CE 6512

Project Evaluation and

Feasibility Study

Zia Wadud

Why a Feasibility Study?

Objectives:

To find out if a civil engineering project can be done:

...is it possible?

...is it justified?

To suggest possible alternative solutions.

To provide management with enough information to know:

Whether the project can be done

Whether the final product will benefit its intended users

What the alternatives are (so that a selection can be made at a later phase)

Whether there is a preferred alternative

A management-oriented activity:

After a feasibility study, management makes a “go/no-go”

decision.

Need to examine the problem in the context of broader

objective/strategy

Contents of a Feasibility Report

Things to be studied:

The present organizational system

Stakeholders, users, policies, functions, objectives,...

Problems with the present system

inconsistencies, inadequacies in functionality, performance,…

Goals and other requirements for the new system

Which problem(s) need to be solved?

What would the stakeholders like to achieve?

Constraints including nonfunctional requirements on the system

(preliminary pass)

Possible alternatives:

“Current system” is always an alternative

Advantages and disadvantages of the alternatives

Things to conclude:

Feasibility of the project The preferred alternative.

Types of Feasibility

Technical feasibility

Is the project possible with current technology?

What technical risk is there?

Availability of the technology?

Economic feasibility

Is the project possible, given resource constraints?

What are the benefits?

What are the development and operational costs?

Are the benefits worth the costs?

Schedule feasibility

Is it possible to build a solution in time to be useful?

Operational feasibility

If the system is developed, will it be used?

Human and social issues…

Technical Feasibility

Is the proposed technology or solution practical?

Do we currently possess the necessary technology?

Do we possess the necessary technical expertise

…and is the schedule reasonable for this team?

Is relevant technology mature enough to be applied to our problem?

What kinds of technology will we need?

Some organizations like to use state-of-the-art technology

…but most prefer to use mature and proven technology.

A mature technology has a larger customer base for obtaining advice

concerning problems and improvements.

Is the required technology available “in house”?

If the technology is available:

…does it have the capacity to handle the solution?

If the technology is not available:

…can it be acquired?

Economic/Financial Feasibility

Our main focus!

Will be covered in detail later

Schedule Feasibility

How long will it take to get the technical expertise?

We may have the technology, but that doesn't mean we have the

skills required to properly apply that technology.

…. Whether hiring or training, it will impact the schedule.

Assess the schedule risk:

Given our technical expertise, are the project deadlines reasonable?

If there are specific deadlines, are they mandatory or desirable?

….. If the deadlines are not mandatory, the analyst can propose

several alternative schedules.

What are the real constraints on project deadlines?

If the project overruns, what are the consequences?

…Deliver a properly functioning information system two months late…

…or deliver an error-prone, useless information system on time?

Missed schedules are bad, but inadequate projects are worse!

Operational Feasibility

How do end-users/managers/policy-makers feel about…

…the problem?

…the alternative solutions you are exploring?

You must evaluate:

Not just whether the project can work…

… but also whether a system will work.

Any solution might meet with resistance:

Does management support the project?

How do the end users feel about the project (often open public

hearing for large scale civil engineering projects after technical

feasibility)?

Inertia within existing system/ Vested interests?

People tend to resist change/other agenda.

Can this problem be overcome? If so, how?

CE 6512

Project Evaluation

Zia Wadud

How Do We Justify a Project?

Is this project worthwhile?

Are the benefits greater than the costs?

Costs to whom? Benefits to whom?

Is this the best way to achieve these benefits

(either engineering & institutional options)?

Can similar benefits be achieved more efficiently by some

other approach?

Is this the best place to allocate resources?

Do other projects have greater payoff?

Are other types of benefits more important?

Methods

Seeks to either give yes/no assessment or more

commonly rank alternative plans

Large number of techniques

Problems of different types of output

Problems of long time horizon

Problems of potential forecasting errors

Problems of deciding on criteria to use

Benefit-Cost Analysis

Takes a long view and a wide view

Expresses all items in monetary terms

Assesses on a single index

Fits with welfare economic theory

Widely used

BUT is not complete

Social vs. Private

Economic Equivalence

Economic equivalence is established, when we

are indifferent between a future payment, or series

of future payments, and a present sum of money.

