Feasibility study

1. • Read Chapter 13
• Read three articles on web site
– J. Agribusiness Including Risk in Economic
Feasibility Analysis: The Case of Ethanol
Production in Texas
– IAMA Journal Article on economic feasibility of Bio-
ethanol Production for Wheat in South Africa
– SJAE Use of Probabilistic Cash Flows
• Lecture 18 Project Feasibility.xls
• Lecture 18 Ethanol Feasibility.xls
• Lecture 18 Growth Functions.xls
Materials for Lecture 19

2. • For me it all started with a term paper
– Ice Plant article by Richardson and Mapp,
Southern Journal of Agricultural Economics (SJAE)
1976 – used risk for feasibility analysis
– The article demonstrated the methodology for risk
based feasibility studies, and it was first to report
• Probability of Economic Success
• Probabilistic Cash Flows to meet cash needs
• Financial/Economic analyses have been used
hundreds of times for a wide variety of firm
based problems
Project Feasibility Analysis

3. Project Feasibility Analysis
• In business most feasibility studies use Excel
spreadsheet models
– This trend by business started in mid-90s
– Excel is the language of business analysis
• Feasibility studies generally ignore risk – many
do a “What if …” study for the Best Case and
Worst Case scenarios
• Some analysts think they considered risk by
including a 10 year “average” price
• Excel deterministic feasibility models are easily
converted to stochastic feasibility models
– Just make the forecasted variables stochastic using
the residuals from the forecast models

4. Project Feasibility Analysis
• Risks to consider for a feasibility analysis are:
– Price of raw inputs, as fuel and labor
– Price of the product or output
– Production risk
– Black Swan events
– Competition and market share over the life of
investment (business)
– Cost of the plant and product development
– Cost of production for the finished product
• Project feasibility is where we put it all
together in an analysis of Time, Money, and
Economic Viability

5. Project Feasibility Analysis
• Project Feasibility: consider the Time, Money (Cost),
and Economic Viability of the finished business
• Simulate the Time to complete or build the plant
• Simulate the Cost of developing the plant
incorporating risk into the plant’s development costs
• Simulate the Economic Viability of the completed
plant (business)
Project
Management
Bid
Analysis
Project
Feasibility
Rate of Return
Cost (money)
Time
P(T)
P(C)
P( )
Project
Management
Analysis
Project
Feasibility
Rate of Return
Cost (money)
Time
P(T)
P(C)
P( )

6. Project Feasibility Analysis
• Proposed business with a new product
• Tasks and duration/costs
Tasks Description Time (mo.) Costs ($1,000)
1 Plant Modification 3-5 300-325
2 Product Development 1-3 200-300
3 Distribution System 2-3 50-100
4 Marketing Program 3-4 100-150
• Finance 100% of project costs @ 9%
• Marginal cost of production/unit Uniform(10,15), a scenario variable
• Fixed Costs/year $200,000
• Inflation Uniform(0.04, 0.05) percent per year
• Demand Projections
Years Price/Unit Quantity Sold/Year
1-3 U(13.5,14) U(500K, 600K)
4-5 U(13,13.5) U(400K, 500K)
6-10 U(12.5,13) U(300K, 400K)

7. Project Feasibility Analysis
• Setting the proposed project up in a Project
Management setting yields the following cost
and time to complete the project
• If these answers are acceptable to
management the next questions is –
– Will the business be economically viable?

8. Project Feasibility Analysis
• The stochastic final cost of building the plant becomes
input into the project analysis phase of the analysis

9. Project Feasibility Analysis
• 10 Year analysis yields many potential reports
– Annual rate of return to assets
– Things look bad after 6th year
CDF of Annual Rate of Return to Assets
0
0.2
0.4
0.6
0.8
1
-0.4 -0.2 0 0.2 0.4 0.6 0.8 1
Prob
ROR2007 ROR2008 ROR2009 ROR2010 ROR2011
ROR2012 ROR2013 ROR2014 ROR2015 ROR2016

10. Project Feasibility Analysis
• Scenario analysis of management control
variables to see if the plant could be more
profitable.
CDF of Alternative Costs of
Production/Unit
0
0.2
0.4
0.6
0.8
1
0.15 0.17 0.19 0.21 0.23
Prob
Average ROR: 1 Average ROR: 2
Average ROR: 3 Average ROR: 4

11. KOVs for Multi-Year Analyses
• Multiple year investments require full consideration of
returns over the planning horizon
– Net Present Value (NPV)
– Present Value of Ending Net Worth (PVENW)
– Ending Cash Reserves (Cash flow statement)
• NPV is the present value of all earnings that leave the
business plus the change in net worth minus
beginning net worth
NPV = -Beg Net Worth +∑{Dividends * (1/(1+r)^t) } + PVENW
For a family owned business substitute family living for dividends
• PVENW value of ending net worth in current dollars
PVENW = Ending Net Worth * (1/(1+r)^T)
Where T is the number of years simulated, eg. 10

