market share of own and competitor
 Domestic and export market
 Quality-price relationship vis-à-vis competitive products
 Economic, social, demographic trends for demand

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  Barriers to the new entry, sales and distributions system, patent protection, projected increase in
consumption, etc.
e. Reasonableness of cost
Cost structures of the proposed project must enable it to realize an acceptable profit with a competitive price.
f. Acceptance of level of risk
To ascertain degree of risk involved, the following factors should be considered:
 Vulnerability to business cycle
 Change in technology
 Competition from substitute
 Competition from imports
 Government control over price and distribution, etc.
3.4. Pre-feasibility Studies
Since formulation of the feasibility study is costly and time consuming task, further assessment of the project
idea is made in a pre-feasibility study. It is an intermediate stage between the project identification and a
detailed feasibility study. The principal objectives of it are to determine:
 All possible project alternatives are examined
 The project concept justifies a detailed analysis of a feasibility study
 The project idea on the basis of available information should be considered either non-viable or
attractive enough
 The environmental situation at the planned site and the potential impact of the projected production
process are in line with national standards.
The difference between the feasibility study and the pre-feasibility study is in the extent of detail of the
information obtained. The structure of the pre-feasibility study should be the same as the structure of the
feasibility study. However, detailed review of the available alternatives must take place at this stage since it
is costly and time consuming to do this in the feasibility stage. In particular, the review should cover the
various alternatives identified in terms of:
 Project or corporate strategies and scope of the project
 Market and marketing concept
 Raw materials and factory supplies
 Location, site and environment
 Engineering and technology
 Organization and overhead costs
 Human resource
 Project implementation schedule and budgeting

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In general, the pre-feasibility study involves subjective judgment of the project in terms of:
Availability of an adequate market: - judgments relating to the number of potential customers, needs of the
customers, strength of the competitors, availability and access to sales and distribution network and export
possibilities.
Project growth potential: - assessment of indicators on projected increase in the number of customers,
increase in the rate of acceptance of the products, the general economic, social and political trend which
could affect the growth potential of the project.
Investment costs: - Costs of raw materials transportation costs, distribution costs, labor costs, production
costs and investment costs are usually considered. If the above costs are very high sustainability of the
project is questionable.
Demand and supply factors: - This involves the projection of both short term and long term requirements of
the project’s output and examining the implications of these on the project’s capacity. Many projects fail
because they have started with a very large capacity only to operate at a much lower capacity. On the other
hand, increasing the capacity of the project shortly after it starts operation is very costly.
Social and environmental considerations: - the project should also conform to the social
considerations of the locality in which it is implemented. In addition; especially in industrial
projects, due consideration should be given to the environmental effects of it on the surrounding.
CHAPTER FOUR
PROJECT PREPARATION
At the end of this chapter students will be able to:
 Understand the process of market and demand analysis
 Understand the process of technical analysis
 Perform the process of Financial and Economic Analysis
 Evaluate financial feasibility of projects
 Conduct ecological analysis
 Identify the types of Financial evaluation criteria
 Identify the cost taken into consideration in financial analysis
4.2. Market and demand analysis
The objective of an investment project is benefit from utilization of resources and satisfying the
market demand in a society. This market analysis is an important key in determining the magnitude
of investment, location, technology requirement, production program, etc. The market analysis (the
concept of marketing) is the orientation of management with regard to their business decisions that

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is market makes all participants in an organization to orient their thinking towards the market. The
major objective of market analysis is to determine whether there is a gap between demand and
supply, i.e., is there a market for the product. The key steps involved in market and demand analysis
are organized into seven sections as follows.
 Situational analysis and specification of objectives
 Collection of secondary information
 Conducting market survey
 Characterization of the market
 Demand forecasting
 Uncertainties in demand forecasting
 Market planning.
The key steps in market and demand analysis and their inter-relationships are illustrated in the
1. Situational Analysis and Specification of Objectives
A situation analysis provides one with the current status of the key aspects of the market and is
participants. The aspects include customers, competitors, and middlemen. It analyses the
characteristics of this aspects such as customer’s preferences and purchasing power, strategies and
actions of competitors, and practices of middlemen. A situation analysis may generate data that will
provide a vague idea of the market and provide a basis for rough demand and revenue projection. If
the situation analysis points a promising picture for the project, a formal market study is warranted
to provide more accurate and reliable data that can be used for investment decision making.
To carry out such a study it is necessary to specify the objectives as clearly and as comprehensive as
possible. A common approach to do this is to structure them in the form of questions.
2. Collection of Secondary Information
Information may be obtained from secondary and /or primary sources. Secondary information is
information that has been gathered in some other context and is already available. Primary
information, on the other hand, represents information that is collected for the first time to meet the
specific purpose on hand. Secondary information provides the base and the starting point for the
market and demand analysis. General sources of Secondary information:
The important sources of secondary information that is useful for market and demand analysis are as
follows:
• National level Report prepared by the Government

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 • Plan Report by the /government
• Statistical abstract
• Economic Survey
• Annual Reports by the Ministry
• Bulletin of Banks
• Publication of Advertising agencies
• Other publications
Secondary information should be used with great caution. Its reliability, accuracy, and relevance for
the purpose on hand should be determined before use.
3. Conduct of Market Survey
Secondary information, though useful often, does not provide a comprehensive basis for market and
demand analysis. It needs to be supplemented with primary information gathered through a market
survey, specific to the project being appraised. The survey could be a census; where the entire
population is covered or a sample survey; only a proportion of the population is covered. Census
studies are prohibitively costly and infeasible because proper sampling can produce the same or
even more accurate results than census studies. Information sought in a market survey may cover
one or more of the following areas:
• Total demand and rate of demand growth
• Demand in different segments of the market
• Income and price elasticity of demand
• Motives for buying
• Purchasing plans and intentions
• Satisfaction with existing product
• Unsatisfied needs
• Attitude towards various products
• Social economic characteristics of buyers
• Customer preferences etc Steps in a Sample Survey
Typically, a sample survey consists of the following steps:
1. Define the target population; in defining the target population the important terms should be
carefully and unambiguously defined. The target population may be divided into various segments

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which may have differing characteristics. For example, all television owners may be divided into
three to four income brackets.
2. Select the sampling scheme and sample size: there are several sampling schemes, simple
random sampling, cluster sampling, sequential sampling, stratified sampling, systematic sampling
and non-probability sampling. Each scheme has its advantage and limitations. The sample size,
other things being equal, has a bearing on the reliability of the estimates - the larger the sample the
greater reliability.
3. Develop the questionnaire: the questionnaire is the principal instrument for eliciting
information from the sample of the respondent. The effectiveness of the questionnaire as a device
for eliciting the desired information depends on its length, the type of questions, and the wording of
questions. Developing the questionnaire require a thorough understanding of the product, and its
usage, imagination, insights into human behavior, and familiarity with the tools of descriptive and
inferential statistics to be used later for analysis.
4. Recruit and Train the Field Investigators: recruiting and training of field investigators must
be planned well since it can be time consuming. Great care must be taken for recruiting the right
kind of investigators and imparting the proper kind of training to them.
5. Obtain information as per the questionnaire from the sample respondent: respondent may be
interviewed personally, telephonically, or by mail for obtaining information. Personal interview
ensures a high rate of responses. They are, however, expensive and likely to result in biased
responses because of the presence of the presence of the interviewer. Mail survey are economical
and evoke fairly candid responses. The response rate, however, is often law, telephonic interview,
common in western countries have very limited applicability in Ethiopia because telephone tariffs
are high an low telephone connection.
6. Scrutinize the information gathered: information gathered should be thoroughly scrutinized
eliminate data which is internally inconsistent and which is of dubious validity. Sometimes data
inconsistencies may reveal only after some analysis.
7. Analyze and Interpret the Information: information gathered in the survey need to be
analyzed and interpreted with care and imagination. After tabulating it as per a plan of analysis,
suitable statistical investigation may be conducted, wherever possible and necessary. For the
purpose of statistical analysis, a variety of methods are available. They may be divided into two
broad categories; parametric and non-parametric methods.

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4. Characterization of Market
Based on the information gathered from the secondary information survey and the market survey,
the market for a product may be described in terms of the following:
a) Effective Demand; Past and Present: In competitive markets effective demand is the
apparent consumption which is defined as: production + imports – exports – changes in stock level.
This figure has to be adjusted for the consumption of the product by the producers.
Consumption series can be computed.
b) Breakdown of Demand: Total / aggregate demand may be broken in to different segments
which may be defined by: nature of product; consumer groups; geographical region etc
c) Price: It may be wise to distinguish between the following prices: manufacturer’s price;
wholesaler’s price; retail price etc
d) Methods of Distribution and Sales Promotion: Since methods of distribution and sales
promotion vary among different products, it will be helpful to describe the fore going aspects for the
product on hand
e) Consumers: Consumers may be characterized demographically using such attributes as age,
income, sex etc or attitudinally using such attributes as preferences, habits, intentions etc
f) Supply and Competition: The location, present production, planned expansion, capacity
utilization level of competitors is crucial information. Substitutes and near substitutes should be
noted too.
g) Government Policy: The role of the government in influencing the market and demand of a
product may be significant; as such government policies and legislations that have an impact on the
product should be spelt out.
5. Demand Forecasting
After gathering information about the various aspects of the market and demand from primary and
secondary sources, attempt may be made to estimate future demand. A wide range of forecasting
method is available to the market analyst.
6. Uncertainties in demand forecasting
Demand forecasting is subjected to error and uncertainly that arise from three main sources Data
about past and present market lack standardization, few observations influence abnormal factors etc.

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Methods of forecasting inability to handle unquantifiable factors, unrealistic assumption excessive
data requirement etc. Environmental changes shift in government policy international development,
discovery of new sources of raw materials.
5. Market planning
The following are the steps followed in market planning
A) Current marketing situation. This deals with:
 Market situation e.g. size growth rate etc.
 Competitive situation e.g. the competitors objectives strategies strengths etc.
 Distribution situation e.g. distribution capabilities of competitors
 Macro-environment e.g. social, political economic technological variables etc.
b) Opportunity and issue analysis. In this section SWOT analysis is conducted
c) Objectives. Objectives which have to be clear, specific and achievable are spelt out
d) Marketing strategy. The marketing strategy covers the following: Target segment, positioning,
product line, price, distribution, sales force, sales promotion and advertising.
e) Action program. This entails operationalizing the strategy in to time phased activities.
4.3. Raw materials and supplies study
There is technical relationship between input and output; the amount of input determines the output
amount. Conversely, you have determined the product type and capacity. The next step to produce
as per the above step is what input to use. The selection of raw material and supplies depends
primarily on the technical requirements of the project and the analysis of supply markets. Important
determinants for the selection of raw materials and factory supplies are environmental factors such
as resource depletion and population concerns, as well as criteria related to project strategies for
example, the minimization of supply risks and the cost of materials inputs. In order to keep the cost
of the supply low, key aspects are to be identified and analyzed in terms of requirements
availability, cost, and risks which may be significant for the feasibility of a project. The raw
materials and supplies study consists of thorough analysis on what type of input? Where to find?
How much it costs? Etc. Thus, the following approaches are often used to study raw materials and
supplies.
4.3.1. Classification of Raw Materials and Supplies
A. Raw Materials (Unprocessed and Semi Processed)

