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LESSON 10

PROJECT FEASIBILITY (CONTD.)

Broad Contents

Characteristics of a Feasibility Study

The Feasibility Study - What Bankers Like to See in Them

The Feasibility Assessment Process

The Process of Feasibility Study

Conclusion Feasibility Study

10.1

Characteristics of a Feasibility Study:

The feasibility study phase considers the technical aspects of the conceptual alternatives and

provides a firmer basis on which to decide whether to undertake the project.

The purpose of the feasibility phase is to:

Plan the project development and implementation activities.

Estimate the probable elapsed time, staffing, and equipment requirements.

Identify the probable costs and consequences of investing in the new project.

If practical, the feasibility study results should evaluate the alternative conceptual solutions

along with associated benefits and costs.

The objective of this step is to provide management with the predictable results of

implementing a specific project and to provide generalized project requirements. This, in the

form of a feasibility study report, is used as the basis on which to decide whether to proceed

with the costly requirements, development, and implementation phases.

User involvement during the feasibility study is critical. The user must supply much of the

required effort and information, and, in addition, must be able to judge the impact of alternative

approaches. Solutions must be operationally, technically, and economically feasible. Much of

the economic evaluation must be substantiated by the user.

Therefore, the primary user must be highly qualified and intimately familiar with the workings

of the organization and should come from the line operation.

The feasibility study also deals with the technical aspects of the proposed project and requires

the development of conceptual solutions. Considerable experience and technical expertise are

required to gather the proper information, analyze it, and reach practical conclusions.

Improper technical or operating decisions made during this step may go undetected or

unchallenged throughout the remainder of the process. In the worst case, such an error could

result in the termination of a valid project -- or the continuation of a project that is not

economically or technically feasible.

In the feasibility study phase, it is necessary to define the project's basic approaches and its

boundaries or scope. A typical feasibility study checklist might include:

Summary level

Evaluate alternatives

Evaluate market potential

Evaluate cost effectiveness

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Evaluate producibility

Evaluate technical base

Detail level

A more specific determination of the problem

Analysis of the state-of-the-art technology

Assessment of in-house technical capabilities

Test validity of alternatives

Quantify weaknesses and unknowns

Conduct trade-off analysis on time, cost, and performance

Prepare initial project goals and objectives

Prepare preliminary cost estimates and development plan

The end result of the feasibility study is a management decision on whether to terminate the

project or to approve its next phase. Although management can stop the project at several later

phases, the decision is especially critical at this point, because later phases require a major

commitment of resources. All too often, management review committees approve the

continuation of projects merely because termination at this point might cast doubt on the group's

judgment in giving earlier approval.

The decision made at the end of the feasibility study should identify those projects that are to be

terminated. Once a project is deemed feasible and is approved for development, it must be

prioritized with previously approved projects waiting for development (given a limited

availability of capital or other resources). As development gets underway, management is given

a series of checkpoints to monitor the project's actual progress as compared to the plan.

10.2

The Feasibility Study - What Bankers Like to See in Them:

A cardinal rule in banking is to borrow from a lender who understands your business; or, never

to lend money on a business project that you do not understand. For this reason, even though

most groups involve their banker early in the process, a feasibility study is often done with an

eye towards explaining the project to potential financers. Bankers, as different clients for the

feasibility study, can have different requirements for the study than group members. In many

cases, the feasibility study is the formal project presentation to a lender. This section

summarizes a feasibility study here with the banker in mind.

Many groups work with bankers with whom they already have an established business

relationship. This relationship could be with another cooperative project or with their personal

business. This can ease the process of obtaining financing for a project. However even when

working with a banker, who is familiar with the members, it is important that the banker know

and understand the unique aspects of cooperatives.

From the perspective of a banker, or other perspective financer, the feasibility study should

contain the information described in the table 10.1 below.

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Table 10.1: Information Content of Feasibility Study

This does not mean that a banker or financer is not interested in other aspects of the feasibility

study. Each has their own area of interest and concern; however, the following will be needed

for most, if not all bankers.

Executive Summary:

This should be short, to the point, yet still complete. If the banker cannot read the

summary and understand the basics of the project the odds are that project will receive

financing. This should contain:

· Project purpose: What is the project and who is involved?

· Repayment possibility: Does the study show the ability of the investment to be

recovered over a specific time period? Does it give investment (cost) parameters?

Can it convince bankers the investment is needed, even if it is marginally feasible?

· Projected Financial Returns: What are the projected financial scale, the revenues,

and the operating costs? What is net the income?

