This document discusses financial feasibility analysis for investment projects. It defines financial feasibility analysis as an analytical tool used to evaluate the viability of an investment by examining expected return and risk. The document outlines factors considered in a financial feasibility analysis such as total capital requirements, equity and credit needs, and cost and revenue budgets. It also distinguishes between feasibility studies and business plans, noting that feasibility studies determine viability while business plans plan implementation. The document describes methods of evaluating projects including discounted and non-discounted criteria such as net present value, internal rate of return, payback period, and accounting rate of return.

1. UNITY University
Faculty of Business & Economics
Department of MBA
Course Name: Project Management
Academic year: 2022, YEAR II, TERM III
12/30/2022 Abdi D. (PhD) 1

2. Course Name: Project Management
Chapter – 3
Financial Feasibility Analysis
12/30/2022 Abdi D. (PhD) 2

3. Purpose of Financial Feasibility Analysis
 For investors to engage in a new investment project, the
project has to be financially viable.
• Invested capital must show the potential to generate an
economic return to investors at least equal to that available
from other similarly risky investments, i.e. the return on
investment needs to be equal or higher.
• For example, an investor expects a manufacturing facility to
generate sufficient cash flows from operation to pay for the
construction of the facility and ongoing operating expenses
and, have an attractive interest rate of return.

4. Cont’d
• Estimates the cost of operating and maintaining a
manufacturing plant, as well as expected income generated.
• Financial feasibility analysis is an analytical tool used to
evaluate the viability of an investment.
• A financial decision is dependent on two specific factors,
expected return and expected risk, and a financial feasibility
analysis is a means for examining those two factors.

5. Cont’d
• It should be conducted before proceeding with the development
of a business idea, and that also applies for financial feasibility
analysis.
• Determining early that a business idea is not financially feasible
can prevent loss of money and waste of valuable time.
• Financial feasibility analysis is usually done during the project
planning process and the results indicate how the project will
perform under a specific set of assumptions regarding
technology, market conditions and financial aspects.

6. Cont’d
• Analyzing the financial feasibility of a project is an essential part
of the decision making process.
• Even though the analysis is used on the first stages of the
decision-making process as a screening method, the analysis
should also be used throughout the process and should be
updated every time any of the assumptions it is based on changes.
• if the results of the analysis show that the proposed project does
not meet the return on investment requirements of the investor,
the business idea is discarded.
• It is therefore very important to regularly update the analysis and
verify that, given the newest information, the project is financially
feasible.

7. Feasibility Study vs. Business Plan
• Feasibility studies and business plans are two separate tools used
for decision making in project development.
– Both tools have common components, but should nevertheless not be
confused as their roles are different.
 A feasibility study is a tool for investigating the viability of the
prospective project.
• A business plan is a tool for planning the actions needed to take
the project proposal from an idea to reality.
• The feasibility study refines the initial business idea, while the
business plan uses information from the feasibility study to
further prepare the project to evolve into an operating business.

8. Cont’d
• A feasibility study is conducted on the very first stages of project
development, before financing is secured and a GO/NON-GO
decision has been made.
• The purpose of the study is to reveal whether or not the project
is viable from all aspects, feasibility study components
• If the results of the study are positive, indicating that the project
will be successful, much of the information from the study is
incorporated into a business plan.
• However, if the results are negative, there is no need to create a
business plan (Matson, 2000).
• A feasibility study usually analyzes several project alternatives or
methods of achieving success.

9. Cont’d
• The purpose is to narrow the scope of the project and to
identify the best scenario.
– A business plan only deals with one scenario, i.e. the scenario found to be
most prominent by the feasibility study.
• A business plan captures the goals and objectives of a business
idea.
• The plan serves as a blueprint for the implementation of the project, as
well as the actions taken during and after project
implementation.

10. Cont’d
• A feasibility study is used throughout the whole process, first as a
screening tool and then as a part of a business plan.
– As the financial feasibility of a project is a key element in a
feasibility study, it is also a key element in a business plan.
• The business plan is often used as a sales document, helping the
project owners to secure financing for the project.
– It is also used to persuade specialists to participate in the
project and public authorities to give permissions for
operations.