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Agricultural Products: The quality, present & potential must be identified. In food processing
industries, only the marketable surplus of agricultural products should be viewed as basic raw
materials, after meeting the consumption and sowing requirements. In the case of commercial crops
the market surplus is the total production minus sowing requirements. In order to estimate the
supplies and availability of agricultural products it may be necessary to collect the data on past
crops and their distribution by market segment. Projects based on agricultural produce to be grown
in the future may call for actual cultivation on experimental farms under varied conditions.
Livestock and Forest product: In most cases of livestock product and forest resources, specific
surveys are called for to establish the viability of an industrial project.
Marine Product: For marine based raw materials, the major problem, to assess the potential of
availability, the yields and the cost of collection. Availability of marine products may not only
depend on ecological factors but also on national policy and bilateral and multilateral arguments
Mineral products: Detailed information on the proposed exploitable deposit is essential. Unless the
reserves are known to be very extensive, the study should give details of the viability open cast or
underground mining, the location, size, depth and quality of deposit and the composition of the ore
with other elements i.e. impurities. A detailed analysis of physical, chemical and other properties of
the subject ore be processed and the results ought to be incorporate in the feasibility report.
B. Processed Industrial Materials and Components
Such inputs can be generally classified under base metals; semi processed materials relating to a
wide variety of industries in different sectors and manufactured parts, components and
subassemblies for assembly-type industries, including a number of durable consumer goods and
engineering goods industry. In all these cases, it is necessary to define requirements availability and
costs in some detail to ensure that the specification in the case of the two latter categories suit the
production programs envisaged for the projects. For base metals availability during a particular time
may depend on unstable international markets, as such their substitutability should be carefully
examined. In case of process intermediates a careful analysis of their external availability and cost
couple with the implication of their domestic manufacture should be made. While the same
considerations prevail for assembly-type industries, backward linkages considerations should be
made.
C. Factory supplies and Auxiliary Materials

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A part from basic raw materials and processed industrial materials and components all
manufacturing projects require various auxiliary materials, usually subsumed as factory supplies
chemicals, additives, packaging materials, paints, oil, greasing, cleaning material etc. The
requirement of such auxiliary materials should be taken in to account in the feasibility study.
D. Utilities
A detailed assessment of the utilities required (electricity, water, steam, compressed air, fuel,
effluent disposal) can only the made after analysis and selection of location, technology and plant
capacity, but a general assessment of these is a necessary part of the input study. An estimate of
utilities consumption is essential for identifying the existing sources of supply and any bottlenecks
and shortage that exist or are likely to develop so that appropriate measures can be taken to provide
for either internal or external additional supplies in good time.
4.3.2. Specification of Requirements
In order to estimate the requirement of materials and supplies during the future operation of the
plant, such requirements should be identified, analyzed and specified in the study both
quantitatively and qualitatively. A number of factors could have a strong influence on the type,
quantities, and qualities of the project inputs in particular the following:
 Socio- economic factors: social and cultural environment, socio economic infrastructure
(social and economic policies and regulation infrastructural service, transport and
communications system etc)
 Commercial and financial (business) factors: projects size, skills and production of the labor
force, market demands regarding product quality, product mix, competition for material
supplies and services etc.
 Technical factors: type of industry, technology and production process, type machinery and
equipment, production capacity and estimated production etc.
Normally specifications will be based on preliminary project design, and only when the detailed
specifications of the inputs available are known, the final engineering design of the project can be
prepared. However, it is very important to consider during this stage of project design that there
exists not only a relationship between material input and engineering design, but also
interdependence with the market and marketing concept location aspects and the availability of
human resources.
4.3.3. Availability and Supply

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The source and the constant availability of basic production materials are crucial to the
determination of the technical and economic viability as well as the size of most industrial projects.
A feasibility study must show how the materials and inputs required will be provided. General
availability, data about materials potential users and supply sources and programs will have to b
analyzed and described. A final assessment of input requirement can be made on only after the plant
capacity as well as the technology and equipment to be used are defined. If a basic input is
available within a country, its location and the area of supplies, whether concentrated or dispersed
should be determined. The alternative uses likely to be made of such materials and the consequent
impact on availability should be assessed for the project in question. The question of transportability
and transport costs should be carefully analyzed. When the basic material has to be imported either
in whole or in part, the implication of such imports should be fully assessed. First the sources of
imported inputs have to be determined. Secondly, the uncertainly of inputs should be sated. Thirdly,
the implication of domestic production of basic materials that was being imported should be
analyzed. In most developing countries such production is accompanied by imported control and
user industries have to adjust to domestic supplies of basic materials.
4.3.4. Supply Marketing and Supply Program
Supply marketing
The objectives of supply marketing are basically cost minimization, risk minimization (reliability of
supplies) and the cultivation of relation with supplier.
Supply Program
The overall purpose of the outline of a supply program in the feasibility study is to show how
supplies of materials and inputs will be secured. Evidence should be presented to justify the
assumption and suggestions. Cost estimates should be based on the supply program presented.
A supply program should deal with the following:
a) Identification of Supplying Sources and Suppliers
In the identification of a particular key supplier, consideration should be given to its geographical
location, ownership, main activities, financial strength and profitability, production capacity, output
over the last years, key customers and business experience with the type of products and the country
concerned. An estimate of the level of priority that the supplier is likely to give the contract is
crucial.
b) Agreement and Regulations

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Letter of intent regarding supply contacts and obligation should be referred to and the general terms
of suggested agreements, such as period of validity, payment terms, currency conditions and
guarantees, outlined. Import policies and regulations including application procedures for obtaining
import licenses validity periods, permits to acquire or use foreign currency possible tax exemptions,
and duty free imports, the existence of import restrictions etc., should be described and their
consequences for the project analyzed.
c) Means of Transport
Means of transport for key materials and inputs by air, water, road or rail should be identified in the
study. The availability, capacity, reliability and technical condition of the facilities must be
analyzed. The study should consequently not only identify existing means of transport but also
analyze their condition, describe how they can be used and suggest measures to be taken by the
company concerned in order to obtain some confidence on the level of reliability and capacity.
Loading and unloading facilities should be analyzed too.
D) Storage
Storage facilities are usually required at the plant, but may also be needed at ports, railway stations,
or other places. The study should indicate the capacity of such facilities describe their utilization and
present estimated quantities to be stored on the basis of anticipated production levels and delivered
of materials and inputs
E) Risk Assessment
Identification and assessment of risks and uncertainties in the supply program should be presented.
A distinction should be made between external and internal project risks factors, including failure of
suppliers to meet their obligations, delayed consignments, supply shortages, quality defects,
transport breakdown, utility malfunctions, strikes, climate variations, changed import regulations
and shortages of foreign exchange for imports.
4.3.5. Costs of Raw Materials and Suppliers
a) Unit Costs
Not only the availability but also the unit costs of basic materials and factory supplies have to be
analyzed in detail as this is a critical factor for determine project economies. In the case of domestic
materials current prices have to be viewed in the context of past trends and future projections of the
elasticity of supply.

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The cost of alternative means of transport should also be considered. For imported materials and
inputs CIF prices (including costs, insurance and freight) should be invariably be adopted together
with clearing charges (including loading and unloading) port charges, tariffs, local insurance and
taxes, and costs of internal transport to the plant.
b) Annual Costs
Estimates of annual operating costs for materials and supplies are to be made. The price basis for the
estimates (price level, quotations from suppliers, world market prices comparisons with similar
inputs in other projects etc) should be stated in order to enable the reader to check their reliability.
It should be made clear whether the cost estimates refer to a hypothetical level of production at full
capacity utilization during the operation phase or to the first year (or some other year) of operation
phase according to the time schedule for project implementation.
Some costs vary with the production level the plant in question, while others are more or less fixed.
Taking into consideration the expected variations in the proposed plant it is advisable to divided
cost item into variable and fixed costs. Costs estimates for materials and inputs can be expressed
either as the cost per unit produced or in terms of a certain production level for, example 100,000
units per year. The later alternative can also be expressed as full capacity utilization which is
equivalent to a certain production level. In either case, it will be possible to carry out a sensitivity
analysis of different levels production and of capacity utilization in the financial calculations.
When calculating indirect costs, the amounts resulting from environment protection and population
control measures should be established per production or per accounting period, whichever is
appropriate. In order to arrive at the total operating costs by product as well as by total costs per
year, the estimated costs per unit are multiplied by the total number of unit to be produced.
c) Overhead Costs of Supplies
When estimating material and input requirements of the project, the project planner has to plan not
only for the level of production cost center but also at the level of service, administration and sales
cost centers.
4.4. Location, Site, and Environmental Impact Assessment
4.4.1. Location and Site
4.4.1.1. Choice of Location
Location analysis has to identify a location suitable for the industrial project under consideration.
The choice of location and site necessitates an assessment of demand, size, and input requirement.

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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 coastal
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.
The feasibility study should also indicate on what grounds alternatives locations have been
identified and give reasons for leaving out other locations that were suitable but not selected.
Traditional approach to industrial location focused, on the proximity of raw materials and
marketing’s, mainly with a view to minimizing transport costs. The modern view requires
consideration of commercial, technical and financial factors, but also of the social and environment
impact a project might have.
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 center of consumption.
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.

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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 cannot 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
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.

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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.
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 nearby 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 locational study should analyze the cost of
alleviating environmental pollution to tolerable levels at alternative locations.
4.4.1.2.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:

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  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
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

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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
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.)
4.4.2. Environment Impact Assessment (EIA)
The site environment impact analysis will cover the impact of the project and the alternatives (in
terms of size, technology etc) on the surrounding area, including its population, flora and fauna.
This analysis should be integrative and interdisciplinary, assessing the overall impact which taking
into account the synergetic effects of inter-linked systems.
Environmental impact assessment is part of the project planning process. Through statute or
practice, 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 in whole or in part.
In countries where the analysis of environmental impact is required by law, the usual procedure is
for the promoters of the projects to prepare an extensive environmental impact statement.
Where such legal provision for environmental protection do not yet exist an environmental impact
assessment should be made in the interest of the investor, in particular when the intention is to apply

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for international financing. A growing consciousness and concern for environmental problems and
ecological consequences have in fact become noticeable worldwide. Therefore, trends anticipated in
the industry life cycle should also be considered in investment planning especially for industries
with high potential environmental impact. Unexpected costs for later plant adaptations,
conservation, rehabilitations or even the shutdown of operations can be avoided or minimized to
countries where environmental protection standards and guidelines are not yet defined.
Objectives of Environmental Impact Assessment
The general objective of environmental impact assessment in, project analysis is to ensure that
development projects are environmental sound.
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 projects for each of the alternatives
project designs.
• To incorporate in the designed 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 impact quantitatively and qualitatively, 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. Sometimes 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.
4.5. Production Program and Plant Capacity

4.5.1. Production program

A production program defined as the level of output to be achieved during specified period and from
this viewpoint, it should be directly related to the specific sales forecasts. It would be prudent to
recognize that full production may not be practicable for most projects during the initial production
operations.
Production program consist of the whole range of project activities and requirement, including
production levels to be achieved under the technical, ecological, social and economic constraints.
This necessitates identifying the principal products or products range including byproducts,
determining the volume of production and relating production capacity to the flow of materials and
performance of services at the selected site.
Determination of the production program
Market requirements and marketing concept : The range and volume of products to be produced
depends primarily on the market requirements and the proposed marketing strategies. This
production program and volume have to be designed under the constraints determined for the
market conditions and the availability of resources both at various levels of production, the latter
determining the minimum sales price for products.
Owing to various technological, production operations and commercial difficulties most projects
experiences initial problems that can take the form of a gradual growth of sales and market
penetration on the one hand and a wide range of production problems such as the adjustment of
labor and equipment to the technology selected on the other. Even if full production were to be
achieved in the first year, marketing and sales might prove to be a bottleneck. Depending on the
nature of the industry a production and sales target of 40-50 per cent of overall capacity for the first
year should be considered reasonably.
Once a production program defines the levels of outputs in terms of end products, and possible of
intermediate products and the interrelation between various production lines and processes, the
specific requirements of materials and labor should be quantified for each stage.

