How to Develop Project Feasibility Studies

How to Develop

Project Feasjbility StUdieS

RevisedEdition

How to Prepare

Project Feasibility Studies Revised Edition

2012 Manila, Philippines

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CONTENTS

Page

Foreword by Antonio D. Kalaw, Jr . ....................................................... v Introduction ............................................................................................ 1 Project Summary .................................................................................... 4 Market Study .......................................................................................... 7 Technical Study .................................................................................... 14 Financial Study ............................ .................................................... ..... 23 Socio-Economic Study ......................................................................... 52 Organization and Management Study.............................................. 54 Environmental Impact Assessment Study ....................................... 57 Detailed Outline of a Project Feasibility Study ................................ 63 Pointers in Evaluating a Project Feasibility Study .......................... 65 A Final Note .......................................................................................... 71 Annexes AnnexA Market Forecasting: Tools and Techniques .................................... 74 Annex B BOI Guidelines in the Preparation of Project Feasibility Studies.. 85 Annex C BOI Feasibility Study Format ............................................................. 89 Annex D ADB Pre-Feasibility Study Report Format ....................................... 95

References ............................................................................................. 98

FOREWORD The first edition of this Manual was originally prepared for businessmen and would-be entrepreneurs who took part in seminars conducted by the Development Academy of the Philippines under its industry development program in the late '70s. The seminars were intended to assist small and medium-scale investors in the Philippines. While the contents of this book have been derived from universal concepts and applications, care has been taken to include only those which are essential in a feasibility study, particularly, if the study is meant to serve as a basis for a loan. A project feasibility study is, after all, supposed to establish the viability of a project, not dwell on details which are required only after the study is found acceptable. In view of current developments such as technological breakthroughs, innovative industry practices, as well as new regulatory requirements, the Academy decided to come up with a revised edition of the book. It features new cases, the requirements and procedures for undergoing an Environmental Impact Study (IES) for selected industries, as well as the Asian Development Bank's (ADB) pre-feasibility study report format. Likewise, this revised edition is designed to serve as a guide for first-timers in project feasibility study (PFS) preparation and as a reference material for students of business and entrepreneurship courses.

Pr ident Development Academy of the Philippines

How to Prepare Project Feasibility Studies

Introduction A PROJECT FEASIBILITY STUDY or PFS is a thorough and systematic analysis of all factors affecting the chances of success of a proposed undertaking. The PFS is a synthesis of separate studies usually dealing with the marketing, technical, financial, socioeconomic, and management aspects of a project. The data, facts, and other findings presented in a PFS generally become the basis for deciding whether the project is to be pursued, revised or otherwise abandoned. At the same time, feasibility studies pervade the entire life of a project, from the time of conception of a project idea to the time the concept is implemented or becomes operational. The role of project feasibility studies in the development of nations cannot be over-emphasized. A PFS is an essential medium of progress both as a means to initiate profitable projects for socio-economic enhancement and industry expansion, and as a tool in evaluating actual project results against projected outcomes. As such, a PFS has repercussions on the social, economic, cultural, and business sectors of society. To be sure, some past undertakings have succeeded without the aid of a study. This, however, cannot be used as a basis for the occasional criticism that project feasibility studies are next to useless; or an argument for the failure of carefully-studied specific projects. In the first place, a project feasibility study is not an antidote for failure or a guarantee of success. Its primary purpose is to enhance the probability of success of a particular undertaking. It follows from the widespread understanding that a carefully planned activity has better chances of success in its implementation than one without a plan. To those who argue that feasibility studies have lost their usefulness in these times of great uncertainty, let it be said that

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such studies are even more important now in evaluating numerous options arising from multiple possibilities. The project feasibility study has proven to be one of the best instruments in meeting past challenges and should prove its worth in this time of constant change. In this Manual, projects are discussed in the context of national development programs, initiated by both government and private institutions to boost progress in the country's administrative regions and in various sectors of society. As a consequence, the applicability of these programs is analyzed and tested both according to region and sector. Although regional and sectoral studies of development programs may be general in nature, they pave the way for a more thorough and specific identification of projects and arrive at different ideas on how to apply national programs in terms of profitable, realistic, and workable projects. Every project goes through what is known as a "project development cycle." As soon as a project is identified, its applicability is examined through further research, leading either to a generalized pre-feasibility study, or directly to an analytic and systematic presentation of findings in the form of a project feasibility study. It is then evaluated in terms of its optimality, practicality, potential, and growth, for presentation to and negotiation with financing sources or institutions, where the study undergoes further evaluation and reevaluation.

