Session 1: Introduction to Project Evaluation and Analysis Learning Outcome
Describe/understand the meaning of Project evaluation and analysis and the difference between discounted and non-discounted methods. Important Learning Terms - Project analysis
- Market analysis
- Technical analysis
- Financial analysis
- Economic analysis
- Environmental Analysis
- Project evaluation
Facet of Project Analysis
The important facets of project analysis are: - Market analysis
- Technical analysis
- Financial analysis
- Economic analysis
- Environmental Analysis
A. Market Analysis
Market analysis is concerned primarily with two questions: - What would be the aggregate demand of the proposed product/service in future?
- What would be the market share of the projects under appraisal?
To answer the above questions, the market analyst requires a wide variety of information and appropriate forecasting methods. The kind of information required are: - Consumption trends in the past and the present consumption level (for telecommunication companies the number of telephone lines, mobile subscribers, air time rates, etc are important factors to be considered)
- Past and present supply position (Who supplies what services?)
- Production possibilities and constraints (In telecommunication industry, bandwidth and regulatory framework matters a lot)
- Structure of competition (the regulations regarding competitions)
- Cost structure (Cost models used in costing variable and fixed costs, direct and indirect costs)
- Elasticity of demand
- Consumer behaviour, intentions, motivations, attitudes, preferences, and requirements.(e.g. on telephone accessories and types of telephone products)
- Distribution channels and marketing policies in use (Should the company use a pre-paid service or billing system?)
- Administrative, technical, and legal constraints.
B. Technical Analysis
Analysis of the technical and engineering aspects of a project needs to be done continually when a project is formulated. Technical analysis seeks to determine whether the prerequisites for the successful commissioning of the project have been considered and reasonably good choices have been made with respect to location, size, process, etc. The important questions raised in technical analysis for the ICT projects are: - Whether the preliminary tests and studies have been done or provided for?
- Whether the availability of human resources, power, and other inputs have been established?
- Whether the selected scale of operation is optimal?
- Whether the production process chosen is suitable?
- Whether the equipment and machines chosen are appropriate?
- Whether the auxiliary equipments and supplementary engineering works have been provided for?
- Whether provision has been made for the treatment of effluents?
- Whether work schedules have been realistically drawn up?
- Whether the technology proposed to be employed is appropriate from the social point of view?
C. Financial Analysis
Financial analysis seeks to ascertain whether the proposed project will be financially viable in the sense of being able to meet the burden of servicing debt and whether the proposed project will satisfy the return expectations of those the shareholders (owners of the firms). The aspects which have to be looked into while conducting financial appraisal in ICT projects are: - Investment outlay and cost of project
- Means of financing –Discussed in Module 2.4
- Cost of Capital –Discussed in Module 2.3
- Projected profitability-Discussed in Module 1.2
- Break-even point –Discussed in Module 2.4 session 4
- Cash flows of the project
- Investment worth wholeness judged in terms of various criteria of merit.
- Projected financial position.
- Level of risk –Discussed in Module 2.2
D. Economic Analysis
Economic analysis, also referred to as social cost benefit analysis, is concerned with judging a project from the larger social point of view.
The questions sought to be answered in social cost benefit analysis are: - What are the direct economic benefits and costs of the project measured in terms of shadow (efficiency) prices and not in terms of market prices?
- What would be the impact of the project on the distribution of income in the society? What is the impact on digital divide of the investment project?
- What would be the contribution of the project towards the fulfillment of certain merit wants like self-sufficiency, employment, and social order?
E. Environmental Analysis
In recent years, environmental concerns have assumed a great deal of significance and rightly so. Investment in the ICT/Telecom industry should give much consideration on the environmental aspects. Among the question to be asked include: - What is the likely damage caused by the project to the environment? E.g. how used prepaid vouchers/cards affect the environment? How installation of transmission stalls affect the environment?
- What is the cost of restoration measures required to ensure that the damage in the environment is contained within acceptable limits?
Relevant cash flows
It is the specific set of the cash flows that should be considered in capital budgeting decision. The capital budgeting decision must be based on the cash flow after taxes, not the accounting income and only the incremental cash flows are relevant to the accept or reject decisions. In capital budgeting analysis, after tax cash flows, not accounting profit are used- it is cash that pays the bills and can be invested in capital projects, not profits. In capital budgeting we are interested in net cash flows defined as follows 
Incremental cash flows
These are cash flows that results directly from the decision to accept the project. They represent the changes in the firms total cash flows that occurs as a direct result of accepting the project. Sunk costs
A sunk cost is an outlay that already has been committed or that already has occurred and hence it cannot be recovered regardless of whether the project is accepted or rejected. They are not included in the cash flows projections. Example: The feasibility study costs that are incurred to assess project's viability. Opportunity costs
It is the cash flows that could be generated from the assets the firm already owns provided they are not used for the project in question. The foregoing benefits (inflows) must be charged as the opportunity cost against the project.
Example: Land that has to be used by the project that could be sold and generate cash inflows. Externalities
Externality is the effect of accepting a project will have on the cash flows in other parts of the firm. This has to be considered in its effect on the overall firm cash flows. Shipping and installation costs
The shipping and installation cost has to be added to the invoice price of the equipment when the total cost of the project is being determined. The fully cost of the equipment including shipping and installation costs, is used as the depreciable basis when depreciation charges are calculated. Something to keep in mind is that depreciation is a won cash expense, hence there is no cash outflow associated with the recognition of the depreciation expenses each year. But it affects the taxable income of a firm, by reducing the amount of taxes paid by the firm. In project analysis depreciation taxes are added back to determine the actual cash outflows. Identifying incremental cash flows
In most cases project’s incremental cash flow can be classified into three. - Cash flow that occur only at the start of the project’s life, time 0.
- Cash flow that continuously throughout the projects life, time period 1 through n.
- Cash flow that occurs only at the end, or the termination, of the project, time period n.
Initial investment outlay
Refer to the increment cash flow that occur only at the start of a projects life, F0. The initial investment includes such cash flows as the purchase price of the new project, and the shipping and the installation costs. In replacement decision, the initial investment also must take into account the cash flows associated with the disposal of the old or replaced asset and any tax effects associated with the disposal. Also, the changes in the net working capital that results from the acceptance of a project is an incremental cash flow that must be considered in the capital budgeting analysis. This must be considered as the initial investment outlay because it occur at the start. Incremental operating cash flow
Capital project also affects the day-to-day cash flow generated by the firm.
The cost reduction would result because the technological advancement of the new machine would allow either the use of less electricity or fewer raw materials in the manufacturing process. These cost savings, as well as any changes in depreciation will affect the taxes paid by the firm. Generally the changes in day to day cash flows that results from purchase of a capital project and will continue until the firm disposes of the assets. The incremental operating cash flows for each year can be computed directly by the following equation: 
Terminal Cash flow
This is the net cash flow that occurs at the end of the life of a project, including the cash flows associated with, the final disposal of the project and returning the firm’s operations to where they were before the project was accepted. It includes the salvage value, with could either be positive (selling the asset) or negative (paying for removal) and the tax impact of the disposition of the project. Any working capital account changes that occurred at the beginning of the project’s life will be reversed at the end of its life.
Review Questions
- What do you understand by the term project evaluation
- Discuss the important facets of project analysis. Explain how important is each of the facet in the analysis of a project
- Why it is important to evaluate projects? Give your explanations based on the telecommunication/ICT related projects.
- What problems might be experienced if project evaluation is not performed? How can the problems be solved?
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