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Technology and know-how: An important factor in determining the production program and plant
capacity is the technology and know-how to be utilized in the project. Specific processes are often
related to certain levels of production or become technically and economically feasible only at such
levels.
The nature of technology choice and usage constitutes a key factor in the determination of plant
capacity. Each technically possible alternative must in addition consider social, ecological,
economic and financial conditions, because production programs and plant capacity are functions of
various interrelated socio-economic strategic and technical factors.
4.5.2. Plant capacity
Plant capacity (also referred to as production capacity) refers to the volume or number of units that
can be manufactured during a given period. Plant capacity may be defined in two ways:
feasible normal capacity and nominal maximum capacity.
Feasible normal capacity refers to the capacity attainable under normal working conditions. This
may be established on the basis of the installed capacity, technical conditions of the plant, normal
stoppages, and downtime for maintenance, holidays, and shift patterns.
Nominal maximum capacity is the capacity which is technically attainable and this often
corresponds to the installed capacity guaranteed by the supplier of the plant.
Plant capacity is influenced by the following factors:
Technological requirement
For many industrial projects, particularly in process type industries, there is a certain minimum
economic size determined by the technological factor. For example, a cement plant should have a
capacity of at least 300 tons per day in order to use to rotary kiln method: otherwise; it has to
employ the vertical shaft method which is suitable for lower capacity.
Input constraints
In developing countries, there may be constraints on the availability of certain inputs. Power supply
may be limited, basic raw materials may be scarce; foreign exchange available for imports may be
inadequate. Constraints of these kinds should be borne in mind while choosing the plant capacity.
Investment cost
When serious input constraints do not exist, the relationship between capacity and investment cost is
an important consideration. Typically, the investment cost per unit of capacity decrease as the plant
capacity increase.

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Market conditions
The anticipated market for the product/service has an important bearing on the plant capacity. If the
market for the product is likely to be very strong, a plant of higher capacity is preferable. If the
market is likely to be uncertain, it might be advantageous to start with a smaller capacity. If the
market, starting from a small base, is expected to grow rapidly, the initial capacity may be higher
than the initial level of demand-further additions to capacity may be affected with the growth of the
market.
Resources of the firm
The resources, both managerial and financial available to a firm define a limit on its capacity
decision. Obviously, a firm cannot choose a scale of operations beyond its financial resources and
managerial capability.
Government policy
The capacity level may be influenced by the policy of the government. Traditionally, the policy of
developing countries was to distribute the additional capacity to be created in a certain industry
among several firms regardless of economics of scale. This policy has been substantially modified
in recent years and the concept of ‘minimum economic capacity’ has been adopted in several
industries.
4.6. Technology and Engineering Study
Technology is defined as the application of scientific knowledge for productive purposes. This
entails the use of science to produce products, services or processes.
4.6.1. Assessment of technology required
The primary goals of technology assessment are to determine and evaluate the impacts of different
technologies on the society and national economy (cost-benefits analysis, employment and income
effects, satisfaction of human needs etc), impacts on the environment (environmental impact
assessment) and techno-economic feasibility assessed from the point of view of the enterprise.
To allow the careful assessment of the suitability of the technological alternatives a logical sequence
should be followed: identification, technology description and project layout, technology market
and alternatives, assessment of availability, technology forecast, assessment of the local integration,
and description of the social economic impact. A. Identification
The technology required is defined not only by the marketing concept and the available raw material
and factory supplies but also by various social economic, ecological financial commercial and

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technical conditions. It should identify, describe and assess the critical elements of the technology
required. Special consideration should be given to existing or possible future constraints on the
acquisition and use of available technologies to further development needs and to the possibility of
feasible technological alternatives.
B. Technology description and project layout
The preparation of a plant layout and design is essential for every project. The first initial stage
should be the preparation of a preliminary project plan and layout on the basis of the production
activities and the technologies alternative envisaged. These second stage of project layout and
design can only be drawn when the details relating to technology plant capacity and machine
specification are finalized.
The preliminary project layout should include several charts and drawings, which need not be
according to scale, but which would define the various physical features of the plant and their
relationship with one another.
C. Technology market and alternatives
The selection of appropriate technology is undoubtedly one of the key elements of such a study. The
study should identify both alternatives technologies and alternatives sources of technology. The
evaluation would then aim at selecting the technology and the source from which it may be secured.
The study should also discuss the contractual terms and conditions which may be of special
significance in relation to the acquisition of a particular technology.
D. Assessment of availability
The market for industrial technology is highly imperfect with alternatives technologies and sources
available from only one or a few sources and alternatives production technologies may be difficult
to find. In this connection, the UNIDO Industrial and Technological Information Bank (INTIB)
became operational in 1980, its main objectives being to ensure a quicker, easier and greater flow of
information to people who need to select technologies.
E. Technology forecast
Technological forecast provides an assessment and forecast of technological trends during the
project implementation phase and the project life cycle, on the one hand or the period limited to the
planning horizon for the project on the other. A technology forecast is especially important for
investment projects in highly innovative.
F. Assessment of the local integration

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An issue of major significance in technology choice is the level of integration or local value added
that can be achieved with respect to a particular technological usage. The study should define the
extent of integration that should be proven technology that has already been applied and utilized and
which can be related to local conditions. The parameters of the appropriate level of integration
should be indicated.
G. Description of the social economic impact
Public policies with regard to the acquisition of foreign technologies, technology absorption and
development have to be identified. The socio-economic infrastructure, including the structure of the
labor force may have a significant impact on the feasibility of the technology to be selected for the
project.
4.6.2. Selection of Technology
The choice of technology is influenced by variety considerations this are: plant capacity, principal
inputs, investment outlay and production cost, use by other units, product mix, and latest
developments, ease of absorption, ecological and environmental impact.
 Plant capacity: Often, there is a close relationship between plant capacity and production
technology. To meet a given capacity requirement perhaps only a certain production
technology may be viable.
 Principal inputs; The choice of technology depends on the principal inputs available for the
project. In some cases, the raw materials available influence the technology chosen. For
example, 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,
preferably in the specific country.
 Product mix: The technology chosen must be judged in terms of the total product-mix
generated by it, including saleable by-products.
 Latest developments: The technology adoption 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.

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  Ease of absorption: The ease with which a particular technology can be absorbed can
influence the choice of technology. Sometimes a high level technology may be beyond the
absorptive capacity of a developing country which may lack trained personnel to handle that
technology.
4.6.3. Appropriateness of technology
Appropriate technology refers to those methods of production which are suitable to local economic,
social and cultural conditions. In recent years, the debate about appropriate technology has been
sparked off mainly by Schumacher and others. The advocates of appropriate technology should be
evaluated in terms of the following questions:
• Whether the technology utilizes local raw materials?
• Whether the technology utilizes local man power?
• 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?
4.6.4. Acquiring Technology
When technology has to be obtained from some other enterprises, the means of acquisition have to
be determined. These can take the form of technology licensing, outright purchase of technology or
a joint venture involving participation in ownership by the technology supplier.
1. Technology licensing: this gives the licensee (the one who receive the technology) the right
to use the patented technology and get related know how on a mutually agreed basis. The
contract for technology licensing should be carefully scrutinized with respect to:
 Definition: The details of the technology including processes and products together with the
technology service required from the technology supplier should be clearly defined. This
should include all necessary documentation such as blue prints, specifications, production
drawings etc
 Duration: Since the duration of a technology agreement must be adequate for affective
technologies absorption, the period required for such absorption should be defined, together
with the scope for progressive technological upgrading and renewal.
 Warranty: The appropriate warranty or guarantee relating to the technology and knowhow
supplied should be indicated

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  Access to improvements: Provision should be made for the licensee to have access to
improvements made by the licensor during the period of agreement.
 Payments: Technology payments can be in the form of a lump sum payment or continuing
royalties or a combination of the two. The suggested form and appointed level of payment
should be indicated.
 Civil Works: Structures and civil works may be divided into three categories site preparation
and development, buildings and structures and, outdoor works. A. Site preparation and
development :
This covers 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 site to the public network: electric power (high tension and low tension), water for
drinking and other purposes, communications (telephone telex, internet etc,) , roads, railway sidings
and (vi) other site preparation and development work.
B. Building and structures
Buildings and structures may be divided in to (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) residual buildings.
C. Outdoor works
Outdoor works cover (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,)
2. Outright purchase (purchase of technology): this mode of acquiring technology may be used in
certain kinds of industries. It is appropriate when:
I. there is no possibility of significant improvement in technology in the foreseeable future
ii. There is hardly any need for technological support from the seller of technology
3. Joint venture agreement: the supplier of technology may participate technically as well as
financially in the project. Financial participation is typically in the form of equity holding. It's

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 argued that financial participation may strengthen the motivation of technology supplier to
transfer improvement promptly.
4.7. Human Resource and Organizational Study
4.7.1. Human Resource Requirement
Human resource requirement means determination of human resource requirement and cost for the
project. The human resources requirement at various levels and during different stages of the project
must be defined as well as their availability and cost. On the basis of the quantitative human
resource requirement of the project, the availability of personnel and training needs, the cost
estimates for wages, salaries other personnel-related expenses and training are prepared for the
financial analysis of the project.
Human resources as required for the implementation and operation, industrial project need to be
defined by categories such as management as supervision personnel and skilled and unskilled
workers and by functions such as general management, production management and supervision,
administration (accounting, purchase etc.) production control, machine operation and transport.
The numbers, skills and experiences required depend on the type of industry, the technology used,
plant size, the cultural and socio-economic environment of the project, location as well as proposed
organization of the enterprise. Human resource requirements will obviously also depend on the
management structure, organizational layout, operating plan and other factors related to the financial
and commercial features of the project.
Staff and labor requirements have to be planned for the implementation or pre-production phase as
well as for the start-up and operation phases. Particular attention should be paid to those enterprise
functions which are essential for the feasibility of the investment and for which special professional
skills and experience of employment and workers are required as in the areas of enterprise
management (entrepreneurial and management functions), marketing, raw material and factory
supplies, production processes and product characteristic, organization, and personnel and
construction management.
The identification of these significant requirements already at the stage of the feasibility study is
both difficult and important. Some common examples of mistakes and their consequence are:
 Failure to provide the project implementation team with experienced and committed
personnel often to delays and additional costs.

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  Bad timing of recruitment may lead to delays and poor utilization of production capacity
during the first operating years.
Timing of requirements
1. Pre -production phase:
During the pre-production phase, it may be assumed that labor requirements occur mainly in
conjunction with preparatory measures needed to start the operational phase. Thus the managerial
staff, supervisors, some foremen, and special machine operators have to be recruited in advance, not
only to be trained, but also to attend to the construction of building and the installation of equipment
that they will later be operating.
2. Operational phase:
Requirements during the operating phase may vary over time. Capacity utilization is usually
improved gradually and additional shifts may be introduced bringing about production and possibly
additional requirements in certain personnel categories. A distinction should be made between
variable and fixed wage and salary costs as well between the local and foreign lab our components.
Availability and Recruitment
Assessment of supply and demand
The following factors should be given due consideration when the availability and employment of
human resources are analyzed: The general availability of relevant human resource categories in the
country and the project region. The supply and demand situation in the project region. Recruitment
policy and methods
Training policy and program
The study should indicate the current supply and demand situation in the region as well as possible
shortages in relevant categories. Strong demand from existing industries and expected demand from
projects under construction might make it more difficult for the project in question to recruit human
resources with the professional background and skills required.
Recruitment planning
Recruitment policy and methods and means of the retaining key personnel for long periods,
probable terms of employment and possible fringe benefits to employees and their families should
be identified. Difficulties in the recruitment of key personnel (such as managers, supervisors and
skilled labor) can be dealt with in different ways:

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Recruitment is combined with intensive training of key personnel in order to meet quality
requirements foreign expertise is recruited. An attempt is often made to compensate for the lack of
experience of local managerial latent through the employment of foreign personnel, either by hiring
individual expatriate or by signing management contracts with foreign companies. Although this is
an expensive course and does not immediately serve the important aim of developing indigenous
managerial skills (especially if it extends over long period as is often the case) the employment of
expatriates may be necessary for the successful implementation of a project.
Training Plan
Since the lack of experienced and skilled personnel can constitute a significant bottleneck for
project implementation and operation in developing countries, extensive training programmers
should be designed and carried out as part of the implementation process of investment projects.
Training can be provided at the factory by managerial and technical personnel and others, by
specially recruited experts or by expatriate personnel. The timing of training programs is of crucial
importance since personnel should be sufficiently trained to be able to take up their positions as and
when required. Training requirements should be defined separately for the preproduction and for the
operation phase in order to provide adequately for production and operational training costs.
Cost Estimates
The manning tables prepared for each department can be used for estimating labor costs.
Estimating the total wage and salary costs.
4.7.2. Organizational Set-Up
Organization is the means by which the operational functions and activities of the enterprises are
structured and assigned to organizational, units represented by managerial staff, supervisors and
workforce, with the objective of coordinating and controlling the performance of the enterprises and
the achievement of its business targets.
The organizational structure of an enterprise indicates the delegation of responsibilities to the
various functional units of the company and is normally shown in a diagram. Usually, the
organization is designed primarily in line with the different functions in the enterprise such as
finance, marketing, purchasing, and manufacturing. However, there is no unique organization
pattern. It is also possible to base organizational structures on products or productions lines (for
instance profit or cost centers) or on geographical areas or markets; the latter are typical for
marketing organizations.