11. Cont’d
The following outline when conducting financial feasibility analysis:
 Estimate the total capital requirements – seed capital, capital for facilities and
equipment, working capital, start-up capital, contingency capital, etc;
 Estimate equity and credit needs - identify equity sources and capital
availability, identify credit sources, assess expected financing requirements,
and establish debt to equity levels;
 Budget expected costs and returns of various alternatives – estimate expected
cost and revenue, the profit margin and expected net profit, the sales or usage
needed to break-even, the returns under various production, price and sales
levels,

12. Project financing
• There are two types of project financing:
– equity and
– debt financing.
– When looking for money, you must consider your company’s debt-to-
equity ratio.
– The relation between amounts borrowed and amounts invested to the
business by the owners. The more money owners have invested in their
business, the easier it is to attract financing.

13. Equity Financing:
 Most small or growth-stage businesses use limited equity financing.
 As with debt financing, additional equity often comes from non-
professional investors such as friends, relatives, employees, customers,
or industry colleagues.
– However, the most common source of professional equity funding
comes from venture capitalists.
– These are institutional risk takers and may be groups of wealthy
individuals,

14. Cont’d
• Government-assisted sources, or major financial institutions.
• Most specialize in one or a few closely related industries.
• Venture capitalists may scrutinize thousands of potential
investments annually, but only invest in a handful.
• The possibility of a public stock offering is critical to venture
capitalists.
• Quality management, a competitive or innovative advantage,
and industry growth are also major concerns

15. Debt Financing:
• There are many sources for debt financing:
• banks,
• savings and loans
• , commercial finance companies, and
• the microfinance institutions.

16. Cont’d
• State and local governments have developed many programs
in recent years to encourage the growth of small businesses in
recognition of their positive effects on the economy.
• Family members, friends, and former associates are all
potential sources, especially when capital requirements are
smaller.

17. Cont’d
• Traditionally, banks have been the major source of small
business funding.
• Their principal role has been as a short-term lender offering
demand loans, seasonal lines of credit, and single-purpose
loans for machinery and equipment.
• In addition to equity considerations, lenders commonly require
the borrower’s personal guarantees in case of default. This
ensures that the borrower has a sufficient personal interest at
stake to give paramount attention to the business. For most
borrowers this is a burden, but also a necessity.

18. Project Decision Making Criteria
A means of assessing whether an investment project
is worthwhile or not
The investment criteria could be classified into two:
1. Non-discounting Criteria
2. Discounting criteria
What is the difference between these techniques?
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19. Cont’d
19
1. Non-discounted techniques:
• These techniques are simple to understand and easy to
compute.
• They don’t recognize the time value of money
• Though these techniques are simple to understand and easy to
compute, they suffer from the following limitations.
 They don’t recognize the time value of money
 They fail to recognize the projects return in totality-they
ignore cash flows beyond the payback period
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20. Cont’d
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2. Discounted appraisal techniques considers both the
estimated total cash inflows and the time value of money.
That is:
 Recognize the time value of money
 Recognize the benefits of the project in totality (except
discounted pay back period)
20

21. 1) Non-discounting Criteria
a) Payback period
b) Accounting rate of return
2) Discounting criteria include:
a) Net present value
b) Profitability Index/Benefit cost ratio
c) Internal rate of return
d) Discounted pay back period
12/30/2022 21

22. Methods of Evaluating Projects:
• In order to evaluate the financial feasibility of an investment
project, relevant measurements or criteria need to be
specified. Remer and Nieto (1995) categorize the evaluation
methods into five basic types:
Discounting Non discounting
1. Net Present Value 4. Payback period
2. Discounted Payback period 5. accounting rate of return
3. Internal rate of return

23. 23
Project appraisal methods
Considering the time value of
money concept
Ignoring the time value of
money concept
•Net present value
•Internal rate of return
•Payback period
•Accounting rate of return

24. 24
Payback period

25. 25
Payback period
• Payback period is the period of time it takes
for a company to recover its initial investment
in a project
• The method measures the time required for a
project’s cash flow to equalize the initial
investment

26. 26
Acceptance criterion
< predetermined cutoff period Accept the project
> Predetermined cutoff period Reject the project

27. 27
Example

28. 28
A company is considering making the following mutually exclusive
Investments in the production facilities for the new products with
an Estimated useful life of four years. The cash inflow and
outflows are Listed as follows:
Project A Project B
$ $
Initial investment 900000 1000000
Cash inflow at the end of year
Year 1 700000 600000
Year 2 100000 400000
Year 3 100000 400000
Year 4 1300000 400000
Project A : 3 years Project B: 2 years
Project B takes only two years to recover its initial investment. With
The shortest payback period, the company will accept project B

29. 29
Advantages of payback period
• Easy to adopt
• Facilities further evaluation
– After obtaining an acceptable payback period, the
project will be evaluated by other financial capital
budgeting techniques