Cashflow of a typical CEE project

Equivalence of Cash Flows

Time Value of Money

$1 today is worth more than $1 dollar next year

How much more depends upon the opportunities for using

or investing that $1

If we invest in a government bond earning i% per year, then

our $1 will be worth $(1+i) at the end of one year and (1+i)t

at the end of t years

Likewise, earning $1 at the end of year t is worth 1/(1+i)t

today

Any arbitrary stream of cash flows to various equivalent

cash flows:

P = present value

F = future value at time t

A = annuity of A per period for N periods

Present Value

The Present Value of receiving cash Ct in a future

year t is obtained by discounting the net benefits at

an appropriate discount rate:

PV of Ct= Ct/(1+i)t

The PV for a series of cash flows is obtained by

summing the discounted benefits for each year:

PV of Project = Σ[Ct/(1+i)t]

Net Present Value: NPV: Benefits +, costs -

Meaning of NPV

NPV > 0, using a discount rate of i%

This project is better than making an investment at

i% per year for the life of the project

This project is worth further consideration

NPV < 0, using a discount rate of i%

This project does not provide enough financial

benefits to justify investment, since alternative

investments are available that will earn i%

The project will need additional, possibly non-cash

benefits to be justified

Equivalence Factors

[F/P,i,N] = future value F after N periods given present value P and

discount rate i; F = P (1+i)N

[P/F,i,N] = present value given future value F, i, & N:

P = F/ (1+i)N

[F/A,i,N] = "uniform series compound amount factor“, How large will

my IRA be after contributing $A at i% for N years?

F = A [{(1+i)N-1}/i]

[A/F,i,N] = "sinking fund payment“, Annual savings to have a down

payment of a house in N years

A = F i /{(1+i)N-1}

[A/P,i,N] = "capital recovery factor“, What will the mortgage

payments be?

A = P i (1+i)N / {(1+i)N-1}

[P/A,i,N] = "uniform series present worth factor“, My business

makes $A/year - should I sell for $X?

P = (A/i) {(1+i) N-1}/(1+i)N

Importance of the Discount Rate

Very low rates favor large projects with distant benefits

Using very low discount rates may lead a country to

undertake massive projects while ignoring current

needs

Very high rates favor staged investments with quick

payback

Using very high discount rates may prevent a country

from ever undertaking large infrastructure investments

Debate about Climate Change Mitigation

What discount rate?

The discount rate (i.e. the interest rate that you use in finding

equivalent values) should be

greater than or equal to your average cost of capital (not

necessarily your cost of capital for a particular project)

at least as high as your other investment opportunities (OCC)

(adjusted for risk)

The discount rate therefore will equal your "minimum

acceptable rate of return"

The discount rate reflects the opportunity cost for the person

or organization that will receive the cash flows (e.g. the

federal government specifies a rate to be used)

The discount rate is not the same as the interest rate

obtained to finance the project

Higher risks will require a higher discount rate

Importance of the Project Life

Projects need to be evaluated over a reasonable project

life (and the economic life will be shorter than physical life)

However, your choice of a project life should NOT determine

the outcome of the analysis (if it does, you must show

sensitivity of the results to project life)

Because of discounting, the "out years" do not add much

to the NPV, so a 20 to 50 year life is usually sufficient for

analysis

The proper assumption is that the very long term effects will

be positive or neutral - NOT that we can live it up now and let

our children and grandchildren worry about the future!

Risks increase with time

So we don't want to be dependent on long-term benefits to

recover our investment.

Choosing a Project among Many

In principle, any project with NPV > 0 is worth

pursuing.

In practice, capital budgets are limited, so that

choices must be made:

What set of projects gives the greatest benefits from using

the available resources?

Common approach in private sector: Hurdle rate of

return

Rank independent projects by rate of return (typically

IRR):

Choose projects (or sets of projects) with highest return

subject to a budget constraint

Choosing a Project among Many

Financial/Economic (Numeric) measures

Net Present Value (NPV) … mainly financial

Benefit-cost ratio, Cost and Benefit Analysis (CBA) …economic, too

Internal rate of return (IRR) … i at point of indifference (NPV=0)

Return on Investment (RoI) … operating cash flow/investment

Payback period (generally undiscounted, not recommended)

Cost effectiveness (in Aviation industry in Europe)

Nonnumeric measures: Mainly business projects (not our focus!)

