UNIT 4

Module 4_APROJECT FEASIBILITY

Stage of Feasibility.As a part of Project Definition phase Feasibility is an important Activity

This needs to be carried out for the chosen option of the project prior to the implementation.

Feasibility study is an important Gateway to Cross and if found feasible, its necessary planning for its implementation is to be carried out.

Feasibility Study Should AddressAs per Guidelines of Planning Commission it should address the following Issues:Raw Material SurveyDemand StudyTechnical StudyProduct PatternProcess SelectionPlant Capacity SizeRaw Material Requirements/availabilityLocation StudyProject Capital Cost Estimates & Source of FinanceProfitability and Cash Flow Analysis

Raw Material SurveySource of Raw MaterialNatural Source Product or By-Product of existing UnitImported Raw MaterialRetrieval / Transportation of Raw MaterialQuality of Raw MaterialGuarantee of Availability of Raw Material, even if the project is delayed Price Guarantees / Forecast of Availability

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Demand Study

Demand StudyDemand Study to EstablishDemand :Based on UsagePerspective ConsumersPresent ConsumptionFuture ConsumptionPossibility for ExportSupply; Based onAssessment of existing Capacity Plants under constructionCurrent Capacity UtilizationExtent of import

Demand Study Contd.Distribution : Covering Following IssuesChannels of DistributionMode of TransportMode of PackingCost of DistributionGovernment Policies

Prices Covering following issuesDomestic and international Price TrendsControl on Price by GovernmentPrevailing Duties and taxes.

Source of InformationPublished literature may provide most of the inputs on above. However Independent Surveys may also be required.Documents usually referred are:Plan Documents issued by Planning CommissionDocuments and Guideline to industries published by the Department of Industrial Development, Ministry of Industries pertaining to Licensed and Installed Capacities, Present Production, imports and Exports, Technical Know-how, Design & Fabrication, Future TrendsEconomic Survey- Ministry of FinanceAnnual Survey of Industries by Central Statistical Organization

Source of Information ContdExport and Import (EXIM) Statistics by Ministry of CommerceMonthly Bulletin of reserve Bank of India for different cost indices for various industrial ProductsSurvey Reports of;Industrial Development Bank of IndiaNational Council of Applied Economic ResearchTimes of India Economic Division EtcThese documents provide details about ProductionConsumptionImport / ExportPrices

Demand Study ContdVarious Market Research Agencies are also available to carry out such paid studies which at times is resorted to for an independent view.Field surveys are also carried out to confirm the findings.Accuracy and Dependability of these Sample Surveys depends on Capability of the Surveying agenciesSample SizeSample Selection

Demand Study ContdLong range Forecast over the plant life are essential Various factors that may influence such forecasts,Gap between study and execution of the project/plantLength of the study Any abnormal change in environment

Technical Study

Technical StudyEstablish Product Pattern / Plant CapacityDemand and Raw material availability data along with economic size of the unit should suffice the basis to firm up the plant capacity.Required Financial resources and the best available technology are additional important input to firm-up the project.Product pattern covering main product and any co-product /by products for a given technology need to be studied to establish technical as well as economical viability.Viable capacity in tandem with demand / supply / dynamics of project/ rightly projected trends is a crucial decision during project feasibility.

Technical Study ContdProcess SelectionEconomic evaluation of different available technologies provided by different licensors is another key step to establish feasibility of the project during definition phase.

Technical knowhow is available from R&D institutions under technology License agreements.

It is in the form of technology package developed by the Project Engineering Company

Technical Study ContdTechnology Package consists of.Process Design Data, Description & SpecificationsProcess Flow DiagramEquipment ListEquipment Specification Data SheetProcess Piping & Instrumentation DiagramInstrument Data SheetUtility SummaryIndicative Plot PlanUtility P & I DPiping ScheduleOperating Instructions

Technical Study ContdAt the time of Prefeasibility, information available for the technology is not as detailed as listed above.

However costs controlling inputs from Technology Licensors is gathered to achieve technology selection.

This is in the form of Technical offers giving enough details to have at least relative assessment of the technology as well as project feasibility with in +/- 3o% band.

