Chapter- 3

Project Analysis
Contents of the Chapter:
1. Market and Demand Analysis
2. Production Program and Plant Capacity
3. Raw Material and Supply Studies
4. Location, Site and Environmental Impact Assessment
5. Technology and Engineering Study
6. Organizational Study
7. Financial Analysis
8. Economic Analysis

1. Market and Demand Analysis

Introduction
Market analysis is a process of assessing the level of demand for product or
service to be produced from the project. This means determining the
marketability of the product or service of the project under consideration.
Market analysis is a critical stage in the feasibility study of projects intended
especially for wealth maximization purposes. Different techniques of demand
forecasting and analysis are used in analyzing the availability of markets for
the products and assessing the level of demand.

Role of market and Demand Analysis

Market and demand analysis is a key process in determining the feasibility of

a project. The basic idea of any project is to benefit either from utilization of
available resources or from satisfaction of existing or potential demand for
output of a project. Once the present effective demand for the project’s
output, the characteristics of the corresponding markets and possible market
concepts have been determined, the desired production program including
the required material inputs, technology and human resources as well as
suitable locations can be defined.

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The demand or market analysis must be carefully structured and planned in
order to obtain required information within the time and cost limits and to
determine the possible marketing and production strategies required to
reach the basic or corporate objectives. Market analysis is discussed based
on the following pattern:
o Concept of marketing
o Marketing research
o Outline of project strategy and steps in demand projection.

Marketing
The term marketing can be explained as a market orientation of
management with regard to business decisions. Market orientation of
investment and finance decisions would therefore, imply the feasibility
studies need to incorporate the design of marketing concept, which should
be based on proper marketing research. Marketing can be characterized by
the following four key elements. These are:
 Business philosophy
 Marketing research
 Marketing instruments and
 Marketing plan and budget.

Business Philosophy- Marketing is above all business philosophy that

doesn’t focus on products or production (unlike the past periods), but puts
the problems, needs and desires of existing or potential consumer groups at
the center of the business activities of the firm. This requires that decision
makers at all levels and in all functional areas of the enterprise will have to
orient their thinking towards the market.

Marketing Research- well planned and systematic market and market

related research is a precondition for market oriented decision making. On

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the basis of information obtained about the potential market as well as the
human, production and financial resources available for the project,
marketing strategies are to be developed to ensure the achievement of the
project objectives.

It is important to note that the market orientation of project preparation is

not limited to sales markets of the enterprise. It is also necessary to analyze
the supply markets and design a concept for securing the required project
inputs.

Marketing Instruments- The successful implementation of marketing

strategies shaping and influencing the market in a well planned manner,
using the necessary combination or mix of marketing instruments.

Marketing plan and Budget- To achieve the marketing objectives, it is

necessary to determine the required measures or means and to prepare a
plan of action on the basis of findings of marketing research and using the
marketing tools available. A project shall be based on well defined marketing
concept in order to achieve the desired objectives.

Marketing Concept
The marketing concept comprises the marketing strategy and operative
measures required to implement the project strategy and reach the project
objectives. A Project strategy is a set of objectives and principles defined for
a project with a view to determining the allocation of resources over a period
of time representing the planning horizon chosen for the project. It is a
central for both the preparation and evaluation of the project and the design
of a proper marketing concept.

The principal question to be addressed by a strategic dimension of a

marketing concept is as to which marketing strategy is suitable to achieve
the marketing targets within the conditions defined by the project strategy.
The marketing strategy to be considered involves the following dimensions:

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  Identification of target groups and products likely to win their favor.
 Determination of competition policies (whether a low price strategy
or differentiation strategy) to defeat competitors.

When we come to the operative dimensions of a marketing concept, a

distinction is made between the four marketing tools, the combination known
as the marketing mix. These four components are:

 Product
 Price
 Promotion and
 Place

Marketing Research

Marketing research is a concise and systematic assessment of information on

the market and market environment. It is the task of marketing research to
obtain, analyze and interpret this information and to provide the basis for
other basic decisions. For the development of the project strategy and the
marketing concept, careful marketing research is essential.

The scope of marketing research required for a feasibility study is

determined by the need to select and justify a project strategy and the
development of the corresponding marketing concept. Any errors made in
this research phase would result in wrong marketing concepts and may place
the whole project in jeopardy. Hence, it shall be done so carefully and
critically.

In general, systems approach to marketing facilities the understanding of

interdependencies between market participants and their activities. The
elements of this system are enterprises and organizations as well as single
persons playing a specific role in the market exchange process.

