Part-II Entrepreneurship

Chapter-4
Project Appraisal and
Management
 Search of Business Idea
• In order to establish a business venture with
an entrepreneurial system an entrepreneur
needs to take the following steps:
• 1. Search for business idea.
• 2. Process the ideas
• 3. Select the best idea
 Part I: Project Identification
• is the first and, perhaps, the most crucial stage
• it is an opportunity study stage.
• an initial screening of project ideas will take
place
 Sources of project ideas
Where do you think the idea comes from?
• Does it drop from the sky?
• Is it innate in the mind?
• Obviously an idea comes from
– people, i.e. individuals, groups,
– corporations, and even nations.
• Projects, by their very nature, have a lot in common.
They usually start as an idea.
 Sources of project ideas
• One can distinguish two levels where project
ideas are born;
– at macro and
– micro level.
• Macro level project ideas:
– emanate from international level or national
level, and
– can have large–scale impact.
 … Sources of project ideas
• Micro level project ideas:
– originates from the smallest household or
neighborhood and local level to solve a
problem and fill need gaps identified at a
small territory level.
• Project ideas can be generated
– formally or informally,
– by an institution or by individuals.
 … Sources of project ideas
• Ideas for projects can be derived from
(sources):
– government organizations including: Ministries,
individuals, local communities’,
– non-government organizations and

– international donor agencies and

– others.
Project identification using the (NPT)
• NPT model is developed By A.K. Noah(2004)
• All projects have one common characteristic-
the projection of ideas and activities into
new endeavors.
• The ever present element of risk and
uncertainty means that the events and tasks
leading to completion can never be foretold
with absolute accuracy.
 … Project identification using the
(NPT)
• The NPT model enables project practitioners
to identify projects from three sources.
(1) Needs (N)
(2) Problems (P)
(3) Trend or pattern (T)
 1. Needs Approach
• Project ideas are normally initiated
by a perceived need in an
organization.
• Project ideas can be developed from
the identification of unsatisfied
community needs.
 … 1. Needs Approach
• Overall projects are identified in
response to a readily apparent
community need or a deficiency in
the development of the local
environment
 … 1. Needs Approach
• The need for investment in a project
generally arises from one of three
sources:
–Market Demand/community demand for
social projects
–Governmental or company mandate
–Cost reduction strategies
 … 1. Needs Approach
• (a) Market demand
– development of new products,
– Seizing opportunities to increase market share of
current products
– Trying to retain current business

• (b) Government or Company mandate

– responding to health,
– Safety
– Environmental concerns
 … 1. Needs Approach
• (c) Cost reduction strategies
–improve efficiency, such as: decreasing
maintenance or operating costs,
–Increasing production while holding costs
stable
 2. Problem Solving Approach

• All projects are geared towards solving a particular

problem or taking advantage of opportunities.
• Problems definitely would revolve around the
following area
– Social issues
– Economic
– Political
– Legal
– Technological
– etc
 … 2. Problem Solving Approach
• Problems are normally deviations from the
normal.
• social problems : such as increase in drug abuse.
Project could be developed towards tackling
these problems, e.g sensitization, education etc.
• Looking at issues like population, age, sex,
several problems can be identified and projects
can be developed
 … 2. Problem Solving Approach
• Economic problems: include unemployment,
poverty, relevant projects in these areas could
be developed.
• Education problems: number of teachers,
pupil to teacher ratio, number of schools etc
 3. Trend Approach
• Projects can also be identified by monitoring
trends
– Population
– Economic
– Educational
– Health
– Technology
– Etc
 … 3. Trend Approach
• For example, an increase in birth rate can
indicate the likely hood of more schools in the
primary and secondary sector, need for more
teachers, etc.
• By monitoring trends we are able to plan for the
future.
 I - Phases of Project Identification
There are four key phases of project identification:

1 General description of project idea: by formal

and informal institutions and individuals.
2 General description of project idea: actual
written description of the specific project idea or
concept that summarizes the main elements of the
proposed project to use in the screening, ranking
and prioritization of project ideas.
 … I - Phases of Project Identification