Technical Study ContdWith this information sensible assessments can be made for the followingIndigenous Vs Foreign Know HowType of Process and stage of development Raw Material RequirementsUtilities RequirementsIndigenous / Foreign ComponentsProduct Yields and PatternOperating and Fixed costsEconomic AnalysisReliability of the technology and Licensor.

Technical Study ContdSelection of the Technology could be based on the Relative consideration of the following issues

Size of investment

Extent / Component of foreign Exchange

Limitation of Power

Disposal of By Products and Effluents.

Technical Study ContdIf the technology is available in open Domain, quite detailed information can be obtained at prefeasibility stage.

Other wise initial screening is based on technical proposal from the technology licensor which is firmed up at detailed engineering stage.

Detailed engineering is done by Engineering Contractors and LSTK contract is the approach normally resorted to by the owner

Last lecture ..Out Line of feasibility StudyRaw Material SurveyDemand StudyTechnical StudyProduct Pattern / Plant CapacityProcess Selection / Inputs as Process PackageContinue with the Location Study..

Location Study

Location StudyProper selection of site is critical to overcome constraints in Project management specifically time and Cost.

Normally Financial Institutions Inspect and Ensure the Reasonability and Authenticity of the Site for the Project.

Site Selection at the early stage also provides better visibility of the Project to get timely finances.

Location Study Contd.Different Consideration in Site Selection are:Availability / Soil / Cost / Seismic DataApproach To the siteProximity to the Raw Material SourceProximity to Products marketAvailability of required Utilities e.g. Power / Water / Other Energy SourcesAvailability of Skilled Man PowerSocial and political EnvironmentApplicability of Any Tax IncentivesDrainage and Effluent Disposal FacilitiesEngineering Support and Maintenance FacilitiesAcceptance by Local Bodies

Location Study Contd.Site Selection / Considerations are as follows:Sufficiently Large to accommodate Plant / Machinery / Buildings / Off Site Facilities / Roads / Parking as per applicable safety Norms and if Possible for Town Ship.Preferably Govt. owned with due approval for Industry DevelopmentShould not Require or at least avoid Displacement of PopulationShould be flat at proper elevation, with proper assessment of Flooding History.Soil should be hard enough to ensure Load Bearing capacity of Machinary as well as not in Earth Quake Prone Zone. Price effective along with above consideration. Please note Cost component of Land is not very significant in the investment of the plant.

Location Study Contd.Approach to Site / Considerations are as follows:Proximity with Railway Siding / National High is always advantageous and should be preferred.

Better connectivity with the Equipment & Machinery sources, Raw Material Source and Product Market to be evaluated and ensured.

Regional Railway and Road Maps should be reviewed to assess above aspects.

Location Study Contd.Transportation/ Considerations are as follows:Transportation Cost of the Raw material:If Raw material Volm is more than that of Products , Plant near the Raw Material Source are preferred. For example Cement Plants are close to the source of lime stone.Refineries are mostly at the coast however also in the Mid land if pipeline connectivity is available for Crude. Mid Land market is an advantage.

Else proximity to the Product Market could also be feasible.An associated OPTIMIZATION would be useful

Along with Transportation of Product and Raw material, transportation of operating Staff should also be given due Care. To be evaluted wrt the option of Town Ship

Location Study Contd.WATER/ An Important consideration for Site selectionFor Water Intensive technologies Availability of Water of Required Quality and Quantity should be ensuredPumping of water and its treatment have significant operating costSea Water is rarely useful and if used as cooling water, requires expensive Metallurgy and high maintenance due to corrosion.If Sub Soil Water is envisaged to be used its availability to be ensured.Local Water Courses / Lakes could be dependable source, but calls for clearances from local Bodies.Hence the required water of right quality and quantity influences site selection.

Location Study Contd.Power/ Considerations areFor Power intensive industries a reliable and economic Power source is critical. Industries like Aluminum, mini steel, calcium Carbide involving Electrolysis operations fall in this category.Option of Captive Power could be required as in India there is power shortage in most of the states. This calls for an additional investment.Options of Captive power or Power form the grid with Stand by power resource, needs to be carefully evaluated to firm-up the site Proximity to Power Generation station will ensure least voltage fluctuations which means less maintenance of Machinery and may affect the process of site selection.