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The following will be some of the steps involved in the process:

 Assessment of the target market structure.

 Customer analysis and market segmentation
 Analysis of channels of distribution
 Analysis of competitors
 Analysis of socio-economic environment
 Life cycle of a subsector
 Projecting marketing data

Project Strategy and Projecting Demand

In most cases, the first step in project analysis is to estimate the potential
size of the market for product proposed to be manufactured (or the service
planned to be offered) and get an idea about the market share that is likely
to be captured. Put differently, market and demand analysis is concerned
with two broad issues:
1. What is the likely aggregate demand for the output? and
2. What share of the market will the proposed project enjoy?

For all investment projects, market analysis is the key activity for
determining the scope of an investment, the possible production programs,
the technology required and often also the choice of location. Two important
implications of market study are:

1. Influence accept or reject decision- if the demand of the project output

is very low, the project may not be accepted. Error in the assessment
of market may lead to accepting of the project that should be rejected
or rejecting the project that should be accepted. Or if it is wrongly
projected, it may lead to wrong investment decision.

2. Influence the determination of plant capacity. It may lead to wrong

choice of capacity-either excess or small capacity.
Excess capacity – overinvestment, idle capacity

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 Cost of small capacity- loss of opportunities, los of the
advantage of economy of scale.

Contents of Demand Analysis

Two types of market information can be distinguished, namely general
market data and specific data for a particular market segment (consumer
group, product or product group).
Most marketing studies include data on the following:
 General Economic Indicators- These are factors that are related to
socioeconomic factors such as product demand, population level and
growth rate, per capita income and consumption, gross domestic
product per capita and annual growth rate, and income distribution.

 Government Policies- demand for goods and services may be

influenced by government practices and legislation, at least to the
extent they are directly related to consumption, production, imports
and exports of the product in question; standards, restrictions, duties,
taxes, as well as subsidies or incentives, credit control and foreign
exchange regulations, etc

 Present Level of Domestic production- present domestic

production by volume and value, including production intended for
internal consumption and not placed on the market is relevant in
determining the demand gap that exists and assessing the feasibility
of the project because the demand gap is one basic source of project
idea.

 Present Level of Imports- Some gap may be filled by imports.

Current level of imports by volume and value (cost, insurance, fright
and local costs) will help design import substitute projects.

 Production and Imports of Substitutes and near-substitutes-

This will influence the demand for the product in question. For

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 example, the demand for a bakery project may be influenced by
existing Pasta factory or imports of Pasta from abroad.

 Critical Inputs and Complementary Products- These are issues

that constrain the feasibility of a project from demand point of view.
For example, a project for automobile assembly will be influenced
directly by the existence of a project for tyres or the raw materials for
the automobile assembly.

 Production targets Determined in National Economic Plans-

Sometimes government policies may directly influence the production
of products in question, substitutes and complementary products. For
example, a project on electronic production and distribution is not
allowed in Ethiopian context. But it is allowed to the extent of dam
preparation and power production (except distribution).
 Present Level of Exports- Another important factor in demand
analysis is the volume and value of exports about the product or
service. This is to incorporate the issue of exporting the goods or
services in the feasibility study.

 Behavioral patterns- demand for goods and services is significantly

influenced by consumer behaviors such as consumer habits and
responses (individual and collective) as well as trade practices in a
given environment. For example, a Pasta project around the
countryside will not be feasible. A project producing space consuming
cars, electronics and other similar products will not feasible in urban
areas for space consumption is critical issue in urban areas, etc.

The specific demand and market data for a particular market segment
should be identified and its availability for the feasibility study ascertained.
The range of data, however, depends on the nature of the product and the
type and the degree of market research that it may involve. It is not
practicable to make any classification or prescribe any guidelines in this

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regard. In one case, past production figures may be decisive; in another,
they may be misleading.

The demand analysis section of the feasibility study should aim at providing
basic information such as:

1. Size and composition of present effective demand in market with

clearly defined geographical limits. It shall try to estimate by
apparent current consumption-amount of consumption of current
time. It is a good starting point to analyze demand but it must be
used with due care. It is computed as follows:

Estimated Current = Import during the year

effective demand + Production during the year
+ Stock at the beginning
- Stock at the end
- Export during the year
2. Major market segment identification by:
 End user types ( direct consumer, industrial users, etc)
 Consumer groups ( income groups, age groups, etc)
 Geographical divisions (regional, national, export)

3. Demand production for the market (for the overall market and the
market segment over the coming 10-15 years). In some kind of
production, estimation even for a short period is very difficult
because of changes in the demand of the product. For example, a
projection of demand for electronics goods is very difficult because
the useful life of such goods is getting shorter every time.