· Economic Benefits: What are the Return on Investment (ROI) and the Internal Rate

of Return (IRR) of the project?

The Financial Package Blueprint:

The banker needs to clearly see what resources the group wants from the bank. The

bank will require information to calculate potential project risk and the bank's exposure

for any monies loaned to the group. They also want to know the financial commitment

to the project from the members. This blueprint should contain the following elements:

· Characteristics of assets to be financed.

· Expected rate of conversion to cash-liquidity What is the project's funding

potential and what repayment terms will be required?

· Risk evaluation data What are internal (yields, costs, etc) and external (inflation,

energy, etc) project risks? What if the key assumptions are not perfect? What is the

bank's exposure?

· Evaluating Economic Consequences Do net reserves cover capital cost? Does the

plan keep the project from capital erosion?

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Financial Forecast What are the next three years projected cash flows, operating

statements, and balance sheets? What are the source and use of funds?

Documentation What rational is used to support the assumptions?

10.3

The Feasibility Assessment Process:

It is often suggested that feasibility studies should encompass at least two assessments:

· Technical feasibility

· Economic feasibility

The technical feasibility embodies an assessment of the physical, technical and technological

dimensions of the project while the economic feasibility assesses the project's economic

viability within its defined domain.

Figure 10.1: The Value Chain Approach to Feasibility Assessment

The value chain approach (shown in Figure 10.1 above) allows the two assessments to be

embedded into a single initiative, facilitating an increased understanding and appreciation of the

domain's effects on the different stages from input sourcing and procurement to customer

service and support. It also facilitates an appreciation of the resources, technology, customer

expectations and infrastructure required for the initiative to succeed, allowing an assessment of

their level and depth at each subsequent stage in the value chain.

10.3.1 Input Sourcing and Procurement:

We begin conducting the feasibility of the business initiative from the logical point in

the value chain, i.e., input sourcing and procurement. The technical dimension of the

analysis at this stage encompasses the availability of the required inputs in the

appropriate levels of quality and quantity. The assessment of availability involves an

evaluation of cycles and trends for both quantity and quality of the inputs. We are also

interested in the physical movement of the inputs from their origination points to the

facilities where they will be processed. Different sources of supply are evaluated for

their quality and quantity as well as cycles/trends in these characteristics. If specific

human resources and technologies are required to facilitate the effectiveness of the

input sourcing and procurement stage, their availability is assessed within the domain of

the project. Likewise, the infrastructure support for effectively procuring inputs from

origination points to processing facility is also assessed.

The economics of input sourcing and procurement emanates directly from the technical

assessment. The prevailing market prices of inputs as well as costs associated with the

procurement are assessed at the input sourcing and procurement stage. The objective is

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not to determine the price but the range of prices that have been typical in the domain

over a reasonable period of time to allow for the capture of the trends and cycles in the

prices. The price trends and cycles can be matched against the quantity and quality

trends and cycles to provide insights into potential bottlenecks in the input sourcing and

procurement function of the business initiative under consideration.

10.3.2 Operations and Production:

The transformation of inputs into outputs occurs at the operations and production stage

of the value chain. This is also the stage that will generally absorb the lion's share of

the investment capital. Therefore, from the capital resource allocation perspective, the

feasibility requirements at the operations and production stage must be conducted with

all the diligence necessary to address all the requisite issues.

The objective of the technical feasibility assessment at operations and production stage

of the value chain is to determine if the technology being envisaged for the proposed

project is suitable for the desired quantity and quality of product the project wants to

present to the marketplace. It also seeks to determine if the equipment and its

associated technologies are at the appropriate operational scale. Within the value chain

framework, the feasibility assessment of the operations and production technologies is

conducted by laying out the physical process from input receipts to packaging and

transfer to storage and warehousing and/or delivery.

Because of the level of specialized knowledge required to do justice to the operations

and production technical aspects of the feasibility assessment, it is pertinent that the

professionals with the required knowledge and experience are recruited to provide the

intellectual content for the process. It is important that you do not lock yourself into a

technological jam by myopically focusing only on a single technology. Instead, you

must encourage your engineering and technical professional input providers to provide

you with the full range of their knowledge about the technologies and equipments

available. You also need to assess the physical layout of the equipment and its impact

on operational efficiency. These professionals must also be encouraged to provide

insights into how the different technologies compare with respect to the number of

people and their requisite skill levels required to operate them from beginning to end as

well as their attendant operational inputs electricity, natural gas or gasoline,

maintenance protocols and shut down protocols, availability and turnaround of

technical support, etc.