Location Study Contd.Regional Development/ Considerations areGovt offers Tax incentives if the industry is located in Backward Areas.

The State Industrial Development Corporations are attracting industries in socially and economically backward areas with lucrative packages.

Financial Institutions also support such projects with relaxed terms of payment.

These options need to be carefully evaluated over the other site related drawbacks and at times found to over come the associated short comings.

Location Study Contd.Effluent Disposal/ Considerations areEffluent Could be Solid, Liquid and Gasses

Gases can be discharged in the atmosphere if meets emission norms set by CPCB (Central Pollution Control Board). This does not pose a major dictate for the site selection.

Problems are more with Solid and liquid Waste disposal.

Proximity to Sea may to some extant ease out the situation of liquid disposals however for Solid waste disposal site is to be care fully located with such options possible.

Cost for treatment and their transportation for disposal have to be carefully taken in to account to firm up the site

Location Study Contd.Acceptability by Local Bodies/Along with pollution norms at new Industry has to adhere to various other clearances by Local Bodies.

Some state governments provide such clearances under single window approach, However at times it could be a frustrating experience to get clearance from multiple agencies.

In some states Industrial Areas are marked for specific type of Industries hence not giving much chance for the owner to select the site for its location.

Location Study Contd.So Various Factors for Site Selection areTechnicalLegalEconomic

If Technical and Legal requirements are met, the final site selection to be based on Economic Considerations.

Associated fixed and recurring costs have to be evaluated with a NPV model with proper discount flow.

For less reliable inputs available for future/recurring expenses, due sensitivity analysis can be done to conclude on the site.

Feasibility study We covered followingRaw Material SurveyDemand StudyTechnical StudyProduct Pattern / Plant CapacityProcess Selection / Inputs as Process PackageLocation StudyLet us see Financial arrangement.

Financial Arrangements

Financing Arrangements:Project can kick off only after availability of Required finances.

Finances required to meet Capital cost to purchase Plant Machinery, Initial Working Capital, Preoperative expenses etc.

Though all the funds are not required at Zero Date but needs to be arranged in advance for a smooth progress of the project to meet time constraint which in turn is linked to Cost Constraint.

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Financing Arrangements (Contd):

Therefore assessment of required funds under different heads, e.g. Capital, Working Capital and operating cost is very important at definition Phase.

Required Finances including Debt : Equity Ratio is to be firmed up to approach any financing Institution.

Financing Arrangements (Contd):

CAPITAL COSTS: All the cost Incurred in the project prior to its start commercial Production is treated as Capital Cost.

Therefore capital cost includes:Assets such as land, Town ship and BuildingsPlant an Machinery, offsite Initial working Capital and pre-operating ExpensesDesign and Engineering FeeLicensors FeeAll the money will not be required at zero date but proper planning is necessary to ensure its timely availability to meet time constraint.

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Financing Arrangements (Contd):

CAPITAL COSTS Contd As per Planning Commission Capital cost covers..Engineering and Project ManagementLump sum Payment for TechnologyEngineering FeeManagement and Supervision during ConstructionEnabling worksConstruction equipment usedCommissioning ExpenditureMiscellaneous fixed assetsPreliminary and preoperative expensesProvision for ContingenciesWorking Capital

Financing Arrangements (Contd):Working Capital Includes:Maintaining Inventories ofRaw MaterialOperating SuppliesIntermediate ProductsFinished Products required to maintain the level of production

This is not Operating Cost as these inventories will be maintained through out the plant life

Bank can provide loans for part of the working capital for the start up of he unit against the hypothecation of Raw material.

Financing Arrangements (Contd):Working Capital ( Contd )The borrowed part is termed as Borrowed Working Capital

The Balance Working Capital which financed from long term sources is treated as Margin Money.

Usually 20-30% of Initial working capital requirement is provided as Margin Money in estimating project cost.