4. Expected market penetration ratio of the project over its life, it may
not be possible for new projects to satisfy the whole demand. Market
share may be built up gradually or it may get a high penetration
ratio at the beginning. There may be some constraints- investment
constraints to produce at high rate at the beginning for instance.
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 5. Pricing structure on the basis of which projections are made for
market growth and penetration.

Basic steps in the projection of Demand

1. Define, assemble and analyze available data related to past

consumption and rates of change over time.
2. Classify such historical consumption data by market segment. This will
help to see how each market segment’s consumption has changed over
time. For example, a certain region’s consumption in the past may be
determined.
3. Determine the principal determinants of past demand and their
influence on it.
a) Factors for the change in consumption such as size of
population, extent of extension services, income.
b) Factors which have an influence on demand.
4. Forecast the future demand through extrapolation of the determinants
(using appropriate forecasting techniques).

Methods of Demand Forecasting (in Brief)

After gathering information about various aspects of market and demand

from primary and secondary sources, an attempt may be made to estimate
future demand. A wide range of forecasting methods are available to market
analysis ranging from the simplest to the most complex methods. These
methods can in general be placed in two groups.

1. Qualitative Methods- this method rely essentially on the judgment of

experts to translate qualitative information in too quantitative estimates.
Examples in these groups are:

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 a) Expert opinion/Jury Executive Method- this method calls for
the pooling of views of group of experts on expected future sales
and combining them in to a sales estimate. The major advantage
of this method is the pooling of expertise knowledge in the
forecasting process. However, the accuracy of the forecast will
depends on the care and experience of the people providing the
inputs.

b) Delphi Method- this method involves converting the views of a

group of experts, who do not interact face-to-face, in to a forecast
through an iterative process. It is used for eliciting the opinions of
a group of experts with the help of mail survey. The process may
include the following steps:
i) A group of experts is sent a questionnaire by mail and
asked to express their view.
ii) The response received from the experts are summarized
without disclosing the identity of the experts, and sent
back to the experts, along with a questionnaire meant to
probe further the reasons for extreme views expressed in
the first round.
iii) The process may be continued for one or more rounds till
a reasonable agreement emerges in the view of the
experts.

2. Quantitative Methods- uses a formal mathematical method to fit cost

functions to past data observations. Examples include Time series
analysis, Regression (correlation) analysis, Moving average, Exponential
smoothing, etc.

a) Trend Projection Method (Time series Analysis)- Time series

analysis forecast based on an analysis of how variables of interest have

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 moved historically over the past periods. It doesn’t make a real attempt
to analysis why the variables has changed as they did in the past. The
change is only related to time. It helps to forecast about the future based
on what has happened in the past. It is more reliable when changes have
a certain pattern and the same pattern is expected in the future too.

Time series analysis is becoming a very simple task with advanced o

computer spreadsheet technologies. When the trend projection is used, the
most commonly employed relationship is the linear relationship.

Y = a +bx
Where: Y = demand for the year (dependent variable)
X = time variable (Independent variable)
a = intercept of the relationship
b = slope of the relationship
b= xy – n xy
 x 2- nx

a = y – b(x)
For example consider the following sales data about sales of a certain
product in the past 12 years. Mathematical computations are used to
determine a and b based on a given set of data.

Required: Forecast sales for the next 5 years and state the sales forecast
equations.

The analysis can be made in a tabular manner computing figures for the
items included in the formulas above. The final equation is as stated below
next to the table.

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 Year Sales (Y)
(X) (Historic XY x
2

al
data)
1 2,109 2,109 1
2 2,530 5,060 4
3 2,287 6,861 9
4 3,194 12,776 16
5 3,785 18,925 25
6 3,372 20,232 36
7 3,698 25,886 49
8 3,908 31,264 64
9 3,725 33,525 81
10 4,129 41,290 100
11 4,532 49,852 121
12 4,487 53,844 144
x=78 y= xy =  x = 650
2

41,756 301,624

Y= 211.26x + 2106.5

b) High- low method- it uses only the highest and lowest observation
values of the dependent variable. The demand function is estimated by
using these two points to calculate the slope coefficient and the constant
or intercept.
Slope coefficient (b) - is the difference between the highest demand and
lowest demand in the past divided by the difference between the highest
and the lowest of the independent variable.
Example: Consider the following observations extracted from 10 years data.

