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
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