Financing Arrangements (Contd):Operating Costs Includes:Costs incurred on a Recurring basis which includesRaw materialLabourUtilitiesRepair and MaintenanceMarketing

And any other incurred year after year when Plant Goes on Commercial production. Costs like Interest on Loans, annual Insurance fall in this category.

Financing Arrangements (Contd):Operating Costs -Contd

Operating cost is a part of feasibility study but only part of it expected to financed by Long term sources.

This part is known as Preoperative Expenses and include expenses prior to commissioning of the unit such as Staff recruitment, Training, Interest Burden, Commitment Charges and other Establishment Expenses.

Finance Sources:Could be internal or ExternalFor Small scale project internal resource could be enough however for large projects External Financing is normally mandatory. Terms of financing and Source Can be listed as:.

Terms of FinancingSourceNormally Financed forShort TermLoan from Commercial Bank, Trade CreditsWorking CapitalIntermediate TermTerm Loans, Lease Financing, Hire Purchase, Fixed deposits from Public, Govt. SubsidiesCapital CostLong Term FinancingCommon Stock, DebtCapital Cost

Financial Structure

Financial Structure:DEBT and EQUITY.Debt means money organized on Loan associated with Interest Rate.

Equity means money taken from Share Holders and other partners and associate with whom profits have to be shared.

With share holders dividend on the shares, linked to profit is to be given

Financial Structure:DEBT Vs. EQUITY.For the entrepreneur, debt Capital is Cheaper as compared to Equity.Interest of Debt is Tax deductable however dividends on Equity are paid out of net Profit After Tax.Debt has fixed liability and can lead to legal action and bankruptcy in case the owner is defaulterOn the other hand Dividend on Equities are to be paid depending on profits and are less risky.However cost of avoiding Risk through Equity is high and Debt is to Equity Ratio needs careful consideration.

Financial Structure:DEBT Vs. EQUITY Contd.A company with more proportion of Debt is considered to by High Leveraged.

A high Leveraged company makes larger profit when product demand is high but at the time of recession it will also incur high losses.The Debt Equity Ratio is to be fixed considering above logic and the type of industry to which it has to be applied.For petroleum industry it could be typically 1:1 while for Cement Industry it is limited to 4:1

Financial Institutions

Financial InstitutionsMost of the projects are financed though Debts or Termed loans.Several National and International institutions finance and promote the establishment of a new project.Driver for Financing Institutions is to find the opportunity to grow their funds by investing in a profitable ventureSome National Financial Institutions are.Industrial Development Bank of India (IDBI) Principal Financial Institution of India. Support the other FIs and supplement resources to promote Industry.Industrial Finance Corporation of India (IFCI) provide long term loans for the promotion of Industry both in Public and Private sectorIndustrial Credit and Investment Corporation of India (ICICI); FI mainly providing foreign currency loans to industrial concerns in Private Sector

NATIONAL Financial Institutions (Contd)Industrial Reconstruction Corporation of India(IRCI) Mainly Provides soft loans for revival of an industrial unit already closed or at the verge of closureState Financial Corporation (SFC) ; Provide loans to small and medium scale units in respective states. Loan in foreign currency for machinery imports is also possible.Unit Trust of India (UTI) : Mobilize the savings of general Public and invest n various Industrial Units.Life Insurance Corporation (LIC) : Provide long term finances to Industrial Units.The Export-Import Bank of India (EXIM Bank) : The EXIM bank provide funds for export promotion for engineering and capital goods. It provides credit to foreign companies and FIs to import Indian Capital goods and services.The State Industrial Development Corporation (SIDC): Provide loans as well as render assistance in putting the Industrial Unit.

FOREIGN Financial Institutions World Bank (International Bank for Reconstruction and Development) WB provides loan for less developed member countries for building Infrastructure. Schools, Irrigation Dams, Power Plants, Roads, Water Supply etc. e.g. projects of relevance to society gets special attention.International Finance Corporation(IFC) Subsidiary of WB and provide loans to Private Sector.International Development Association (IDA)- Also a Subsidiary of WB and provide soft loans to under developed Countries.United Nations Development Program(UNDP) and United Nations Industrial Development Organization (UNIDO) Institutions of United Nations and provide funds for Industrial Development

FOREIGN Financial Institutions Contd International Monetary Fund (IMF) : Part of UN and Compliments the efforts of WB to promote economic growth

Asian Development Bank (ADB) Finances infrastructure and Industrial projects in Asia.