30. 30
Disadvantages of Payback period
• Ignore the cash flows after payback period
• Adopt an arbitrary standard for the payback
period
• Ignores the timing of cash flow

31. 31
Discounted payback period
• The payback period method is criticized for
ignoring the timing of cash flows, therefore
discounted cash flows are used to calculate
the discounted payback period

32. 32
Example

33. 33
A company is considering making the following mutually exclusive
investments in the production facilities for the new products with an
estimated useful life of four years. The cash inflow and outflows are
listed as follows:
Project A Project B
Initial investment 900000 1000000
Cash inflow at the end of year
Year 1 700000 600000
Year 2 100000 400000
Year 3 100000 400000
Year 4 1300000 400000
Discount cash inflow (20%)

34. 34
Project A Project B
$ $
Initial investment 900000 1000000
Discounted cash flow
Year 1 700000 400000
1.21 1.21
Year 2 100000 400000
1.22 1.22
Year 3 100000 400000
1.23 1.23
Year 4 100000 400000
1.24 1.24
Discount payback period
Project A 900000-710647
626929
= 583333 = 500000
3+ = 3.3 years
Project B 100000-777778
231481
2+ = 2.96 years
= 69444 = 277778
= 57870 = 231481
= 626929 = 192901

35. 35
Accounting rate of return

36. 36
Accounting rate of return
• The accounting rate of return compares the
average accounting profit with the average
investment cost of project
• The accounting profit can be expressed either
before tax or after tax

37. 37
Calculation procedures
ARR =
Average net profit per year (over the life of the project)
Average investment cost
Average net profit per year =
Total profit
No. of life of the project
Average investment cost =
Initial investment
2

38. 38
In evaluating an investment project, the ARR of the project is
compared with a predetermined minimum acceptable accounting
Rate of return:
ARRs Comments
< minimum acceptable rate Reject project
= minimum acceptable rate Accept project
> minimum acceptable rate Accept project
Highest Choose highest ARR
Acceptance criterion

39. 39
Example

40. 40
A company is considering whether to buy specialized machines
For a new production line. The purchase price of machinery is
$400000 and its estimated useful life is four years. There is no scrap
Value after four years
The project income statements:
Year1 Year 2 Year 3 Year 4
$ $ $ $
Revenue 310000 280000 280000 310000
Depreciation 10000 100000 100000 100000
Other expenses150000 100000 110000120000
Profit before tax 60000 80000 70000 90000
Taxation (15%) 9000 12000 10500 13500
51000 68000 59500 76500
Should the company buy the new machinery if the minimum acceptable
Rate of return is 20%?

41. 41
Average net income =
51000+68000+59500+76500
4
= $63750
Average investment =
400000+0
2
= $200000
The cost of machinery is $400000 at the beginning
The cost of machinery is $0 at the end as depreciation is provided
On straight line method and there is no scrap value
ARR =
$63750
$200000 = 31.875%
Since the ARR is 31.875%, which is higher than the minimum
Acceptable rate of 20%, the company should invest in the new
machinery.

42. 42
Advantages of ARR
• It is easy to understand and compute
• It avoids using gross figures. Therefore, it
enables comparisons to be made between
projects with different useful lives

43. 43
Disadvantages of ARR
• It ignores the time value of money
• ARR method seems to be less reliable than the
NPV method. It adopts the accounting profit
instead of cash flows calculation. The change
of depreciation method may also alter the
accounting profit

44. 44
Net present value method

45. Net Present Value:
• Net Present Value (NPV) is the difference between the present
value of all cash inflows and cash outflows associated with an
investment project.
• Net present value of a project is the sum of the present values
of all the cash flows associated with it. The cash flows can be
positive or negative.

46. NPV
• In order to calculate the NPV, (considerate )
– the interest rate used for discounting the cash flows needs to
be determined. The interest rate is often referred to as
Minimum
– Attractive Rate of Return (ARR) and it represents the rate at
which the investor can alternatively invest his money, i.e. the
return of the most preferable alternative investment.
– The planning horizon of the project also needs to be
determined, and the cash flows for each period of the
planning horizon projected .