During the project appraisal, the implementing group pinpoints the variances between actual project results and the data provided in the project feasibility study. Taking into account changing conditions and deviations from the expected outcome, the project is then improved in terms of performance, scheduling, and costs. PERT/CPM (Program Evaluation and Review Technique/Critical Path Method) techniques are usually incorporated in project implementation so as to reduce variances between the projected outcome and the actual results. The consequences of the project's reappraisal will also provide each region and sector with information on specific types of projects. The data implies an influence on further decisions to be made on future project studies. Thus, the project development cycle is completed. The following Guide to the preparation of Project Feasibility Studies applies to both industrial and agricultural ventures. While this Guide focuses on industrial projects, the PFS preparer is free to make the necessary adjustments to fit the recommended form and content to agro-based projects as well. The overall guideline is for the PFS to include comprehensively the major concerns of any PFS: marketing, production, finance, organization, and socio-economic viability of an industrial or agricultural project.

During the assessment of a project, recommendations on revisions to the Project Feasibility Study or the non-feasibility of the proposed undertaking are made. At this point, the project is going through the "Go" or "No go" phase. If it is found to be too risky to be feasible, the project is eventually shelved. Any revisions and reevaluations of the project, however, may enhance its feasibility during the implementation stage. As soon as the project is implemented, its outcomes are appraised against the data presented in the feasibility study.

2 How to Prepare Project Feasibility Studies

Introduction 3

Project Summary THE FIRST SECTION of a Project Feasibility Study is THE PROJECT SUMMARY. It presents the highlights, descriptive definition, long-range objectives, feasibility criteria, history, and basic conclusions of the project under study. It gives the analyst and the financier a "capsule view" of the whole project. This portion starts with the name of the firm, the location and size of its head office, plant site, and factory. It then presents a comprehensive description of the business, its operations, and its product lines. Major assumptions used and findings on the market, technical, financial, socio-economic, and management feasibility of the project are discussed. The status and timetable of the project must also be stated. In outline form, the project summary contains the following: A. NAME OF THE ENTERPRISE

Briefly explain the reason for the choice of name.

3. Project potential and proponent Give a conceptual description of the project's potential worth and importance and the person or group of people who will manage it.

D. LONG-RANGE OBJECTIVES What does the project expect to achieve in ten years, in terms of size, capacity, volume, worth, role in its industry, and impact on the economy? E. FEASIBILITY CRITERIA What were the most important guidelines used to judge the feasibility of the project? Was it profitability? Did it seriously consider the project's impact on the socio-economic environment? F. HIGHLIGHTS OF THE PROJECT

1. History How did the project come about?

B. LOCATION Pinpoint the location of the head office and the plant site and give the main reasons for choosing the project sites. The factors which affect the choice of location are the sources of raw materials, labor, and utilities; proximity to the market; nature of available transportation; and the cost of land and buildings. The project must choose a location where maximum efficiency can be attained at the lowest possible cost. C. DESCRIPTIVE DEFINITION OF THE PROJECT

1. Related national program Is the project in line with any government-initiated or priority program? 2. Affinity to regional or sectoral studies

Is the project a result of encouraging findings in certain regions or sectors of the country? 4

How to Prepare Project Feasibility Studies

2. Project timetable and status How long will it take for the project to be operational? What stage is the project presently in? 3. Nature of the industry Briefly describe the industry, its product lines, the demandsupply situation, history, growth patterns, problems and potentials, and role in the economy.