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Organizational Design
The organization design for both the construction and the operating phase depends on internal and
external project requirements and conditions and is prepared for the following two reasons: First,
the organization of the project and enterprises should aim at the optimal coordination and control of
all project inputs, which make it possible to implement the project strategic economically.
Secondly, the organizational set up serves to structure the investment and production costs and to
determine the costs linked with the corresponding organization units.
The design of the organization usually includes the following steps:
• The goals and objectives for the business are stated;
• The functions that are necessary to achieve the goals are identified;
• The necessary functions are grouped or related;
• The organizational framework or structure is designed;
• All key jobs are analyzed designed and described,
• A recruitment and training program is prepared.
The organizational planner will then have to consider some of fundamental aspects of optimal
organization. These may include:
• The span of control that is the numbers of employees reporting to supervisor.
• The number of organization levels
• A subdivision of activities by functions, process, equipments, location, product or classes of
customers.
• The distribution of responsibilities and authority.
4.8. Financial and Economic Analysis
Basically, financial analysis should accompany the design of the project from the very beginning.
This is only possible when the financial analyst is integrated into the feasibility study team at an
early stage. From a financial and economic point of view, investment can be defined as a long term
commitment of economic resources made with the objectives of producing and obtaining net gains
(exceeding the total initial investment) in the future.

4.8.1. Total investment costs

Initial investment costs

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Initial investment costs are defined as the sum of fixed assets (fixed investment costs plus
preproduction expenditures) and net working capital. Fixed assets constituting the resources
required for constructing and equipping an investment project, and net working capital
corresponding to the resources needed to operate the project totally or partially.
Investment required during plant operation
The economic life time is different for the various investments (buildings, plant, machinery and
equipment, transport equipment etc). In order to keep a plant in operation, each item must therefore
be replaced at the appropriate time and the replacement costs must be included in the feasibility
study.
Pre-production expenditures
In every industrial project certain expenditure due, for example, to the acquisitions or generation of
assets are incurred prior to commercial production. These expenditures, which have to be
capitalized, include a number of items originating during the various stages of project preparation
and implementation.
Preliminary capital-issue expenditures: These are expenditures incurred during the registration and
formation of the company, including legal fees for preparation of the memorandum and articles of
association and similar documents and for capital issues.
Expenditures for preparation studies: There are three types of expenditures for preparatory studies:
Expenditures for pre-investment studies; consultant fees for preparing studies, engineering and
supervisor of erection and construction; other expenses for planning the project
Other pre-production expenditures: Included among other pre-production expenditures are the
following:
• Travel expenses
• Preparatory installation: such as workers, camps, temporary offices and stores.
• Pre-production marketing costs, promotional activities, creation of the sales network etc.
• Training costs including fees, travel, living expenses, salaries and stipends of the trainees
and fees payable to external institutions;
• Know-how and patent fees
• Interest on loans accrued or payable during construction
• Insurance costs during construction

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 Trial runs, start-up and commissioning expenditures: This item includes fees payable for
supervision of starting-up operation, wage, salaries, fringe benefits and social security contributions
of personnel employed, consumption of production materials and auxiliary supplies, utilities and
other incidental start- up costs. Operating losses incurred during the running period up to the stage
when satisfactory levels are achieved also have to be capitalization.
Net working capital
Net working capital is defined to embrace current assets (the sum of inventories, marketable
securities, prepaid items, accounts receivable and cash) minus current liabilities (accounts
payable). It forms an essential part of the initial capital outlays required for an investment project
because it is required to finance the operations of the plant.
4.8.2. Production Cost
 It is essential to make realistic forecasts of production and manufacturing cots for a project proposal
in order to determine the future viability of the project.
 The production costs are classified into four major categories. They are:
1. Factory costs,
2. Administrative overhead costs,
3. Depreciation and cost of financing and
4. Operating Cost (the sum of factory and administrative overhead costs).
4.7.3. Marketing Costs:
 Marketing costs comprise the costs for all marketing activities and may be divided into direct
marketing costs and indirect marketing costs.
 Direct marketing costs – are costs for packaging and storage, sales, product
advertisement, transport and distribution costs.
 Indirect marketing costs – are costs related to marketing department. They are
salaries for personnel, materials and communication, market research, public relation
and promotional activities.
4.7.4. Project Cash Flows
Cash flows are basically either receipt of cash (cash inflow) or payments (cash outflows) typical
operational cash flows for a project are shown below
Operational cash outflows
• Increase in fixed assets (investment)

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 • Operating costs (less depreciation)
• Marketing expenses
• Production and distribution losses
• Corporate (income taxes)
Operational cash inflows
• Revenues from selling of fixed assets
• Sales revenues
• Other income due to plant operations
4.7.5. Methods of Financial Evaluation
The process of identifying the financial benefits is called capital budgeting, which may be defined
as the decision-making process by which organizations evaluate projects that include the purchase
of major fixed assets such as buildings, machinery, and equipment.
1. Cash flow discounting in financial evaluation
Basic assumptions underline cash flow discounting in financial evaluation
The basic assumption underlying the discounted cash-flow concept is that money has a time value.
A sum of money available now is worth more than an equal sum available in the future. This
difference can be expressed as a percentage rate indicting the relative change for a given period
which, for practical reasons, is usually a year. Considering that a project may obtain a certain
amount of funds (F). If this sum is repaid after one year including the agreed amount of interest (I)
the total sum to be paid after one year would be (F+I) where, F+I= F (1+r) and r is defined as the
interest rate (in percentage per year) divided by 100 (if the interest rate is, for example 12.0 per cent
then r equals 0.12).
(a) Net Present Value (NPV) Method
NPV = present value of cash flow – present value of initial cost
The decision rule associated with NPV method is to accept all proposals with a NPV greater than
zero. This indicates accepting all projects that add value after providing a return,
consistent with the cost of capital and risk. Where two or more projects are mutually exclusive,
then the project with the highest NPV should be chosen. The following example will make the
concept clear:
Example 1: A firm is considering investing in a project which costs 6,000 Br and has the following
cash flows

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 YR 1 2 3 4
C.F 1500 3000 2000 2500
The cost of capital is 10%and the project has no salvage value. Using the NPV method advise the
firm on whether to invest in the project
YR CF PVIF (10%) P.Vs

1 1500 0.9091 1363.65

2 3000 0.8264 2479.20
3 2000 0.7513 1502.60
4 2500 0.6830 1707.50
Total P.Vs = 7053.00
Less project cost (6000.00)
NPV = 1053.00
Decision: Accept the project since NPV >0
Merits of NPV criterion:
• It recognizes the importance of the time value of money.
• It takes into consideration the benefits occurring over the entire life of the project.
• It follows the principle of shareholder's wealth maximization.
Demerits of NPV criterion
The main drawbacks of this method are:
• In some cases it may be difficult to determine the appropriate discount rate. The choice of
an appropriate discount rate is important because the relative desirability of the project will
change with the change in discount rate.
• This method favors the project with the higher NPV. In some cases, the project with a
higher NPV may involve a higher initial outlay which may exceed the budgeted investment
outlay for the project.
• This method may not give satisfactory results when the two projects in question have
different economic lives.
Internal Rate of Return (IRR)
IRR is the discount rate that equates the NPV of a project to zero. It is the project rate of return
(Yield)

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Steps in the IRR trial and error calculation method
• Compute the NPV of the project using an arbitrary selected discount rate
• If the NPV so computed is positive then try a higher rate and if negative try a lower rate.
• Continue this process until the NPV of the project is equal to zero
• Use linear interpolation to determine the exact rate
Example 3: A project has the following cash flows
YR 1 2 3 4
C.F 300 400 700 900
The cost of the project is 1500 Br. Determine whether project is acceptable if the cost of capital is
18% using the IRR method.
1. We first select an arbitrary discount rate say 9% and compute the NPV

2 since, NPV at 9% is positive and large we select another discount rate larger than 9%, say
15%

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 3 since, NPV at 15% is positive but not large, we select a slightly higher rate, say, 18%
YR C.F PVIF (18%) P.Vs
1 300 0.8475 254.25
2 400 0.7182 287.28
3 700 0.6086 426.02
4 900 0.5158 462.22
Total P.Vs 1431.77
Less cost (1500.00)
NPV at 15% - 68.23
Since NPV at 18 is negative, IRR therefore lies between 15% and 18%, and since zero NPV will the
between -38.23 and 38.19, to get the correct (exact) IRR we have to interpolate between 15% and
18% using interpolation formula
Decision: Reject the project since IRR is less than the required rate of return (cost of capital)
Advantages of IRR
• Can be used to compare projects of different sizes
• Considers time value of money
• Indicates the exact profitability of the project Disadvantages of IRR
• Some projects have multiple IRRs if their NPV profile crosses the x-axis more than once (project
cash flow signs change several time)
• Assumes re-investment of cash flows occurs of project’s IRR which could be exorbitantly high
• Doesn’t provide a decision criteria
• Not conclusive for mutually exclusive projects
c) Profitability Index (PI)/ present value index (PVI)/ benefit-cost ratio
It is the relative measure of project’s profitability and can be used to compare project of different
sizes
PI = present value of cash flows/Initial cost
Decision criteria: If, PI >1, Accept project, PI < 1, Reject project, PI = 1, Indifferent
Example 4: A project has the following cash flows

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Year 1 2 3 4
CF 300 400 700 900
If the required rate of return is 9% and the project initial cost is 1500 Br, calculate the PI of the
project and advice if the project is acceptable
YR CF PVIF 9% PVs
1 300 0.9174 275.52
2 400 0.8417 336.68
3 700 0.7722 540.54
4 900 0.7084 637.46
Total PV = 1790.00
Decision: The project is acceptable since PI > 0
Advantages of PI
• Recognized time value of money
• Compares projects of different sizes
• Gives a decision criteria
Disadvantages of PI
• Does not indicate the risk
2. Traditional or Non-Discounted Method
A. Accounting (average) rate of return (ARR)
It considers the accounting profits of a firm over a period of time.
Average,annual, profits
AR= *100
Average,investiments
Where average investment = ½ (cost of project + salvage value)
Illustration:
Assume 90,000 Br is invested in a project with the following after tax net profits.
Year 1 2 3
Net profit 20,000 10,000 30,000
The life of the project is 3 years and no salvage value, compute ARR of the project

Average_ profits= = 20,000

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 Average investment = ½ (90,000 +0) = 45,000

ARR = *100%= 44%

Advantages of ARR
• Easy to compute and use
• Computed from readily available accounting information Disadvantages of ARR
• Ignores time value of money
• Ignores uncertainty of cash flows and there is no consideration of risk in calculation
• Uses accounting profits rather than cash flows
• Doesn’t give a decision criteria
• Not consistent with investor’s wealth maximization
B. Payback period
This is the number of year taken to recover the original (initial) investment from annual cash flows.
The lower the payback period the better the project is.
Example 1: Assume a company wants to invest in two mutually exclusive projects of 1000 Br each
generating the following cash flows. If the required rate of return is 10%. Which of the projects
should the company invest in?
Year 1 2 3 4 5 6
A 500 400 300 400 0 0
B 100 200 300 400 500 600
Yr cash flows of A Cumulative frequency of A cash flows of B Cumulative frequency of B
1 454.51 454.51 90.91 90.91
2 330.58 785.09 165.29 256.20
3 225.40 1010.49 225.40 481.60
4 273.21 1283.70 273.21 754.81
5 1283.70 310.46 1065.46
6 1283.70 338.68 1403.95
Pay back for A = 2.95years Pay back for B = 4.79years. The management should undertake
project A since it has a lower pay bock period.
Example 2:
Year Project A Project B
1 30000 7000
2 30000 15000
3 35000 20000
4 35000 56000

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Year Project A Project B
Net cash flow Accumulated cash flow Net cash flow Accumulated cash flow
1 30000 30000 7000 7000
2 30000 60000 15000 22000
3 35000 95000 20000 42000
4 35000 130000 56000 98000
5 40000 170000 45000 143000

Payback period
Project A: 3 years + 5000*/35000
Payback period for Project A= 3.14 years
Project B= 3 years + 28000/56000
Payback period for Project B= 3.5 years
The management should undertake project A since it has a lower pay bock period.
The major advantages of this method are:
 Like ARR it is easy to calculate PB.
 It takes into account cash flows (and is hence superior to ARR).
 It helps identify projects which can earn quick returns (useful in industries where rapid
technological change is common).
This method has the following drawbacks:
 It does not consider the cash flows after the payback period.
 It does not consider the timing of cash flows.
 It does not show whether or not the project that has been accepted is going to maximize the
wealth of the stakeholders.
The evaluation method for this method are:
 The project is accepted when the actual payback period is less than the required or
predetermined payback period.