The previous information provides the foundation for the economic assessment of the

alternative technical solutions that can be used in the production process and their

attendant operational requirements. The technical efficiencies of the alternative

technologies should be weighed against their economic efficiencies to determine their

overall effectiveness in the project's feasibility. The best sources of the economic data

to support the assessment of the technologies and operations are the suppliers of the

equipment.

Such primary data can be collected by providing a detailed description of your product

to potential suppliers in a Request for Quote (RFQ) offer. The principal advantage of

using a Request for Quote (RFQ) is to improve your knowledge of alternative solutions

which you may be unaware of, should you settle on the supplier you know. Given the

rate of technical obsolescence, it is imperative that capital investments in technologies

are made to maximize their longevity given technical and economic efficiency

considerations. You should not overlook the alternative of not making direct

investments in operations and production technologies, but seek to assess the

possibilities of allying with a company with existing processing and operation capacity.

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The technical nature of the operations and production stages of the feasibility

assessment requires that unbiased people who are knowledgeable of the processes are

hired to help review the responses to the Request for Quote (RFQ). You should arrange

for the responding suppliers to make presentations so you and your consultants can ask

the necessary questions. Although this process can be cumbersome and time

consuming, it is worthwhile if the equipment, buildings and other operational inputs are

a significant component of the proposed project's capital outlay.

10.3.3 Warehousing, Storage and Delivery:

Generally, agricultural value-added products are stored or warehoused prior to delivery

to customers. Therefore, the feasibility analysis should assess the implications of

warehousing, storage and delivery systems for the project. It is important that the

feasibility study assesses alternative sources of warehousing and storage from owning

facilities to renting facilities to strategic alliance with others. The objective of these

alternatives is to provide the project with realistic alternatives for consideration if the

project is found to be feasible. The feasibility assessment should not only focus on the

physical facilities but also on the management technologies of warehouse and storage

facilities management. The product tracking systems that facilitate maximization of

space utilization and turnover are critical components of the assessment process.

Additionally, available infrastructures to support the physical movement of products to

warehouses or storage, and from there to customers, must also be assessed. For

example, transportation systems may influence how consumer ready products can be

shipped to improve processor efficiently.

The economics of the physical buildings, location, infrastructure, technologies and

other associated resources are brought to bear on the technical options to ensure that the

most technically efficient and economically effective alternatives qualify for

consideration. The best sources of technical and economic information are suppliers of

warehousing and storage services. Trucking and rail companies are often very

forthcoming in providing information on delivery charges for specific products from

certain locations to certain destinations. The accuracy of the data supplied by these

service suppliers is dependent on the clarity and precision of the input information they

need to calculate their estimates. Thus, the stepwise process of gathering information is

important because it provides the requisite information that feeds into future steps.

10.3.4 Sales and Marketing:

Marketing and sales are often taken for granted in feasibility studies. However, they

provide a direct insight into the project's potential market and the Structure, Conduct

and Performance (SCP) characteristics of the players within the industry. Therefore,

the sales and marketing feasibility assessment bridges the intra-firm feasibility

dimensions (those inside the firm) with the extra-firm feasibility dimensions (those

outside of the firm).

The conceptual backbone for the Structure, Conduct and Performance (SCP) is the

assessment of the demand and supply conditions of the product and the behavior of the

other firms in the industry. The supply and demand conditions should cover the size

and scope economies in the industry, seasonality and trends, availability and strength of

substitutes to the product, industry growth rates and demand elasticities.

Industry (market) structure refers to the number and size of the firms (products) in the

industry (market) that you intend to enter. Industry conduct describes the pricing

behavior and price discovery mechanisms used by firms in the industry. In addition, it

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assesses product distribution mechanisms and available channels as well as promotional

initiatives that are used in the industry. The intensity of research and development and

the extent of legal tactics in the industry all provide indications of the depth of the

transaction costs emanating from the conduct of firms in the industry. Finally, the

industry performance assesses the profitability of firms in the industry. This requires

information on prices, product quality, technical progress and industry capacity

utilization.

10.3.5 Non-Market Factors:

A technically and economically feasible project can fail when confronted with certain

government policies and/or regulations. Therefore, feasibility studies should assess the

existing and/or planned regulatory initiatives that impinge on the project. For example,

environmental regulations that are in place and their technical and economic

compliance effects on the project must be analyzed to assess their implications for

technology, location, and other decisions. Similarly, there is need to assess the

implications of specific policies targeted to the industry of interest and evaluate changes

in these policies. For example, policies that offer significant competitive advantage to

the industry but are subject to change by administrative fiat need to be assessed for the

potential effect on the viability of the proposed project.

