Project Feasibility

&Finance

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Capital Investments
– Current outlay of funds (can be aided by further future outlays)
– Expected to generate a stream of benefits extending far into the future

Importance:
1. Substantial outlay
2. Long term effects (Leading in nature)
3. Irreversible

Difficulties:
4. Measurement problems (cannibalization, improving morale of the workers)
5. Uncertainty (extends far into the future)
6. Temporal Spread (large tenure create problems in estimating discount
rates)
Types of Capital Investments
Categorization #1
– Physical (fixed assets)
– Monetary (investments)
– Intangible (r&d, market development)

Categorization #2
– Strategic (new business diversification)
– Tactical (replacing old machinery)
Types of Capital Investments
Categorization #3
– Mandatory (Asset retirement obligations)
– Replacement
– Expansion
– Diversification
– R&D
– Miscellaneous (Pet projects like landscaped gardens)
Phases of Capital Budgeting
• Planning
– Articulation of its broad investment strategy
– Preliminary screening of project proposals
• Analysis
– Feasibility Study (marketing, technical, financial, economic and
ecological aspects)
• Selection
– Capital Budgeting Techniques
• Financing
– Debt or Equity or Grants
• Implementation
• Review
Facets of Project Analysis
The important facets of project analysis are:

• Market Analysis
• Technical Analysis
• Financial Analysis
• Economic Analysis
• Ecological Analysis
Market Analysis
Primarily there are 2 questions concerned with Market Analysis

• What would be the aggregate demand for the proposed product/service

in the future?
• What would be the market share of the project under appraisal?

In order to answer the above questions the analyst would need wide variety
of statistics and appropriate forecasting methods.
Market Analysis Information Required
• Present consumption level and the past consumption trend
• Production possibilities and constraints
• Structure of competition
• Cost structure
• Consumer behavior, intentions, motivations, preferences and
requirements
• Distribution channels
• Legal constraints
Technical Analysis
Technical analysis of the project needs to be done so as to determine if the
pre requisites for the successful commissioning of the project are taken into
consideration.

Choices have been made with respect to location, size, process etc. Significant
questions with respect to technical analysis are as below

• If the prelim tests & studies have been done?

• Availability of raw material, power and other inputs is established?
• Made-to-order
• If the proposed layout of the building, plant & site is appropriate?
• Gantt Charts: If work schedules look realistic?
Financial Analysis
Financial analysis seeks to ascertain if the project will satisfy the ROI and also
if is it financially viable. While conducting a financial analysis one has to
analyze the following aspects.

• Cost of project and Investment sum

• Means of financing
• Cost of Capital
• Profitability
• Break-even point
• Cash flows
• Risk Level
Economic Analysis
Economic analysis is concerned with evaluating a project from social point of
view. The focus in on the social costs and benefits of project and not on the
monetary costs and benefits. Following questions need to be answered in
social cost benefit analysis.

• Impact of project on the level of savings and investments in the society

• Contribution of the project towards the fulfillment of employment, social
order and self-sufficiency
Ecological Analysis
Ecological analysis should be carried out for environment polluting industries
(chemicals, drugs, leather processing) and also for power plants and irrigation
schemes as environment concerns have become significant recently. Key
points to note in such an analysis are:

• Damage caused to the environment by the project

• Cost of restoration to ensure damage control to environment is within
permissible limits
Issues in Major Investment Decisions
Following issues should be examined before making an investment decision.

• Investment Story
• Risks
• Discounted cash flow (DCF) value
• Financing
• Impact on Short-Term EPS
• Real Options
Risks & Mitigants
• Funding Risk
– Identification of sources for equity contribution.
– Stipulation for minimum upfront equity contribution.
– Disbursement only after financial tie-up for the project.
• Regulatory Risk
– All major statutory approvals including MoEF and forest clearance stipulated as a pre - disbursement
condition
– Concession agreement is reviewed commercially, and risks identified
– Suitable undertakings/guarantees are obtained from sponsors to negate any adverse effect of concession
provisions
– Financing of projects on time-tested concession formats approved by the Planning Commission
• Land Acquisition Risk
– Minimum land acquisition stipulated as a pre-disbursement clause
– Projects in sensitive states avoided
– Land acquisition is the responsibility of Concession Authority
– Compensation is paid by the authority on account of any adverse delay
• Market Risk
– Independent consultant appointed by Lenders to conduct market potential/ traffic study
– Project funding is structured based on cash flow projections to ensure smooth Debt servicing
Risks & Mitigants
• Execution Risk
– Contracts for Civil works/Procurement of equipment on a fixed time fixed price basis.
– Contracts to be finalized before any disbursement
– Reputation of EPC contractor considered
– Suitable provisions for Liquidated damages/ penalty are incorporated in contract documents.
• Technology Risk
– Projects based on proven technology are financed
– Recourse stipulated in case of emerging technologies
• Explicit Political Risks
– Most concession agreements / licenses have clear provisions classifying political risks into 2 categories:
• Direct Political and Indirect Political
• Mitigation mechanisms including compensation is specified in the agreement itself
• Implicit Political Risk
– Policy Risk: Change in policies towards infrastructure like tax sops, concession agreements, grant policies
– Revenue/Toll Rate Risk: Change in toll rates
– Regime Change Risk
– Change in Applicable Laws / Tax Laws
– Cross Border Governing Law Enforcement Risk
– Concession Agreements / Licenses govern all aspects of projects under a contract based system and
governments honor signed contracts
Contractual Arrangements to Mitigate Risk
Parties Agreements Mitigation mechanisms

Shareholders Agreement/Share
They bear the risks of project design, construction, completion,
Subscription Agreement, Sponsor
Project Sponsors: Support Undertakings, Corporate operation, and maintenance and repayment to the lenders. The cost
overrun risk is also borne by the sponsors.
Guarantees.