3 Screening: an initial review of project ideas and

concepts to see if they should be advanced or
abandoned at an early stage.
4 Prioritization, ranking and selection: Projects
against a set of criteria to identify the best projects
to move actively into the design stage and
development.
 Pre-Feasibility Study
• The pre-feasibility study is a preliminary
screening of identified projects on the basis of
their :
– technical,
– social,
– environmental,
– economic and
– financial viability.
 … Pre-Feasibility Study
• If an opportunity study provides sufficient
information, the pre-feasibility stage could be
dropped and the feasibility study should be
viewed as an intermediate stage between a
project opportunity study and a detailed
feasibility study.
 … Pre-Feasibility Study
• The principal objectives of pre-feasibility
study are to determine whether:
– All project alternatives have been well-
examined;
– A detailed analysis through feasibility study is
required;
– Functional or support studies, such as: market
surveys, laboratory tests or pilot test are
necessary; and
– The available information justifies the viability of
investment opportunity.
 … Pre-Feasibility Study
• The viabilities of all alternatives, at this stage, are
assessed in terms of their costs and benefits to
select few viable solutions for further detail
study.
• The difference between the pre-feasibility and
feasibility lies in the degree of detail of
information obtained and the depth with which
project alternatives are discussed.
 Part II: Project Preparation (PP)
• Project preparation is a process of carrying out
feasibility study, feasibility study result and initial
proposal report which will enable to se how feasible
and viable the project is.
• Feasibility studies aim to objectively and rationally
uncover
– the strengths and weaknesses of an existing
business or proposed venture,
– opportunities and threats present in the
environment,
– the resources required to carry through, and
– ultimately the prospects for success.
 … Part II: Project Preparation (PP)
• In its simplest terms, the two criteria to judge
feasibility are :
– cost required and
– value to be attained.
• Feasibility study
– results preliminary project proposal document that
contains all the information necessary for an
investment decision for the implementing agency.
– critically examines economic and environmental
factors affecting projects.
 … Part II: Project Preparation (PP)
• Feasibility study includes:
I. Market and Demand Analysis
II. Raw materials and supplies study (Input Analysis)
III. Technical analysis
IV. Institutional Feasibility
V. Social analysis
VI. Environmental Analysis
 I. Market and Demand Analysis
• To assess whether there exists unsatisfied
demand for the product and to determine
the share that can be captured by the project
through appropriate market strategies.
• Market appraisal requires a description of the
product, its major uses, scope of the market,
possible combination from market
substitutes, special features of the product
with regard to quality and price.
 II. Raw materials and supplies study
(Input Analysis)
• It is important to critically assess the
availability of the appropriate inputs needed
to produce the proposed product.