Observation X Y
Highest observation 96 1456
Lowest observation 46 710

Based on the above data, slope of the equation can be determined as:
1,456 – 710= 14.92/x

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 96 -46
To compute the constant, we can use either the highest or the lowest
observation of the data. Both calculations yield the same answer because
the solution technique solves two linear equations with two unknowns, the
slope coefficient and the constant because:

Y = a +bx
A = y – bx
Therefore, at the highest observation of x,
The constant = 1,456 – (14.92 x96) = 23.68
y= 23.68 + 14.92x

c) Regression analysis- is a very popular demand forecasting tool in

practice. It involves extrapolating the past trend of demand with
identified factor affecting the demand such as income to the project the
future consumption. It measures the average amount of change in the
dependent variable associated with a unit change in one or more
independent variables. There are two types of regression analysis. These
are:

i. Simple regression (using one independent variable) and

ii. Multiple regression analysis (that uses several independent
variables).

In general, regression analysis involves:

 Determining the trend of consumption by analyzing the past
consumption statistics and
 Projecting future consumption by extrapolating the trend.
Simple Regression Analysis: For example, in the above case if the
assumption is changed as demand is a function of number of households in
each year (one independent variable i.e. house hold). The equation to
forecast demand called the regression equation and the forecast results will
be as shown below:

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Note: The formula to compute a and b in the equation are the same except
that the independent variable in this case is not time but number of
households.

Year No. of Sales

households (Historical XY x2
(X) data)
(Y)
1 815 2,109 1,718,835 664,225
2 927 2,530 2,345,310 859,329
3 1,020 2,287 2,332,740 1,040,000
4 987 3,194
5 1,213 3,785
6 1,149 3,372
7 1,027 3,698
8 1,324 3,908
9 1,400 3,725
10 1,295 4,129
11 1,348 4,532
12 1,422 4,487
x= 13,927 y= xy=50,038,739  x 2=
41,756 16,613,611

Y= 3.5041x – 587.11

Multiple regression analysis- this is a regression analysis that used if

demand is affected by more than one variable such as number of households
and time. The number of households must be forecasted first in another
forecasting.

Year No. of Sales

households (Historical
data)
1 815 2,109
2 927 2,530
3 1020 2,287
4 987 3,194
5 1213 3,785
6 1149 3,372
7 1027 3,698
8 1324 3,908

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 9 1400 3,725
10 1295 4,129
11 1348 4,532
12 1422 4,487

Intercept = 1792.08354
Year = 191.76807(X1)
Households = 0.38005946(X2)
Y= 1792.08 + 191.77X1 + 0.38X2
Note: These assumptions are made using various tables and formulas that
shall be covered in other courses such as operation research in detail and in
the same manner as the case of Simple regression analysis.

The regression line minimizes the sum of the squared vertical differences
from the data points to the regression line. Goodness of fit test indicates the
strength of the relationship between the variables. When the regression (co-
relation) trend projection method is used, the most commonly employed
relationship is the linear relationship (one independent variable).
Y= a +bx
y = demand for the year (dependent variable)
x = Independent variable
a = intercept of the relationship
b= slope of the relationship
The results should be interpreted with diligence:
1. Explanatory variable must make sense- there should be plausible
relationship between the dependent and independent variables.
2. The right model must be selected.
3. Results should be interpreted with due care.
4. Outliers, observation that is very far from the majority observation,
may be disregarded in order to avoid their effect on the regression
results.

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d) Exponential Smoothing Method- in exponential smoothing forecast
results are modified in the light of observed errors.
i) If forecast value for year t (Ft) is less than the actual value for year
t (St), the forecast for the year t+1, is higher than Ft. i.e. (If Ft <St,
Ft+1 >Ft)
ii) If Ft>St, Ft+1< Ft.
Where: - Ft+1 = forecast for year t+1.
- Et= error in forecast for year t = St-Ft
-  = Smoothing parameter (which lies b/n 0 and 1)
How should the first forecast (F1) and the smoothing parameter () be
chosen?