4. Mode offinancing Briefly discuss the sources of funds, the financing terms, and the reasons for choosing such sources and terms. 5. Investment costs How much funding is needed to make the project fully operational? How are these funds to be allocated? Project Summary 5

G. MAJOR ASSUMPTIONS USED AND SUMMARY OF FINDINGS AND CONCLUSION: 1. Market feasibility Discuss the nature of the unsatisfied demand which the project seeks to meet, its growth and the manner in which it is to be met. Here, the supply-demand situation is examined, the target markets analyzed, and the marketing program formulated. 2. Technical feasibility Discuss the nature of the product line, the technology necessary for production, its availability, the proper mix of production resources, and the optimum production volume.

3. Financial feasibility Present the overall financial picture in terms of operating cash requirements, profitability, and cash flow.

4. Socio-economic feasibility What are the effects of the project on society and the regional and national economy as a whole? Is it generally beneficial to the people? Is it in line with any national or regional economic development program?

5. Management feasibility What is the management structure? Is it appropriate for the managerial needs of the project? What is the salary scale? Is it compatible with industry standards?

6 How to Prepare Project Feasibility Studies

Market Study THE MARKET STUDY is the lifeblood of virtually every project feasibility study. While profitability is generally the focal point of a project study, the question of demand is the most basic issue. Obviously, there can be no discussion of profitability or of the other aspects of the feasibility evaluation if there is no demand for. the product. It is therefore imperative that the market study be gtven the first consideration. The market study seeks to determine the following: 1. The size, the nature, and growth of total demand for the product; 2. The description and price of the product to be sold; 3. The supply situation and the nature of competition; 4. The different factors affecting the market of the product; and 5. The appropriate marketing program for the product.

A. PRODUCT DESCRIPTION In describing the product to be marketed, the following are taken into consideration:

1. Name of the product 2. Features of the product - its physical, chemical, and agronomic properties 3. Uses of the product - as a finished commodity, as input to other production activities 4. Major users of the product - individuals and/or firms 5. Geographical areas of dispersion - where product is mostly found or to distributed, in the case of a new commodity

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B. DEMAND An analysis of demand is part of the important task of identifying the needs of consumers and determining whether they are willing and have the capacity to pay for the products a business intends to produce. In forecasting demand, one takes into consideration not only production and importation figures of the past but also such other factors as credit availability, income distribution, population growth, price variations, age composition, the degree of urbanization, tastes and preferences, money supply, Gross National Product or GNP, and so on. Thus, demand analysis involves analyzing macroeconomic variables, i.e., data on the level of the individual firm or at least on the level of an industry grouping (an industry being defined as the conglomeration of all firms producing a more or less homogenous output). An example of "macro" analysis would be to study the Gross National Product (GNP) and its components. If GNP is expected to rise rapidly, businessmen would ordinarily expect good times for their businesses. In selling a product for mass consumption, the prospective investor might give more attention to the growth rate of a GNP component like Personal Consumption Expenditures. Or a producer of equipment would be more interested in the Gross Capital Formation component. An exporter would, of course, be interested in the export figures of goods and services. On the "micro" level, the demand for a firm's product is a function of many variables such as the price of a product, the price of a substitute product, income, population, etc. An analysis of income distribution, for example, could give us an idea of what types of products consumers can afford. Two other important concepts in demand analysis are 1) price elasticity, which measures the response of quantity demanded of a particular product to variations in its price, and 2) income elasticity, which measures the response of quantity demanded of a particular product to variations in income.

8 How to Prepare Project Feasibility Studies

The size, the nature, and growth of total demand for the product must be determined in the following manner: 1. Who and where is the market? Segment the market according to type, manner of use, income classification, location, age, etc. The manner of segmenting the market would depend on the type of product being considered. For instance, the market for automobiles could best be segmented by using income as a yardstick. On the other hand, the market for heavy equipment could be better understood by pinpointing industry classification. 2. What is the total domestic demand from the historical point of view? 3. Is there a foreign market? If so, determine the historical demand. 4. Evaluate demand growth patterns in the past and project future demand by applying appropriate projection methods.