47. 47
Net present value method
• Net present value (NPV) method is a process that
uses the discounted cash flow of a project to
determine whether the rate of return on that project
is equal to, higher than, or lower than the desired
rate of return
• With the NPV method, we can compare the return
on investment in capital projects with the return on
an alternative equal risk investment in securities
traded in financial market

48. 48
Calculation procedures
1. Determining the discount rate
2. Calculating the NPV:
NPV =
FV1 FV2 FV3 FVn
(1+r)1 (1+r)2 (1+r)3 (1+r)n
+ + + - I0
where FV = future value of an investment
n = no. of years
r = Rate of return available on an equivalent risk
security in the financial market
I 0= initial investment

49. Net Present Value cont…
• The Net Present Value (NPV) of a project is the sum of the project values of all
the cash flows-positive as well as negative-that are expected to occur over the life
of the project.
• The general formula for NPV is:
• where
• Ct = net cash flow at the end of year t(
• n= life of the project
• r = discount rate
• I investment cost
I
r
c
NPV
n
t
t
t


 
1 )
1
(

50. 50
3. Interpreting the NPV derived as follows:
NPVs Comments Reasons
<0 Reject the project The rate of return from the project is
small than the rate of return from an
equivalent risk investment
=0 Indifferent to accept
or reject the project
The rate of return from the project is
equal to the rate of return from an
equivalent risk investment
>0 Accept the project The rate of return from the project is
greater than the rate of return from an
equivalent risk investment
Highest Accept the project If various project are considered, the
project with highest positive NPV
should be chosen

51. Measures of Project Worth ( example 1)
Year Cash flow
0 Birr (1,000,000)
1 200,000
2 200,000
3 300,000
4 300,000
5 350,000
If the cost of capital (discount rate) is 10%, then NPV is calculated
as follows
273
,
5
000
,
000
,
1
)
10
.
1
(
000
,
350
)
10
.
1
(
000
,
300
)
10
.
1
(
000
,
300
)
10
.
1
(
000
,
200
)
10
.
1
(
000
,
200
5
4
3
2
1








NPV

52. 52
Eg 2. A company is considering making several investments in the
Production facilities for the new products with an estimated useful
Life of four years. The cash inflows and outflows are listed as follows:
Project
A B C D
$ $ $ $
Initial investment 900000 1000000 303730 1500000
Cash inflow
Year 1 120000 400000 100000 10000
Year 2 250000 400000 100000 10000
Year 3 400000 400000 100000 1000000
Year 4 1300000 400000 100000 1000000
The appropriate discount rate of these investment is 12%

53. 53
Required:
(a) Calculate the NPV of each investment and determine whether
to accept it or not (assuming the company has unlimited
resources)
(b) If the company has limited resources, determine which
investment should be accepted by referring to the highest NPV

54. 54
Project A
NPV =
120000 250000 400000 1300000
1.12 1.122 1.123 1.124
+ + + - 900000
= $517327 (accepting)
Project B
NPV =
40000 400000 400000 400000
1.12 1.122 1.123 1.124
+ + + - 1000000
= $214920(accepting)
(a)

55. 55
Project C
NPV =
100000 100000 100000 100000
1.12 1.122 1.123 1.124
+ + + - 303730
= $0 (indifferent to accept or reject)
Project D
NPV =
10000 10000 1000000 1000000
1.12 1.122 1.123 1.124
+ + + - 1500000
= -$135801(rejecting)
(a)
(b) With limited resources, the company should only accept project A
because it generates the highest NPV

56. 56
Advantages of NPV
• Consistency with the time value of money
concept
• Consideration of all cash flows
• Adoption of cash flows instead of accounting
profit

57. Benefit-Cost Ratio Or profitability Index (PI)
• The benefit-cost method is often used for public projects.
• The method compares project benefits to the cost of the project,
and for the project to be viable, the benefits have to be greater than
the cost.
• Park (2002) describes benefit-cost analysis as “a decision-making
tool used to systematically develop useful information about the
desirable and undesirable effects of public projects”.
• Benefit-Cost Ratio BCR= Present value of inflows/Initial Investments
• PI= Present value of cash inflows/Present value of cash outflows
– If BCR is greater than 1, accept the project If BCR is less than 1, reject
the project.