 A simple and reasonable factory rule of thumb is to choose F1 as the

mean of the warm up sample. (The warm-up sample consists of
several observations preceding the period for which the forecasting
exercise is began).
 For choosing , consider several values in the range of 0 to 1 and
choose the value that minimizes the MSE (Mean Square error) in the
warm-up period.
MSE =  (Si –Fi)2
N
Where: Si = the actual sales in the period i
Fi = the forecast in the period i
N = number of periods in the warm up sample.
Example: Assume that the actual sale of a given product in period 1 is
28,000 units while the forecast sale is 29,000 units for the initial period.
Assume further that the actual sales value for the next ten periods is the
following:

Period 1 2 3 4 5 6 7 8 9 10 11
Sales 2 29 28.5 31 34.2 32.7 33.5 31.8 31.9 34.3 35.2
(‘000units 8
)

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Given = 0.2, derive the forecast of sales for the next ten periods.

T Data Forecast Error Forecast for t+1

(St) (Ft) (et=St-Ft) (Ft+1= Ft + x et)
1 28 -1 F2= 29+0.2(-1) = 28.8
2 29 0.2 F3= 28.8 + 0.2(0.2)= 28.84
3 28.5 28.8 -0.3 F4= 28.8 =+ 0.2(0.2) = 28.7
4 31 28.7 2.3 F5 = 28.7 + 0.2(2.3) = 29.2
5 34.2 29.2 5.0 F6= 29.2 + 0.2(5.0) = 30.2
6 32.7 30.2 2.5
7 33.5 30.7 2.8
8 31.8 31.3 0.5
9 31.9 31.4 0.5
10 34.3 31.5 2.8
11 35.2 32.1 3.1 F12 = 32.1+ 0.2(3.1) 32.7

e) Moving Average Method

As per the moving average method of sales forecasting, the forecast for the
next period is equal to the average of the sale for several preceding periods.

Ft+1 = St +St-1+ St-2 + …… + St-n+1

N
Where: Ft+1 = Forecast for the next period
St= Sales for the current period
N= Period over which averaging is done
Example: Consider the following time series (figure in ‘000 of units):

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 Year Sales (St)
1 28.0
2 29.0
3 28.5
4 31.0
5 34.2
6 32.7
7 33.5
8 31.8
9 31.9
10 34.3
11 35.2
12 36.0

Assuming the forecaster has set “N” to be equal to 4, make a forecast of

sales for the periods 5 through 12.
Solution:
F5 = 28+29+28.5+31 = 29.1
4
F6 = 29+28.5+31+34.2 = 30.7
4
F7 = 28.5 + 31+34.2+32.7 = 31.6
4
.
.
.
F12 = 31.8+31.9+34.3+35.2 = 33.3
4

Other traditional forecasting techniques such as the naïve method may also
be used. A naïve method assumes constant amount of demand from period
to period though it may not be appropriate method of forecasting.

3) Causal Method for Demand Forecasting

It has several methods of forecasting. These are:

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  Consumption level method
 Income elasticity of demand
 Price elasticity of demand
 End use method (also called Consumption Coefficient Method)
 Leading Indicator method
 Chain Ratio method
i. Consumption level method
ii.
iii.
iv. Chain Ratio
It is a causal method to forecast sales. Under this approach, the potential
sales of a product may be estimated by applying a series of factors that are
likely affecting the demand for the product and hence, used to measure the
level of aggregate demand.
Example: General Foods of US estimates the potential sales for a new
product, a freeze-Fried instant Coffee (Maxim), in the following manner:
o Total amount of coffee sales-------------------------- 174.5 million units
o Proportion of coffee used at home --------------------------- 0.835
o Coffee used at home------------------------------------- 145.7 million units
o Proportion of non-decaffeinated coffee used at home------- 0.937
o Non-decaffeinated coffee used at home ------------ 136.5 million units
o Proportion of instant coffee --------------------------------- 0.400
o Instant non-decaffeinated coffee used at home-------- 54.6 million
units
o Estimated long-run market share for maxim --------------- 0.08
o Potential sales of Maxim ------------------------------ 4.37 million units
============
Problems in demand Forecasting

 Data may not be available (few observations)

 Available data may not be structured; and may not be suitable for
analysis and investigation (lack of standardization).

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 Influence of abnormal factors (war, natural disaster).
 Data needed may be classified one for use.
 Uncertainty- the forecasting period is full of uncertainties.
 Environmental change:
o Technological changes
o Shift in government policy
o Developments in the international scene
o Discovery of new sources of raw materials
 Model constraint
o Difficult to identify a suitable model
o Inability to handle unquantifiable factors
o Unrealistic assumptions
o Excessive data requirement

Location and Site Selection

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Introduction

The main issues of the feasibility study being addressed in this chapter are
determination of the specific location and site suitable for the project.
Location and site are often used interchangeably but must be distinguished.
Ideally, a project can be located in lots of potential locations and specific
sites. But a project shall be put at a project location taking in to account
various factors such as proximity to inputs or to markets and others.