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  The project is rejected when the actual payback period is greater than the required or
predetermined payback period.
 When there are mutually exclusive projects, the one with the lowest payback period but less
than cut off payback period must be selected.

CHAPTER FIVE

PROJECT IMPLEMENTATION, MONITORING AND EVALUATION

5.1. Organization
The primary formal relationships for organizing are responsibility, authority, and accountability.
They enable us to bring together functions, people, and other resources for the purpose of achieving
objectives. The framework for organizing these formal relationships is known as the organizational
structure.
It provides the means for clarifying and communicating the lines of responsibility, authority, and
accountability.
Line and Staff Organization
When staff specialists are added to a line organization to "advise; "serve;” or “support" the line in
some manner, we have a line and staff organization. These specialists contribute to the effectiveness
and efficiency of the organization. Their authority is generally limited to making recommendation to
the line organization. Sometimes this creates conflict. However, such conflict can be reduced by
having staff specialists obtain some line experience, which will tend to make them better understand
the problems facing the line managers they support. Such functions as human resources
management and research and development are typical staff functions.
Most large organizations belong to this type of organizational structure. These organizations have
direct, vertical relationships between different levels and also specialists responsible for advising
and assisting line managers. Such organizations have both line and staff departments. Staff
departments provide line people with advice and assistance in specialized areas (for example,
quality control advising production department).
Divisional Organization

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A divisional organizational structure gives a larger business enterprise the ability to segregate large
sections of the company's business into semi-autonomous groups. These groups are mostly
selfmanaged and focused upon a narrow aspect of the company's products or services. As with any
organization structure, divisions have both strengths and weaknesses.
Unlike departments, divisions are more autonomous, each with its own top executive-often a vice
president-and typically manage their own hiring, budgeting and advertising. Though small
businesses rarely use a divisional structure, it can work for such firms as advertising agencies which
have dedicated staff and budgets that focus on major clients or industries.
In this type of structure, the organization can have different basis on which departments are formed.
They are:
(i) Function,(ii) Product,(iii) Geographic territory,(iv) Project and(iv) Combination approach.
Matrix Organization
It is a permanent organization designed to achieve specific results by using teams of specialists from
different functional areas in the organization. This type of organization is often used when the firm
has to be highly responsive to a rapidly changing external environment.
In matrix structures, there are functional managers and product (or project or business group)
managers. Functional manager are in charge of specialized resources such as production, quality
control, inventories, scheduling and marketing. Product or business group managers are in charge of
one or more products and are authorized to prepare product strategies or business group strategies
and call on the various functional managers for the necessary resources.
The matrix organizational structure divides authority both by functional area and by project. In a
matrix structure, each employee answers to two immediate supervisors: a functional supervisor and
a project supervisor. The functional supervisor is charged with overseeing employees in a functional
area such as marketing or engineering. Project supervisors manage a specific and often impermanent
project. The problem with this structure is the negative effects of dual authority similar to that of
project organization. The functional managers may lose some of their authority because product
managers are given the budgets to purchase internal resources. In a matrix organization, the product
or business group managers and functional managers have somewhat equal power. There is
possibility of conflict and frustration but the opportunity for prompt and efficient accomplishment is
quite high.
5.2. Project Planning

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Project planning is a rational determination of how to initiate, sustain, and terminate a project. After
the initiation stage, the project is planned to an appropriate level of detail. The main purpose is to
plan time, cost and resources adequately to estimate the work needed and to effectively manage risk
during project execution. As with the initiation process group, a failure to adequately plan greatly
reduces the project's chances of successfully accomplishing its goals.
The success of a project is never an accident. When you take up a project, you cannot simply start
the implementation and find your way as the project develops. If you try that, you can lose direction
quite early, miss your goals and deadlines, and overspend your resources on the wrong priorities,
leading to the failure of the project. So, a project should be clearly structured and managed. There
are five different project management phases.
5.2.1 Project management phases
Following are the five project management steps:
1. Initiation: Project initiation is a phase where you define a business case at a broad level and
create a project charter consisting of broad goals, budget, rough timeline, constraints, etc.
2. Project planning: During this phase, teams establish specific measurable goals, deliverables, a
clear project roadmap, risks and ways to manage them, tracking mechanisms, project
management tools, communication methodologies, etc.
3. Execution: During this stage, managers establish workflows, and the work is done by the teams.
4. Project monitoring and controlling: In this project management phase, the progress towards the
milestones is monitored using the tracking mechanisms. Reports are generated and reviewed by
stakeholders, and changes are implemented according to the inferences and findings.
5. Completion and closure of the project: At the end of the estimated project period, the project is
completed and handed over. The outcomes and deliverables are reviewed and quantified, and the
success/failure of a project is determined. The teams review performance, success and failures,
and take with them the learning from the project for continuous improvement of their own
performance as well as the performance of the organization.
The Crucial Project Planning Phase
Among these project management steps, project planning is one of the most important stages, as the
project starts to take shape in it, and it can make the difference between success and failure of the
project.
5.2.2. What is project planning?

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Project Planning generally consists of: Determining how to plan (e.g. by level of detail or rolling
wave); Developing the scope statement; Selecting the planning team; Identifying deliverables and
creating the work breakdown structure; Identifying the activities needed to complete those
deliverables and networking the activities in their logical sequence; Estimating the resource
requirements for the activities; Estimating time and cost for activities; Developing the schedule;
Developing the budget; Risk planning; and Gaining formal approval to begin work.
Additional processes, such as planning for communications and for scope management, identifying
roles and responsibilities, determining what to purchase for the project and holding a kick-off
meeting are also generally advisable. For new product development projects, conceptual design of
the operation of the final product may be performed concurrent with the project planning activities,
and may help to inform the planning team when identifying deliverables and planning activities.
Components of a project plan
Project planning involves defining three different aspects of a project. They are:
1. Scope of the project
Scope of the project includes project requirements, the vision behind it, measurable goals, outcomes
and deliverables, and the activities that can and cannot be done for the successful completion of the
project.
2. Budget and allocation of resources
Budget is one of the most critical aspects of a project. Budget needs to be allocated for different
phases, tasks and activities based on their priorities and requirements. Allocating fewer resources
for something is equally damaging to the project as allocating more for the same. Project

planning carefully weighs different requirements and priorities of the project before determining the
budget for each. In addition to the budget, the project also needs other resources, such as manpower,
tools and facilities. Project planning also takes these into account.
3. Timelines
Every task and activity in the project takes a certain amount of time for different teams to complete.
Adequate time should be given for each, and there should be an estimated timeline for each. Further,
a project may be implemented in the long term. So, it may be divided into various phases, which
will be deemed complete at the achievement of specific milestones. Project planning involves

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defining these timelines, creating a schedule for each team and individual, and determining the
milestones for various phases of the project.
5.2.4. Importance of project planning
Project planning requires a concerted effort from your teams to work towards common goals for the
project to succeed. If you don’t have a project plan, you may accidentally let your teams make their
own plans that they deem fit. It can cause chaos and different teams may take the project in different
directions, leading to catastrophic failure of the project. So it is absolutely essential to have a project
plan.
When you do project planning, and when your team follows a predetermined project plan using
industry-standard project management tools, you are more likely to prioritize the tasks correctly,
cross milestones according to the schedule, and meet objectives within the specified time and
allocated resources. So, a project plan plays a crucial role in the success of the project.
Why Project Planning?
One of the objectives of project planning is to completely define all work required so that it will be
readily identifiable to each project participant.
This is a necessity in a project environment because:
 If the task is well understood prior to being performed, much of the work can be pre
planned.
 If the task is not understood, then during the actual task execution more knowledge is
gained, in turn, leads to changes in resource allocations, schedules, and priorities.
 The more uncertain the task, the greater the amount of information that must be processed in
order to ensure effective performance.
These considerations are important in a project environment because each project can be different
from others, requiring a variety of different resources, but having to be performed under time, cost,
and performance constraints with little margin for error.

There are four basic reasons for project planning:

 To eliminate or reduce uncertainty
 To improve efficiency of the operation
 To obtain a better understanding of the objectives
 To provide a basis for monitoring and controlling work

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 Planning is decision making based upon futurity. It is a continuous process of making
entrepreneurial decisions with an eye to the future, and methodically organizing the effort needed
to carry out these decisions. Furthermore, systematic planning allows an organization to set goals.
The alternative to systematic planning is decision making based on history. This generally results
in reactive management leading tocrisis management, conflict management, and fire fighting.
5.3 Project Control
Project Control is a formal process in project management.
The PMBOK defines Project Control with the following statement:
“A project management function that involves comparing actual performance with
planned performance and taking appropriate corrective action (or directing others to
take this action) that will yield the desired outcome in the project when significant
differences exist.”
Project Control involves the regular review of metrics and reports that will identify variances
from the project baseline. The variances are determined by comparing the actual performance
metrics in the execution phase against the baseline metrics assigned during the Planning Phase. If
significant variances are discovered (variances that place the completion of the project in
jeopardy) adjustments are made to the project plan.
 A significant variance does not explicitly require a change to the project plan but these
variances should be reviewed to determine if preventative action is necessary. Controlling
also includes taking preventative action in anticipation of possible problems.
 Project Control is important because it may determine the success of the project by the
stakeholders.
 Project success relates to project cost, completion date, customer expectations,
performance, etc.
5.3.1. The Project Control Process
Controlling procedure need to address such questions:
o Are we on planned track?
o Are we on expected budget?
o Are we on planned schedule?
o Are we delivering what we said we would?