• The final result of input analysis is estimates

of all kinds of inputs by quantities and costs.
 III. Technical analysis
• Technology Package: Involves the identification
and selection of the type of technology
applicable for the project.
• Location: This signifies the identification and
selection of proper site and location for the
project by considering compatibility of activities.
• Scale of operation: This deals with the
production program and plant capacity (of the
project)
 III. Technical analysis
• Land use: this simply involves the
identification of the major land use category
up on which the project is in place
(commercial, industrial, social, mixed use etc)
• Recurrent costs: This involves the process of
estimating the regular budget required by the
project for a defined duration usually per
annum.
 IV. Institutional Feasibility
• Many institutional constraints can be tackled
through good project preparation.
Some of the salient factors of this analysis include:
– Identification of those things which can be controlled
and those which can be influenced.
– Sound internal organizational structure, competent
management and supervisory personnel;
– Adequate technical skilled personnel and provision
of the necessary training facilities
 V. Social analysis
• Social analysis includes the study of
demographic, social and cultural
characteristics of the population affected by
the project and extent of readiness of the
community to accept the cause of the project
or to participate in project design and
management in case the project is social
projects.
 … V. Social analysis
• Demographic characteristics: Involves the
indication of the age structure as well as the
sex composition of the section of the
population that are directly as a result of the
implementation of the project.
• Social Organization: Assessing the availability
as well as the readiness of social organization
for the implementation of the project.
 … V. Social analysis
• Cultural Acceptability: Involves the
assessment of the level of cultural
acceptance of the implementation of the
project (insuring compatibility of the project
with the culture of the community)
• Community Participation: It depends on the
level and extent of community participation
in the various stages of the project from
beginning up to its finalization.
 VI. Environmental Analysis
• Environmental aspects of a project refers to the
impact of the project on nature and habitat of
earth such as plants and forests, water, air, wild
and domestic animals human beings, etc.
• In environmental impact assessment, the
feasibility study discuss in detail the impacts of
the proposed projects on the environment and
to choose the equipment and production
systems that minimizes pollution, soil
degradations and others.
 … VI. Environmental Analysis
• The feasibility study should include a
laboratory details on how to dispose-off the
wastes of the project that pollute air and
water.
 … VI. Environmental Analysis
• There are a number of questions that need to
be answered during the analysis, such as:
– What is the impact of the project?: In using
renewable resources such as air, water, land, etc;
and non-renewable resources like minerals and
deposits that deplete through time with more
concern of future generations.
– How does the project affect the eco-systems such
as soil erosion, atmosphere, rivers, lakes and
desertification?
 … VI. Environmental Analysis
… There are a number of questions that need to
be answered during the analysis, such as:
– What is the impact on biological system such as
conservation of unique habitat, endangered
species, wild life, overgrazing and deforestation?
– What hazardous chemicals are used that will
harm the health of employees and surrounding
people of the project area?
– What chemicals and wastes are emitted from the
project that will pollute air and water?
VII. Feasibility Study Result and Initial
Proposal Report study Results
• The research and study projects, undertaken by
government and non-governmental
organizations, are finalized by producing reports
that contain different investment opportunities.
• Opportunity studies are sketchy in nature and
rely more on aggregate estimates than on
detailed analysis.
• Cost data are usually taken from comparable
existing projects not from quotations of sources
such as equipment suppliers.
 … VII. Feasibility Study Result and
Initial Proposal Report study Results
• Hence these reports should provide
preliminary information on markets,
entrepreneurial input, the business
environment and other factors that affect
project implementation.
 … VII. Feasibility Study Result and
Initial Proposal Report study Results
• The major outputs of general opportunity
studies are to
– Clearly state the problem that we want to
address or the opportunity that we want
to take advantage of.
– Provide essential information on the
external factors influencing the
performance of projects.
 … VII. Feasibility Study Result and
Initial Proposal Report study Results
• The major outputs of general opportunity
studies are to
– Provide background information with emphasis
on risks, competitiveness, profitability and other
conditions for each opportunity identified in the
sector; and enable investors to screen out and
select the most attractive opportunities for
further analysis. If the opportunity study
provides sufficient information, it is possible to
pass the pre-feasibility study.
 VIII. Financial Analysis
• The objective of financial analysis is to
ascertain
– whether the proposed project will be financially
viable in the sense of being able to meet the
burden of servicing debt and
– whether the proposed project will satisfy the
return expectations of those who provide the
capital.
• Sometimes are called quantitative, do use numbers
and computations, but the criteria being measured
may be either subjective or objective.
• A large majority of all firms using project selection
models use profit/profitability as the sole measure of
acceptability. Some of these models include:
a) Pay back period (PBP)
b) Average rate of return
c) Discounted cash flow
d) Internal rate of return (IRR)
e) Profitability Index
f) Break-even analysis
 … ii. Financial and Economic
evaluation (Numeric models)
a) Pay back period (PBP)
• The pay back period for a project is the initial