In addition, the specific site of a project shall be properly studied and

selected in a chosen location as there may be various sites for a project in a
certain area of location. It is obvious that the location and site of the project
not only affect the profitability of the project but also influences the long-run
goodwill of the company. Hence, they shall be selected considering various
relevant factors. Project location and site selection also affects the lives of
the residents in positive as well as in negative ways. A proper environmental
impact assessment is essential before locating a project somewhere.

Basic issues concerning Location and Site

The choice of location and site follows an assessment of demand size, and
input requirements. It is part of the technical analysis of the feasibility study.
As has been indicated above, though often used interchangeably, the terms
location and site should be distinguished.

Location refers to a fairly broad, general geographical area, such as city or

sub-city, an industrial zone, or a coastal area. But site refers to a specific
piece of land where the project would be set up. It may refer to the specific
kebele or village for instance in erecting a project.

Location Analysis

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Location analysis has to identify locations suitable for the industrial project
under consideration. A project can potentially located in a number of
alternative regions and it is made from a wide geographical area within
which several alternative sites may have to be considered. The choice of
location is not always based on systematic step by step analysis and
assessment of a gradually reduced number of possible locations ending with
the optimum solution. A location may sometimes be suggested at an early
stage by the project promoter. However, the methodology of analyzing such
a suggestion is the same and the location in question will still have to fulfill
the key requirements identified as an essential or critical for a feasible and
viable implementation, and operation of the project.

The impacts and requirements to be identified may be classified as follows:

o Natural environment, geographical conditions and protection
requirements.
o Ecological impact of the project, environmental impact assessment.
o Socioeconomic policies, incentives and restrictions, and government
plans and policies
o Infrastructural services, condition and requirements, such as:
 the existing industrial infrastructure,
 the economic and social infrastructure,
 the industrial framework,
 urbanization and
 literacy

The identification of key requirements helps to reduce the number of

potential locations and sites at an early stage. An analysis of key aspects is
basically made in qualitative terms and does not enter in to any financial
calculations.

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The primary task at this stage is rather to sort out unrealistic and less
attractive alternatives through preliminary analysis than to make the correct
rating.

The Natural Environment

In selecting a location for a project, two issues related to the natural
environment shall be critically observed:
 Climatic conditions and
 Ecological requirements
Climate is one of the important factors in the choice of locations.
 On one hand, there is a direct impact on the project costs of such
factors as dehumidification, air conditioning, refrigeration, or special
drainage.
 On the other hand, the environmental effects of the project may be
significant. Hence, information shall be gathered on temperature
rainfall, flooding, dust, fumes, and other factors for different locations.
Climatic conditions can also determine the success of a project in an indirect
way the construction, the operation and management of the plant may be
less efficient or more expensive if an adequately skilled labor force is
reluctant to work in areas with extreme climatic conditions. Thus, climatic
conditions shall be specified in terms of:
air temperature
humidity
sunshine hours
winds
precipitation
hurricane risk, etc
Each of these can be specified in great deal such as maximum, minimum,
and average temperatures on an average day in particular months or over a
period of ten years.

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Environmental Impact Assessment (EIA)

Environmental impact assessment (EIA) is an assessment which aims at

ensuring that development projects are environmentally sounded (friendly).
Environmental impact assessment is designed top develop an understanding
of the environmental consequences of a newly planned or existing project
and of any project- related activities. This is another critical factor for the
selection of location for a project. This issue is becoming very sensitive these
days, especially, when project feasibility is developed for applying for
international funding. So the feasibility study should include a thorough and
realistic analysis of the environmental impact of industrial investment
projects.

Environmental impact assessment is part of the project planning process.

Environmental benefits or costs of a project are usually externalists or side
effects that affect the society in a whole or in part. Actual economic actors
take decisions in the pursuit of their maximum benefit. When the
identification, measurement and valuation of externalities are not translated
in to prices via tax and subsidy arrangements, these actors, while
acknowledging the presence of externalities, will take decisions without
taking them in to account.

Some examples of tax and subsidy treatment of externalities will help

understanding the case:
1. The manufacturer of the paper pulp demand large quantities of
water. In the process, such water washes away chemical products
thus becoming polluted. If the firm throws away the polluted water as
it come out of the process, over ground and/or underground rivers
become polluted too. As a consequence:
a. Drinking water will become dangerous for humans and
cattle.