C. SUPPLY The supply situation may be determined as follows: 1. Who and where are the direct competitors? Classify them according to size, product quality, location, performance, and market segment performance. It is important to determine the type of competition existing. Are there only a few big firms producing the product being considered? Are there many small firms with no single firm controlling the market? Or is it an industry of big and small firms? The type of competition in existence would influence the decisions on production capacity and marketing strategies. 2. Determine the historical domestic supply based on local production and importations. 3. If there is a foreign market, determine the historical supply patterns in the targeted countries based on local production and importations. 4. Evaluate supply growth patterns and project future supply by applying appropriate projection methods.

Market Study 9

D. DEMAND-SUPPLY ANALYSIS It is now essential to combine the findings on the demand

and supply situation. The analysis may be conducted in the following manner: 1. Compare the demand and supply trends. 2. Determine the amount of demand unsatisfied, especially in the projections. If demand appears to be fairly satisfied by supply, it is useful to consider either or both of the following: a. Whether factors affecting the market may disrupt the equilibrium so as to cause demand to grow faster than supply. b. Whether the quantity of the product is such that it may create additional demand or cause a shift of a portion of the existing demand in its favor. 3. Determine the share of the market by establishing the proposed production volume (determined in the technical study) as against the total market size. E. PRICE STUDY In economic theory, price is determined mainly by the demandsupply situation. An increase in demand with constant supply

will hike prices. The opposite (i.e., high supply, low demand) would likely result in the lowering of prices. There are, however, other factors which exert some influence on the price. Without any change in demand or supply, prices may go up if raw material costs rise; or prices may decline if the government decides to subsidize production. Prices may also be determined by the simple cost-plus method used by accountants. Keeping all these in mind, the price study may best be conducted as follows: 1. Determine the selling prices of all similar and substitute products. 2. Look into the history of these prices (including the range of fluctuations) and establish the factors that mostly influence their fluctuations over time. 3. Determine the responsiveness of demand to price changes. 10 How to Prepare Project Feasibility Studies

Will there be a tremendous, slight or negligible increase or decrease in demand if prices are lowered or raised? 4. Establish the product's selling price, taking into consideration all of the above, the market segment targeted, and the operating costs and expenses (determined in the technical and financial studies). Likewise, estimate the increases foreseen in subsequent years. F. FACTORS AFFECTING THE MARKET There are certain factors affecting the market that may or may not be difficult to quantify and/or predict. This section takes into consideration the following: 1. Demand may be significantly affected by population growth, income changes, tastes, rural/urban developments, prices of substitute and complementary products, and such marketing tools as advertising, promotions, credit policies, etc. 2. Supply may be influenced by the development of substitute products, the entry or exit of firms, sources and cost of production factors, government policies, improved technology, etc. 3. Prices may be affected by production costs, price controls, inflation, etc.

G. ANALYSIS OF RESEARCH DATA Data analysis and interpretation is one of the most critical phases of market research. It answers such questions as 'What does this information mean?' and 'Is the information relevant to establish a marketing plan?' Following are the different types of Data Analysis. 1. Descriptive Analysis - describes the data gathered using mean, median, mode, frequency distribution, range, and standard deviation. 2. Inferential Analysis - tests the validity of the hypothesis and identifies standard errors. Market Study 11

3. Difference Analysis - determines if differences exist between groups of respondents, e.g., evaluate statistical significance of difference in the means of two groups in a sample using t-test of differences and analysis of variance.

4. A ssociative Analysis - determines associations or relationships of variables in the survey using cross tabulation and correlation. 5. Predictive Analysis - forecasts based on the results of the survey. Care should be taken in choosing the right analytical tool in undertaking the market research for a PFS. Annex I presents a comprehensive discussion of procedures in market research. H. MARKETING PROGRAM The marketing program should be the end product of a market study. After defining the market and price targets, the marketing program comes in as the implementing arm. It consists of the following procedures: 1. Determine the types of marketing programs prevalent in the industry and gauge their respective effectiveness.

