Riphah International University

Project Planning and

Control

Lecture 2: Project Feasibility and Selection

 Project Appraisal

 The fundamental question is to whether if

the Business Case/Project Feasibility is
convincing to invest in a project?
 The details of the Project Feasibility must
indicate how the proposed investment might
contribute to the overall objectives of the
organisation and to do this, it must establish
the predicted costs and benefits for the
whole life of the project
 Organisations are often faced with a range
of competing Business Cases - each
representing a potential investment
opportunity. The problem is to decide which
ones should proceed
 There must be a formal and transparent
process for selecting from a number of
competing investment opportunities
Objectives of Project Appraisal/Feasibility
The Key Objectives of Project
Feasibility are:

• To ensure you are not embarking

on a “Titanic” – The Risks and
Returns should coincide

• To ensure that you are not

“missing your train”- To establish
successfully that the project is the
need of the time and exceeds the
opportunity costs of doing or
not doing anything else, in a
sensible manner.
 Why Project Environment Appraisal
• A number of investment opportunities (in the form of potential project) may exist and
these must be examined and compared in terms of the deliverables and viability –
SELECTION

• Project Managers are responsible for making the most effective use of finite
RESOURCES – and this will often necessitate deciding where to allocate resources,
when to allocate resources and how much resource to allocate.

• This fact emphasises the need to minimise the RISKS associated with decisions made,
through the use of a structured investment appraisal process.

• To establish that the Business Opportunity is:

• Profitable
• Reliable
• Achievable/Do-able
• Sustainable
• Needed (Defines a relevant solution to a business problem or justifies its role as a
key opportunity, aligned with organizational objectives)
Project Environments

- Macro
Spheres/General
Environment

- Competitive/Meso
Environment

- Internal/Micro
Environment
 Tools and Techniques for Appraisal
• For Micro level/Internal
environmental analysis, tools
like SWOT and TOWS analysis
are used.

• For Meso level/Competitive

Environment analysis, tools
like BCG Matrix, Porters 5
Forces Model, McKinsey 7s
Model are used.

• For Macro level/General

Environment, tools like PEST,
PESTLE and STEEPLE are
used.
SWOT Analysis
PEST Analysis
PESTLE Analysis
 Porter’s 5 Forces Model

Potential/Threats of new

entrants

Intensity of rivalry Power of Customers/

Power of suppliers
Buyers

Potential/Threats of

substitutes
BCG Matrix
Dogs: Projects with a low share of a
low growth. Do not generate cash
for the company

Cash Cows: Projects with a high

share of a slow growth market.
Generate more than is invested in
them.

Question Marks: These are projects

with a low share of high growth
market. They consume resources
and generate little in return

Stars: Projects that are in high growth

markets with a relatively high share
of that market. Stars tend to
generate high amounts of income
McKinsey’s 7-S Model
Structure: e.g., Functional, Project, Matrix,
Network, JV, Holding, Centralised, Decentralised

Systems: Procedures, Processes, e.g., financial

systems, Information systems

Style: Cultural, e.g., management style, working

pattern

Staff: Numbers/Types of personnel within the

organisation

Skills: Distinctive capabilities of personnel and

organisation, e.g., Core competencies

Strategy: Allocation of the organisation’s resources

over time, environment, competition, customers

Shared Values: Central belief and attitudes,

aspirations, common aim
 Parts of Feasibility Study
 A Project Feasibility must define a BUSINESS PROBLEM or OPPORTUNITY
 Must suggest a SOLUTION, addressing parts like:
 Justification of the Project (Technical/commercial and or Procedural Feasibility)
 Project Objectives, Scope, Deliverables and Milestones
 Its cost and benefit analysis (Monetary and non monetary costs)
 Resource Requirements (Human, Technical, Economic, Assets)
 Legal Requirements (Contracts and Approvals etc.)
 Timeline of implementation
 Method of implementation (Project implementation plan)
 Project Constraints, Limitations and Risks

 An analysis of ALTERNATIVES
 Project Appraisal Scenarios

WILL THE
SCALE – CAN PROJECT HOW SOON
WE MAKE A WILL I SEE
AFFORD PROFIT A RETURN?
THIS?

COULD WE DO WE NEED
MAKE ADDITIONA
BETTER L
MONEY RESOURCE
ELSEWHERE ?

WHAT ARE THE WHAT ARE THE KEY

RISKS OF MILESTONES
AND DECISION
DOING (OR HOW LONG IS POINTS
NOT THIS
DOING)? PROJECT?
Process of Analysis/Appraisal

Project Initiation
Phase

Project
Planning
Phase
 Capital Investment Appraisal
 It is a formal Process of evaluation in order to aide/facilitate decision
making process

 It includes a cost benefit analysis and takes into account all the
relevant factors such as:
 Capital Costs, Operating Costs and Fixed Costs
 Support and Maintenance Costs
 Disposal Costs
 Expected gains (monetary and non monetary)

 It compares different projects by using tools like:

 ROI
 IRR
 Pay Back Period
 NPV
 Return on Investment
Return on investment (ROI)

The simplest way to ascertain whether the investment in a project is viable

is to calculate the return on investment (ROI).