Non Residents Indians (NRI) NRIs or their owned (at least 60% )companies, partner ship firms, trusts, societies can invest in Industrial projects in foreign currency.

Appraisal by FIs:Stringent Appraisal Procedure to over come to seek Sanction and clearance.

Main thrust in the appraisal is on the cost estimates and profitability analysis.

Commercial and Technical aspects also receive enough attention.

Types Cost Estimates

Accuracy of Cost EstimatesAccurate Cost Estimates are essential not only to organize funds but also to assess the project feasibility.Accuracy evolves with more information available on the project as it progresses.Following are different types of estimates..Order of Magnitude Estimate (+/- 60%)Study Estimate (+/- 30%)Preliminary Estimate (+/- 20%)Definitive cost Estimate (+/- 10%)Detailed Estimate (+/- 5%)

Order of Magnitude EstimatesAccuracy +/- 60%Mostly deduced form the investment in a similar project in past. Different Variants areCapacity ProratedR2 = R1 X C2/C1Based on Turn Over Ratio R2 = C X V2 X PC is capital Rato i.e. Plant investment in Rs / Plant Annual Sales in Rs.V2 is Annual sales Volm for proposed plantP Price / Slaes VolmBased on six tenth Factor R2 = R1 X (C2 / C1)0.6 Based on Inflation IndexInstalled Cost Now = Installed cost Past X Cost Index Now / Cost Index in PastLocation Index : Based on Plant cost at Other Location Prorate with Location Index. These indexes based on Productivity of the countries are available with Project Management Companies.

Study EstimatesAccuracy +/- 30%Based on Preliminary Flow Sheet and Cost Controlling Size Parameter of the equipments.Equipment Budgetary cost is estimated using past data bank or correlationsPlant cost estimated using This estimate of Equipment cost and factors for Civil, Electrical, Piping, Instrumentation, insulation, installation etc.Budgets are sanctioned based on such estimates which means there could be about 30% in case project costs over run.If over run is because of some other mistake in the cost estimate, it would be difficult to manage for the Entrepreneur.

Preliminary EstimatesAccuracy +/- 20%Based on Firm Technology Package ready for implementation.At this stage budget allocations are frozen and firm Implementation Schedule is available.Project Zero Date normally corresponds to this level of information.As project progresses more information is available mainly from the quotes from different equipments and services and uncertainty of cost estimates reduces as shown in the next slide ....

Successive Cost EstimatesCapital Cost EstimateProbability Density

Estimate AEstimate BEstimate CEstimate DIncreasing Mean More missing prices are included with increase in clarity

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Preliminary Estimates ContdPreliminary estimates Based on Firm Technology Package means based on following additional informationFinal P&IDsOverall Plot PlanPreliminary Equipment and Building Lay outFinal equipment Process Specification Data SheetsPreliminary Pump and motor ListPreliminary Piping MOCFinal Instrumentation List and Specs.Please note at the stage of Feasibility study above information is not available and this additional information will enhance the accuracy of estimates

Definitive Cost EstimateAccuracy +/- 10%Based on Inputs from Detail Engineering.Additional Inputs available at this stage are :Equipment Purchase Specifications, Vendor Quotes/Award CostSchedule of items for works tender/contractor QuotesReasonably accurate Material Take offs for steel, piping and electrical Equipment based on GADsHouse GADs

Detailed Cost EstimateAccuracy +/- 5%Based on completion of Detail Engineering, ordering of equipment and machinery and award of major field contracts.Additional Inputs available at this stage are :Ordered Value of Plant equipment and MachineryAwarded cost of all Major ContractsFinal Material Take OffsNinety Percent Construction Drawings.

Cost Estimates ContdEstimated Cost can not be better than +/- 5%.