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 b. Fishes will become contaminated too and thus useless as
food.
c. Water may become unsuitable for irrigation.
d. Water may become unsuitable for further use in other
industrial process.
e. Tourism and nautical and fishing activities may suffer.
The paper pulp firm will not continue these damages as
part of its costs unless a tax is imposed on the disposal of
polluted water.
2. The building of dam for irrigation and electricity results in large
artificial lakes that make for the possibility of :
 Tourism and water sports
 Increase in rainfalls.

The firm that manages the irrigation and electricity project

will not compute these benefits in its balance sheet unless
a subsidy is paid.

3. A further example is a family that repairs and paints the front of its
house, planting a garden as well. All neighbors will benefit but none
will pay.

In order to make prices reflect these externalities, in example one a tax may
be imposed, calculated per cubic meter of polluted water. Such tax, by
increasing t5he price of polluted water disposal, would be giving the right
signal to the decentralized decision making units, ion this case the paper
pulp manufacturing firm. The tax would internalize in the polluting unit the
cost born by other decentralized units as a result of that pollution. As a
consequence, the polluters will face an option between:

o Building a system to purify out-flowing water or

o Paying taxes that will be used either to purify the water, or to
compensate those damaged by the polluted water.

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 In example two the government may either:

 Grant the rights to exploit tourism and water sports to the

irrigation and electricity company if this is institutionally
unfeasible,
 Sell those rights to another company and pay the proceedings to
the irrigation and Electricity Company.

In example three, the state may:

 Grant prizes to the nicest houses in the neighborhood, levying a

tax on real estate to finance them, and
 Legislate on the maintenance of pavements and house fronts.

None of these taxes and subsidy is a simple transfer of funds. Tax and
subsidy arrangements are meant to internalize externalities, charging
(taxing) decentralized units (firms and families) for the damages and paying
them for the benefits (subsidies, prizes). These instruments have role that
was simply non-existent in the past.

Environmental impact assessment is required by a law in some countries and

could be critical if international financing is sought for the project. It is also a
requirement to include an EIA in a project feasibility study top get permit

The general objective of EIA being ensuring that development projects are
environmentally sound, to arrive at appropriate decisions, public
participation from the earliest stage throughout the development project
cycle is essential. Environmental impact assessment as a result will have the
following specific objective:

 Promoting a comprehensive, interdisciplinary investigation of the

environmental consequences of the project and its alternatives.
Interdisciplinary persons are required because the environmental
impact may have various forms.

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  Developing an understanding of the scope and magnitude of
environmental impacts of the project under alternative designs.
Different design may have different impact and costs.
 Incorporating any existing regulatory requirements in the project
design, standards, environmental audit, …
 Identifying measures for reducing adverse environmental impacts
and enhancing beneficial impacts.
 Identifying critical environmental problems which require further
investigation.
 To assess environmental impacts qualitatively and quantitatively,
as a required, for the purpose of determining the overall
environmental merit of each alternative.

The environmental impacts of each phase of the project development cycle

will usually differ. During the planning phase for instance, the environmental
effects will be strictly social and economic. New political and social
alignments may arise among proponents and opponents.

The impacts of the construction phase are one time effects, while that of
those of the operational phase are recurring. In addition, all the
environmental impacts of a project may not be known immediately. Some of
the impacts may be known after a longer period of time.

Socio-Economic Policies

The other factor influencing choice of location is socioeconomic policies.

Socioeconomic policies encompass two basic factors:

1. Public policies- government regulations and restrictions about public

policies may be critical for the location of a project. In public policies such
as identification of industry zones, incentives to encourage investment
projects, etc are important location factors. For example, some area may
be prioritized for a certain project and/ or tax holiday may be given for

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 projects in a certain area. Hence, investors will consider such advantages
in selecting location.

The impact of public policies has increased considerably in recent years

and the extent to which such policies are applicable to a particular
investment proposal should be clearly defined.

Apart from the element of persuasion, public policies ay directly

determine industrial locations when there is a substantial involvement of
public or institutional finance. Hence, the location of some public financed
projects may be decided by the government regardless of economic,
market, and inputs consideration. This is because the project may be
targeted to balance resource distribution among the society through
locating projects in a backward regions or it may be based on a wider
policy for regional dispersion of industries.

2. The Fiscal and legal regulations and procedures- applicable for

alternative locations should be defined. The various national and local
authorities to be contacted in respect of power and water supplies,
building regulations, fiscal aspects, security needs, etc should be listed.