The results of the foregoing analysis form the backdrop for assessing the feasibility of

your product in the defined market domain. It helps you position your product within

the context of what already exists and how it may differentiate itself to ensure its

competitive advantage. The characteristics that are engineered into the product, as well

as the pricing, promotion and distribution or placement opportunities are all influenced

by a clear understanding and appreciation of the industry's Structure, Conduct and

Performance (SCP).

10.3.6 Data Collection:

Information on industry structure and performance may be obtained from various

government statistics, such as those developed and maintained by the Department of

Commerce. These databases offer information on the number of firms and employees,

average wages and benefits, total value of shipments, gross margins, etc. In addition to

government databases, specific industries also collect their own statistics and

commission reports that may be purchased. Interviews with specific industry experts

can also be a major information source. Similarly, significant information may be

obtained from industry news in the main media or in industry-specific publications. For

example, when industry news reports indicate that plant closures are increasing, it may

be logically extrapolated that industry capacity is high and utilization is low. The

implication of this for performance is often easily inferred for undifferentiated or

commodity industries. Marketing and promotional information may be obtained from

special publications focusing on product marketing and promotions. These function-

specific publications often discuss the successful initiatives and can provide significant

insights into the approaches used in particular industries. Another source of

information on industries is academics publications and government documents.

Because Structure, Conduct and Performance (SCP) issues present important policy

implications, they are the subject of study in many government and academic

documents and they can provide important and significant insights on market structure,

conduct and performance situation in many industries.

For agricultural value-added initiatives, secondary data can suffice for the input

sourcing and procurement segment of the feasibility assessment. The sources of these

secondary data include industry and trade publications as well as statistics of industry

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associations. Additionally, a number of government departments collect, analyze and

publish some of these data. In special cases, primary data collection may be necessary

and this may be done through formal surveys or interviews. For example, different

suppliers may be asked to provide information on their products prices, quantities and

qualities as well as the stability of their quotes, e.g., the frequency with which they

change their prices, quantities and quality. In most cases, when potential suppliers feel

the project initiative is credible, they will invest their best efforts to provide the required

information.

It is important to note that the effective collection of primary data can be expensive and

time consuming. An alternative to primary data when secondary data is not neatly

available is to pull them together from different sources, ensuring that measurements

and definitions are similar across sources. It may sometimes be necessary to transform

data from different sources to comparable units to attain the necessary congruence

required

for

analysis.

10.3.7 Customer Service and Support:

What do customers want? Ask them. The final step in the value chain framework to

feasibility assessment is finding out what customers needs are not being satisfied by the

current marketplace. The purpose of this is to determine if the proposed project's offer

stand to make a difference in satisfying customer needs. The results will provide a

credible input into the project's product differentiation index and allow the proponents

to identify the appropriate placement and promotional options to employ. Customer

service and support research allow the proposed project to gain insights into the nature

and structure of its potential market. It can develop market segments at this step,

allowing it to refocus other components of the initiative or revisit earlier steps in the

feasibility assessment process. Since customers are the final arbiters on the success of a

product, assessing how the project addresses their unmet needs is fundamental to the

project's economic feasibility.

Information for the customer segment of the feasibility can be obtained from reviewing

consumer publications and industry publications for general assessment of needs and

how the project's offering addresses them. Direct information may be obtained by

conducting focus group interviews, surveys and/or interviews. While these initiatives

can be expensive, they are worthwhile if technical and economic assessments thus, far

are supportive of the project and more information is required to make the decision.

For this reason, it is prudent for the customer segment to be where it is in the value

chain, i.e., the end. However, it is important to remember that the process described in

this document is hardly linear but rather iterative, using information from one stage to

dig deeper into or gather new information gathered from an earlier stage.

10.3.8 The Decision Recommendation:

The purpose of a business feasibility study is to make a decision about whether to

proceed with a particular business opportunity. It provides the general internal and

external value chain conditions that confront the business initiative and evaluates the

proposed initiative's ability to be economically viable if it is found to be technically and

operationally feasible. Therefore, the emphasis on the recommendations resulting from

the feasibility study is economic or financial.

