PROJECT SELECTION & FEASIBILITY ANALYSIS
- 1. MODULE_2 PROJECT SELECTION & FEASIBILITY ANALYSIS
- 2. 1. PROJECT SELECTION The decision-makers use selection models to choose the project with the maximum probability of success.
- 3. 2. BASIC APPROACHES TO PROJECT SCREENING A project screening model provides valuable information for project selection. Common project selection techniques include the checklist model and simplified scoring model. The selection criteria may also include the following: Cost of development. Potential return. Risk level Stability of the development process. Stakeholders’ interference Product durability and potential.
- 4. 2. BASIC APPROACHES TO PROJECT SCREENING 2.1 Checklist Model:
- 5. 2. BASIC APPROACHES TO PROJECT SCREENING 2.2 Simplified Scoring Model: In the simplified scoring model, each criterion is ranked according to its relative importance. The numbers in the column labelled ‘Score’ in Table 3 replace Xs of Table 2 with their assigned score values:
- 6. 3. THE FEASIBILITY STUDY A feasibility study is a formal study to decide whether a project is viable. When considering a project, the study would investigate the feasibility of project that could be undertaken to meet the needs of the organisation. In other words, a feasibility study is a formal study to decide whether proposed projects can be undertaken to best meets the needs of the organisation. A feasibility study team should be appointed to carry out the study (although individuals might be given the task in the case of smaller projects). The remit of a feasibility study may be narrow or wide. The feasibility study team must engage in a substantial effort of fact finding.
- 7. 3.1 KEY AREAS OF FEASIBILITY There are four key areas of feasibility: a) Technical feasibility b) Operational feasibility c) Economic or financial feasibility d) Ecological feasibility Technical feasibility; means that any proposed solution must be capable of being implemented. Operational feasibility; is a key concern. If a project makes technical sense but conflicts with the way the organization does business, the solution is not feasible.
- 8. 3.1 KEY AREAS OF FEASIBILITY Economic or financial feasibility; any project will have some costs and benefits. Economic or financial feasibility have three strands. a) The benefits must justify the costs. b) The project must be the ‘best’ option from those under consideration for its particular purpose. c) The project must complete with projects in other areas of the business for funds. Even if it is projected to produce a positive return and satisfies all relevant criteria, it may not be chosen because other business needs are perceived as more important.
- 9. 3.1 KEY AREAS OF FEASIBILITY Ecological feasibility; Environmental impact and sustainability are much talked about issues in recent days. An assessment of ecological feasibility takes into consideration the possible impact of the project on the environment. The possible negative impact a project may have on the environment may include environmental stress, environmental risk and deforestation.
- 10. 3.2 FEASIBILITY STUDY REPORT Once each area of feasibility has been investigated, a number of possible projects may be put forward. The results are included in a feasibility report. The feasibility study report may be submitted to the organisation's senior management for consideration or perhaps to the likely project manager. A typical feasibility study report may include the following sections: terms of reference, details of the project cost/benefit analysis, development and implementation plans and recommendations as to the preferred option.
- 11. 4. METHOD OF FINANCIALAPPRAISAL There are several methods for the financial appraisal of a project, and evaluating whether the project would be of value to the organisation. a) The accounting rate of return method (or return on investment, ROI) b) The payback period c) The discounted cash flow (DCF) appraisal. There are three methods of project appraisal using DCF. i. The net present value (NPV) method ii. The discounted payback method iii. The internal rate of return (IRR) method
- 12. 5. THE ACCOUNTING RATE OF RETURN (ARR) The expected accounting return on investment (ROI) or accounting rate of return (ARR) for the project is calculated, and compared with a pre-determined minimum target accounting rate of return. The accounting rate of return (ARR) measures the profitability of investment in a project by expressing the expected accounting profits as a percentage of the book value of the investment.
- 13. 5.1 EXAMPLE; THE ACCOUNTING RATE OF RETURN A company has a target accounting rate of return of 20%. ARR is calculated as estimated average annual profits over estimated average investment. The company is now considering the following project. The capital asset would be depreciated by 25% of its cost each year, and will have no residual value. You are required to assess whether the project should be undertaken.
- 14. 3.1 EXAMPLE; THE ACCOUNTING RATE OF RETURN (Cont’d) The project would not be undertaken because it would fail to yield the target return of 20%.
- 15. 5.2 THE COMPARISON OF MUTUALLY EXCLUSIVE PROJECTS Mutually exclusive projects are two or more projects from which only one can be chosen. The ARR method of financial appraisal can also be used to compare two or more projects which are mutually exclusive. The project with the highest ARR would be selected, provided that the expected ARR is higher than the company's target ARR.
- 16. 5.2 THE COMPARISON OF MUTUALLY EXCLUSIVE PROJECTS
- 17. 5.2 THE COMPARISON OF MUTUALLY EXCLUSIVE PROJECTS Bolts Limited calculates ARR as the average annual profit over average investment and has a minimum target ARR of 18%. Based on the ARR method, which (if any) of the two machines would be purchased by Bolts Limited? ***Both machines would provide an ARR in excess of the minimum required, but Machine Y would be chosen because it has a higher ARR.***
- 18. 5.2 LIMITATIONS & BENEFITS OF THE ARR METHOD There are a number of other disadvantages with the ARR decision method.
- 19. 5.2 LIMITATIONS & BENEFITS OF THE ARR METHOD The ARR method also have some distinct advantages. 1) It is easy to calculate and simple to understand. 2) It involves the familiar concept of a percentage return. 3) It looks at the project’s entire life.
- 20. 6. PAYBACK PERIOD The payback period is the length of time required before the total of the cash inflows received from a project is equal to the cash outflows, and is usually expressed in years. It is the length of time the project investment takes to pay itself back. Payback is often used as a 'first screening method'. when a capital investment project is being considered, the first question to ask is: 'How long will it take to pay back its cost?' The organisation might have a target payback, and so it would reject any project unless its payback period were less than a certain number of years.
- 21. 4.1 EXAMPLE: THE PAYBACK METHOD A company is considering an investment in a project to acquire new equipment costing $100,000. The equipment would have a five-year life and no residual value at the end of that time. The straight-line method of depreciation is used. The expected profits after depreciation from investing in the equipment are as follows. What is the payback period for the investment?
- 22. 4.1 EXAMPLE: THE PAYBACK METHOD Solution: The payback period is calculated based on the cumulative annual profits before depreciation. Annual depreciation is $20,000, and the profit before depreciation each year is found simply by adding $20,000 to the annual profit estimate.
- 23. 4.1 EXAMPLE: THE PAYBACK METHOD The payback period can be calculated in years and months
- 24. 6.1 ADVANTAGES OF THE PAYBACK METHOD In spite of its limitations, the payback method continues to be popular, and the following points can be made in its favour. a) It is simple to calculate and understand. b) It can be used as a screening device as a first stage in eliminating obviously inappropriate projects prior to more detailed evaluation. c) The fact that it tends to bias in favour of short-term projects means that it tends to minimize uncertainty about financial and business risk.
- 25. 6.2 DISADVANTAGES OF THE PAYBACK METHOD There are a number of serious drawbacks to the payback method. a) The choice of a maximum payback period for an investment is arbitrary and subjective. b) It ignores all cash flows after the end of the payback period, and so is not concerned with the total expected returns from the investment.