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 o Are we meeting quality and performance standards?
o Are we meeting stakeholder expectations?
o What have we accomplished?
o Will the project objectives be met?
o What deviations/variances exist?
o What corrective actions are we taking?
The project control includes project status reporting, schedule control, cost control, quality control
and risk control.
 Controlling process consists of following steps:
1) Establish A Baseline of Measurement:
The baseline of measurement is actually represented by your project plan. This includes your
control schedule, project budget, and any design or performance specifications related to project
deliverables. The estimates embodied in these documents create the basis from which variance is
measured. The success of project measurement and control depends on how accurate estimated
baseline is? What if an estimate is wrong? What if an element of your baseline is a poor
representation of what’s actually achievable?
In case of variance it is difficult to know who is responsible for variance, estimator or task
performer. The baseline is derived from the cost and duration information found in work
breakdown structure and scheduling decisions.
2) Measuring Progress and Performance:
Time and Budget are two quantitative measures. Many methods are available to measure these
two. Qualitative measures (i.e. technical specification, production function, reliability etc.) are
difficult to measure. Tracking time performance is easier than monitoring budgets. Some of
valuable and essential control techniques are:
 Gantt Chart
 Control Chart
 Critical Path Method (CPM)
 Program Evaluation and Review Technique (PERT)
 Critical Ratios
3) Analysing the Performance:

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Almost all the projects need to be guided right throughout in order to receive the required and
expected output at the end of the project. Project status report must be generated on every week or
every month. Comparisons of actual and expected (planned) must be done for proactive
correction.
Variances
Variances are deviations from plan. Think of a variance as the difference between what was
planned and what actually occurred. There are two types of variances: positive variances and
negative variances.
 Positive variances: Positive variances are deviations from plan that indicate an ahead-
ofschedule situation has occurred or that an actual cost was less than a planned cost. This is a
good news to the project manager, who would rather hear that the project is ahead-of-
schedule or under budget.
Positive variances bring their own set of problems, which can be as serious as negative variances.
Positive variances can allow for rescheduling to bring the project to completion early, under
budget or both.
Resources can be reallocated from ahead-of- schedule projects to behind-schedule projects. It can
also result from schedule slippage. Consider budget. Being under budget means that not all
dollars were expended, this may be the direct result of not having completed work that was
scheduled for completion during the period.
 Negative variances: Negative variances are deviations from the plan that indicate a
behindschedule situation has occurred or that an actual cost was greater than a planned cost.
Being behind a schedule or over budget is not what the project manager wants to hear.
Negative variances, just like positive variances, are not necessarily bad news. For example, you
might have over spent because you accomplished more work during the report period than was
planned. But, in over spending during this period, you could have accomplished the work at less
cost than was originally planned. In most cases, negative time variances affect project completion
only if they are associated with critical path activities or if the schedule slippage on non-critical path
activities exceeds the activity’s total float. Negative cost variances can result from uncontrollable
factors such as cost increases from suppliers or unexpected equipment malfunctions. Some negative
variances can result from inefficiencies or error.
5.3.2. Project Control Techniques

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 a) Gantt chart:
A Gantt chart, commonly used in project management, is one of the most popular and useful ways
of showing activities (tasks or events) displayed against time. Typically, tasks are shown on the
vertical axis, and the project time span is represented on the horizontal axis. Each task has a
corresponding bar that shows the time span required for that task. The bar can be filled in to show
the percentage of the task that has been completed.
Gantt chart represents:
• What the various task/ activities are?
• When each activity begins and ends?
• How long each activity is scheduled to last?
• Where activities overlap with other activities, and by how much overlap?
• The start and end date of the whole project?
b) Control Chart:
Control chart is an efficient way of analysing performance data to evaluate a project process.
Control charts, also known as Shewhart charts named after Walter A. Shewhart. Every process has
variation. Some variation may be the result of causes which are not normally present in the process.
Some variation is simply the result of numerous, ever-present differences in the process.
The control chart is a graph used to study how a process changes over time. Data are plotted in time
order. A control chart always has a central line for the average, an upper line for the upper control
limit (for ahead from scheduled) and a lower line for the lower control limit (for behind the
schedule). These lines are determined from historical data. By comparing current data to these
lines, we can draw conclusions about whether the process variation is consistent (in control) or is
unpredictable (out of control, affected by special causes of variation).
One goal of using a Control Chart is to achieve and maintain process stability. Process stability is
defined as a state in which a process has displayed a certain degree of consistency in the past and is
expected to continue to do so in the future.
The control chart is a graph used to study how a process changes over time. Data are plotted in time
order. A control chart always has a central line for the average, an upper line for the upper control
limit (for ahead from scheduled) and a lower line for the lower control limit (for behind the
schedule). These lines are determined from historical data. By comparing current data to these lines,

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we can draw conclusions about whether the process variation is consistent (in control) or is
unpredictable (out of control, affected by special causes of variation). This consistency is
characterized by a stream of data falling within control limits based on plus or minus 3 standard
deviations (3 Sigma) of the centreline.
The control chart is used to:
 Monitor effects of the variables on the difference between target and actual performance
of project.
 Analyse and understand process variables
 Determine process capabilities.
c) Critical Path Method:
The Critical Path Method or Critical Path Analysis is a mathematically based algorithm for
scheduling a set of project activities. It is an important tool for effective project management.
Critical path method commonly used with all form of projects, including construction, software
development, research project, product development, engineering and plant maintenance, among the
others. Any project with the interdependent activities can apply this technique of scheduling.
Critical path method is based on mathematical calculations and it is used for scheduling project
activities. This method was first introduced in 1950s as a joint venture between Remington Rand
Corporation and DuPont Corporation.
The initial critical path method was used for managing plant maintenance projects. Although the
original method was developed for construction work, this method can be used for any project
where there are interdependent activities. In the critical path method, the critical activities of a
program or a project are identified. These are the activities that have a direct impact on the
completion date of the project.
Key Steps in Critical Path Method:
1. Identifying the key activities of project
2. Determining the Sequence of Activities
3. Drawing Network Diagram
4. Time estimate for each activity
5. Identifying the Critical Path: The critical path is the longest path of the network diagram.
The activities in the critical path have an effect on the deadline of the project. If an activity
of this path is delayed, the project will be delayed.

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 d) Program Evaluation and Review Technique:
CPM assumes low uncertainty in scheduled timings. The Program Evaluation and Review
Technique (PERT) is a network model that allows for randomness in activity completion times.
PERT was developed in the late 1950's for the U.S. Navy's Polaris project.
PERT process involves following steps:
 Specifying the task/activities
 Determining the sequence of activities
 Constructing Network Diagram
 Estimate the Time
 Critical Path
 Update the PERT chart
There are three estimation times involved in PERT; Optimistic Time Estimate (O), Most Likely
Time Estimate (M), and Pessimistic Time Estimate (P).
Optimistic Time Estimate: This time assumes that everything will go according to plan and
with minimal difficulties.
Most Likely Time Estimate: This is the time that, in the mind of the functional manager,
would most often occur should this effort be reported over and over again.
Pessimistic Time Estimate: This time assumes that everything will not go according to plan
and maximum difficulties will develop.
Critical Ratios: Schedule Performance Index (SPI) and Cost Performance Index(CPI) ratios
are critical tools in project management.
 The budget (Cost) and the schedule (Time) are two important considerations in any project,
and since projects that overrun budgets and time frames are not viable for organizations.
SPI and CPI ratios are generated from Earn Value System.
e) Schedule Performance Index:
The ratio of schedule efficiency that indicates the percent of work performed out of the total work
scheduled. A number less than 1 indicates that the project is behind schedule.
SPI= EV/PV
f) Cost Performance Index:
The ratio of cost efficiency or value earned per unit actual cost. A number less than 1 indicates that
the project is spending more money than budgeted.

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 CPI= EV/AC
Lastly, compare the schedule and cost performance indices to each other to determine
The Critical Ratio (CR), CR = SPI x CPI Where:
SPI= Schedule Performance Index
CPI=Cost Performance Index
EV=Earned Vale (Budgeted Cost of Work Performed)
PV= Planned Value (Budgeted Cost of Work Scheduled)
AC=Actual Cost (Actual Cost of Work Performed)
5.4. Human Aspects of Project Management
For the successful execution of a project, a satisfactory human relation is must without such a
system other systems of project management do not work well. To achieve satisfactory human
relations in the project setting, the project manager must successfully handle problems and
challenges related to: Authority, Orientation, Motivation, Group functioning.
i. Authority: In project management, the project manager whose activities cut across functional
lines of command lacks the desired formal authority. While the manager has formal control
emanating from contracts and agreement:" as far as outside agencies involved in project work
are concerned, in his own organization he has to be contacted with split authority, and dual
subordination. His effective authority would stem from his ability to develop rapport with the
project personnel, his skill in professional reputation and stature, his skill in communication
and persuasion.
ii. Orientation: Most of the managers, working for a project are engineers or technologist when
an engineer assumes managerial responsibility, he faces some different type of problems,
which he is supposed to: Perform the task of planning, organizing, directing and controlling the
resources of the firm in the world of uncertainty. Adopt a more creative approach to solve non
program and unstructured problems. Attach greater importance to efficient utilization of
resources and resolution of human relation problem. Thus, for achieving the task he must
himself be an accomplished engineer turned manager.
iii.Motivation: The project manager works within the boundaries of a socio-technical system.
The principal behavioural factor, which he can influence, is the motivation of the project
personnel. In order to succeed in motivating project personnel, the project manager must be a
perceptive observer of human beings, must have the ability to appreciate the variable needs of

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 human being, and must have a skill in several styles of management suitable to different
situations.
iv. Group Functioning: For building an effective group the company must presume a genuinely
participative style of management. With the managerial philosophy the project manager can
facilitate the development of mutual trust and acceptance, open communication, co-operation
and project attitude. In this task the needs leadership capabilities, sensitivity to human nature,
perceptiveness, concern for welfare of others, maturity and impartial approach. Actually this is
difficult and challenging task.
5.5. Pre -requisites for Successful Project Implementation
Project execution has a direct correlation to project progress and stakeholder’s expectations but,
time and cost over runs of the project are the main hurdles in successful implementation of a project.
This problem is very common especially in the public sector. Due to such time and cost over runs,
projects tend to become uneconomical, resources are not available to support other projects and
overall development is adversely affected.
To minimize time and cost over runs and thereby to improve the prospects of successful completion
of projects, following things can be done:
1) Adequate formulation of the project
2) Sound project organization.
3) Timely availability of funds.
4) Better contract management.
5) Use of the principle of responsibility accounting.
6) Proper planning for implementation.
7) Judicious tendering and procurement of required equipment.
8) Advance actions and effective monitoring.

Chapter Six
Project Financing
Project Financing is the financing of long-term infrastructure, industrial projects and public
services using debt or equity. Debt is typically repaid using cash flow generated from the
operations of the project.

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A feasibility study would serve little purpose if it was not backed by a reasonable assurance that
resources were available for a project if the conclusions of the study proved positive and
satisfactory. A preliminary assessment of project financing possibilities should already have been
made in most cases before a feasibility study is undertaken. This is especially true if a project
opportunity or pre-feasibility study has previously been performed, as such studies would indicate
the order of magnitude of the required capital outlay.
A feasibility study should only be made if financing prospects to the extent indicated by such
studies can be defined fairly clearly. Resource constraints may define the parameters of a project
well before an investment decision is made, and at various stages of project formulation. A large
steel plant may not be practicable in a small country with extensive iron ore deposits but with very
limited financial resources. Such resource constraints may limit the consideration of certain
projects or restrict project capacity to the minimum economic levels. Financial constraints could
exist at all levels of project sponsorship and occur whether a particular project is under
consideration by an individual entrepreneur, a major industrial group (domestic or foreign), or a
governmental or semi-governmental agency.
Apart from some instances where resource constraints constitute a major limiting factor in the
consideration of project possibilities and project size, it is only when the basic techno-economic
parameters of a project are defined that the detailed requirements of financing can be adequately
assessed.
Thus, in a feasibility study, the capital outlay of a project can be appropriately determined only
after plant capacity and location have been decided, together with estimates of the costs of a
developed site, buildings and civil works, technology and equipment.
Defining the financial requirements of a project at the operational stage in terms of working
capital is equally necessary, although too often neglected. This can only be determined once
estimates are made of production costs, on the one hand, and sales and income, on the other.
These estimates should cover a period of time and be reflected in a cash flow analysis. Unless
both estimates are available and unless the available resources are sufficient to meet the fund
requirements, both in terms of initial capital investment and working capital needs over a period
of time, it would not be prudent to proceed to the financing decision and project implementation.
There are innumerable instances of projects that ran into serious financing problems because of
inadequate estimates of fund requirements at the initial investment or operational stages, because

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investment, production costs and marketing costs were underestimated, or sales and income were
overestimated.
6.1 Sources of Project Finance
Project finance may come from a variety of sources. The main source including equity, debt and
government grants. Financing from this alternative sources have important implications on
projects overall cost, cash flow, ultimate liability and claims to project incomes and assets.
6.1.1. Equity
A generally applied financing pattern for an industrial project is to cover the initial capital
investment by equity and long-term loans to varying extents, and to meet working capital
requirements by additional short-and medium term loans from national banking sources.
However, as explained before, the minimum net working capital requirements should be financed
from long-term capital. In certain projects, equity capital covers not only the initial capital
investment but also net working capital requirements, for the most part. This generally occurs in
situations where institutional capital is scarce and available only at high cost.
In other cases, where relatively inexpensive long-or medium-term credit is available, there is a
growing tendency to finance projects through such loans. In all cases, a balance needs to be
struck between long-term debt and equity. The higher the proportion of equity the less the debt
service obligations and the higher the gross profit before taxation. The higher the proportion of
loan finance, the higher the interest payable on liabilities. In every project, therefore, the
implications of alternative patterns and forms of financing must be carefully assessed; a financing
pattern should be determined that is consistent with both availability of resources and overall
economic returns.
Equity can be raised by issuing two types of shares: ordinary shares (common shares in United
States terminology); and preference shares. Preference shares usually carry a dividend at least
partly independent from profit, without, or with only limited, voting rights. Preference shares can
be convertible to common shares, they can be cumulative or non- cumulative in terms of
dividends, or they can be redeemable or non-redeemable, with the redemption period varying
between 5 and 15 years. Dividends on ordinary shares with full voting rights, however, depend on
the profitable operation of the company. There is currently a trend towards more than one class of
common shares, involving greater voting rights combined with lower dividends and receipts and
fewer privileges, or vice versa.