Precise cost estimates are possible after project goes in to commercial Production.

At feasibility study stage at maximum +/- 30% estimates are available.

The objective is to set a realistic Target, achievable and worth striving for.

This self deceiving exercise is to be done to set realistic goals through sensitivity analysis and organize for the funds with certain margins.

Various Types of EstimatesProgress of Project% ErrorOrder of Magnitude+/- 60%Study Estimate+/- 30%Preliminary Estimate +/- 20%Definitive Estimate +/- 10%Detailed Estimate +/- 5%

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Successive Cost EstimatesCapital Cost EstimateProbability Density

Estimate AEstimate BEstimate CEstimate DIncreasing Mean More missing prices are included with increase in clarityThis gap to be minimized

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Feasibility study We covered followingRaw Material SurveyDemand StudyTechnical StudyProduct Pattern / Plant CapacityProcess Selection / Inputs as Process PackageLocation StudyFinancial arrangementCapital Cost, Working Capital, Operating CostFinance SourcesFinancial structure - Debt : EquityFinancial InstitutionsDifferent Types of Cost estimatesLet us now discuss Time Estimates Estimates..

Time Estimates

Estimates of Project Implementation ScheduleAt the definition phase , like cost estimates, - schedule estimates are also approximate but needs to be carried out to establish at path for the project.A qualitative difference in Cost Estimates and Schedule Estimates:Cost estimates are of higher importance than Time EstimatesCost estimates directly linked to Quantum of Work while Time estimates can be optimized by parallel scheduling some activities.Time is a commodity which can be bought with increased cost

Basis of Time EstimatesThe cost estimates is a summing process of the cost of all the activities.However Time estimates is the manipulation of parallel and sequencing of time required by different activities .Time of each activity depends on Quantum of workAssociated ConstraintsAvailable resourcesObviously all the data is not available w.r.t. above aspects however approaches adopted to have reasonable estimates of time schedule are as follows.

Basis of Time Estimates- ContdTime study Approach:Time for completing the work (T) is estimated using Total Quantity of work (Q), Productivity Factor (P) (i.e. output per man day) and normal Size of Crew (n).

These variable are related as : T = Q/n.P

In real life projects none of these data is available at least at feasibility stage.

This approach is adoptable for repetitive manufacturing projects involving labor intensive jobs such as Garment industry.

Basis of Time Estimates- ContdPrevious Project Data.Data from completed similar previous project, are reasonably good basis to have Project Time assessment.

Time required for each activity and with proper networking of the activities, Project schedule can be assessed.

Such data may require due judgmental corrections in view of available manpower and facilities at different locations / countries.

Basis of Time Estimates- ContdGuess estimating Approach.Experienced Project Personnel are asked to guess project / activity duration.To cover the uncertainty normally three estimates are madetO= Optimistic Timetp= Pessimistic Timetm=Most likely time

Expected time is estimated as te = (tO + 4tm + tp ) / 6

Basis of Time Estimates- ContdRange Estimate

Based on range estimates from different vendors at budgetary proposal stage

Approximate and subject to further negotiation with short listed vendor contractor as the project progresses.

Basis of Time Estimates- ContdRange Estimate / Estimates from Vendors and Contractors

Based on range estimates from different vendors at budgetary proposal stage

Approximate and subject to further negotiation with short listed vendor contractor as the project progresses.In competitive scenario these estimates could be quite optimistic.

Time Taken Vs Time requiredObjective is to estimate the time required to complete a job

Estimates as above are approximate and based on past experience.

In line with Parkinsons Law, Work expands so as to fill the time available for its completionSo what is the realistic time at the project feasibility stage ?

Allocated and Committed TimeThere are some activities will require fixed time like curing of Concrete or duration for incubation.So duration of each activity is to be with in the limit of its compressibility.Allocation should be reasonable.In practice a reasonable allocation of time is given to implementing agency and their commitment is obtained. If it is not realistic implementing agency will revert with arguments and Logic. This may look like robbing X to pay Y but practically it is most Pragmatic approach

CAT Vs. RATAt prefeasibility stage a schedule estimate with in +/- 20% is reasonable enough to accept.