12. Project Feasibility – Ethanol Plants in Texas
• Ethanol production is dependent on
– Inputs could be: corn, sorghum, wheat, potatoes, etc
– Fuel requirements are: natural gas and electricity
– Sale of co-product of DDGS
– Sale of ethanol
• Local communities want a plant because it hires more
35 people year around, farmers have dependable
market for grain, and it generate jobs during the
construction phase of 9 to12 months

13. • Develop a Feasibility Model for an
Ethanol plant in Texas
• Location: High Plains due to feedlots
and local corn/sorghum supplies
• Rail transportation facilities available to
import corn and ship ethanol
• KOVs
– Net Present Value
– Annual cash flows
– Probability of cash flow deficits
– Probability investors get their money back or the
P(Increase Real Net Worth)
Project Feasibility – Ethanol Plants in Texas

14. • Stochastic variables
– Corn and sorghum prices
– DDGS price
– Ethanol price
– Electricity and natural gas prices
• Develop MVE distribution for these prices based on
prices for the past 10 years
• Problem with stochastic prices
– Must use Texas prices and we have forecasts for National
prices
Texas Price = a + b National Price + e
Simulate a stochastic national price and use to simulate a
Texas price
Project Feasibility – Ethanol Plants in Texas

15. • Develop a Financial Simulation Model :
Income Statement, Cash Flow, and Balance
Sheet
• Simulate 10 years using corn as the feed
stock, repeat process using sorghum
• Assume a learning curve for management to
bring the plant up to its full capacity
• Validation exercises
– 4 Ps
– Touring test with other economists
– Present results to local investors
– Present results to politicians
Project Feasibility – Ethanol Plants in Texas

16. • A new business may need a few months
or years to grow sales to their potential
• May take months or years to learn how
to reach potential for a prod function
• In either case, assume a stochastic
growth function and simulate it, if
nothing else is available, use a Uniform
distribution
• Example of a growth function for 8
years
Learning Curve or Demand Cycle

17. Fan Graph for Realized Sales over 10 Years
-
50,000
100,000
150,000
200,000
250,000
Sales1 Sales3 Sales5 Sales7 Sales9
Average 5th Percentile 25th Percentile
75th Percentile 95th Percentile
Learning Curve or Demand Cycle

18. • A new concept in project feasibility
analysis
• Explicitly consider externalities
– Such as cleanup costs at end of business
• Strip mining reclamation
• Removal of underground fuel tanks
• Removal of above ground assets
• Restoration of site
– Prevention of future environmental hazards
• Removal of waste materials
• 100 year liners for ponds
Life Cycle Costing

19. • Steps to Life Cycle Costing Analysis
– Identify the potential externalities
– Determine costs of these externalities
– Assign probabilities to the chance of
experiencing each potential cost
• Assume distributions with GRKS or Bernoulli
– Simulate costs given the probabilities
– Incorporate costs of cleanup and
prevention into the project feasibility
– These terminal costs may have big Black
Swans so prepare the investor
Life Cycle Costing

20. • Bottom line is that LCC will increase the costs
of a project and reduce its feasibility
• Affects the downside risk on returns
• Does nothing to increase the positive returns
• Need to consider the FULL costs of a
proposed project to make the correct decision
• J. Emblemsvag – Life Cycle-Costing: Using Activity-Based
Costing and Monte Carlo Simulation to manage Future Costs
and Risks John Wiley & Sons Inc. 2003
Life Cycle Costing

21. • LCA is a tool for determining the impact
of a new process or project on the
environment and climate change
• LCAs are concerned with quantifying
– Energy Use and CO2 Balance
– Green House Gases (GHGs)
– Water use and indirect Land use
– Nutrient (N,P,K) use and other factors
• Thus far these are deterministic
analyses – This will soon change
Life Cycle Analysis

22. • May 2 in this room
• Open book, notes and computer programs
• Please bring your own computers if you want
• Two parts to the exam – Part A is short, do it first
• Print each part as you finish it.
• DO NOT wait until the end to print Part A!!!!
• No talking, texting, tweeting, face booking or other social
interaction during the exam
• Pizza will be provided at noon. Take a short break.
• The type of problem for Part B will be familiar to you
• Practice advice: Redo all Labs on simulation
What to Expect on Lab Exam

23. • Questions on all aspects of the material covered
in class since the last exam
• Short answer essay questions
– You should not need more space than what is
provided for a complete answer
– DO NOT repeat the question as part of your answer
• It wastes time for you and the grader
• A few calculator questions
• NO Cheat Sheet is permitted
What to Expect on Final Exam