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6.1.2. Loan financing
Since it is relatively easy for a sound project to obtain loans, the process of project financing may
well start by identifying the extent to which loan capital can be secured, together with the
interest rate applicable. Such loan capital would need to be separately defined in the following
forms: short-and medium term borrowings from commercial banks for working capital purposes,
or supplier credits of various forms; and long-term borrowings preferably from national or
international development finance institutions.
a) Short-term loans:
Short-term loans from commercial banks and local financial institutions are available against
hypothecation, or pledging, of inventories. The limits to which inventories are financed by
commercial banks are fixed by the banks, and depend on banking practices in the country, the
nature of the project and inventories, and the credit rating of the enterprise and its management.
The limits usually vary between 50 and 80 per cent, leaving a margin of from 20 to 50 per cent of
inventories to be financed from other sources.
Bank borrowing for working capital can be arranged on a temporary basis. If at any time the cash
flow statement suggests that sufficient liquid funds are available, such commercial bank
borrowings should be substantially reduced or entirely eliminated, without however jeopardizing
the overall liquidity of the project. In some cases, such a cash-flow surplus may be needed for
further capacity expansion, so that the enterprise may need to rely on long-term bank credits for
some time. Working capital needs should even be partly met out of long-term funds (equity
capital and long-term loans), since the largest portion of working capital is permanently tied in
inventories (raw materials, work-in progress, finished goods and spare parts).
b) Long-term loans:
Loan financing is usually subject to certain regulations, such as restrictions on the convertibility
of shares and declaration of dividends. Apart from these regulations, certain ratios in the capital
structure of the company need to be maintained. Investment may also be financed partly by issues
of bonds and debentures. The market for bonds and debentures tends to be fairly limited as far as
new projects are concerned, but such securities are often issued to finance the expansion of
existing enterprises.
An important source of finance is also available at government-to government level for many
developing countries. This can take the form of general bilateral credit or tied credit, which may

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be related to the purchase of machinery and equipment from a particular country or even from a
particular source. In addition to share capital and loan finance, an important financial category at
the operational stage is the internal cash generated by the project itself. This can take the form of
accumulated reserves (retained profits and depreciation).
c) Supplier credits:
Imported machinery and spares can often be financed on deferred credit terms. Machinery
suppliers in industrialized countries are generally willing to sell machinery on deferredpayment
terms with payments spread over 6 to 10 years, and sometimes even longer. This term is available
against bank guarantees; this enables such machinery suppliers to obtain refinancing facilities
from financial institutions in their own countries.
6.1.3. Leasing
Instead of borrowing financial means it is sometimes possible to lease plant equipment or even
complete production units, in other words, productive assets are borrowed. Leasing, as the
borrowing of productive assets is called, requires usually a down payment and the payment of an
annual rent, the leasing fee. These assets are, however, contained in the balance sheet of the lessor
and not in the balance sheet of the borrowing firm, the lessee. Therefore, leasing essentially
represents a form of off-balance sheet financing. This aspect may be important in situations in
which a firm prefers to maintain a certain debt-equity ratio or is not in a position to further
increase its debentures.
Provided that both the lessor and lessee fall under the same tax regulations, purchase equipment
under the same conditions and enjoy identical financing conditions, the accumulated leasing costs
should not differ significantly from the costs of purchasing and financing of the purchase of the
same assets. Only when lessors enjoy certain advantages, owing, for example, to their position in
the capital-goods or financial markets (credit rating), may the leasing costs be lower for the lessee
than total costs in case the items are purchased.
In the case of investment projects the problem is basically to decide which alternative should be
preferred, leasing or purchasing of capital assets. For the evaluation of the two financing
alternatives the discounted cash flow method should be applied. The initial down payment, the
current leasing fees and any additional payments under the leasing agreement are then part of the
cash outflows, replacing all initial investment costs computed for the purchasing alternative. Since
the duration of leasing contracts is in general much shorter than the technical and economic life of

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an asset, it is necessary to include the residual value (cash inflow) of the leased asset when
comparing leasing with loan financing. The inflow for the lessee would usually not be the book
value but either the book value or the market value (minus the lessor's cost of selling the used
items), whichever is lower.
If the investor has a choice between loan and leasing financing,' he would compare the
discounted cash flow for both cash flow arrays to determine which alternative would bring the
higher yield (IRR, NPV), bearing in mind, however, the liquidity aspect and risks involved. If tax
regulations have different effects on leasing financing, these tax impacts need to be included in
the cash flow discounting.
Funds to finance leases may be obtained from independent leasing companies (service or
financing leasing companies, lease brokers), banks, insurance companies, pension funds and
industrial development agencies. Leasing financing of investment projects in developing countries
has been introduced by international financing institutions such as the International Finance
Corporation, and may become an interesting financing alternative, especially in cases where
leasing has certain advantages over loan financing.
If the investor has a choice between loan and leasing financing,' he would compare the
discounted cash flow for both cash flow arrays to determine which alternative would bring the
higher yield(IRR, NPV), bearing in mind, however, the liquidity aspect and risks involved. If tax
regulations have different effects on leasing financing, these tax impacts need to be included in
the cash flow discounting.
6.2. Cost of Capital
Capital for financing of investments may be obtained from private and institutional resources
(banks, insurance companies, funds etc.). However, behind these institutions stand again private
investors. In all cases private savings are therefore the ultimate source of capital. Basically, all
savings are made to provide for future needs, but this alone would not be an incentive to invest or
lend money to an investor, because lending would mean a long-, medium- or short-term
commitment reducing the liquidity of the lender, and would also imply uncertainty concerning the
full return of the funds lent.
To obtain finance, an investor must therefore pay a charge-the cost of capital or of finance-for the
funds lent. This charge comprises an interest rate, usually expressed as a percentage per annum, as
well as certain fixed charges (commitment fee, charge on capital not drawn, commissions etc.).

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Interest is usually computed for the outstanding balance of the corresponding liabilities of a firm,
for example, interest payable on a bank loan, dividends payable on equity capital (such as
preference shares) and interest payable on a current account.
For the investor the cost of capital is determined by the conditions that can be obtained for the
project on the capital market. For the amount stemming from own funds (savings) investors
should charge their opportunity cost of capital, that is, the interest they would obtain if they
invested in another feasible venture(provided such alternatives exist).
Impact of financing cost on financing policies
The cost of equity capital for the project or firm is basically determined by the minimum
accumulated return,' 29 expressed as the NPV of the future income of the shareholders, and the
minimum annual rate of return, expressed as the rate of return on equity capital. The acceptable
minimum rates depend on the opportunity cost of capital, the expected business risks, and the
valuation of any gains or benefits obtained in addition to the payment of dividends. The purpose
of the concept of equity is to give the management of the firm more flexibility with regard to the
best use of the annual net profits in the interest of the shareholders or owners and the firm. The
debt service (interest and amortization) is fixed and legally binding for the firm, and has to be
paid even when the generation of cash is insufficient in certain years, whereas payment of
dividends is in general linked to a sufficiently high profit and cash generation. The determination
of the right (optimal) capital mix is therefore essential when a financing strategy is designed for
an investment project.
Different financing institutions impose different financing conditions. A government guarantee is
even sometimes required for multilateral financing. It is important that the enterprise is not
obliged to start with loan amortization before the start-up of operations. Very often financial costs
are capitalized during the implementation period, and debt service starts when sufficient cash is
generated through the operation of the new production facilities. It may be possible to combine
relatively short-term supplier credits (for instance, a three-year grace period and a four-year
amortization period) with longer-term financing from multilateral banks. In this case, supplier
credits could be disbursed last and amortized first, while leaving multilateral financing for early
disbursement and late amortization. Thus, generally suitable loan terms can be obtained.
In new as well as expansion projects, the kind of debt service will also have to be decided on. The
following two systems are possible: periodical debt service with equal amortization instalments

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(constant principal) plus gradually decreasing interest; and periodical debt service with constant
payments (annuities), in which case the sum of the declining amortization and increasing interest
payments is constant over the amortization period of the loan. The first system requires less total
financing cost but a fairly substantial initial debt service during the start-up of the project. The
second system, although it has a higher total financing cost, is preferable for the new enterprise
because the initial debt-service burden is smaller than under the first system. The various forms
and sources of financing have different implications in terms of impact on different projects and
may even affect project formulation. Supplier credits and other forms of medium-term credit,
though initially advantageous in terms of coverage of resource gaps at the initial stage, constitute
a heavy debt burden during early years of production; their incidence on production costs should
be determined and accounted for in the cash flow analysis. National and international institutions
that provide loan finance require that projects should be formulated in considerable detail, so that
their full implications are adequately highlighted. In some cases, they insist that the feasibility
study should be prepared by recognized independent consultants or that management
responsibilities for certain major projects be assumed by experienced and acceptable parties.
6.3 Public policy and regulations on financing
The hard core of the entrepreneurial decision in respect of financing is to choose between equity
raised through the sale of shares and that raised through payments by the project sponsor. In most
cases, the initial equity base is provided only by the project sponsors. The extent of such initial
equity depends on the anticipated profitability and on availability of funds for this purpose and of
alternative sources of capital participation, all under the prevailing regulations on financing and
taxation of income from capital investment.
Where a project is expected to yield a high rate of profitability, maximum participation would
be sought by the sponsors within an appropriate equity debt pattern and subject to fund
constraints. In the case of any resource gap or where the sponsors wish to limit their risks to a
particular proportion of equity, outside participation can be invited to provide additional equity or
loans. Funds can be mobilized either from national sources (individual or institutional), or through
foreign participation.
When a developing country has a reasonably well developed capital market, equity funds can be
raised through public issues of shares. Such share issues are usually underwritten by banks and
other financial institutions. In some cases, financial institutions, including specialized institutions

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dealing in industrial financing, participate in share capital to varying extents. Usually such
participation is in the form of minority shareholding. In some developing countries, it may be
necessary for institutional agencies to acquire majority holdings initially and release them
gradually to domestic entrepreneurs as and when domestic entrepreneurship is willing to take over
all, or a part of, such holdings.
In considering foreign equity participation, a basic policy question may arise regarding the extent
(if any) of foreign influence after such participation. In a number of developing countries, foreign
equity participation requires governmental approval. In some countries, such approval is often not
granted, particularly to non-priority sectors of investment. In other cases, only minority foreign
participation is generally permitted. In certain countries, however, even majority foreign
participation is welcomed, particularly in sectors involving large investments or in projects with a
great employment potential. Thus, in cases where foreign equity participation is considered, the
first need is to assess the policy implications and the reaction of government authorities.
Thereafter, the implications of foreign equity participation on the project should be evaluated.
In some cases, where foreign technological assistance and support may be required for a number
of years, or where access to improved and new technologies may be required, it may be desirable
to have the technology supplier or licensor also participate in capital ownership. Technical
management may sometimes have to be entrusted to a foreign company, usually a licensor, in
which case foreign capital participation may be desirable. The extent of foreign participation
would, however, have to be considered on a case-by-case basis and be determined within the
framework of national policies by such factors as the nature and magnitude of investment outlay,
and the technological and management support required, the extent of the resource gap that could
otherwise develop, and the relations between a technology licensor and licensee.
6.4. Financing Institutions
Most developing countries have established development financing institutions, usually called
industrial finance corporations or industrial development banks. In most developing countries,
there is more than one institution available to finance projects. Most countries have established
financial institutions at the state and national levels. Some of the national institutions provide
foreign currency loans which are financed by international institutions, such as the World Bank
and its affiliates.