2. Draw up a marketing plan that identifies and defines the target market, the selling price, the packaging of the product, the distribution network, the sales management mechanism, and the advertising and promotions program. The important components of the marketing program may best be summarized by the four Ps: product, price, place, and promotions. The first two components are essentially determined in the previous sections of the market study. Place refers to the way the product is distributed or made available to the end-user. Promotions is concerned with making the end-users aware of, and desire, the product.

would again depend greatly on the type of product being marketed. In general, a consumer product would require a sizable organization that concentrates on distribution channels and promotions. Non-consumer items would probably require a distribution network or a small-sized sales force. In any case, the most ideal organization is one that allows maximum efficiency at the lowest workforce level possible. The sales promotion plan and the channels of distribution should be appropriate to the product and the market. Consumer buying habits in the particular field should be considered in the selection of outlets. Potential distributors may include retailers, wholesalers, jobbers, industrial leaders, industrial distributors and manufacturer's agents. A plan for consumer credit and financing and for sales allowances can be formulated on the basis of marketing channels selected. I. PARTS OF A MARKETING PLAN I. II. Ill. IV. V. VI. VII.

Introduction General Business Condition Competitive Conditions Market Research Results Sales and Distributions Plan Advertising and Sales Promotions Other Related Aspects (such as product formulation, packaging, legal clearance, raw material procurement, etc.) VIII. Budget Summary IX. Profitability (net income targets)

3. Design the marketing organization which will implement the plan and determine the costs involved. The organization 12 How to Prepare Project Feasibility Studies

Market Study 13

Technical Study AFTER THE MARKET STUDY, the technical aspect of the project is analyzed. The technical study consists of the following: 1. Selection of:

a. b. c. d. e. f. g.

The manufacturing process. The machinery capacity and design. The machinery supplies. The plant location. The plant layout. The building and structures specifications. The raw materials and their sources.

2. Determination of: a. b. c. d. e.

The quantity and quality of the products to be produced. The labor needed, both skilled and unskilled. The utilities required. The waste disposal method. The transportation necessary.

3. Computation of the total project cost and enumeration of the major items of capital cost. 4. Detailed listing of the estimated production and overhead costs that will be incurred in operating the proposed production plant.

A. THE PRODUCT(S)

This portion describes the product(s) to be manufactured and sold. The description specifies the product's physical, mechanical, and chemical properties and identifies its various uses, both as finished goods and as intermediate inputs as raw material to another process. B. MANUFACTURING PROCESS The selected manufacturing process must be described simply and clearly, preferably with the aid of flow charts and diagrams. The existence of alternative processes and how they compare with the chosen process must be discussed. The analysis should further touch on the manufacturing processes used in existing plants, both domestic and foreign. Finally, a review of licensing agreements and patents, if any, would also be helpful. C. PLANT SIZE AND PRODUCTION SCHEDULE State the minimum and maximum rated capacities of the plant. The minimum capacity is that level of production where the resources are not fully utilized, but are employed at a minimum economical level. In general, the minimum economical level is that level of production where the firm's fixed costs are at least covered by the resulting revenue. The firm's fixed costs are determined in the financial study. The maximum capacity is that level of production where all resources are fully utilized.

5. Consideration of any major technological development in the industry which may affect the commercial or technical soundness of the project.

From there, the actual capacity utilization, the number of shifts per day, and the number of operating days per year are then defined.

The technical study covers the following topics, and where applicable, costs which will be used in the financial study should be computed.

Finally, the factors in determining the plant size must be id~ntified a~d described. The findings in the market study will be a maJOr input in this section.