58. Benefit-Cost Ratio or PI:
• Benefit-Cost Ratio: There are two ways of defining the relationship
between benefits and costs:
• Example: 12% discount
NBCR = BCR-1= 0.145
I
PVB
BCR 
1



 BCR
I
I
PVB
NBCR
(1)
(2)
PVB = present value of benefits, I = initial investment
100,000
Benefits Year 1 25000
Year 2 40000
Year 3 40000
Year 4 50000
145
.
1
000
,
100
)
12
.
1
(
000
,
50
)
12
.
1
(
000
,
40
)
12
.
1
(
000
,
40
)
12
.
1
(
000
,
25
4
3
2





BCR
When BCR > 1 or NBCR > 0 accept
When BCR < 1 or NBCR < 0 reject the project

59. 59
Internal rate of return

60. 60
Internal rate of return
• The internal rate of return is the annual percentage
return achieved by a project, of which the sum of
discounted cash inflow over the life of the project is
equal to the sum of discounted cash outflows or
• A rate of return which brings about equality between
the present value of future net benefits & initial
investment.
• If the IRR is used to determine the NPV of a project, the
NPV will be zero.
• The company will accept this project only if the IRR is
equal to or higher than the minimum rate of return or
the cost of capital

61. 61
Calculation procedures
1. By trial and error, find out the discount rate that will
give a zero NPV
where FV = future value of an investment
n = no. of years
r = internal rate of return
I 0= initial investment
2. If the NPV is positive, try a higher discount rate in
order to give a negative NPV and vice versa
NPV =
FV1 FV2 FV3 FVn
(1+r)1 (1+r)2 (1+r)3 (1+r)n
+ + + - I0 = 0

62. 62
3. After getting one positive NPV and one
negative NPV, use interpolation to find out
the rate giving zero NPV
IRR = L +
P
P – N
(H – L)
Where L = Discount rate of the low trial
H = Discount rate of the high trial
P = NPV of cash flows of the low trial
N = NPV of cash flows of the high trial

63. 63
4. In evaluating an investment project, the
IRR is compared with the management’s
predetermined rate
IRRs Comments Reasons
< lowest acceptable level of return Reject NPV<0
= lowest acceptable level of return Accept NPV=0
> Lowest accepted level of return Accept NPV>0
Highest Accept If several project are
considered, the
highest IRR should
be chosen

64. 64
Example

65. 65
A project costs $400 and produces a regular cash inflow of $200 at
the end of each of the next three years. Calculate the IRR. If the
minimum rate of return is 15 %, suggest with reason whether you
Should accept the project or not.
NPV =
$200 $200 $200
(1+r)1 (1+r)2 (1+r)3
+ + - $400 = 0
NPV =
$200 $200 $200
1.22 1.222 1.223
+ + - $400 = 8.4
Assuming the discount rate is 22%
NPV =
$200 $200 $200
1.24 1.242 1.243
+ + - $400 = -3.8
Assuming the discount rate is 24%

66. 66
IRR = L +
P
P – N
(H – L)
Where L = Discount rate of the low trial
H = Discount rate of the high trial
P = NPV of cash flows of the low trial
N = NPV of cash flows of the high trial
IRR = 22% +
8.4
8.4 – (-3.8)
(24 – 22)%
= 23.38%
Since the IRR (23.38%) is higher than the minimum rate of return (15%),
The project should be accepted

67. Exercise 1
       4
3
2
1
1
000
,
45
1
000
,
40
1
000
,
30
1
000
,
30
000
,
100
r
r
r
r 







Year 0 1 2 3 4
Cash flow (100,000) 30,000 30,000 40,000 45,000
IRR is the value of r which satisfies the following equation:

68. Project Analysis & Management
(ASA)
Year 1 2 3 4 5
CFs 5000 4000 3000 2000 8000
…Cont’d
Exercise 2
A project requires a new investment of 20,000 and produces the
following cash flows. Compute the IRR of the project

69. Financial statement

70. Balance sheet

71. Cash flow statement

72. Individual Home Based exam (10%)

73. Quick Quiz Q1(5%)
• Assume that a minimum of 10 percent return is required and
select the best project alternative using:
A. Payback period
B. NPV
C. IRR
Expected financial Return (in Birr)
73
year Project A Project B Project C
0-Investment (1,000) (1,000) (1,000)
1 300 1,500 525
2 300 250 525
3 300 250 525
4 300 250 525
5 1,500 250 525
Total 1,700 1,500 1,625

74. Quiz 2(5%)
Year Project I Project II
0 (500) (500)
1 325 175
2 150 175
3 150 175
4 50 175
• Example: Assume that Mina PLC, a financial analyst, is doing a
consulting work for evaluating the two projects given below. The projects
costs Br. 500 million each and the required rate of return for each of the
projects is 12%, the projects’ expected net cash flows are as follows:
Required:
1. Calculate each of the project’s payback, net present value( NPV) and
Internal rate of return (IRR)
2. Which project or projects should be accepted if they are independent?