In this Band their could be Committed Activity Targets (CAT) and Reserved Activity Targets (RAT)

RAT is confidential to the owner while planning with implementing agency is for CAT.

Of course in the end CAT always try to eat RAT.

Feasibility study We covered followingRaw Material SurveyDemand StudyTechnical StudyProduct Pattern / Plant CapacityProcess Selection / Inputs as Process PackageLocation StudyFinancial arrangementCapital Cost, Working Capital, Operating CostFinance SourcesFinancial structure - Debt : EquityFinancial InstitutionsTypes of Cost Estimates..Time estimates CAT & RATProfitability Analysis

Project Profitability

Project ProfitabilityEstimates at the project feasibility stage are approximate and needs to be continuously updated as the project Progresses.

However, there is no question in progressing on a project unless it is viable at the zero date of Project feasibility (during Definition Phase).

Further analysis is such that it ensures that with in the band of uncertainty, the project remains profitable. Necessary sensitivity analysis is carried out to ensure this aspect.

Methods for economic ViabilityFollowing methods are used for Economic Viability

Pay Back Period (PBP)

Return On Investment (ROI)

Net Present Value (NPV)

Internal Rate of Return (IRR)

Benefit Cost Ratio (BCR)

Pay Back PeriodAnnual Income computed as gross earning less operating costs excluding DepreciationThis is the time Required to recover the original Investment.If not uniform Annual Income it is the number of years over which income accumulated will be equal to the original Investment.Low PBP, more profitable project.Indicates how fast money sunk in the project can be recovered

Pay Back Period (Contd)More relevant for the borrowed investment and for companies requiring cash f low.

PBP is not the right indicator of profitability as the purpose of any investment is just not to recover the investment but to have sustained profitability.

For long plant life projects, inference based on PBP could be misleading.

Return on InvestmentIf Cap inv = Rs 150 LakhsProject Life 10 YearsSalvage Value at the end of 10 years = 0Estimated profit Rs 15 Laks for first 5 years and 7.5 Laks for Balance

Return on Investment (Contd)ROI > Borrowing Rate for the project to be viable

This method better than PBP as it considers the project life.

Mostly applicable for the projects of short Life period.

For long Project it has limitations as it does not consider any time value of the money.

Net Present Value Methods discussed so far do not consider Time Value of Money.This means all future amounts to be discounted by at least intrest value to determine their Present Value (PV).

S= Cash Flow at t yearr= discount rateNet present Value:The Net Present value of a Project is the Sum of the present Values of all the cash flows Positive as well negative That are expected to Occur over the life of the Project.

St = Cash flow at the end of Year tn = Life of the projectr = discount rate, I = Investment

Assumes all investment in first year only, not always true.Better definition

Internal Rate of Return (IRR)This method is based on discount rate hence considers time value of Money.

Internal Rate of Return (IRR) is the discount rate at which NPV is Zero.

Project with higher IRR are more profitable

IRR should be more that prevailing money rate in order the project to be viable.Iterative method is required to estimate IRR

Benefit Cost Ratio

A modified form of NPVNPV normalized with Investment

BCR > 1 Profitable ProjectHigher BCR, more profitability

Functions In ExcelNPV : NPV function calculates that present value for each of the series of cash flows and adds them together to get the net present value.The function is =NPV ((Discount Rate), Cash Flow Range)

Functions In ExcelIRR : You can think of it as a special case of NPV, where the rate of return that is calculated is the interest rate corresponding to a 0 (zero) net present value.=IRR(values Range,Initial Gauss of IRR)

Estimated NPV should give zero at this discount rate

EXAMPLE

To SummarizePrefeasibility Study in definition phase should address Profitability along with above discussed aspects e.g.Raw MaterialDemandTechnologySite SelectionRequired BudgetEstimated ScheduleProfitabilityAccuracy of Estimates improves as project progresses, however at the Stage of Feasibility accuracy of about 30% is reasonable.For Profitability Mostly NPV is used as it takes care of time value of the money.