When there are only a few potential customers for the project’s
output, revenue risk is likely to be transferred to those customers by
means of a long-term sales contract.
Customers Off-take Agreements
Contracts may include: take-or-pay clause, minimum throughput
agreement, tolling contract etc. The risk of payments is mitigated
through a proper payment security mechanism.

When a government grants a concession to a project company, there

Government/ will be a Concession Agreement that gives the company the right to
Statutory Concession/Implementation build and operate the project facility. Concession agreement may
Agreements
Authorities require the government to construct supporting facilities such as
access roads, contains non-compete condition etc.

The risk of project construction is mitigated to the construction

Construction contractors by entering into a fixed time fixed price contract with
Contractors EPC Agreement them and the contract adequately providing for liquidated damages
(penalties) in case of delay in construction.
Weaknesses in Capital Budgeting
Capital budgeting system of a firm is the main factor which differentiates
value-creating firms from a value-destroying firms. Various insufficiencies in
the capital budgeting system results in poor quality of investment decisions.
Some of the common weaknesses in the system are:

• Poor alignment between Strategy and Capital budgeting

• Deficiencies in Analytical Techniques
• No linkage between Compensation and Financial Measures
• Reverse Financial Engineering
• Inadequate post-audits
• Weak integration between capital budgeting and expense budgeting
Strategy and Resource
Allocation

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Quote
Warren Buffett on Capital Allocation

“…The heads of many companies are not skilled in capital allocation. Their
inadequacy is not surprising . Most bosses rise to the top because they have
excelled in an area such as marketing, production, engineering,
administration – or sometimes, institutional politics.

…CEOs who recognize their lack of capital allocation skills, often try to turn to
their staff, management consultants or investment bankers which accentuates
the problem.

In the end, plenty of unintelligent capital allocation takes place in corporate

America (and you hear about restructuring)…”
Grand Strategy
The thrust of grand strategy is:
1. Growth
1. Concentration (Focusing on expanding current product)
2. Vertical Integration (Backward vs Forward)
3. Diversification (Concentric vs Conglomerate)
2. Stability
3. Contraction
1. Liquidation
2. Divestiture
Rationale for a Grand Strategy
Likely outcomes
Strategy Principal motivations Profitability Growth Risk
Concentration - Ability to serve a High Moderate Moderate
growing market
- Familiarity with
technology and market
- Cost leadership
Vertical - Access to raw materials High Moderate Moderate
Integration or customers
Concentration - Improved utilization of High Moderate Moderate
diversification resources
Conglomerate - Limited scope in present Moderate High Low
diversification business
Stability - Satisfaction with status High Low Low
quo
Divestment - Inadequate profit High Low Low
Allocation of Resources: BCG Matrix
Market Growth Rate

Stars ?
Market
Share Low

Dogs
Cash Cows (funds released
(funds by
generated) divesting/sellin
g)

Low
 Allocation of Resources: GE Stoplight
Business Strength
Strong Average Weak

High Invest Invest Hold

Attractiveness
Industry

Medium Invest Hold Divest

Low Hold Divest Divest

 Allocation of Resources: McKinsey Matrix
Competitive Position
Industry Attractiveness
Good Medium Poor Criteria:
1. Industry Size
2. Industry Growth
3. Industry Profitability
Question 4. Capital Intensity
High Winner Winner
Mark 5. Technological Stability
6. Competitive intensity
7. Cyclicality
Attractiveness
Industry

Average Competitive Position Key

Medium Winner Loser
Business Success Factors:
1. Market Share
2. Tech Knowhow
3. Product Quality
4. After-sales service
Profit 5. Price competitiveness
Low Loser Loser
Producer 6. Low Operating Cost
7. Productivity
Business Level Strategy
1. Cost Leadership – Ex: Dell
– Direct selling
– Built-to-order
– Low-cost service
– Negative working capital

2. Differentiation
– Involves offering a product/service that is perceived by customers as distinctive or
unique so that they are expected to pay a higher price. (May not be the case always
and firms may offer a quality product at an affordable price)
– Can be achieved through product quality, product range, bundled services, brand
image, delivery convenience.
– Calls for investment in R&D and marketing skills
– Ex: Intel, Rolex
Business Level Strategy
3. Focus
– Concentrating on a narrow line of products or a limited market segment.
– Ex: McDonalds with its limited menu offerings

4. Network Effect Strategy

– Success with the network strategy depends on the ability of a Company to lead the
charge and establish a dominant position to create a virtuous circle.
– Ex: Microsoft with its Windows platform, eBay with its online auction platform