The easiest approach to the economic decision is to gather all the information at the

different stages of the value chain and identify those that require capital expenditure

and estimate these expenditures. Additionally, identify the different types of people and

skills required to operate each stage of the value chain and determine what their wages,

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salaries and benefits will be. Finally, identify other project related costs such as

infrastructure development or improvements, occupancy, advertising and promotion,

office supplies and utility as well as fees and municipal or state development taxes

specific to the project. Next, using the production capacity, projected market share

growth rates and the estimated market size, in conjunction with price information

collected in the various stages of the feasibility study; develop a projected revenue or

sales statement. It is important to specifically define all assumptions that drive the

income and cash flow projections, e.g., the mean or median wages, salaries and

benefits, current price and industry average of plant operating capacity, etc. Also,

analyze all the data that were collected to determine their ranges, adjusted for special

circumstances and use these to conduct the sensitivity analysis on the economic

outcomes of the project.

10.3.9 Cost and Revenue Projections:

The cost and revenue projections together allow the development of the net cash flow

emanating from the business over the projected time frame. This statement can then be

subjected to capital investment analysis by selecting a reasonable discount rate and

estimating the Net Present Value (NPV) and/or estimating the Internal Rate of Return

(IRR) associated with the projected cash flow. A positive Net Present Value (NPV)

implies an economically feasible project and the larger the positive Net Present Value,

the more economically feasible the project, assuming the technical and operational

feasibility can be assumed. If the project owners are making a decision based on the

Internal Rate of Return, then they need to determine their required rate of return and

compare it to the estimated Internal Rate of Return. If the Internal Rate of Return (IRR)

exceeds their required rate of return, then the project is economically feasible. On the

other hand, if the estimated Internal Rate of Return is less than the proponents' required

rate of return, then the project is deemed economically infeasible even if it is both

operationally and technically feasible.

10.3.10 Sensitivity Analysis:

It is important that the project cash flow is subjected to the full range of sensitivity

analysis under a range of prices based on data that is collected for the feasibility study.

This will provide the full range of conditions that support the feasibility of the project.

The wider the band of feasible outcomes results from varying the critical assumptions,

the more confident you can be about the viability of your project. On the other hand, if

the band of feasibility is narrow vis-à-vis the critical variables, then the project's

viability is more susceptible to uncertain shifts in its marketplace. For this reason, it is

emphasized that the sensitivity analysis of the feasibility analysis be conducted over the

full range of the project's industry possibilities. These possibilities may be divided into

three blocks worse case, normal case and best case scenarios. Additionally, the

sensitivity analysis must be conducted for different scenarios, for example, best price

with worst demand conditions. This provides insights into the critical bottlenecks to the

project's viability and allows the proponents to assess the decision recommendations

within a more informed framework.

10.4

Conclusion:

The purpose of a feasibility study is to help assess the viability of a business proposition,

technically, operationally and economically. The value chain framework for conducting

feasibility studies has the unique advantage of laying out the project in its logical configuration

from input procurement to customer service and assessing the technical, operational and

economic feasibility at each stage, and finally putting it all together to assess the total project

feasibility. The advantage in this approach is revealed in exposing the bottlenecks to feasibility

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along the value chain so they can be assessed for possible improvement. The iterative nature of

the approach is also helpful because it allows the analyst to revisit previous steps when

information from latter steps suggests the need. In the end, the logical and step-wise process for

conducting feasibility assessment within the value chain framework helps enhance transparency

of the analysis and provide the foundations for better decisions.

The report was laid out to reflect expectation of presentation of a good feasibility report. Thus,

it is expected that such a report will cover the input sourcing and procurement, operations and

production, warehousing, storage and delivery. These three cover the logistics aspects of the

production process and draws on the infrastructure conditions, technological and technical

realities, human resource availability, capabilities and skills and customer expectations of

quality associated with the product. Marketing, sales and customer service take the analysis

into the project's external domain to assess industry structure, conduct and performance

characteristics as well as regulatory hurdles that confront the project. The customer service and

support component demand of the analyst to determine the specific needs of customers that may

be addressed by the project's offering and estimate the product differentiation index.

Pulling all the information together into financial units, the analyst can build the investment,

operational costs and revenue projections over a reasonable time frame and estimate the Net

Present Value (NPV) and/or the Internal Rate of Return (IRR) to facilitate making decision

recommendations. A project returning a positive Net Present Value is deemed feasible and the

larger the Net Present Value the better. Project analyst needs to determine the required rate of

return that investors in the project would deem acceptable and compare it to the Internal Rate of

Return to determine the project's feasibility. If the former is lower than the estimated Internal

Rate of Return, then the project is judged to be feasible and vice versa.

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