fixed investment in the project divided by the
estimated annual cash inflows from the
project.
• The ratio of these quantities is the number of
years required for the project to repay its
initial fixed investment.
 … ii. Financial and Economic
evaluation (Numeric models)
a) Pay back period (PBP)
• For example, assume project costs
100,000.00 to implement and has annual net
cash inflows of 25,000.00. Then, the payback
period is calculated as follows:
• Pay back period = 100.000.00/25,000.00 = 4
years
 … ii. Financial and Economic
evaluation (Numeric models)
a) Pay back period (PBP)
• This method assumes that the cash inflows
will persist at least long enough to pay back
the investment, and it ignores any cash
inflows beyond the payback period.
• The method also serves as an inadequate
proxy for risk.
• The faster the investment is recovered, the
less the risk to which the firm is exposed.
 … ii. Financial and Economic
evaluation (Numeric models)
b) Average rate of return
• Often mistaken as the reciprocal of the payback
period.
• The average rate of return is the ratio of the average
annual profit (ether before or after tax) to the initial
or average investment in the project. Because
average annual profits are usually not equivalent to
net cash inflows, the average rate of return does not
usually equal the reciprocal of the payback period.
Assume, in the example just given, that the average
annual profits are 15,000.00
• Average rate of return = 15,000/100,000 = 0.15
 … ii. Financial and Economic
evaluation (Numeric models)
b) Average rate of return
• Neither of the aforementioned quantitative
evaluation methods are recommended for
project selection though payback period is
widely used and does have a legitimate value
for cash budgeting decisions.
• The major advantages of these models are
their simplicity, but neither takes into
account the time value of money.
 … ii. Financial and Economic
evaluation (Numeric models)
c) Discounted cash flow
• Also referred to as the Net Present Value
(NPV) method, the discounted cash flow
method determines the net present value of
all cash flows by discounting them by the
required rate of return (also known as hurdle
rate, cutoff rate) as follows:
• NPV (project) = Ao+
 … ii. Financial and Economic
evaluation (Numeric models)
c) Discounted cash flow
• Where,
• Ft= the net cash flow in period t,
• K=the required rate of return,
• Ao = initial cash investment (because this is an
out flow, it will be negative)
• pt = to include the impact of inflation (or
deflation) where pt is predicted rate of inflation
during period t, we have
• NPV (project) = Ao -
 … ii. Financial and Economic
evaluation (Numeric models)
c) Discounted cash flow
• Early in the life of the project, net cash flow is
likely to be negative, the major out flow being
the initial investment in the project, Ao.
• If the project is successful, however, cash flows
will become positive.
• The project is acceptable if the sum of the net
present values of all estimated cash flows over
the life of the project is positive.
 … ii. Financial and Economic
evaluation (Numeric models)
c) Discounted cash flow
• A simple example will suffice for indicating
this. Using our 100,000.00 investment with a
net cash inflow of 25,000.00 per year for a
period of eight years, a required rate of
return of 15 percent, and an inflation of rate
of 3 percent per year, we have
• NPV (project)=100,000.00 -
 … ii. Financial and Economic
evaluation (Numeric models)
c) Discounted cash flow
• Because the present value of the inflows is
greater than the present value of the out
flow that is, the net present value is positive
the project is deemed acceptable.
 … ii. Financial and Economic
evaluation (Numeric models)
d) Internal rate of return (IRR)
• If we have a set of expected cash inflows and cash
outflows, the internal rate of return is the discount
rate that equates the present values of the two sets
of flows.
• If At is an expected cash outflow in the period t and
Rt is the expected inflow for the period t, the internal
rate of return is the value of K that satisfies the
following equation (note that the Ao will be positive
in this formulation of the problem):
• Ao+A1/(1+k)+A2/(1+k)2+....+An/(1+k)n=R1/(1+k)
+R2/(1+k)2+….+Rn/(1+k)n
 … ii. Financial and Economic
evaluation (Numeric models)
d) Internal rate of return (IRR)
• Where, t=1,2,3….,n, The value of k is found
by trial and error.
 … ii. Financial and Economic
evaluation (Numeric models)
e) Profitability Index
• Also known as the Benefit-Cost Ratio (BCR),
the profitability index is the net present value
of all future expected cash flows divided by
the initial cash investment. (Some firms do
not discount the cash flows in making this
calculation). If this ratio is greater than 1.0,
the project may be accepted.
 … ii. Financial and Economic
evaluation (Numeric models)
f) Break-even analysis (BEA)
• Break-even analysis refers to the
determination of the balance performance
level where project income is equal to project
expenditure.
• The total cost of an operation is expressed as
the sum of the fixed and variable costs with
respect to output quantity. That is,
TC(X)=FC+VC(x)
 … ii. Financial and Economic
evaluation (Numeric models)
f) Break-even analysis (BEA)
• Where,
– x is the number of units produced,
– TC(x) is the total cost of producing x units,
– FC is the total fixed cost, and VC(x) is the total
variable cost associated with producing x units.
 … ii. Financial and Economic
evaluation (Numeric models)
f) Break-even analysis (BEA)
• In this case the total revenue resulting from
the sale of x units is defined as:
• TR(x)=px, where p is the price per unit. The
profit due to the production and sale of x
units of the product is calculated as
• P(x)=TR(x)-TC(x)
 … ii. Financial and Economic
evaluation (Numeric models)
f) Break-even analysis (BEA)

• The break even point of an operation is

defined as the value of a given parameter
that will result in neither profit nor loss.
 … ii. Financial and Economic
evaluation (Numeric models)
f) Break-even analysis (BEA)
• The parameter of interest may be the
– number of units produced,
– numbers of hours of operation,
– number of units of a resource type allocated, or
– any other measure of interest.
At the break even point, we have the following relation
ships.
TR(x) = TC(x) or
P(x)=0