Return on investment % = Expected return × 100

Investment

This calculation does not, however, take into account the cash flow of the
investment which in a real situation may vary year by year.
 Payback Period
• Payback is the period of time it takes to recover the capital outlay
of the project, having taken into account all the operating and
overhead costs during this period.

• Usually this is based on the undiscounted cash flow so does not

take into account the time value of money

• Payback is particularly important when the capital must be

recouped as quickly as possible as would be the case in short-term
projects
Pay Back Period = Investment/average per year return

e.g. a project investment is Rs 100 and average return is Rs 10 per

year, so payback period would be = 100/10 = 10 years
 Net Present Value
It measures the actual cash flow to obtain a realistic measure of the
profitability of the investment with respect to time value of money

Can be calculated forward and backwards as well

Forward Analysis of NPV

Find the Future Value (FV) of investment compared with time value
of money

Backward Analysis

Find the Present value (PV) of the future returns to today’s

value
 Net Present Value
Example
Forward analysis

Project Investment = Rs 100

Project Return after 3 years = Rs 115
Future value of Rs 100 if kept at bank at interest rate of 5%/annum
= Present Value (1+r)n
Where n = number of years
r= % return/100
= 100 (1+0.05)3
= Rs115.76
So if the Bank pays more than the Project returns, the Project is not feasible

Backward Analysis = Future Value x 1/(1+r)n

=
115 x 1/(1+ 0.15)3 = Rs 97.75
So, if the Project does not meet or exceed its present value of the Money, it is not feasible
 Internal Rate of Return
• Internal rate of return is the discount rate that makes the NPV of
the project = 0

• IRR tells us how high the discount rate would need to be before a
project is unacceptable

IRR = (FV/PV)1/n – 1

= (121/100)1/2 -1

= (1.21)0.5 -1

= 1.1 -1 = 0.1 or 10%

 NPV vs IRR
• NPV directly measures the increase in value to the firm

• Whenever there is a conflict between NPV and another decision

rule, you should always use NPV

• IRR is unreliable in the following situations

• Non-conventional cash flows
• Mutually exclusive projects

N.B: Mutually exclusive projects are projects amongst which only one
can be selected. E.g. Replacing a machine or repairing it are two
mutually exclusive projects, you may choose only one at a time and
disqualify other
 NPV vs IRR
e.g. If the Required Rate of Return is 10%
For project A, the investment is Rs 100
For B, it is Rs130
The cash flows are given here as

Year Project A Project B

0 -100 -130
1 70 90
2 50 70
NPV 99.17 132.23
IRR 9.54% 10.94 %

Definitely, here the Project B is more feasible and IRR compliments NPV
 NPV Vs IRR
See another Example

Year Project A Project B

0 -100 -250

1 105 130

2 49 254

NPV (@10%) 128.92 317.35

IRR 24.9 % 23.9 %

Notice the difference in IRR and NPV

Capital Investment Process
 Capital Rationing
• In this situation, the decision maker is faced with
a limited capital budget. As a result, it may not
be possible to take all positive net present value
projects. Under this scenario, the problem is to
find that combination of projects (within the
capital budgeting constraint) that leads to the
highest Net Present Value.

• The problem here is that the number of

possibilities become very large with a relatively
small number of projects. Thus, in order to make
the problem "manageable", we can systematize
the search.
 Capital Rationing

We would want to choose that set of projects within the capital budgeting
constraint that gives the highest:

Net Present Value

INVESTMENT

This ratio is called the profitability Index

 Capital Rationing

Suppose we have a Capital Budget of Rs 100 and 5 viable

options

Project Investment NPV

A 45 50

B 15 16

C 80 82

D 5 10

E 20 24

What will be your right mix ?

 Qualitative Aspects of Project Appraisal
A Qualitative Assessment must also be
performed to consider the non-financial
elements. This may Include areas such as:

- Strategic Fit
- Risk Assessment
- Competitive Position
- Technical/Operational/Marketing drivers
- Track record
- Contribution to current or future activities
- HSE/Legal/HR/Commercial issues or
challenges
- Management of change considerations
etc.,
 Facilitation of Capital Investment
• By the use of capital
investment appraisal
techniques, more clarity is
gained to make an
informed decision

• Qualitative inputs should

not be ignored

• Cost + Risk > Benefits =

Reject

• Benefits > Cost + Risks =

Approve
 Limitations of Capital Budgeting
• Discount Rate:
Organizations sometimes seriously lack the understanding that the Discount Rate is:

Minimum Return required (Adjusted for Time Value) + Adjustment For Risk

• An Organization might classify projects as A, B or C with C being the riskiest project.

Project classified ‘A’ might have nothing added to the discount rate while ‘B’ projects would
have a certain amount added with an even larger amount added for the ‘C’ projects.

• Companies generally assume they are actually earning the discount rate if they achieve a
NPV of Zero or greater.

• These limitations can be used to manipulate the results of an otherwise unfavorable

project and make it appear to have a larger return than it actually has. Therefore, a
Project Manager should:
• Evaluate the cash outflows after the payback data and how long does it take to recoup
those cash flows?
• See how will cash inflows be reinvested throughout the life of the project and will
those reinvestments earn the same or greater amount than the discount rate on the
project?