Sacred cow

Operating necessity

Competitive necessity

Product line extension

Comparative benefit model (Q-sort)

Numerical Problems

Problem 1: Once a cement factory is in production, the sixth

year of the project, it will produce cement valued Tk. 1,475,000

annually over the economic life of the factory, estimated at 15

years. What is the present value of the cement production, if the

discount rate is (a) 12% per annum? (b) 3% per quarter?

Problem 2: For one of your project equipments, you are faced

with a choice between a gasoline or a diesel powered model.

While the diesel plant offers a longer life and lower operating

costs, the gasoline plant has lower capital cost (i.e. initial

purchase cost). Given the following information and assuming no

other differences in performance, which model would you

purchase? i = 10%

Diesel: operating life 10 years, price per model Tk. 100,000,

Annual M&O Tk. 10,000. Gasoline: 5 years, Tk. 50,000, Tk.

15,000

Finances Are Important, but They

Aren't Everything

Environmental Impact Assessment

Understand the expected impacts of the major

alternatives on the environment

Sustainability

Can (or should?) this project (or this program) be

sustained indefinitely? Three sets of concerns:

Financial/ economic

Social

Environmental

Broader Economic Issues

Prices of resources may not reflect their true costs

Local rather than world rates for energy costs

Natural resources priced at extraction cost rather than at

market cost

Opportunity cost of land may be omitted (build the highway

through the park)

Government may require use of excess labor as a public policy

Generational equity

Discounting of future costs and benefits may lead to long-term

decline in the environment

"Worry about today and the future will take care of itself"

Broader Economic Issues

Distributional Equity

Costs and benefits will be unevenly distributed

If total benefits exceed total costs, there is at least a

possibility of compensating the losers

Pareto optimality - some are better off and none are worse

off (after compensation)"No one is hurt" (a very strong

constraint on development)\

Regional Economic Impact

Multiplier effect of project expenditures on the local economy

Use of local labor & resources

Non-financial Externalities

Many impacts - both positive and negative - may be left out

of the cash flow analysis

Environmental impacts & need for remediation

Externalities

An external cost, or an externality, arises when the

social or economic activities of one group of

persons have an impact on another group and that

impact is not fully accounted for by the first group

Road congestion

Accidents

Pollution

Will be covered in detail later

Dealing with Multiple Attributes

Multicriteria analysis, Delphi method, Scoring model

There may be a clear winner, but unless one option is the

best in all categories, it is impossible to say it is the best

overall

Avoids need to reduce everything to monetary units

Allows the easier incorporation of qualitative factors

More concerned with specific effects than overall economic

efficiency (e.g., is focused on distribution of impacts)

Weighting schemes may help, but the weights themselves

are inherently a value judgment

Selection of the best project in complicated cases will be a

political issue rather than an economic issue

Example: MCA

Example: MCA

Dealing with Multiple Attributes

Problems with MCA

Issues of double counting

Specification of objectives

Weighting of objectives

Weighting of effects

Different units of measurement

No theoretical underpinning

http://www.communities.gov.uk/documents/corpor

ate/pdf/1132618.pdf

Risks and Uncertainty

Certainty: when the probability of the specific outcome is 1.

Risk: when you can assign a probability to the possible

outcomes.

Uncertainty: when you cannot assign a probability.

Why risks arise?

Project risks (e.g. can we build this on budget and on schedule?)

Market risks (e.g. will the market for real estate remain strong?)

Economy risks (e.g. will there be a recession?)

Country risks (e.g. will the government remain stable and supportive

of new infrastructure projects?)

Higher risk: Would you expect higher or lower returns on

investment?

Return under risk = ΣpiNPVi , where pi is the probability of

event/outcome i happening. Note: Σpi =1

Summary

Feasibility study

Economic and financial evaluation methods

Time value of money, discount rates

Considering multiple attributes

Risks and uncertainty