The corporate and individual income taxes, excise taxes, and other
national or local taxes should be ascertained for different locations
together with the incentives and concessions available for new industries.
This should differ considerably for different areas and may be significant
location determinants in some case. It would also be useful to list any
building and other standards and regulations to which the project need to
conform.

Infrastructural Conditions

Relevance of Infrastructure- The availability of a developed and

diversified economic and social infrastructure is often of key importance for a

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project. The Feasibility study should identify such key infrastructural
requirements because they are vital to the operation of any project.
Quantitative and qualitative requirements for energy, utilities, labor, land,
etc during construction and operation might be met only in a few locations if
the project is relatively big size. Technical infrastructure and transport and
communication will be seen here.

Transport and Communication- Transport facilities such as by water, rail,

air, or road may be available for the inflow of various inputs and for the
marketing products. As a result, a project that is judged as critically
dependent on access to certain means of transport may have limited number
of possible locations. The availability of good communication facilities
including telex and telephone should also be ascertained for alternative
locations. The same reasoning is usually applicable for projects based on a
biog consumption of power, water, factory supplies, human resources and
waste disposal mechanisms.

Availability and cost shall be detailed for the total volume of inputs in to the
proposed plant and the total out puts leaving the plant with comparisons for
various alternative locations. This can be viewed as trade-off between
proximity to suppliers/ inputs and proximity to markets for products.

Final Choice of location

The location 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 impact the final choice
will have on the project. In a feasibility study, a good starting point for the
final selection of a suitable location is:

 The location of raw materials and factory supplies if the raw

materials are bulky.

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  The location of the principal consumption centers in relation to
the plant, in case project is market oriented i.e. if the products
are perishable or more bulky than the raw materials.

If inputs are obtained from different sources, mathematical models may be

used to optimize costs. And an intermediate location that may serve all
purposes may also be selected. The simplest locational model is to calculate
the transport production and distribution costs at alternative locations
determined by the availability of raw materials and principal markets.
However, as many industrial projects are affected by several factors, projects
may be located at sources of resources, outlets of products or at
intermediate levels without affecting project economies.

Choice of site

Once the location or alternative locations are decided up on, a specific

project site or alternative sites should be defined in the feasibility study. This
will require an evaluation of the characteristics of each site.

The feasibility study should analyze and assess alternative sites on the basis
of key aspects and site specific requirements. Qualitative as well as
quantitative considerations are to be taken in to account like that of location
selection. Differences in existing social infrastructure facilities are sometimes
as important as transport costs for material inputs and product distribution.
The analysis should result in a selection of a specific site and conclusions
regarding the feasibility and viability.

The structure of site analysis is basically the same as that of location

analysis and the key requirements identified for the location of the project
may give guidance also for site selection. The selection of the specific site for
the project could also be done simultaneously with choice of location and it
shouldn’t necessarily be done after location has been selected. Hence, when
considering factors for location analysis, the factors used to evaluate
potential sites may also be listed.
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For sites available within a selected area, the following requirements and
conditions are to be assessed:

 Ecological conditions for sites- these include factors such as soil

type, site hazards, seismic history, etc.
 Environmental impacts- these include the nature of the project in
relation to restrictions, standards and guidelines of the government
concerning noise, air pollution, effects if it is close to reside3ntial
areas, etc.
 Cost of land- cost of land differs from site to site depending on the
course of its proximity to main streets and other transport facilities,
major markets, customers, etc. Hence, there will be some trade-off
in here. To minimize cost of land, other qualities of the site may be
compromised or vice versa.
 Infrastructure- This concerns the work involved in obtaining utility
connections such as markets, resources, customers, etc and the
cost associated with them.
 Site preparation and development cost-Some areas are more
appropriate for construction without much preparations and
development efforts while other areas may need several works to
make them ready for use. This will contribute to the cost of the
land.
 Strategy of the projects such as future expansion- some sites
may be attractive with existing planned capacity but may not
enable future expansion. After the project is in operation, the
owners may think of expanding it in the future. Hence, a site that
enables such as an expansion will be preferred.

The importance of each of these characteristics varies depending on the

nature of the project, the type of civil constriction completed, the weight of
the heavier equipment items, the type of effluent and the number of
workers. Hence, different areas within the same region can be subjected to

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various restrictions and incentives, and environmental conditions may
discourage the selection of sites close to an existing polluting industry such
as abattoirs or sites within urban settlements in the immediate
neighborhood.

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