14 How to Prepare Project Feasibility Studies

Technical Study 15

The production schedule describes the projected scale of operation for the next several years. Will production increase in time? By how much? The factors that determine these considerations are the expected growth in market share, the availability of financing for possible expansion, the access to more raw materials, and the level of utilization of plant capacity. D. MACHINERY AND EQUIPMENT Machinery and equipment required must be identified and itemized according to type and use. Specifications, capacities, and costs should be described in detail. Likewise, the origin of the machinery, whether local or imported, as well as the manner and cost of transporting and installing them must be indicated. The total cost of installed imported machinery and equipment is computed as follows: FOB: (In currency of port of origin Add: Freight and Insurance* (% of FOB) CIF (Convert CIF cost of Philippine pesos using the current foreign exchange) Add: Tariff Rate* (% of CIF) Add: Import Charges*(% of CIF) Total Cost Add: Compensating Tax* (% of Total Cost) Landed Cost Add: Installation Cost* (% of Total CIF) Installed Cost A balancing of capacities must be presented to show that the machinery and equipment are capable of producing the desired maximum output. E. PLANT LOCATION A thorough and comparative analysis of each potential location should be made to determine the ideal plant site for the project. 16 How to Prepare Project Feasibility Studies

The evaluation process has to consider the following factors: 1. The availability of raw materials and accessibility to their sources. 2. The availability of cheap or moderately priced utilities such as power, water, or fuel. 3. The combined cost of transporting raw materials and fuel to the plant site. 4. The proximity to distribution outlets. 5. The availability of skilled and unskilled labor. Maps and charts of the proposed plant location must be included. F. PLANTLAYOUT The plant layout should be clearly depicted through diagrams and descriptions. A good plant layout is characterized by minimum material handling, effective space utilization, smooth workflow throughout the plant, safe and conducive working area for the workers, safety and sanitation facilities, and flexibility of arrangements. G. BUILDING AND FACILITIES The site, type, and costs of the building and land, as envisioned in the project, should be adequately described. The construction cost of the building and facilities should be presented as adapted to the machinery and equipment that will be used in the project. Land improvements such as roads, drainage facilities, etc. and their respective costs should be computed and included as well. H. RAW MATERIALS AND SUPPLIES The required raw materials and supplies should be itemized and the basis for their selection must be presented. Descriptions and specifications of their physical, mechanical, and chemical properties must also be given. Current and

Technical Study 17

prospective costs of raw materials, the availability and continuity of supply, and the current as well as prospective sources should also be discussed. The volume of such materials required at various phases of operations must likewise be presented. I. UTILITIES

This portion indicates the amount, cost, and sources of electricity, fuel, water and/or other potential energy sources. These factors must be determined in relation to the production schedule and capacity utilization defined. Alternative sources of these utilities and the feasibility of their use must also be described .

J. WASTE DISPOSAL The quantity of production wastes, the manner of their disposal, and the cost involved is discussed. The analysis may be expanded to consider the possibilities of further utilizing these wastes. K. PRODUCTION COST

How much will it cost to produce one unit of output? To arrive at this computation, the following must be determined: a) raw material costs, b) labor cost, c) overhead cost (fixed costs), d) operating costs (variable costs), and e) other pertinent costs.

SUGGESTED FORMAT FOR THE TECHNICAL STUDY I. Description of the Product I Service

II. Manufacturing Process A. Process Flow Diagram III. Plant Size (Capacity) and Production Schedule IV. Machinery and Equipment V. Plant Location VI. Plant Layout VII. VIII. IX. X. XI.

Building and Facilities Raw Materials and Supplies Utilities Waste Disposal Production Cost A. Direct Materials B. Direct Labor C. Manufacturing Overhead XII. Appendices A. Plant Layout I Equipment B. Equipment Listing and Cost C. Utilities Calculation D. Plant Facilities Breakdown Cost E. Projected Cost of Production

L. LABOR REQUIREMENTS

The various jobs and functions necessary during the operational stage must be described. For costing purposes, labor is generally classified into three types - direct, indirect, and administrative. Here, the number of workers to be employed for each job classification, the pay scales, employee development programs, the organizational setup, and the aggregate labor costs are described in detail.

18 How to Prepare Project Feasibility Studies

Technical Study 19

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