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Various international institutions and funding facilities exist for the financing of industries in
developing countries. Some of these, such as the World Bank, including the International
Development Association as well as the International Finance Corporation, the Special Fund of
the Organization of Petroleum Exporting Countries, the Kuwait Fund for Arab Economic and
Social Development, and the International Investment Bank of the Council for Mutual Economic
Assistance, operate on a world-wide scale. Even though many of these funds will be used
primarily for infrastructure and agricultural development rather than for industry, the provision of
funds on soft terms for infrastructure is one of the fundamental prerequisites of successful
industrialization.
There are also institutions operating on a regional basis, such as the African Development Bank,
the Asian Development Bank, the European Investment Bank and the Inter-American
Development Bank. Funds have been set up by the oil-exporting countries, such as the Arab Fund
for Economic and Social Development and the Islamic Development Bank. Bilateral institutions
have been established in most of the countries of the Organization for Economic Cooperation and
Development and, in some oil-exporting countries, including Kuwait, the United Arab Emirates
and Venezuela. In this context, the role of the export financing and guaranteeing agencies must be
mentioned. The primary task of such agencies is to provide financial support of exports from
industrialized countries; only as a secondary task are they designed to help developing countries.
Commercial banks, including those in the Eurocurrency market and the currency markets of the
Association of South-East Asian Nations, are becoming increasingly active in industrial
development financing. However, they lend to only a few developing countries. A major step
towards easier terms and availability of loans would be achieved with the establishment of a
multilateral guarantee system for commercial loans.
In many developing countries, the availability of industrial finance in the form of institutional
finance and from other sources has grown to such an extent that new entrepreneurs can start
industrial ventures while providing a relatively small share of the total equity required. The
situation varies widely, but in some countries, the initial portion of equity to be raised by sponsors
of industrial projects can be as low as 10-25 per cent of the total finance needed.
The various aspects discussed above need to be fully assessed before evolving a financing
package suitable for a project under consideration. Invariably, the package is determined by
identifying the most economic pattern in terms of cost of finance, assessing the feasibility of

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obtaining capital on such a basis, and ensuring that the pattern is consistent with both public
policies and regulations, and the projected cash flows of the proposed enterprises.

Chapter Seven
Social Cost Benefit Analysis (SCBA)
What is SCBA?
SCBA called economic analysis is a methodology developed for evaluating investment projects
from the point of view of the society (economy) as a whole. It is based on the assessment of the
utility of a project for the society as distinct from the financial and economic utility for the
promoter group. While in the latter the focus is limited to financial benefits and costs directly
accruing to the enterprise, in social cost benefit analysis the benefits and costs accruing to the
society as a whole are considered. It is a technique for making enterprise decisions, from society’s
stand point.
For example: Suppose, a manufacturer produces cigarettes and sell it Rs.40 a packet and another
manufacturer produces soaps and sell it Birr 20 a bar.
Now, if we think about the impact of soaps and cigars on the society, the question may be:
 Does the price of cigar take note of the smoker’s higher probability of cancer?
 Does the price of soap take note of the benefits from the use of soap e.g. reduced risk of
spread diseases?
Obliviously, a commercial entrepreneur can't give well answer to these questions.
 While the concept of SCBA is simple, the methodology to be adopted for such an
analysis is quite elaborate and intricate. As it is based not only on the consideration of
quantitative information but also on qualitative information and subjective judgment.
 Therefore, to reflect the real value of a project to society, one 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.
Scope of SCBA
SCBA can be applied to both public and private investments.
 Public Investment: SCBA is important especially for the developing countries where
govt. plays a significant role in the economic development.

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  Private investment: Here, SCBA is also important as the private investments are to be
approved by various governmental and Quasi-governmental agencies which bring to bear
larger national considerations in their decisions.
Objectives of SCBA
The main focus of SCBA is to determine:
i. Economic benefits of the project in terms of shadow prices.
ii. The impact of the project on the level of savings and investments in the society.
iii.The impact of the project on the distribution of income in the society; and
iv.The contribution of the project towards the fulfilment of certain merit wants (selfsufficiency,
employment etc.).
7.1 Rationale for SCBA
 In SCBA the focus is on social costs and benefits of a project.
 These often tend to differ from the monetary costs and benefits of the project.
 The principal reasons for discrepancy are:
 Market imperfections
 Externalities
 Taxes and subsidies
 Concern for savings
 Concern for redistribution
 Merit wants
 Market imperfection
 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 exists, market prices do not reflect social values.
The common market imperfections found in developing countries are:
i. Rationing
ii. Prescription of minimum wage rates, and
iii. Foreign exchange regulation.
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

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competitive market. When minimum wage rates are prescribed, the wage paid to labour are
usually more than what the wage would be in a competitive labour market free from such wage
legislations.
The official rate of foreign exchange in most of the developing countries, which exercise close
regulation over foreign exchange, is typically less than the rate that would prevail in the absence
of foreign exchange regulation. This is why foreign exchange usually commands premium in
unofficial transactions.
Externalities
Externalities are impacts of a project which can be both harmful and beneficial. A project may
have beneficial external effects. For example, it may create certain infrastructural facilities like
roads which benefit the neighboring areas. Such benefits are considered 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 this external benefit created by the project.
Likewise, a project may have a harmful external effect like environmental pollution.
In SCBA, the cost of such environmental pollution is relevant, though the project sponsors may
not incur any monetary costs. It may be emphasized that externalities are relevant in SCBA
because in such analysis all costs and benefits, irrespective to whom they accrue and whether they
are paid for or not, are relevant.
In choosing a particular project the additional benefits derived from a particular project should
exceed the corresponding additional cost
The cost benefit analysis can be undertaken in three steps
Step-1: This step involves the identification of alternatives to be assessed.
Step-2: In this step a prediction of the likely consequences associated with each alternative
projects
This means the likely effect of the project on the social and environmental aspects is predicted For
Example:
Consider a development project - Construction of Dam. In this step the possible intangible benefits
that a project may bring to the community and on the environment is predicted.
These are benefits like,
 The number of unemployed people that would get employment opportunity
 Benefit obtained from the infrastructure improvement (saved time, reduced cost, etc.)

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  Decrease yearly flood damage (soil erosion, deforestation, reduced property
damage )
 Recreational benefit to the society
 Intangible Cost (harmful impact of the project)
 Deforestation created by the project
 Number of people displaced from the site
Example 2
Consider the Railway project- Here we need also to identify and describe changes that can be
brought out by the project in the transport sector. The Railway projects might have the following
social benefits and costs:
 Potential benefits:
 It reduces motor vehicles operation and maintenance cost to both government and private
sector as they switch over from road to railways.
 It will reduce travel time of people using the road (opportunity cost of time)
 Reduce atmospheric pollution in the city
 Reduce investment and operation cost of road
 Reduce traffic accident in the city
 Expected cost of the project
 Loss of revenue to private investor
 Number of people losing their job
Step-3: Involves the task of estimating (assigning) values for the cost and benefits occurring as a
result of implementing the project
Estimating the cost or the benefit of intangibles is somewhat difficult and requires the application
of both direct and indirect method. Consider the case of a project that might cause damage on the
environment say, west disposal to the river or air pollution
Let us consider the nature of the cost involved in environmental quality (cost valuation). Cost of
environmental problem refers to the west disposal cost imposed on the society by the production
and consumption activities of the project.
West Disposal Cost: is the sum of pollution prevention cost and pollution cost (i.e,)
West Disposal Cost = Pollution Prevention Cost + Cost of Pollution

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Pollution Prevention Cost: are those costs incurred to prevent the pollution either partly or fully.
These are costs like,
 Costs incurred by local government (society) to treat its sewage before dumping it into the
river.
 Pollution Cost: these can be either pollution avoidance cost or welfare damage cost.
 Pollution avoidance costs: are private or public expenditure made to avoided pollution
damage once pollution has already occurred. Once the environmental damage has occurred a
society can choose either to avoid the damage through some remedial measure or to bear it.
The cost of such measure is considered as a best estimate to value the damage (cost of the
project).
The economic activities of production and consumption relay up on the environment’s role as a
resource suppliers and as a waste assimilator. Thus, properly valuing project’s effect that brings
improvement on natural environment is an important issue in project appraisal.
 Concern for redistribution
A private firm does not bother how its benefits are distributed across various groups in the
society. The society, however, is concerned about the distribution of benefits across different
groups.
A birr of benefit going to an economically poor section is considered more valuable than a birr of
benefit going to an affluent section.
 Merit wants
Goals and preferences not expressed in the market place, but believed by policy makers to be in the
larger interest, may be referred to as merit wants.
For example, the government may prefer to promote an adult education programme or a balanced
nutrition programme for school-going children even though these are not sought by consumers in
the market place. While merit wants are not relevant from the private point of view, they are
important from the social point of view.
7.2 UNIDO Approach
The UNIDO approach of project appraisal: The UNIDO approach was first anticipated in the
guidelines for project evaluation, which provide a comprehensive framework for Social Cost
Benefit Analysis (SCBA) in developing countries.

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The rigor and length of this work created a demand for a succinct and operational guide for
project evaluation in practice. This approach is mainly based on the publication of UNIDO
(United Nation Industrial Development Organization) named guide to practical project appraisal
in 1978.
Project appraisal is made for both proposed and execute projects. It is the structured process of
assessing the viability of a project or proposal. It involves calculating the feasibility of the project
before committing resources to it. It often involves making an assessment between various
options and this done by making use of any decision techniques or economic evaluation method.
The UNIDO method of project appraisal involves five stages:
1. Calculation of the financial profitability of the project measured at market prices.
2. Obtaining the net benefit of the project measured in terms of economic (efficiency) prices.
3. Adjustment for the impact of the project on savings and investments.
4. Adjustment for the impact of the project on income distribution.
5. Adjustment for the impact of the project on merit goods and demerit goods whose social
values differ from their economic values.
 Each stages of appraisal measures the desirability of the project from different angle.
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.
7.3. Net Benefit in Terms of Economic Prices
The commercial profitability analysis (calculated in stage 1) would be sufficient only if the
Project is operated in Perfect market. Because, only in a perfect market, market prices can reflect
the social value. Benefit/cost (B/C) is defined as a systematic process for calculating and
comparing benefits and costs of a project for two purposes:
1. To determine if it is a sound investment (justification/feasibility); and
2. To see how it compares with alternate projects (ranking/priority assignment).
Benefit/cost analysis is also commonly referred to as Cost-Benefit Analysis, CBA, Benefit/cost
Analysis, and BCA. The analysis is identical despite the naming differences. Benefit/cost
Analysis is one type of economic valuation- an analysis that assesses the relative value of a
project monetised that estimates. As the name implies, benefit/cost analysis determines the value
of a project by dividing the incremental monetized benefits related to a project by the incremental

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costs of that project. The result is called the Benefit/Cost Ratio and is often the primary output of
the analysis process.
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. Therefore, developing the shadow prices is very
much vital.
Shadow pricing:
 Shadow prices reflect the real value of a resource (input or output) to society as
opposed to their financial or market value.
 Shadow Prices are also referred as economic prices, accounting prices, economic
/accounting efficiency prices etc.
 Use of shadow prices is considered essential particularly due to market imperfections,
Non-market economy, fiscal policy of the state etc.

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